Adjustments for Financial Reporting

Understanding the learning objectives

• The cash basis of accounting recognizes revenues when cash is received and recognizes expenses when cash is paid out.
• The accrual basis of accounting recognizes revenues when sales are made or services are performed, regardless of when cash is received; expenses are recognized as incurred, whether or not cash has been paid out.
• The accrual basis is more generally accepted than the cash basis because it provides a better
• matching of revenues and expenses.
• Adjusting entries convert the amounts that are actually in the accounts to the amounts that should be in the accounts for proper periodic financial reporting.
• Adjusting entries reflect unrecorded economic activity that has taken place but has not yet been recorded.
• Deferred items consist of adjusting entries involving data previously recorded in accounts. Adjusting entries in this class normally involve moving data from asset and liability accounts to expense and revenue accounts. The two types of adjustments within this deferred items class are asset/expense adjustments and liability/revenue adjustments.
• Accrued items consist of adjusting entries relating to activity on which no data have been previously recorded in the accounts. These entries involve the initial recording of assets and liabilities and the related revenues and expenses. The two types of adjustments within this accrued items class are asset/revenue adjustments and liability/expense adjustments.
• This chapter illustrates entries for deferred items and accrued items.
• Failure to prepare adjusting entries causes net income and the balance sheet to be in error.
• For a particular item such as sales or net income, select a base year and express all dollar amounts in other years as a percentage of the base year dollar amount.