Finance 2 summary
Chapter 3. Measuring business income
Net income: Difference between revenues and expenses when revenues exceed expenses.
Net income = Revenues - Expenses
Revenues: Increases in stockholders' equity resulting from selling goods, rendering services,
or performing other business activities.
Expenses: Decreases in stockholders' equity resulting from the costs of selling goods or
rendering services and the costs of the activities necessary to carry on a business.
Continuity: Measuring business income requires that certain expense and revenue
transactions be allocated over several accounting periods.
Periodicity: Measuring business income requires assigning revenues and expenses to a
specific accounting period.
Fiscal year: 12-month accounting period.
Interim periods: Accounting periods less than 12-months.
Matching rule: Revenues must be assigned to the accounting period in which the goods are
sold or the services performed, and expenses must be assigned to the accounting period in
which they are used to produce revenue.
The cash basis of accounting: accounting for revenues in the period in which cash is
received and for expenses in the period in which cash is paid.
Earnings measurement: The Manipulation of revenues and expenses to achieve a specific
outcome.
Accrual accounting: Revenues and expenses are recorded in the periods in which they
occur rather than in the periods in which they are received or paid.
1. Recoding revenues when they are earned.
2. Recording expenses when they are incurred.
3. Adjusting the accounts.
Revenue recognition: The process of determining when revenue should be recorded.
Following conditions must be met before revenue is recognized:
- Persuasive evidence of an arrangement
- A product or service has been delivered
- The seller's price to the buyer is fixed of determinable
- Collectability is reasonably assured.
, Finance 2 summary
The adjustment process: four types:
Type 1. Allocating recorded costs between two or more accounting periods.
Type 2. Recognizing unrecorded expenses
Type 3. Allocating recorded, unearned revenues between two or more accounting periods.
Type 4. Recognizing unrecorded, earned revenues.
Deferral: The postponement of the recognition of an expense already paid (type 1) or of
revenue received in advance (type 3).
Accrual: The recognition of a revenue (type 4) or expense (type 2).
- Type 1 Adjustment: Allocating Recorded Costs (Deferred expenses)
Companies make often expenditures that benefit more than one period, these costs are
debited to an asset account. At the end of an accounting period, the amount of the asset that
has been used is transferred from the asset account to an expense account. Two important
adjustments: prepaid expenses & depreciation of plant and equipment.
Prepaid expenses: Expenses including rent, supplies, and insurance that are paid in
advance.
Depreciation refers only to the allocation of an asset’s cost, not to any decline in the asset’s
value. To maintain historical cost in specific long-term asset accounts, separate accounts
(Accumulated depreciation accounts) are used to accumulate the depreciation on each long-
term asset. In accounting, depreciation refers only to the allocation of an asset’s cost, not to
any decline in the asset’s value.
Contra accounts: accounts which are deducted from their related asset accounts on the
balance sheet.
Carrying value/book value: net amount of an asset (as presented on the balance sheet).
- Type 2 Adjustment: t recognizing unrecorded expenses (Accrued expenses):
In accrual accounting, an expense must be recorded in the period in which it is incurred,
regardless of when payment is made. Some expenses (like interest on borrowed money,
wages, taxes, utilities) incurred during the period which have not been recorded in the
accounts, these require adjusting entries.
Chapter 3. Measuring business income
Net income: Difference between revenues and expenses when revenues exceed expenses.
Net income = Revenues - Expenses
Revenues: Increases in stockholders' equity resulting from selling goods, rendering services,
or performing other business activities.
Expenses: Decreases in stockholders' equity resulting from the costs of selling goods or
rendering services and the costs of the activities necessary to carry on a business.
Continuity: Measuring business income requires that certain expense and revenue
transactions be allocated over several accounting periods.
Periodicity: Measuring business income requires assigning revenues and expenses to a
specific accounting period.
Fiscal year: 12-month accounting period.
Interim periods: Accounting periods less than 12-months.
Matching rule: Revenues must be assigned to the accounting period in which the goods are
sold or the services performed, and expenses must be assigned to the accounting period in
which they are used to produce revenue.
The cash basis of accounting: accounting for revenues in the period in which cash is
received and for expenses in the period in which cash is paid.
Earnings measurement: The Manipulation of revenues and expenses to achieve a specific
outcome.
Accrual accounting: Revenues and expenses are recorded in the periods in which they
occur rather than in the periods in which they are received or paid.
1. Recoding revenues when they are earned.
2. Recording expenses when they are incurred.
3. Adjusting the accounts.
Revenue recognition: The process of determining when revenue should be recorded.
Following conditions must be met before revenue is recognized:
- Persuasive evidence of an arrangement
- A product or service has been delivered
- The seller's price to the buyer is fixed of determinable
- Collectability is reasonably assured.
, Finance 2 summary
The adjustment process: four types:
Type 1. Allocating recorded costs between two or more accounting periods.
Type 2. Recognizing unrecorded expenses
Type 3. Allocating recorded, unearned revenues between two or more accounting periods.
Type 4. Recognizing unrecorded, earned revenues.
Deferral: The postponement of the recognition of an expense already paid (type 1) or of
revenue received in advance (type 3).
Accrual: The recognition of a revenue (type 4) or expense (type 2).
- Type 1 Adjustment: Allocating Recorded Costs (Deferred expenses)
Companies make often expenditures that benefit more than one period, these costs are
debited to an asset account. At the end of an accounting period, the amount of the asset that
has been used is transferred from the asset account to an expense account. Two important
adjustments: prepaid expenses & depreciation of plant and equipment.
Prepaid expenses: Expenses including rent, supplies, and insurance that are paid in
advance.
Depreciation refers only to the allocation of an asset’s cost, not to any decline in the asset’s
value. To maintain historical cost in specific long-term asset accounts, separate accounts
(Accumulated depreciation accounts) are used to accumulate the depreciation on each long-
term asset. In accounting, depreciation refers only to the allocation of an asset’s cost, not to
any decline in the asset’s value.
Contra accounts: accounts which are deducted from their related asset accounts on the
balance sheet.
Carrying value/book value: net amount of an asset (as presented on the balance sheet).
- Type 2 Adjustment: t recognizing unrecorded expenses (Accrued expenses):
In accrual accounting, an expense must be recorded in the period in which it is incurred,
regardless of when payment is made. Some expenses (like interest on borrowed money,
wages, taxes, utilities) incurred during the period which have not been recorded in the
accounts, these require adjusting entries.
