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The accruals concept states that revenue incurred in a particular period should be matched with expenditure incurred in that period.  Such principle gives rise to the accruals and prepayments adjusting entries.  For example an organization pays the salaries on a monthly basis four days after the end of the month.  If the financial year-end of the firm is 31st December the salaries for December will be paid on the 4th of January.  Therefore to be in line with the accruals premise the accountant has to record the salaries payable for December under the accruals despite they have not yet been paid.

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The prudence concept stipulates that doubtful losses should be recorded in the accounts, while doubtful profits should not be accounted for.  Therefore if the organization doubts a particular debtor in his ability to pay his debt, an adjusting entry for doubtful debt allowances should be made to reflect such doubtful loss.

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The service revenue should be accounted for in the month in which it is incurred, that is April.  This is done so in order to comply with the accruals concept.

Financial statements prepared under the cash premise hold the disadvantage that they focus solely on the cash flow of the firm.  This will thus omit useful information on the profitability of the organization.  In this respect accounting standards stipulate that financial statements are prepared under the accruals-basis, which does not hold such a limitation.

The two main types of adjusting entries are deferrals and accruals.  Both deferrals and accruals are an asset or liability account that is not realized until a future date.  However, deferrals encompass elements pertinent to prepaid expenditure (expenses paid prior to their occurrence) and unearned revenue (cash received for revenue not yet incurred), while accruals are elements relevant to accrued expenditure (expenditure incurred but not yet paid) and accrued revenue (revenue incurred but not yet received).

Details Debit Credit
1. Depreciation Expense ($400 x 3) $1,200
Accumulated Depreciation – Equipment $1,200
2. Unearned Rent $3,300
Rent Revenue $3,300
3. Interest Expense $500
Interest Payable $500
4. Supplies Expense ($2,800 – $700) $2,100
Supplies $2,100
5. Insurance Expense ($200 x 3) $600
Prepaid Insurance $600

Exercise 3-8

Details Debit Credit
1. Accounts Receivable $875
Service Revenue $875
2. Utilities Expense $520
Utilities Payable $520
3. Depreciation Expense $400
Accumulated Depr. – Dental Equipment $400
3. Interest Expense $500
Interest Payable $500
4. Prepaid Insurance ($12,000 – $1,000) $11,000
Insurance Expense $11,000
5. Supplies Expense ($1,600 – $400) $1,200



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