1 chapter 4 income measurement and accrual accounting financial accounting, alternate 4e by porter...
TRANSCRIPT
1
Chapter 4
Income Measurement
and
Accrual Accounting
Financial Accounting, Alternate 4e by Porter and Norton
2
Recognition: formally recording an item in the financial
statements of an entity
Recognition and Measurement
I know I need to record this...
Measurement: quantification of the
effects of the item on the entity
...but at current value or historical
cost?
3
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
4
Cash basisstatement
Accrual basis statement
Statement ofCash Flows
Cash flows from operating activities: $(4,000)
IncomeStatement
Net income $ 7,000
What accounts for the difference?
5
Revenue Recognition Principle
Exceptions: Long-Term Contracts - over life of project Franchises - upon substantial performance Commodities - when readily convertible Installment Sales - when cash is collected Rent and Interest - continuously when earned
Revenue is recognized when realized and earned - usually at point of sale.
6
Expense Recognition
Income Statement
Inventory
SuppliesPrepaid assets
PP&EIntangibles
as used
Balance Sheet
when sold
over period they provide benefits
ASSETS: EXPENSES:Cost of goods sold
Supplies expenseInsurance expenseRent expense
Depreciation expenseAmortization expense
Other expenses (as incurred)
7
Matching Principle
Directly
Indirectlyover period theyprovide benefits
Simultaneouslyupon theiracquisition
e.g. Inventory e.g. Buildings e.g. Utilities
Match Expenses with Associated Revenues
8
Types of Adjusting Entries
ALL RECOGNIZE REVENUE OR
EXPENSE BEFORE OR
AFTER CASH IS EXCHANGED
Deferred expense
Accrued liability
Accrued asset
Deferredrevenue
9
Deferred Expense - Cash paid before expense is incurred
Examples:» Prepaid rent
& insurance» Office supplies» Plant & equipment
Costs are initially recorded as assets and allocated to expense in future periods
10
Deferred Expense Example #1 – Prepay rent on office space for one year on Sept. 1
Initial transaction:Assets = Liab. + O/E + Rev. – Exp.Prepaid Rent 2,400Cash (2,400)
Monthly adjustment:Assets = Liab. + O/E + Rev. – Exp.Prepaid Rent (200) Rent Exp. (200)
11
Deferred Expense Example #2 - Purchase delivery truck on January 1 for $21,000. Estimated useful life is 5 years (60 months); estimated salvage value is $3,000.
Initial transaction:Assets = Liab. + O/E + Rev. – Exp.Delivery Truck 21,000Cash (21,000)
Monthly adjustment:Assets = Liab. + O/E + Rev. – Exp.Acc. Depr. (300) Depr. Exp. (300)
12
Deferred Revenue - Cash received before revenue is earned
Examples:» Rent 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.
13
Initial transaction:Assets = Liab. + O/E + Rev. – Exp.Cash 2,400 Rent Collected
in Advance 2,400
Monthly adjustment:Assets = Liab. + O/E + Rev. – Exp.
Rent Collected Rent Rev. 200 in Advance (200)
Deferred Revenue Example #1 - Receive $2,400 for twelve months rent in advance
14
Initial transaction:Assets = Liab. + O/E + Rev. – Exp.Cash 6,000 Subs. Collected
in Advance 6,000
Monthly adjustment:Assets = Liab. + O/E + Rev. – Exp.
Subs. Collected Subs. Rev. 500 in Advance (500)
Deferred Revenue Example #2 -Sell 500 1-yr. subscriptions at $12 each
15
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
16
At end of month, between pay periods:Assets = Liab. + O/E + Rev. – Exp.
Wages Pay. 4,000 Wages Exp. (4,000)
Next payday:Assets = Liab. + O/E + Rev. – Exp. Cash (28,000) Wages Pay. (4,000) Wages Exp.
(24,000)
Accrued Liability Example #1 - Pay biweekly wages of $28,000
17
Initial transaction:Assets = Liab. + O/E + Rev. – Exp.Cash 20,000 Notes Pay. 20,000
Monthly adjustment:Assets = Liab. + O/E + Rev. – Exp.
Interest Pay. 300 Interest Exp. (300)
Accrued Liability Example #2 - Borrow $20,000 for three months. Principal plus 9% interest due at end of loan period.
18
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
Revenue
19
First day of the month:Assets = Liab. + O/E + Rev. – Exp.Rent Rec. 2,500 Rent Rev. 2,500
Upon receipt of cash:Assets = Liab. + O/E + Rev. – Exp. Cash 2,500Rent Rec. (2,500)
Accrued Asset Example – Rent payment due within first 10 days of month
20
Ethical Considerations
The accountant’s primary responsibility is to accurately portray the affairs of the company
in the financial statements
When to recognize expenses?
When to recognize revenue?
21
Steps in the Accounting Cycle
1. Collect and analyze info
2. Journalizetransactions
3. Post J/Es togeneral ledger
4. Preparework sheet
5. Preparefinancial
statements
6. Record &post AJEs
7. Close theaccounts
Continuously
Periodically
End of the period
22
Closing Entries
net income or (net loss)closed to
Retained Earnings
Revenue accounts $ xxExpense accounts (xx)
Return all balances in temporary accounts to zero for the next period
23
End of Chapter 4