Measuring Business Income: The Adjusting Process: Chapter Outline
Measuring Business Income: The Adjusting Process: Chapter Outline
Measuring Business Income: The Adjusting Process: Chapter Outline
Learning Objective 1: Apply the recognition criteria for revenues and expenses
A. Revenue Recognition
1. The revenue recognition criteria states that revenues are recorded when earned.
Revenue is earned in most cases when the business has delivered a completed good or
service to the customer.
2. The amount of revenue recorded equals the cash value of the goods or services
transferred to the customer.
B. Recognition criteria for expenses
1. The matching objective directs accountants to identify all expenses incurred during the
accounting period; measure the expenses and match the expenses against the revenues
earned during that period.
2. Expenses (example: sales commission) with a natural link to revenues will be matched
against the revenue of a period. Other expenses (example: rent) that are not easily linked
with a particular sale will be identified with a particular time period.
Because of these concepts, special journal entries, called adjusting entries, must be recorded to ensure that
all revenues and expenses for the accounting period have been properly recorded.
3. Only very small businesses use cash-basis accounting. In cash-basis accounting, cash
receipts are treated as revenues, and cash payments are treated as expenses.
4. Three concepts used in accrual basis accounting are the accounting period, the
recognition criteria for revenues and expenses, and the time-period assumption.
3. Accrued expenses are expenses that are incurred by the end of the period but will not be
paid until a later period. The adjusting entry records the expense and a liability. Salaries,
interest, and taxes are examples of accrued expenses. The text uses the example of
salaries to illustrate this topic. It is an example that many students should be able to relate
to, as they have experienced being paid on a schedule – either a weekly, bi-weekly or
monthly basis. That schedule wouldn’t necessarily correspond with the end of the month.
Salary Expense XX
Salary Payable XX
4. Accrued revenues are revenues that have been earned (because the good or service has
been delivered) but not yet received. The adjusting entry records a revenue and a
receivable. Interest and service revenue are examples of accrued revenues
Interest Receivable XX
Interest Revenue XX
5. Unearned revenues arise when a business receives cash in one period but does not earn
all of it until the next period. Even though this is presented last, due to its level of
difficulty, it is a prepaid (deferral) type of adjusting entry – the only difference is the cash
is not paid in advance; rather the cash is received in advance. The cash is prepaid by the
customer and the recognition of the revenue is deferred until it is earned.
a. An unearned revenue is a liability because the business owes the customer a
good or service. The receipt of the cash would increase cash and increase a
liability.
Cash XX
Unearned Revenue XX
b. The adjusting entry records the part of the unearned revenue that has been
earned.
Unearned Revenue XX
Service Revenue XX
D. In summary, each adjusting entry adjusts an income statement account--either a revenue or an
expense. Each adjusting entry also adjusts a balance sheet account—either an asset or a liability.
No adjusting entry ever adjusts the balance of Cash. (Exhibit 3-8 summarizes the adjusting
entries and Exhibit 3-9 illustrates all of the adjusting entries and T-accounts for Hunter
Environmental Consulting (HEC).)
Learning Objective 5: Prepare the financial statements from the adjusted trial balance
A. The financial statements are prepared using the account balances found on the adjusted trial
balance.
B. The income statement is prepared first, followed by the statement of owner’s equity, and then the
balance sheet.
C. The essential features of all financial statements are:
1. The heading of the statement, which includes:
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