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Lecture Principles of financial accounting (2/e) - Chapter 3: Adjusting accounts and preparing financial statements

After completing this chapter you should be able to: Explain the importance of periodic reporting and the time period assumption, explain accrual accounting and how it improves financial statements, identify the types of adjustments and their purpose. | Chapter 3 Adjusting Accounts and Preparing Financial Statements Chapter 3: Adjusting Accounts and Preparing Financial Statements The Accounting Period C 1 To provide timely information, accounting systems prepare reports at regular intervals. This results in an accounting process impacted by the time period (or periodicity) assumption. The time period assumption presumes that an organization’s activities can be divided into specific time periods such as a month, a three-month quarter, a six-month interval, or a year. Most organizations use a year as their primary accounting period. Many organizations also prepare interim financial statements covering one, three, or six months of activity. When we divide business activities into arbitrary fixed periods of time, it is often necessary to have special accounting for transactions that cross from one time period to the next. Most of our time will be spent looking at the special adjusting process for some of these transactions. Accrual Basis | Chapter 3 Adjusting Accounts and Preparing Financial Statements Chapter 3: Adjusting Accounts and Preparing Financial Statements The Accounting Period C 1 To provide timely information, accounting systems prepare reports at regular intervals. This results in an accounting process impacted by the time period (or periodicity) assumption. The time period assumption presumes that an organization’s activities can be divided into specific time periods such as a month, a three-month quarter, a six-month interval, or a year. Most organizations use a year as their primary accounting period. Many organizations also prepare interim financial statements covering one, three, or six months of activity. When we divide business activities into arbitrary fixed periods of time, it is often necessary to have special accounting for transactions that cross from one time period to the next. Most of our time will be spent looking at the special adjusting process for some of these transactions. Accrual Basis versus Cash Basis Accrual Basis Revenues are recognized when earned and expenses are recognized when incurred. Cash Basis Revenues are recognized when cash is received and expenses are recorded when cash is paid. C 2 The accrual basis dictates that revenues be recognized when earned and expenses be recognized when incurred. The accrual basis of accounting is considered to be in compliance with generally accepted accounting principles, or GAAP. The cash basis of accounting dictates that revenues be recognized when the cash is actually received and that expenses are recorded when the cash is paid. Cash Basis Revenues are recognized when cash is received and expenses are recorded when cash is paid. Accrual Basis versus Cash Basis Non-GAAP C 2 Accrual Basis Revenues are recognized when earned and expenses are recognized when incurred. The cash basis is not considered to be compliant with GAAP. While you may be on the cash basis for your transactions, almost all companies follow the .