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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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Welingkar’s Distance Learning Division
Financial Accounting
CHAPTER-3. Accural Accounting &The balance sheet
We Learn – A Continuous Learning Forum
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Accrual vs. Cash AccountingAccrual 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)
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Accrual vs. Cash AccountingAccrual 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)
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Accrual vs. Cash AccountingAccrual 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.
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Operating Cycle of BusinessOperating 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.
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Operating Cycle of BusinessOperating Cycle of Business
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 BusinessOperating Cycle of Business
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Sound Financial Management of a companyinvolves
matching the sources and uses of cash, so that
obligations become due as assets mature into cash.
Operating Cycle of BusinessOperating Cycle of Business
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 SheetReview of Balance Sheet
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Assets
• Are anything of value that is owned or due to the business.
• Classified as
Non-currentCurrentOthers
Financial AccountingAccrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Non-Current Assets
Consist of
Net Fixed Assets
Investments in subsidiaries
Intangibles
Others
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance 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 asGross Fixed Assets (cost) less
accumulated depreciation.
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance 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 BondsImmovable properties.In capital of subsidiaries.
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Non-Current Assets
Consist of Net Fixed AssetsInvestments in subsidiaries Intangibles
Represent the use of cash to purchase assets with an undetermined life and may never mature into cash.
Research & Development PatentsMarket Research Goodwill
Standard accounting principles require most intangibles to be expensed as purchased and not capitalized.
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Non-Current Assets
Consist of Net Fixed AssetsInvestments 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
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Current Assets
Consist of CashAccounts Receivables
InventoryNotes ReceivablesPrepaid ExpensesOthers
They are assets that mature in less than one year .
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance 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.
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Current Assets
Consist of CashAccounts Receivables
are money due from customers. are third most liquid asset after cash & short term investments
some receivables can become uncollectiblethis expense is termed ‘ bad debts’these can be recorded by two methods $ Allowance method $ Direct write off Method
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Current Assets
Consist of CashAccounts 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 drTo Allowance for Bad Debts cr
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Current Assets
Consist of CashAccounts 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
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Current Assets
Consist of CashAccounts 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.
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Current Assets
Consist of CashAccounts 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
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Current Assets
Consist of CashAccounts Receivables
Inventoryconsists 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.
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Current Assets
Consist of CashAccounts 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
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance 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 360Sales in a year
Inventory Days = Actual Inventory x 360 Cost of Goods sold in a year
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Current Assets Consist of Cash
Accounts Receivables Inventory
Quality Measurement & GoalsBoth 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.
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Current Assets Consist of Cash
Accounts Receivables Inventory
Quality Measurement & GoalsBoth Receivables and Inventory can be managed by controlling their quality which is measured in days
Investment in Inventory and Accounts receivableis 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 ofoverstocking and inefficient collections.
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Liabilities
Consist of CurrentNon-CurrentContingentEquity
“ Liabilities and net worth are sources of cash listed in descending order from the soonest to mature obligations to never to mature obligations.”
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance 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)
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Liabilities
Consist of CurrentNon-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.
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Liabilities
Consist of CurrentNon-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.
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance Sheet - Terms
Liabilities
Consist of CurrentNon-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 notein the Balance Sheet
Financial Accounting Accrual Accounting and the Balance Sheet Chapter Three
Balance Sheet - TermsBalance 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
SharesEarned Equity – retained earnings ( profits) shown as
Reserves and Earned Surplus.
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”