Chapter 3 Accrual Accounting

Learning Objectives1.Understand the concept and principles under accrual –basis a

ccounting• The time- period concept• The accrual basis principle• The revenue principle• The matching principle• Capital expenditure and revenue expenditure2.Complete the accounting cycle • The adjustment process• Prepare the financial statements• Understand how to close the books3.Use the C/R and D/R to evaluate a business

一、 The concept and principles under accrual –basis accounting

1. Review the time- period concept

• Slice the time into small segment.

• To ensure the financial statement is reported at regular intervals.

• Produce the periodic accounting elements

2.The accrual –basis principle

• Used for measuring the profit(Rev.,Exp.)

• Record the transaction when it occurs.

---Record revenues as they are earned.

---Record expenses as they are incurred.

• Record both cash and noncash transactions.

• It’s the combination of revenue and matching principles.

3.The revenue principle(1)When to record revenue. The business has finished the earning process(earn): --- has delivered the good or performed the service to the c

ustomer, ---meanwhile has the right to collected the cash ---no matter whether the cash is received. (2) What amount of revenue should be recorded.

The amount of revenue recorded should be equal to the cash value of the goods or services transferred to the customer.

Exhibit 3-3

(3) 3 types of revenue earned

• Sale on cash

+cash , +revenue

• Sale on credit

+A/R , +revenue

• Collect cash in advance

+cash , +unearned revenue

+revenue, - unearned revenue

4.The matching principle (1)It’s the principle for recording expenses

(2)When to record the expenses.

• Get benefit from the transaction.

• Have the responsibility to pay for the it.

(3)The meaning of match

Related expenses and revenues should be recognized at the same period.

• If there’s cause-and-effect relationship, and subtract the expenses from the revenues that created the expenses.

• If not, the expenses should be associated with a time period.

(4) 3 types of expense occurred

• Benefit and pay at the same time +expense, -cash• Pay first ,benefit later---Prepaid +prepaid, -cash +expense, -prepaid• Benefit first,pay later---accrued +expense, +liability - cash, -liability

5 、 Capital expenditure and revenue expenditure

(1) Capital expenditure is referred to the expenditure that create

revenue for several periods(recorded as asset).

.(2)Revenue expenditure is referred to the expenditure that create revenue for current period(recorded as

expense).

二 .Complete the accounting cycle ( 四 )Adjusting the accounts to update the F.S.1.Features of adjustments• Based on the accrual basis• Adjust the revenues ,expenses(NI) .• Also adjust the related asset and liability ac

counts.• Irrelevant with cash• Made at the end of accounting period• Without source documents

2.Category of adjustment Exhibit3-10,3-11

(1) deferrals: cash transactions occur before the recognition of Rev & Exp.

• Prepaid expenses: +expenses,-assets

• Unearned revenues: +revenues,-liabilities

(2)Accruals: Rev & Exp occur before cash transactions.

• Accrued expenses: + expenses,+liabilities

• Accrued revenues: +revenues, +assets

3. The steps of adjusting process

• Make the adjusting entries

• Post the adjustment to ledger

( 五 )Preparing the adjusted trial balance

• It’s made after the adjustments .

• To check the final balances of all accounts

Exhibit 3-13 3-14

( 六 )Preparing the Financial Statements

from the adjusted trial balance

Exhibit3-14, 3-15, 3-15, 3-17

Summary problem P126

( 七 )Closing the Books(Accounts)

1. Temporary(normal )accounts• Revenue accounts• Expense accounts• Income summary accounts• Dividend accounts The balances of these accounts should be

closed and have a zero balance to begin the next accounting period.

2. Closing entries perform two functions

• Set the balances of temporary accounts to zero, and to prepare the accounts for the next period’s transactions.

• Transfer the balances of temporary accounts into retained earnings.

3.Permanent (real)accounts

• Assets

• Liability

• Owners’equity

The balances of permanent accounts are carrying to the next period, need not be closed.

4. Steps of closing process(1)Make the closing entries• Debit each revenue account for the amount of its c

redit balance; Credit income summary account.• Credit each expense account for the amount of its

dedit balance; Debit income summary account.• Debit(credit) income summary account for the for

the amount of its credit (debit)balance; Credit(debit) R.E

• Credit dividend account; Debit R.E

(2)Post the closing entries to accounts

5 、 The relationship of temporary accounts

Revenue

Income summary

Expense

R. E.

Dividends

三、 Financial Statement Analysis

1.Current Ratio

• Total current assets/Total current liabilities

• Represents the amount of current assets for $1 current liabilities.

• Measures the company’s ability to pay current liabilities with current assets.

2.Debt Ratio

• Total liabilities/total assets

• Indicate the proportion of a company’s assets that is financed with debt.

• Measures a company’s ability to pay total liabilities.

P141 Summary Problem