Classification of Accounts
Business activities can be reflected in any one of the five broad categories... Read More
When preparing its complete financial statements, a company will review its operations in order to determine whether any accruals or adjustments are needed. This allows for allocation of revenue and expense items into the proper accounting period.
The process of translating business transactions into the accounting system is relatively straightforward. Challenges, however, arise whenever cash receipts or disbursements occur in periods which differ from the related revenue or expense, or when the reportable values of assets vary. This necessitates accruals or valuation adjustments.
Based on accrual accounting, revenue must be recorded when earned and expenses recorded when incurred. This must be the case irrespective of when the cash movement takes place. This allows for revenue and expenses to be reported in their proper accounting periods.
There are four types of accrual entries that may be required. Each of them requires an originating entry and at least one adjusting entry at a later date:
Valuation Adjustments
Valuation adjustments are made to a company’s assets or liabilities. Essentially, valuation adjustments make accounting records reflect the current market value of the asset or liability rather than the historical cost.
An increase in assets will be accompanied by a gain on the income statement or an increase in other comprehensive income. Conversely, a decrease in assets will be accompanied by a loss on the income statement or a decrease in other comprehensive income.
Question
If at the end of an accounting period, cash was received, but no revenue was earned, the accounting treatment will affect:
A. accrued revenue and an asset
B. prepaid expense and an asset
C. accrued revenue and a liability
Solution
The correct answer is C.
The originating entry will be the recording of cash received and a corresponding liability which is reduced while revenue is earned.
Reading 22 LOS22e:
Describe the need for accruals and valuation adjustments in preparing financial statements