accrual accounting concepts chapter 3. why is accrual accounting needed? cash received or paid...

Download Accrual Accounting Concepts Chapter 3. Why is Accrual Accounting Needed? Cash received or paid Revenue earned Expense incurred

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  • Accrual Accounting ConceptsChapter 3

  • Why is Accrual Accounting Needed?Cash received or paidRevenue earnedExpense incurred

  • Accruing RevenueRevenue Recognized

  • Accruing ExpenseReceive invoice for purchaseExpense Recognized

  • Family Health Cares November Transactions

    To illustrate accrual concepts of accounting, we will use the following November 2013 Family Health Care transactions.

    On November 1, received $1,800 from ILS Company as rent for the use of Family Health Cares land as a temporary parking lot from November 2013 through March 2014.On November 1, paid $2,400 for an insurance premium on a 2-year, general business policy.On November 1, paid $6,000 for an insurance premium on a six-month medical malpractice policy.Dr. Landry invested an additional $5,000 in the business in exchange for capital stock.Purchased supplies for $240 on account.

  • Family Health Cares November Transactions Cont.

    Purchased $8,500 of office equipment. Paid $1,700 cash as a down payment, with the remaining $6,800 ($8,500 - $1,700) due in five monthly installments of $1,360 ($6,800/5) beginning January 1. Provided services $6,100 to patients on account.Received $5,500 for services provided to patients who paid cash.Received $4,200 from insurance companies, which paid on patients accounts for services that have been provided.Paid $100 on account for supplies that had been purchased.Expenses paid during November were as follows: wages, $2,790; rent, $800; utilities, $580; interest, $100; and miscellaneous, $420.Paid dividends of $1,200 to stockholders (Dr. Landry).

  • Summary of Accruals and Deferrals

  • DeferralsCash received or paidRevenue earned or expense incurredDeferralsAccrualsCash received or paidRevenue earned or expense incurredAccruals

  • Adjustments for Family Health Care

    We now analyze the accounts for Family Health Care at the end of November to determine whether any adjustments are necessary. Specifically, we will focus on the following adjustment data, which are typical for most businesses.

    Deferred expenses:Prepaid insurance expired, $1,100.Supplies used, $150.Depreciation on office equipment, $160.

    Deferred revenue:4. Unearned revenue earned, $360.

    Accrued expense:5. Wages owed but not paid to employees, $220.

    Accrued revenue:6. Services provided but not billed to insurance companies, $750.

  • Summary of Transactions for Family Health Care

  • Accrual Accounting and the Accounting CycleThe Accounting CycleIdentify TransactionsPrepare Financial StatementsRecord TransactionsRecord Adjustments

  • Adjustment for SuppliesAnswer each of the following questions concerning supplies and the adjustment for supplies. (a) The balance in the supplies account, before adjustment at the end of the year, is $1,475. What is the amount of the adjustment if the amount of supplies on hand at the end of the year is $241? (b) The supplies account has a balance of $418 (after adjustment), and the supplies expense account has a balance of $1,943 at December 31, 2004. If 2004 was the first year of operations, what was the amount of supplies purchased during the year?

  • WagesThe balances of the two wages accounts at December 31, after adjustments at the end of the first year of operations, are Wages Payable, $1,960, and Wages Expense, $87,430.

    Determine the amount of wages paid in cash during the year.

    *Transactions recorded in Chapter 2 examples were structured so cash was received or paid at the time of the transaction.In real world, cash may be received or paid at a different time than when the revenue is earned or expense is incurred.If revenue is only recorded when it is received in cash, an income statement may show a loss during a period though significant earning activities have taken place.If expenses are only recorded when they are paid in cash, an income statement for a period may show more income than the actual income. Accrual accounting is designed to avoid misleading information arising from the timing of cash receipts and payments.Transactions are recorded as they are incurred.Accrual accounting transactions affect the accounting equation.Transactions will be recorded even though cash is not received or paid until a later point.*Revenue is recognized (recorded) when earnedWhen services are provided with cash to be received at a later date, services are said to be provided on account.When services are provided on account, an asset called Account Receivable is recorded to represent the amount that is expected to be received in cash in the future.Revenue is said to be recognized when the service is provided, the earnings process is complete, and the customer is legally obligated to pay for the product or service.

    *A company may purchase goods and services with terms which allow payment at a later time.These transactions represent purchases made on account.When purchases are made on account, a liability account called Accounts Payable is recorded for the amount to be paid at a later time.Liabilities are recognized when the obligation is incurred

    *Adjustments are necessary because, at any point in time, some elements of the accounting equation are not up to date. Adjustments are necessary to match revenues and expenses; it is the application of the matching concept.The adjustment process completes the information necessary for financial statement preparation.If all of a companys transactions are in cash, no adjustments are necessary.*Deferrals are created by recording a transaction in a way that delays the recognition of an expense or revenue.Common examples include prepaid/deferred expenses or unearned/deferred revenues.Prepaid or deferred expenses are items such as prepaid insurance; the amount is initially recorded as an asset, but become expenses over time.Unearned or deferred revenues are revenues for which cash is collected in advance of revenue actually being earned so a liability is recorded until the revenue is earned.Accruals are created when a revenue or expense has been earned or incurred, but has not been recorded at the end of an accounting period.Common examples include accrued expenses/liabilities or accrued revenues/assets.Accrued expenses or liabilities are expenses that have been incurred but are not recorded in the accounts; an example would be wages incurred during a month which are unpaid on the last day of the month.Accrued revenues or assets are revenues earned but not yet recorded; an example would be revenue for patient services earned but not yet billed to the insurance companies.*The income statement is prepared by summarizing the transactions listed under the Income Statement column of Exhibit 2. Then, the retained earnings statement will be prepared. The balance sheet will be prepared from the worksheet by reporting the closing balances of the asset, liability and equity columns. Finally, the statement of cash flows will be prepared.*Revenues are a result of providing services or selling products to customers. Fees earned represents services provided for cash, on account, and those accrued at the end of the month. Family Health Care has revenues from patient services and rental revenue. Revenues from the primary operations of the business are reported separately from other revenues; since the primary operation of the business is providing services to patients, rental revenue is reported under Other Income. Expenses are matched against revenues to determine Net Income.Expenses now include depreciation expense of $160.Wages expense of $3,010 includes the $2,790 of wages paid plus the accrual of $220 at the end of the month.Expenses not related to the primary operation of the business are reported as Other Expenses.Operating income is determined by deducting operating expenses from fees earned; Family Health Care reports operating income of $6,030.Other income of $360 from rental revenue is then added to operating income to determine the net income for November of $6,390.*November net income of $6,390 (from the income statement) is added to the retained earnings of $3,320 at November 1.Dividends paid of $1,200 are deducted.Ending retained earnings of $8,510 is included on Family Health Cares balance sheet at November 30, 2013.*The balance sheet shown is a classified balance sheet which has various sections, subsections, and captions.ASSETS:Assets on a classified balance sheet are normally reported as Current assets, Fixed assets, and Intangible assets.Current assets are cash and other assets that are expected to be converted to cash or used up within one year through normal operations. These also include accounts receivable, notes receivable, supplies, and prepaid expenses. Fixed assets are physical assets of a long-term nature. Except for land, fixed assets depreciate over a period of time. Accumulated depreciations, a contra account to property, plant, and equipment, is included in the fixed asset section of the balance sheet.Family Health Care reports $8,340 of office equipment which is equal to cost of $8,500, less accumulated depreciation of $160.Intangible assets represent rights that will provide a long-term benefit to a company but do not have physical presence; examples are patent rights, copyrights, and goodwill.Family Health Care has no intangible assets.LIABILITIES:Liabilities on a classified balance sheet are also split into current liabilities and long-term liabilities.Current liabilities are due within a short period of time, usually one year or less, and are to be paid for from current assets and include accounts payable and wages payable.Long-term liabilities are not due for a long time (usually more than one year). As long-term liabilities come due, they are reclassified to current liabilities.Family Health Care has $16,800 of notes payable, $6,800 due

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