Accounting: Accrual Accounting Concepts

The lecture last night discussed accrual accounting concepts such as timing issues, and the basics of adjusting entries. The discussion went into more detail on periodicity assumption and how accounting divides the economic life of a business into artificial time periods. These time periods are generally a month, a quarter, or a year, now whether it is a fiscal year or a calendar year that is determined by the company itself. The lecture then reviews the revenue recognition principle which expects companies to acknowledge revenue in the accounting period for which it is earned. Now the expense recognition principle (matching principle) dictates that efforts (expenses) be matched with results (revenues). The lecture lightly discusses “cooking the books” then immediately goes into the difference between accrual versus cash basis of accounting. Accrual accounting is when companies identify profits when earned, even if cash is not received. Cash-basis accounting records revenue only when cash is received, and only records expense when cash is paid. Thus cash-basis accounting violates the revenue and expense recognition principles. The discussion then went into the basic adjusting of entries which ensures that the revenue and expense recognition principles are followed. Adjusting entries are categorized as either deferrals (prepaid expense or unearned revenue) or accruals (accrued revenue or accrued expense). The lecture then discussed adjusting entries for pre-paid expense, when expenses are pre-paid an asset account will be debited to illustrate the service that the company will receive in the future. Pre-paid expenses are costs that expire with the passing of time (e.g., rent and insurance) or through use (supplies). Now recording this daily would be impractical and unnecessary, companies postpone the acknowledgment of these costs until they prepare financial statements, they then make adjusting entries accordingly. The lecture also discussed adjusting entries for