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Midterm

Chapters 4, 5, 6; The 2nd Midterm

6 Pages
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Department
Accounting
Course Code
ACC 100
Professor
Walter Krystia

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Chapter 4 Accrual Accounting, Adjusting Entries, and Accounting Cycle
Recognition The process of including an item in the financial statements of an entity.
Recognition consists of the addition of the amount involved into statements totals together
with a narrative description of the item in a statement. Examples: Inventory, Sales,
Donations) Shareholders, bankers, and other creditors have limited access to relevant
information about a company. They depend on the periodic financial statements issued by
management to provide necessary information to make their decisions. The process by
which the accountant depicts, or describes, the effects of economic events on the entity is
called recognition.
Measurement Measurement of an item in financial statements requires that two choices
be made. First the accountant must decide on the attribute to be measured. Second, a scale
of measurement, or unit of measure, must be chosen.
The Attribute to Be Measured The cost of the asset at the time it is acquired is the
most logical choice. Cost is the amount of cash, or its equivalent, paid to acquire the asset.
The simplest approach is to show the property on the balance sheet at its original cost, thus
the designation historical cost. The use of historical cost is not only simple but also
verifiable. An alternative to historical cost as the attribute to be measured is realizable
value. Realizable value is the amount of cash, or its equivalent, that could be received
currently from the sale of the asset. For the company’s piece of property, realizable value is
the estimated selling price of the land, reduced by any commissions or other fees involved in
making the sale. Two accountants might not necessary arrive at the same realizable value
for the land depends on the banker lending money to you. Historical cost is the attribute
used to measure many of the assets recognized on the balance sheet.
The Unit of Measure The use of the dollar as a unit of measure for financial
transactions is widely accepted. Example: The Land. Measure with square meters; will
never change. Worth value is measured with money which is $10,000 and it will not always
have the same purchasing power. Inflation, or a rise in the general level of prices in the
economy, results in a decrease in purchasing power.
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Cash Basis Accounting Records revenue when cash is received (Cheques, credit card, or
cash), it also records expenses when cash is paid. Doesnt show all of the company’s
economic activities; can be manipulated if the contractor feels that his revenue is already
high enough, he can ask not to be paid till January next year; the movement of cash doesnt
provide the external user with full information to make decisions. Statement of Cash Flows
from Operating Activities.
Accrual Basis Accounting Records revenue when its earned; records expenses when
they are incurred, used or consumed to generate revenue; under accrual accounting we
record the economic activity that the company is engaged in. Statement of Earnings.
Example: A contractor is hired to paint a house and to install a music system. In October,
the contractor buys the paint, paints the house, installs the music system and pays all his
employees: Total Expenses Paid: $30,000 Cash. In November the contractor is paid $50,000
cash.
Cash: October Revenue = $0 Expenses = $30,000 Net Loss = - $30,000/ November
Revenue = $50,000 Expenses = $0 Net Income = $50,000.
Accrual: October Revenue = $50,000 Expenses = $30,000 Net Income = $20,000/November
Revenue/Expenses/Net Income = $ 0
What would be the net income under accrual accounting and under cash
accounting?
Accrual and Cash accounting net income would be the same.
External Users need 2 things: understanding of all economic transactions (accrual
accounting); to know how a company manages their cash (cash accounting). The difference
between the two is the time period we record the transactions in.
Time Period Assumption: Means that the life of a company can be divided into arbitrary
time periods. Only in the reporting of information do we act as if the company stops and
starts the next day. A month or a year is artificial because of the going concern assumption
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Description
Chapter 4 Accrual Accounting, Adjusting Entries, and Accounting Cycle Recognition The process of including an item in the financial statements of an entity. Recognition consists of the addition of the amount involved into statements totals together with a narrative description of the item in a statement. Examples: Inventory, Sales, Donations) Shareholders, bankers, and other creditors have limited access to relevant information about a company. They depend on the periodic financial statements issued by management to provide necessary information to make their decisions. The process by which the accountant depicts, or describes, the effects of economic events on the entity is called recognition. Measurement Measurement of an item in financial statements requires that two choices be made. First the accountant must decide on the attribute to be measured. Second, a scale of measurement, or unit of measure, must be chosen. The Attribute to Be Measured The cost of the asset at the time it is acquired is the most logical choice. Cost is the amount of cash, or its equivalent, paid to acquire the asset. The simplest approach is to show the property on the balance sheet at its original cost, thus the designation historical cost. The use of historical cost is not only simple but also verifiable. An alternative to historical cost as the attribute to be measured is realizable value. Realizable value is the amount of cash, or its equivalent, that could be received currently from the sale of the asset. For the companys piece of property, realizable value is the estimated selling price of the land, reduced by any commissions or other fees involved in making the sale. Two accountants might not necessary arrive at the same realizable value for the land depends on the banker lending money to you. Historical cost is the attribute used to measure many of the assets recognized on the balance sheet. The Unit of Measure The use of the dollar as a unit of measure for financial transactions is widely accepted. Example: The Land. Measure with square meters; will never change. Worth value is measured with money which is $10,000 and it will not always have the same purchasing power. Inflation, or a rise in the general level of prices in the economy, results in a decrease in purchasing power. www.notesolution.com
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