Page 116 - Accounting Principles (A Business Perspective)

3. Adjustments for financial reporting

The career paths outlined above do not nearly cover all of the many professional options available to tax
specialists. For example, are you concerned that a traditional tax accounting job may be too tame for you? Special
agents of the IRS routinely participate in criminal investigations and arrests, working closely with other federal law

enforcement agencies. Are you interested in law? Accounting offers an ideal undergraduate degree for aspiring
business and tax attorneys. If you think you may be interested in a career as a tax specialist, be sure to consult with
one of your school’s tax professors about the many job opportunities this field provides.
Chapters 1 and 2 introduced the accounting process of analyzing, classifying, and summarizing business
transactions into accounts. You learned how these transactions are entered into the journal and posted to the ledger
accounts. You also know how to use the trial balance to test the equality of debits and credits in the journalizing and
posting process. The purpose of the accounting process is to produce accurate financial statements so they may be

used for making sound business decisions. At this point in your study of accounting, you are concentrating on three
financial statements—the income statement, the statement of retained earnings, and the balance sheet. Detailed
coverage of the statement of cash flows appears in Chapter 16.
When you began to analyze business transactions in Chapter 1, you saw that the evidence of the transaction is
usually a source document. It is any written or printed evidence that describes the essential facts of a business
transaction. Examples are receipts for cash paid or received, checks written or received, bills sent to customers, or
bills received from suppliers. The giving, receiving, or creating of source documents triggered the journal entries
made in Chapter 2.
The journal entries we discuss in this chapter are adjusting entries. The arrival of the end of the accounting

period triggers adjusting entries. Accountants use adjusting entries to bring accounts to their proper balances
before preparing financial statements. In this chapter, you learn the difference between the cash basis and accrual
basis of accounting. Then you learn about the classes and types of adjusting entries and how to prepare them.
Cash versus accrual basis accounting

Professionals such as physicians and lawyers and some relatively small businesses may account for their
revenues and expenses on a cash basis. The cash basis of accounting recognizes revenues when cash is received
and recognizes expenses when cash is paid out. For example, under the cash basis, a company would treat services
rendered to clients in 2010 for which the company collected cash in 2011 as 2011 revenues. Similarly, under the
cash basis, a company would treat expenses incurred in 2010 for which the company disbursed cash in 2011 as 2011
expenses. Under the “pure” cash basis, even the purchase of a building would be debited to an expense. However,

under the “modified” cash basis, the purchase of long-lived assets (such as a building) would be debited to an asset
and depreciated (gradually charged to expense) over its useful life. Normally the “modified” cash basis is used by
those few individuals and small businesses that use the cash basis.

Cash Basis Accrual Basis
Revenues are recognized As cash is received As earned (goods are
delivered or services are
performed)
Expenses are recognized As cash is paid As incurred to produce
revenues

Exhibit 14: Cash basis and accrual basis of accounting compared

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