MGTB05 Chapter 4 Notes

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Financial Accounting
Daga Sandra

MGTB05 Financial Accounting I Chapter 4—Adjustments, Financial Statements and the Quality of Earnings Adjusting Revenues and Expenses Accounting Cycle  the accounting cycle is the process used by entities to analyze and record transactions, adjust the records at the end of the period, prepare financial statements, and prepare the records for the next cycle Purpose and Types of Adjustments  adjusting entries are necessary at the end of the accounting period to identify and record all revenues and expenses of the period and so assets and liabilities are recorded at the amounts that represent future probable benefit/sacrifices as at the end of the period  four types of adjustments:  revenues:  deferred revenues: previously recorded liabilities that were created when cash was received in advance and must be adjusted to reflect the amount of revenue earned  accrued revenue: revenue that was earned but not recorded because cash was received after the services were performed or goods delivered, need to recorded  expenses:  deferred expenses: previously recorded assets, that were created when cash was paid in advanced and must be adjusted to reflect the amount of expense incurred in using these assets to generate revenue  accrued expenses: expenses that were incurred but were not recorded because cash was paid after the goods or services were used, need to be recorded Adjustment Process  a trial balance is a list of all accounts with their balances, to provide a check on the equality of the debits and credits  long-term assets such as property, plant and equipment increase when assets are acquired and decrease when they are sold but since these assets are used over time to generate revenue, a part of their cost should be expenses in the same period  depreciation is an allocation of an asset’s cost over its estimated useful life to the company; it is not directly subtracted from the asset account but is accumulated in a contra account  a contra account is an account that is directly related to another account but has a balance on the opposite side of the T-account, is a reduction of the primary account  the carrying amount (book value or net book value) of an asset is the difference between its acquisition cost and accumulated depreciation, its related contra account  income tax payable adjustments are made last because all other adjustments need to be incorporated in computing profit before income taxes so income tax payable can be determined  the cash account in generally unaffected in adjustments because cash has already been received or paid by the end of the period and adjustments are required because the related cash part of the transaction is done at a different time Materiality and Adjusting Entries  materiality suggests that minor items that would not influence the decisions of financial statement users are to be treated in the easiest and most convenient manner  an item of information, or an aggregate of items, is material if it is probable that its omission or misstatement would influence or change a decision, an item is material if it exceed 1.5% of total assets or sales or 5-10% of profit  allows accountants to estimate amounts and to ignore specific accounting principles if the results of their actions do not have a material effect on the financial statements Preparing and Analyzing Financial Statements  relationships among financial statements
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