210 ch4


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University of Evansville - Accounting 210 Chapter 4

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210 ch4

  1. 1. 8/e Income Measurement and Accrual4 Accounting
  2. 2. RecognitionThe process of formally recording or incorporatingan item into the financial statements of an entity asan asset, a liability, a revenue, an expense, and thelike. Sales
  3. 3. MeasurementHistorical Cost – simplest and most verifiableCurrent Value – the estimated value of the assetReliability vs. RelevanceBecause of its objectivenature, historical cost is theattribute used to measure manynon-current assets.
  4. 4. Cash vs. Accrual BasisCash basis: revenues and expenses arerecorded only when cash is received or paidAccrual basis: revenues are recognized whenearned; expenses are recognized when incurred LO2
  5. 5. Cash basis Accrual basis statement statement Statement of Income Cash Flows StatementCash flows from Net income:operating activities: $ 7,000 $(4,000) What accounts for the difference?
  6. 6. Revenue Recognition Principle Revenue is recognized when realized or realizable and earned—usually at time of saleExceptions: Long-term contracts Franchises Commodities Installment sales Rent and interest LO3
  7. 7. Expense Recognition Principle Match expenses with associated revenues Directly Indirectly over Simultaneously period they upon their provide benefits acquisitione.g. Inventory e.g. Buildings e.g. Utilities LO4
  8. 8. Expense Recognition Balance Sheet Income StatementASSETS: EXPENSES:Inventory when sold Cost of goods sold Supplies expenseSupplies as used Insurance expensePrepaid assets Rent expensePP&E Depreciation expense over period theyIntangibles Amortization expense provide benefits l Other expenses (as incurred)
  9. 9. Types of AdjustmentsDeferred Accruedexpense RECOGNIZE liability REVENUE OR EXPENSES BEFORE OR AFTER CASH IS EXCHANGEDAccrued Deferred asset revenue LO5
  10. 10. Adjustments SummaryExamples: Deferred Expense cash received before expense is incurred Deferred Revenue cash received before revenue is earned Accrued Liability expense incurred before cash is paid Accrued Asset revenue is earned before cash is received
  11. 11. Deferred ExpenseCash paid before expense is incurred Examples: • Prepaid rent • Prepaid insurance • Office supplies • Property and equipment Costs are initially recorded as assets and allocated to expenses in future periods
  12. 12. Deferred Expense ExamplePrepay $2,400 for insurance for one year on September 1
  13. 13. Deferred Expense ExampleSeptember 30 adjustment to recognize insurance expense: $2,400 / 12 months = $200 /month
  14. 14. Deferred Expense ExamplePurchase new store fixtures on January 1 for $5,000; estimated usefullife is 5 years 60 months); estimated salvage value is $500Purchase of Store fixtures:
  15. 15. Deferred Expense ExampleMonthly adjustment: ($5,000 – $500) 1/60 = $75 per month for 60 months)
  16. 16. Deferred RevenueCash received before revenue is earned Examples: • Insurance collected in advance • Subscriptions collected in advance • Gift certificates Receipts are initially recorded as liabilities (unearned or refundable receipts) and recorded as revenues in future periods when earned
  17. 17. Deferred Revenue ExampleReceived $2,400 for an insurance policy in advance:
  18. 18. Deferred Revenue ExampleMonthly adjustment: ($2,400 annual 1/12 = $200 per month for 12 months)
  19. 19. Accrued LiabilityExpense incurred before cash is paid Examples: • Payroll • Taxes • Interest Record expense (and corresponding liability) in period incurred; pay for it in a future period No cash flow on recording, only when paid
  20. 20. Accrued Liability ExampleBiweekly wages are $280,000
  21. 21. Accrued Liability ExampleAt end of month, between pay periods:
  22. 22. Accrued Liability ExampleNext payday:
  23. 23. Accrued Liability ExampleOn March 1, assume a 9%, 90-day, $20,000 loan is taken
  24. 24. Accrued Liability ExampleMonthly adjustment: ($20,000 principal 9% 1/12 = $150/month )
  25. 25. Accrued Liability ExamplePayment of principal and interest on May 30
  26. 26. Accrued AssetRevenue earned before cash is received Examples: • Rent • Interest Record revenue (and corresponding receivable) in period earned; receive payment in a future period
  27. 27. Accrued Asset ExampleRent payment of $2,500 due within first 10 days of month
  28. 28. Accrued Asset ExampleUpon receipt of cash:
  29. 29. Adjustments SummaryExamples: Deferred Expense cash received before expense is incurred Deferred Revenue cash received before revenue is earned Accrued Liability expense incurred before cash is paid Accrued Asset revenue is earned before cash is received
  30. 30. Ethics and Accrual Accounting Accountants must remember their primary responsibility is preparing financial statements is to portray the affairs of the company accurately to various outside users. Bankers, stockholders, and others rely on the accountant to serve their best interests.
  31. 31. Steps in the Accounting Cycle 1. Collect and 7. Close the analyze info 2. Journalize accounts transactions6. Record andpost adjusting 3. Post entries transactions to general ledger 5. Prepare financial 4. Prepare statements work sheet LO6
  32. 32. The Use of a Worksheet Used at the end of the period to gather the information needed to prepare financial statements without actually recording and posting entries The worksheet is not a financial statement Useful device to organize the information needed to prepare the financial statements at the end of the period
  33. 33. The Closing ProcessPurpose: To return the balance of revenue, expense, and dividend accounts to zero to begin the next period to transfer the net income (or loss) and dividends of the period to Retained Earnings
  34. 34. Interim Statements Financial Statements prepared monthly, quarterly or at other intervals less than a year Used for internal purposes
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