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Accrual vs. Cash Basis AccountingACCRUAL ACCOUNTING CASH BASIS
• Records impact of transactions when they occur
• Required by IAS1 – Presentation of Financial Statements
• Records:▫ Revenue when ________▫ Expenses when ________
• Use by virtually all businesses
• Records transactions only if cash is involved▫ Cash receipts▫ Cash payments
• Ignores underlying economic activities
• Used by ________ or ________ operations
Copyright ©2014 Pearson Education2
Accrual accounting•Records _____ cash and non-cash
transactionsCash transactions Non-cash transactions
Collecting payments from customers
Sales on account
Receiving cash from interest earned
Purchases of inventory on account
Paying salaries, rent, and other expenses
Accrual of expenses incurred but not yet paid
Borrowing money Depreciation expense
Paying off loans Usage of prepaid rent, insurance, and supplies
Issuing shares (for cash) Earning of revenue when cash was collected in advanceCopyright ©2014 Pearson Education
4
Time Period Concept•Accounting information is reported at
regular intervals▫Basic accounting period is ________
•Calendar year▫January 1 – December 31
•Fiscal year▫12-month period ending on a date other
than December 31•Interim periods
▫Month or quarterCopyright ©2014 Pearson Education
5
Time-period concept
©2010 Pearson Prentice Hall. All rights reserved.
1-7
Ensures that accounting information is reported at regular intervals
IAS 1 requires an entity to present a complete set of financial statements at least annually.
Companies also prepare financial statements for interim periods of less than a year.
Copyright ©2014 Pearson Education
Revenue Recognition Principle• What is Revenue?
▫ Exchange of __________________• When should revenue be recorded?
▫ Transfer of __________ The entity has transferred to the buyer the significant risks and
rewards of ownership of the goods▫ Transfer of __________
The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold
▫ Amounts _______________ The amount of revenue can be measured reliably
▫ ______________ It is probably that the economic benefits associated with the
transaction will flow to the entity▫ ______________
The costs incurred or to be incurred in respect of the transaction can be measured reliably
8
Matching Principle
Identify expenses incurred
Measure the
expenses
Match against
revenues earned
Copyright ©2014 Pearson Education9
Adjusting the Accounts
•Transactions▫In chapter 2, we discussed “transactions”
and accounting when they occur▫Some events do not relate to specific
transactions, so we have to “adjust” for them
•Adjusting Entries▫Financial statements issued at end of
period▫Several accounts on trial balance need to
be brought up-to-date Certain transactions that have not been
recordedCopyright ©2014 Pearson Education
11
Categories of Adjustments
Deferrals
Depreciation
Accruals
Copyright ©2014 Pearson Education12
Think of what is being deferred or accrued:_________ _________
Deferrals•Business has paid or received cash in
advancePrepaid expense
• Recorded as an _____ when purchased
• _______ when used or expired
Unearned revenue
• Recorded as a ________ when payment is received
• Recorded as ________ when earned
Copyright ©2014 Pearson Education13
Prepaid Expenses•Recorded as assets when purchased
▫Example: On June 1, you prepay 3 months of rent for $3,000
•Expensed when used (or when time passes) JOURNAL
Date Accounts and explanation Debit Credit
Jun 1 _______________ 3,000
Cash 3,000
Paid three months’ rent in advance
Jun 30 Rent expense 1,000
_____________ 1,000
To record rent expenseCopyright ©2014 Pearson Education 14
Prepaid Rent
Prepaid rent
Jun 1 Jun 30
Rent expense
Jun 30
Amount expired
Amount remaining
Balance Sheet
Income Statemen
t
Copyright ©2014 Pearson Education15
Prepaid Expenses•Recorded as assets when purchased•Some pass with time. •Other assets expensed when used
▫Example: Purchase $700 of supplies on Jun 2 JOURNAL
Date Accounts and explanation Debit Credit
Jun 2 Supplies 700
Cash 700
Paid cash for supplies
Jun 30 Supplies expense 300
Supplies 300
To record rent expense
Copyright ©2014 Pearson Education16How do we know this number?
Supplies
Supplies
Jun 2 $700 Jun 30$___
$400
Supplies expense
$___Jun 30
Amount usedAmount on
hand
Balance Sheet
Income Statemen
t
Copyright ©2014 Pearson Education17
Supplies/Inventory _____
Depreciation
•Allocates cost of Property, Plant and Equipment (PPE) to expense over __________▫_______= estimated duration of how long
long-term asset will last▫Depreciation represents wear-and-tear and
obsolescence•Examples of PPE:
▫Buildings▫Equipment▫Furniture
Copyright ©2014 Pearson Education18
Accumulated Depreciation (__)•Depreciation expense (Exp)
▫amount allocated to __________•Accumulated Depreciation (XA)
▫Sum of ____________ expense and increases over plant asset’s life
•______-asset▫Normal credit balance (opposite to the
contra)▫Always has a companion account
•Book value (sometimes called Net Book Value)▫Cost of plant asset less accumulated
depreciation Copyright ©2014 Pearson Education19
Depreciation•Example: Company buys Equipment with
5-year useful life for $24,000 on June 2.▫Assume the asset has no salvage value▫Depreciation = $24,000/60 months =
$400/month
Copyright ©2014 Pearson Education
20
JOURNAL
Date Accounts and explanation Debit Credit
Jun 2 Equipment 24,000
Cash 24,000
Jun 30 Depreciation expense 400
Accumulated depreciation 400
*Note:___________________
DepreciationEquipment
Jun 2 $24,000
Depreciation Expense
$400Jun 30
Balance Sheet Income
Statement
Accumulated Depreciation
Jun 30$400
Copyright ©2014 Pearson Education21
$24,000/60 = $400
Book Value
Balance SheetDecember 31, 2010
Equipment $24,000
Less: Accumulated Depreciation
(400)
Book value $23,600
Copyright ©2014 Pearson Education22
Unearned Revenue•Sometimes called “Advances from
Customer”•Receive cash before revenue is earned•Creates a liability
▫Business owes customer a good or serviceJOURNAL
Date Accounts and explanation Debit Credit
Jun 1 Cash (A) 400
Unearned service revenue (L) 400
Received cash for revenue in advance.
Copyright ©2014 Pearson Education23
Unearned Revenue•When revenue is earned
▫Liability is reduced▫Revenue is increased
JOURNAL
Date Accounts and explanation Debit Credit
Jun 30 Unearned revenue 200
Service revenue 200
To record unearned service revenue that has been earned.
Copyright ©2014 Pearson Education24
Accruals
Accrued Expenses
• Record expense before paying cash
• Salaries, interest, and income taxes
Accrued Revenues
• Record revenue before collecting cash
• Earned and will collect next period
Copyright ©2014 Pearson Education25
Accrued Salaries
JOURNAL
Date Accounts and explanation Debit Credit
Dec 31 Salaries expense 6,000
Salaries Payable 6,000
To accrue salaries expense
Jan 3 (Fri)Dec 31 (Tues)
$15,000 weekly salaries
$6,000 $15,000
Copyright ©2014 Pearson Education26
2-days accrued
Accrued Salaries
JOURNAL
Date Accounts and explanation Debit Credit
Jan 3 Salaries Payable 6,000
Salaries Expense (Salaries Payable)
9,000
Cash 15,000
Pay Salaries
Jun 1 Jan 3Dec 31
$15,000 weekly salaries
$6,000 $15,000
Copyright ©2014 Pearson Education27
Accrued Revenue
•Revenue earned but not yet received•Assume that a company is hired on June
15 to wash trucks each month for $600 (starting on June 15). The company will be paid on July 15. JOURNAL
Date Accounts and explanation Debit Credit
Jun 30 Accounts receivable ($600 x ½) 300
Service revenue 300
To accrue service revenue.
Copyright ©2014 Pearson Education28
Prepaids and AccrualsPREPAIDS – CASH FIRST
FIRST LATER
Prepaid expenses
Prepaid expense Expense
Cash Prepaid expense
Unearned revenues
Cash Unearned revenue
Unearned revenue Revenue
ACCRUALS – CASH LATER
FIRST LATER
Accrued expenses
Expense Payable
Payable Cash
Accrued revenues
Receivable Cash
Revenue ReceivableCopyright ©2014 Pearson Education
29
Summary of the Adjusting Process•Two purpose of adjusting process
▫Measure (_____) income▫Update balance sheet
•Every adjusting entry affects at least one (of each):▫Revenue or expense▫Asset or liability
Copyright ©2014 Pearson Education30
Summary of Adjusting Entries
Type of Account
Category of Adjustment Debit Credit
Prepaid expense Expense Asset
Depreciation Expense Contra asset
Accrued expense Expense Liability
Accrued revenue Asset Revenue
Unearned revenue Liability Revenue
Copyright ©2014 Pearson Education31
Exercise 3-22A• Jenkins Motor Company faced the following
situations. Journalize the adjusting entry needed at December 31, 2010, for each situation. Consider each fact separately.▫a. The business has interest expense of $9,500
incurred during 2010 that it must pay early in January 2011.
▫b. Interest revenue of $4,500 has been earned but not yet received.
▫c. On July 1, when we collected $13,600 rent in advance, we debited Cash and credited Unearned Rent Revenue. The tenant was paying us for 2 years’ rent, starting on July 1, 2010.
1-32
Exercise 3-22A
JOURNAL
Date Accounts and explanation Debit Credit
(a)
(b)
(c)
Copyright ©2014 Pearson Education33
Exercise 3-22A•d. Salary expense is $1,800 per day—Monday
through Friday—and the business pays employees each Friday. This year, December 31 falls on a Wednesday.
•e. The unadjusted balance of the Supplies account is $3,300. The total cost of supplies on hand is $1,200.
• f. Equipment was purchased at the beginning of this year at a cost of $100,000. The equipment’s useful life is 5 years with no salvage value. ©2010 Pearson Prentice Hall. All rights reserved.
1-34
Exercise 3-22A
JOURNAL
Date Accounts and explanation Debit Credit
(d)
(e)
(f)
Copyright ©2014 Pearson Education35
Exercise 3-22A
•Record depreciation for this year and then determine the equipment’s book value.
Copyright ©2014 Pearson Education
36
Balance SheetDecember 31, 20X6
Equipment $100,000
Less: Accumulated Depreciation
( )
Book value
The Adjusted Trial Balance
•Prepared after adjustments are journalized and posted
•Useful step in preparing financial statements
Copyright ©2014 Pearson Education37
The Financial Statements
Income Statement• Lists revenues & expenses
Statement of Changes in Equity• Shows changes in components of equity
Balance Sheet• Reports assets, liabilities and
shareholders’ equityCopyright ©2014 Pearson Education
39
Flow of Data in Financial Statements
Income Statement
Revenues $$,$$$
Less: Expenses ($$,$$$)
Net Income $$,$$$
Statement Changes in Equity
Beginning equity balance $$,$$$
Plus: Net income $$,$$$
Less: Dividends ($,$$$)
Ending equity balance $$,$$$
Copyright ©2014 Pearson Education40
Flow of Data in Financial Statements
Statement of Changes in Equity
Beginning equity balance $$,$$$
Plus: Net income $$,$$$
Less: Dividends ($,$$$)
Ending equity balance $$,$$$
Balance Sheet
Current assets $$,$$$ Liabilities $$,$$$
PPE $$,$$$ Share Capital $$,$$$
Other assets $$,$$$ Retained earnings $$,$$$
Total assets$$$,$$
$Total liabilities & shareholders’ equity $$$,$$$
Copyright ©2014 Pearson Education41
Closing the books
•Prepares the accounts for next period•Temporary accounts are set to zero and
closed into Retained earnings•Permanent accounts are not closed
Copyright ©2014 Pearson Education43
Temporary
• Closed• _______, _______ and _______
Permanent
• Not closed
• Assets, liabilities and equity
Copyright ©2014 Pearson Education44
Closing Entries
©2010 Pearson Prentice Hall. All rights reserved.
Close DividendsDebit Retained earnings Credit Dividends
Close ExpensesDebit Retained earnings Credit each expense
account
Close RevenuesDebit each revenue account Credit Retained earnings
Copyright ©2014 Pearson Education 45
P3-67A
Account Amount Account Amount
Accounts payable $14,400 Interest expense $900
Accounts receivable 16,100 Note payable, long term
6,100
Accumulated depreciation – Equipment
6,900 Other assets 14,400
Advertising expense 10,900 Prepaid expense 6,000
Cash 7,900 Retained Earnings 22,000
Share capital 5,600 Salary expense 17,800
Current portion of note payable
1,000 Salary payable 2,900
Depreciation expense 1,700 Service revenue 95,000
Dividends 31,200 Supplies 3,600
Equipment 41,700 Supplies expense 4,400
Unearned Service Rev
2,700
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This is your trial balance. Record all of the closing entries. What is the ending balance in Retained Earnings?
Problem 3-67A
Retained Earnings
$Beginning Balance
$ Revenues$
$
Dividends
Expenses
$ Ending Balance
Copyright ©2014 Pearson Education48
Classifying Assets & Liabilities•Classified as current or long-term term
based on liquidity▫How quickly an item can be converted to
cashCash Most liquid
Accounts receivable Very liquid
Inventory Somewhat liquid
PPE Not liquid
Copyright ©2014 Pearson Education49
• Converted to cash, sold or consumed in the next year
Current assets
• Held for longer than one year
• Includes plant assets
Non-current assets
• Must be paid within one year
Current liabilities
• Due date more than one year from balance sheet date
Non-current
liabilitiesCopyright ©2014 Pearson Education
50