Question

1.Explain the time period assumption using the adjusting and closing process as the basis for your explanation.

2. Explain what the statement of cash flows tells you that the income statement does not

3. Define accruals/deferrals and tie them to the adjusting process.\

4. Explain why balance sheets are classified.

Answer 1

1. Time period assumption

The time period assumption states that the life of a business can be divided into equal time periods. These time periods are known as accounting periods for which companies prepare their financial statements to be used by various internal and external parties.

The length of accounting period to be used for the preparation of financial statements depends on the nature and requirement of each business as well as the need of the users of financial statements. Normally, an accounting period consists of a quarter, six months or a year.

2. The statement of cash flows tells you that the income statement does not-

An income statement tells you the revenues a company made and the expenses it made during a particular period of time. A cash flow statement will give you an idea of how much cash came into the company and how much went out of the company.

For an investor it is important to find out the capability of a company to generate cash. The cash flow statement will explain to the investor how much actual money was generated by the company which is not provided by the income statement.

3. accruals/deferrals and tie them to the adjusting process.

An accrual of an expense refers to the reporting of an expense and the related liability in the period in which they occur, and that period is prior to the period in which the payment is made. An example of an accrual for an expense is the electricity that is used in December, but the payment will not be made until January.

If an expense of $5,000 is incurred in a period but has not been paid by period end or the invoice has not been received by period end, the following adjusting entry will be made to the company's general ledger at the end of the period:

Debit Expense 5,000 Credit Accounts Payable 5,000

A deferral of an expense refers to a payment that was made in one period, but will be reported as an expense in a later period. An example is the payment in December for the six-month insurance premium that will be reported as an expense in the months of January through June.

If an advance payment of $5,000 for services has been made by period-end but the service will not be made until a future period, the following adjusting entry will be made at month-end to prepaid expenses, an asset account:

Debit Prepaid Expenses 5,000 Credit Cash 5,000

4. Importance of Classifying Balance Sheet

A classified balance sheet helps to organize the different items on a balance sheet, making the information easier to read and understand. The more organized format helps managers in making decisions without digging and sorting through the information.

A classified balance sheet divides assets up into different categories of assets, such as fixed assets, current assets, investments, property, intangible assets and long-term assets. Similarly, a classified balance sheet divides a company's liabilities into categories such as short-term liabilities, long-term liabilities and equity.

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