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Revenue recognition principle
- The principle that companies recognize revenue in the accounting period
- in which it is earned.
- The principle that dictates that companies match efforts (expenses) with
- accomplishments (revenues).
- “Let the expenses follow the revenues.” Thus, expense recognition
- is tied to revenue recognition. Applied to the preceding example, this
- means that the salary expense Conrad incurred in performing the cleaning
- service on June 30 should be reported in the same period in which it
- recognizes the service revenue. The critical issue in expense
- recognition is determining when the expense makes its contribution to
- revenue. This may or may not be the same period in which the expense is
- paid. If Conrad does not pay the salary incurred on June 30 until July,
- it would report salaries payable on its June 30 balance sheet.
- Accounting basis in which companies record, in the periods in which the
- events occur, transactions that change a company's financial statements,
- even if cash was not exchanged.
- Accounting basis in which a company records revenue only when it
- receives cash, and an expense only when it pays out cash.
- Entries made at the end of an accounting period to ensure that the
- revenue recognition and matching principles are followed.
- Adjusting entries are necessary because the trial balance—the first pulling
- together of the transaction data—may not contain up-to-date and complete
- data. This is true for several reasons:
- 1. Some events
- are not recorded daily because it is not efficient to do so. Examples
- are the use of supplies and the earning of wages by employees.
- 2. Some costs are
- not recorded during the accounting period because these costs expire
- with the passage of time rather than as a result of recurring daily
- transactions. Examples are charges related to the use of buildings and
- equipment, rent, and insurance.
- 3. Some items may
- be unrecorded. An example is a utility service bill that will not be
- received until the next accounting period.
- Adjusting entries are required
- every time a company prepares financial statements. The company
- analyzes each account in the trial balance to determine whether it is
- complete and up to date for financial statement purposes. Every adjusting entry will include one income
- statement account and one balance sheet account.
Prepaid expenses (prepayments)
- Assets that result from the payment of expenses that benefit more than
- one accounting period. (ex. prepaid insurance)
- Prepaid expenses are costs that expire
- either with the passage of time (e.g., rent and insurance) or through use (e.g., supplies).
The length of service of a productive asset.
- he process of allocating the cost of an asset to expense over its useful
- One very important point to understand: Depreciation
- is an allocation concept, not a valuation concept. That is,
- depreciation allocates an asset's cost
- to the periods in which it is used. Depreciation does not attempt to
- report the actual change in the value of the asset.
- The difference between the cost of a depreciable asset and its related
- accumulated depreciation.
ex: (Equipment) $5,000 - $40 (accumulated depreciation)= book value
- Cash received before a company earns revenues and recorded as a
- liability until earned.
- Companies record cash received before revenue is earned by increasing
- (crediting) a liability account called unearned
- Unearned revenues are the opposite of prepaid expenses. Indeed, unearned
- revenue on the books of one company is likely to be a prepayment on the
- books of the company that has made the advance payment. For example, if
- identical accounting periods are assumed, a landlord will have unearned
- rent revenue when a tenant has prepaid rent.
Revenues earned but not yet received in cash or recorded.
Adjusted Trial Balance
- A list of accounts and their balances after all adjustments have been
- Revenue, expense, and dividend accounts whose balances a company
- transfers to Retained Earnings at the end of an accounting period.
- Balance sheet accounts whose balances are carried forward to the next
- accounting period.
- Entries at the end of an accounting period to transfer the balances of
- temporary accounts to a permanent stockholders' equity account, Retained
A temporary account used in closing revenue and expense accounts.
Revenue and expense accounts---> Income summary----> Retained Earnings account
Post-closing trial balance
- A list of permanent accounts and their balances after a company has
- journalized and posted closing entries.