Accounting is based on either the cash basis or the accrual basis. The main difference between these two is in the dictation of how the companies’ transactions are recorded. Revenues and expenses may be recorded when the cash related with them is received/paid or when they are earned/incurred.

In cash basis accounting, companies record revenues when they receive the cash and they record expenses when the cash is paid.

In accrual basis accounting, companies record revenues when they perform services (rather than when they receive cash) and record expenses when they are incurred (rather than when paid).

The time-period concept (or alternatively periodicity concept) assumes that unlimited economic life of a company will be divided into artificial time periods and that financial statements can be prepared for specific periods such as a month, quarter, or year.

Accounting periods may be monthly, quarterly, semiannually or yearly.

The 12-month accounting period used for the annual financial statements is called as fiscal year.

Calendar Year = January 1 to December 31.

If the accounting period is shorter than one year, then it is called as an interim period. Interim periods may be monthly or quarterly.

Revenue is the gross increase in owner’s equity from delivering goods or services to customers and clients.

Expense is the cost of assets consumed or services used during the revenue earning process.

Revenue recognition principle dictates that revenue is recognized when it is earned not the cash is received.

In deferred revenue, revenue is recognized after the cash is received.

In accrued revenue, revenue is recognized before the cash is received.

Matching Principle (Expense recognition principle) means that you will record the
expenses at the same time with the revenues related with these expenses are recorded.

When an expense is recognized after the cash paid, then it is called as deferred expense (prepaid expense).

When an expense is recognized before the cash is paid, then it is called as accrued expense.

The process of analysing and updating of accounts at the end of the period before the financial statements are prepared is called the adjusting process.

The journal entries that bring the accounts up to date at the end of the accounting period are called adjusting entries.

There are two basic categories of adjusting entries. These are deferrals and
accruals.

Depreciable amount is the cost of an asset, or other amount substituted for cost, less than its residual value.

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.

Useful life is the estimated lifespan of a plant asset.

To calculate the depreciation expense, we will use straight-line depreciation method.

Accumulated Depreciation is a contra asset account and it will accumulate the
depreciation expense during the useful life of depreciable asset.

The book value represents the cost invested in the asset that the business has not yet expensed or unexpired, in other words, reminder usefulness of plant asset.

The company has journalized and posted all adjusting entries. Next, it prepares another trial balance from the ledger accounts. This is called an adjusted trial balance.