A. Measuring Business Income
a. explain why financial statements are prepared at the end of the regular accounting period.
Major Financial Statements:
? The balance sheet: provides a \? The income statement: reports on the \
? The statement of cash flows: reports the cash receipts and cash outflows classified according to operating, investment and financing activities.
? The statement of stockholder's equity: reports the amounts and sources of changes in equity from transactions with owners.
? The footnotes of the financial statements: allow uses to improve assessment of the amount, timing and uncertainty of the estimates reported in the financial statements.
The most accurate way to measure the results of enterprise activity would be to measure them at the time of the enterprise's eventual liquidation. Business, government, investors, and various other user groups, however, cannot wait indefinitely for such information. If accountants did not provide financial information periodically, someone else would.
The periodicity or time period assumption simply implies that the economic activities of an enterprise can be divided into artificial time periods. These time periods vary, but the most common are monthly, quarterly, and yearly.
The information must be reliable and relevant. This requires that information must be consistent and comparable over time and also be provided on a timely basis. The shorter the time period, the more difficult it becomes to determine the proper net income for the period. A month's results are usually less reliable than a quarter's results, and a quarter's results are likely to be less reliable than a year's results. Investors desire and demand that information be quickly processed and disseminated; yet the quicker the information is
released, the more it is subject to error. This phenomenon provides an interesting example of the trade-off between relevance and reliability in preparing financial data. ? In practice, financial reporting is done at the end of the accounting period. Accounting periods can be any length in time. Firms typically use the year as the primary accounting period. The 12-month accounting period is referred to as the fiscal year. Firms also report for periods less than a year (e.g. quarterly) on an interim basis.
? Accounting period must be of equal length. Financial statements are prepared at the end of the regular accounting period to allow comparison across time. User Comments
Posted by Jeanette @ 2003-10-25 14:15:45. same period --- allow comparision
basic assumption in preparing financial statements is ---- the firm will continue in operation,--- going concern,'
assigning revenue - expenses ---- base on matching principle Posted by GiGi @ 2004-01-29 06:25:01.
remember that there are 4 types of financial statements
b. explain why the accounts must be adjusted at the end of each period. Why?
? Most external transactions are recorded when they occur. The employment of an accrual system means that numerous adjustments are necessary before financial statements are prepared because certain accounts are not accurately stated. ? Some external transactions might not even seem like transactions and are recognized only at the end of the accounting period. Examples include unrecorded revenues and credit purchase.
? Some economic activities do not occur as the result of external transactions. Examples include depreciation and the expiration of prepaid expenses.
? Timing: Often a transaction affects the revenue or expenses of two or more accounting periods. The related cash inflow or outflow does not always coincide with the period in which these revenue or expense items are recorded. Thus, the need for adjusting entries results from timing differences between the receipt or disbursement of cash and the recording of revenue or expenses. For example, if we handle transactions on a cash basis, only cash transactions during the year are recorded. Consequently, if a company's employees are paid every two weeks and the end of an accounting period occurs in the middle of these two weeks, neither liability nor expense has been recorded for the last week. To bring the accounts up to date for the preparation of financial statements, both the wage expense and the wage liability accounts need to be increased.
A necessary step in the accounting process, then, is the adjustment of all accounts to an accrual basis and their subsequent posting to the general ledger. Adjusting entries are therefore necessary to achieve a proper matching of revenues and expenses in the determination of net income for the current period and to achieve an accurate statement of the assets and equities existing at the end of the period.
Adjustment principles
? The revenue recognition principle ? The matching principle
What to adjust?
Each adjusting entry affects both a real account (assets, liability, or owner's equity) and a nominal or income statement account (revenue or expense). The four basic types of adjusting entries are:
1. deferred expenses that benefits more than one period: for example, prepaid expenses (e.g. prepaid insurance, rent) are expenses paid in advance and recorded as assets before they are used or consumed. When these assets are consumed, expenses should be recognized: a debit to an expense account and a credit to an asset account. Another example is depreciation. The cost of a long-term asset is
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