1. 8/e
Income
Measurement and
Accrual
4 Accounting
2. Recognition
The process of formally recording or incorporating
an item into the financial statements of an entity as
an asset, a liability, a revenue, an expense, and the
like.
Sales
3. Measurement
Historical Cost – simplest and most verifiable
Current Value – the estimated value of the asset
Reliability vs. Relevance
Because of its objective
nature, historical cost is the
attribute used to measure many
non-current assets.
4. Cash vs. Accrual Basis
Cash basis: revenues and expenses are
recorded only when cash is received or paid
Accrual basis: revenues are recognized when
earned; expenses are recognized when incurred
LO2
5. Cash basis Accrual basis
statement statement
Statement of Income
Cash Flows Statement
Cash flows from Net income:
operating activities: $ 7,000
$(4,000)
What accounts for
the difference?
6. Revenue Recognition Principle
Revenue is recognized when realized or
realizable and earned—usually at time of sale
Exceptions:
Long-term contracts
Franchises
Commodities
Installment sales
Rent and interest
LO3
7. Expense Recognition Principle
Match expenses with associated revenues
Directly Indirectly over Simultaneously
period they upon their
provide benefits acquisition
e.g. Inventory e.g. Buildings e.g. Utilities
LO4
8. Expense Recognition
Balance Sheet Income Statement
ASSETS: EXPENSES:
Inventory when sold Cost of goods sold
Supplies expense
Supplies
as used Insurance expense
Prepaid assets Rent expense
PP&E Depreciation expense
over period they
Intangibles Amortization expense
provide benefits
l
Other expenses
(as incurred)
9. Types of Adjustments
Deferred Accrued
expense RECOGNIZE liability
REVENUE OR
EXPENSES
BEFORE OR AFTER
CASH IS
EXCHANGED
Accrued Deferred
asset revenue
LO5
10. Adjustments Summary
Examples:
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. Deferred Expense
Cash 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
14. Deferred Expense Example
Purchase new store fixtures on January 1 for $5,000; estimated useful
life is 5 years 60 months); estimated salvage value is $500
Purchase of Store fixtures:
16. Deferred Revenue
Cash 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
19. Accrued Liability
Expense 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
26. Accrued Asset
Revenue earned before cash is received
Examples:
• Rent
• Interest
Record revenue (and corresponding
receivable) in period earned; receive payment
in a future period
29. Adjustments Summary
Examples:
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. 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. Steps in the Accounting Cycle
1. Collect and
7. Close the analyze info
2. Journalize
accounts transactions
6. Record and
post adjusting 3. Post
entries transactions to
general ledger
5. Prepare
financial 4. Prepare
statements work sheet
LO6
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. The Closing Process
Purpose:
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. Interim Statements
Financial Statements prepared monthly,
quarterly or at other intervals less than
a year
Used for internal purposes