Accural Accounting & The Balance Sheet
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Accrual accounting records revenue as earned and expense as incurred. This presentation explains the concept of accrual accounting and the basic terms that entail a balance sheet.
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Accural Accounting & The Balance Sheet
- 1. Welingkar’s Distance Learning Division Financial Accounting CHAPTER-3. Accural Accounting & The balance sheet We Learn – A Continuous Learning Forum
- 2. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Accrual vs. Cash Accounting Accrual Accounting Records Revenue as earned ( regardless of when cash is paid) Records Expense as incurred ( regardless of when expense is paid)
- 3. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Accrual vs. Cash Accounting Accrual Accounting Records Revenue as earned ( regardless of when cash is paid) Records Expense as incurred ( regardless of when expense is paid) Cash Accounting • Records revenue as cash is received ( regardless when the sale is made) • Records Expense when paid ( regardless when the sale is made)
- 4. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Accrual vs. Cash Accounting Accrual Accounting •Records Revenue as earned • Records Expense as incurred Cash Accounting • Records revenue as cash is received • Records Expense when paid Cash Accounting is not accepted by GAAP hence not used by companies.
- 5. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Operating Cycle of Business • Operating cycle of a business starts from cash brought in by owners which is used to by inputs. These are converted into finished product or service and sold to customers. To create receivables. When receivables are collected, we get cash again, to buy inputs. • The different phases of this cycle are shown in the next slide.
- 6. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Operating Cycle of Business Purchases Inventory Cash A/cs Payable Production Finished Goods Sales A/cs Receivables Collections
- 7. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three The Balance Sheet shows where the funds are i.e. Assets and who has helped business to acquire them. i.e. Liabilities. Operating Cycle of Business
- 8. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Sound Financial Management of a company involves matching the sources and uses of cash, so that obligations become due as assets mature into cash. Operating Cycle of Business
- 9. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three With sound review of a company’s Balance Sheet , one can monitor the ability of that company to collect revenues manage its inventory plus satisfy its creditors & shareholders. Review of Balance Sheet
- 10. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Assets • Are anything of value that is owned or due to the business. • Classified as Non-current Current Others
- 11. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Non-Current Assets Consist of Net Fixed Assets Investments in subsidiaries Intangibles Others
- 12. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Non-Current Assets Consist of Net Fixed Assets Include Land, Buildings, Machinery & Equipment, Furniture & Fixtures, Vehicles etc. Are long term investments that enable the business to carry on its operations. Stated at book their value which is calculated as Gross Fixed Assets (cost) less accumulated depreciation.
- 13. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Non-Current Assets Consist of Net Fixed Assets, Investments Common forms of investment of surplus funds, by the companies are Government or Trust Securities. Shares, Debentures, or Bonds Immovable properties. In capital of subsidiaries.
- 14. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Non-Current Assets Consist of Net Fixed Assets Investments in subsidiaries Intangibles Represent the use of cash to purchase assets with an undetermined life and may never mature into cash. Research & Development Patents Market Research Goodwill Standard accounting principles require most intangibles to be expensed as purchased and not capitalized.
- 15. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Non-Current Assets Consist of Net Fixed Assets Investments in subsidiaries Intangibles Standard accounting principles require most intangibles to be expensed as purchased and not capitalized. except purchased patents that may be amortized over the life of the patent
- 16. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Current Assets Consist of Cash Accounts Receivables Inventory Notes Receivables Prepaid Expenses Others They are assets that mature in less than one year .
- 17. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Current Assets Consist of Cash Cash pays bills and obligations. Other assets cannot pay bills unless they are converted into cash. Includes all bank accounts, money market and short-term savings accounts.
- 18. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Current Assets Consist of Cash Accounts Receivables are money due from customers. are third most liquid asset after cash & short term investments some receivables can become uncollectible this expense is termed ‘ bad debts’ these can be recorded by two methods $ Allowance method $ Direct write off Method
- 19. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Current Assets Consist of Cash Accounts Receivables these can be recorded by two methods $ Allowance method An estimate is prepared for bad debts for the period and expense is recorded by journal entry Bad Debt dr To Allowance for Bad Debts cr
- 20. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Current Assets Consist of Cash Accounts Receivables these can be recorded by two methods $ Allowance method An estimate is prepared for bad debts for the period The estimate is based on - % of sales method – income statement approach or - aging of receivables – balance sheet method
- 21. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Current Assets Consist of Cash Accounts Receivables these can be recorded by two methods $ Allowance method $ Direct write off Method the expense is recorded when specific account goes bad. journal entry is passed to debit Bad Debt expense and credit Accounts Receivables- xxx company.
- 22. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Current Assets Consist of Cash Accounts Receivables these can be recorded by two methods $ Allowance method $ Direct write off Method the method does not comply with Matching Revenue principle, as expense is recorded much later when specific account is un- collectible and goes bad
- 23. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Current Assets Consist of Cash Accounts Receivables Inventory consists of materials company purchases to covert and sell as finished products. the level of inventory has to be managed in such a way that required materials are always available for production and sale with minimum funds locked in it.
- 24. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Current Assets Consist of Cash Accounts Receivables Inventory the correct level of inventory is a function of the length of the company’s inventory cycle. Inventory Cycle in Days = Ordering phase in days + Production phase in days + Finished Goods and Delivery Phase in days
- 25. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Current Assets Consist of Cash Accounts Receivables Inventory Quality Measurement & Goals Both Receivables and Inventory can be managed by controlling their quality which is measured in days as follows. Receivables Days = Actual Receivables x 360 Sales in a year Inventory Days = Actual Inventory x 360 Cost of Goods sold in a year
- 26. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Current Assets Consist of Cash Accounts Receivables Inventory Quality Measurement & Goals Both Receivables and Inventory can be managed by controlling their quality which is measured in days Ideal receivables days should be close to average days of credit allowed to customers. Ideal inventory days should be just over inventory cycle days.
- 27. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Current Assets Consist of Cash Accounts Receivables Inventory Quality Measurement & Goals Both Receivables and Inventory can be managed by controlling their quality which is measured in days Investment in Inventory and Accounts receivable is a function of sales and days. Increase due to sales is healthy. But due to increase in days is costly as it is an indication of overstocking and inefficient collections.
- 28. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Liabilities Consist of Current Non-Current Contingent Equity “ Liabilities and net worth are sources of cash listed in descending order from the soonest to mature obligations to never to mature obligations.”
- 29. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Liabilities Consist of Current Liabilities Are those obligations that mature and must be paid within 12 months. They include Accounts Payable, Accrued Expenses, Notes Payable ( both Bank& Other) and Current Portion of Long Term Debt ( that part payable in next 12 months)
- 30. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Liabilities Consist of Current Non-Current Liabilities Are those obligations that are not due and payable in the coming year. Include long term secured or non secured loans, funds received from associates and promoters.
- 31. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Liabilities Consist of Current Non-Current Contingent Liabilities Are those obligations that hopefully never become due. They are potential liabilities which are not due on the day of reporting, but may, depending upon results of pending law suits and warranties and cross guarantees issued.
- 32. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Liabilities Consist of Current Non-Current Contingent Liabilities Are those obligations that hopefully never become due. They are potential liabilities which are not due on the day of reporting, but may, depending upon results of pending law suits and warranties and cross guarantees issued. These are indicated by a foot note in the Balance Sheet
- 33. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three Balance Sheet - Terms Liabilities Consist of Current Non-Current Contingent Equity and Net Worth Equity and net worth are last to mature source of funds. It has two parts : Purchased Equity – Paid up Equity Shares and Preference Shares Earned Equity – retained earnings ( profits) shown as Reserves and Earned Surplus.
- 34. Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three “ Accrual accounting records revenues as earned and expense as incurred, ignoring when payments arranged.” “ Operating cycle of business involves process of converting the raw material to cash’ “Matching principle demands that against revenue of a period all expenses in that period are included” “Non-current assets are those that do not mature into cash in a year” “contingent Liabilities are potential and not actual ones as of date”