University:
Grand Rapids Community College
Course:
Financial and Managerial Accounting: Information for Decisions - John J. Wild
Academic year:

2024
Views:

110

Pages:

2
Author:

stud_ice13

The Accounting Period: Importance and Role of Accrual Accounting Periodic Reporting: • • • The value of financial information is tied to its timeliness. To be useful for decision-makers, accounting reports must be prepared regularly, allowing organizations to monitor performance and make informed decisions. The time period assumption divides an organization’s activities into specific periods, such as a month, quarter, or year. This regular reporting ensures that financial information reflects the company's operations during set intervals. Most organizations use a year as the primary accounting period, known as the fiscal year, which can differ from the calendar year depending on the company’s needs. For instance, companies like Netflix use a calendar year, while others, like Target, align their fiscal year with the end of their natural business cycle. Accrual Accounting vs. Cash Accounting: • • Accrual basis accounting records revenues when they are earned (when services or goods are delivered) and records expenses when they are incurred (matched with the associated revenues). This method provides a more accurate reflection of business performance and ensures comparability of financial statements across periods. Cash basis accounting, in contrast, records revenues only when cash is received and expenses when cash is paid. While simpler, it often fails to match revenues with the period in which they were earned, providing a less accurate representation of the company’s financial health. Example: o o Under accrual accounting, if a company prepays $2,400 for 24 months of insurance starting in December 2021, only $100 of the expense is recognized each month. The unexpired portion is reported as a Prepaid Insurance asset on the balance sheet. In cash accounting, the entire $2,400 would be recognized as an expense in December 2021, and no asset would appear on the balance sheet for the remaining coverage, causing mismatches between expenses and benefits. Recognizing Revenues and Expenses: • The revenue recognition principle ensures that revenues are reported when services or goods are provided, not necessarily when cash is received. This principle ensures accurate reflection of earned income for each period. • The expense recognition (matching) principle ensures that expenses are recorded in the same period as the revenues they help generate. This matching creates a clearer link between revenues and the costs incurred to earn them. Adjusting Entries: • • Adjustments are made to ensure that all revenues and expenses are recognized in the appropriate periods. These adjustments are needed because some transactions extend over multiple periods or are not fully recorded at the time financial statements are prepared. There are four types of adjustments, each made using a three-step process: 1. Determine the current balance. 2. Determine what the adjusted balance should be. 3. Make the necessary entry to adjust the account. Adjusting entries are critical for ensuring accurate reporting of financial performance, especially for companies using accrual accounting, as they involve adjusting both income statement and balance sheet accounts (excluding cash).