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Chapter 4

MGMT 30A Chapter Notes - Chapter 4: Earnings Management, Uptodate, Historical Cost

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Patricia Wellmeyer

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Chapter 4
Accounting divides the economic life of a business into artificial time periods (month, quarter,
Accrual Method: recognizes transactions in the period they are incurred, irrespective of when
cash is exchanged
Revenue recognition principle: requires companies to recognize revenue in the accounting
period in which the performance obligation is satisfied (recognize revenues in the period they
are earned)
Expense recognition (Matching) principle: match expenses with revenues in the period when
the company makes efforts to generate those revenues (recognize expense in period thy are
incurred to generate revenue)
Adjusting entries: recorded n order to make sure financial statements adhere to the accrual
basis of accounting each time financial statements are prepared by identifying accounts that,
through the passage of time, need adjustment due to consumption (expense) or creation of an
4 type of adjusting entries:
1. Prepaid expenses (prepayments): expenses paid in cash and recorded as assets
before they are used or consumed, cash paid before expenses incurred
Involves adjusting assets for consumption (recognizing expenses): Prepaids,
supplies, P, P&E for depreciation
2. Unearned Revenues: revenues received in cash and recorded as liabilities before
they are earned, Cash received before revenue is earned
Involves recognizing the earning of revenue for the portion of liability that
has been satisfied as of the date of the financial statements
3. Accrued revenues: revenues earned but not yet received in cash or recorded,
expense incurred before cash is paid
Involves recognizing expenses and obligation (liability) to pay for those
expenses: salaries/wages payable, interest payable, etc
4. Accrued expenses: expenses incurred but not yet paid in cash or recorded, revenue
earned before cash is received
Involves recognizing receivables for revenue earned (for sales, services,
interest) but not yet billed
Items of note for adjusting entries:
No cash is involved in adjusting entries
Journal entries always affect one balance sheet and one income statement account
Once adjusting entries are posted to general ledger accounts, financial statements can
be prepared
Closing the accounts: done to prepare accounts/accounting system for the next accounting
period after year-end financial statements are prepared by zeroing out all nominal (temporary)
accounts (revenues, expenses, and dividends) and transferring current year income (revenues
and expenses) and dividends to retained earnings
Straight line method of accounting for depreciation:
Depreciation amount = (cost salvage value) / useful life
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