Chapter 4

 Accrual Accounting Concepts

• Accrual Accounting and the need for adjusting entries

• Accrual vs cash basis of accounting

• Revenue and expense recognition

• Adjusting entries

• Adjusting entries

• Prepaid expenses, deferred revenues accrued expenses accured revenues

• The adjusted trail balance and fiananical statements

• Closing the book

• Post closing trail balance

 

 

Accrual Accounting

• Users require financial info on a regular basis

• Accounting divides the economic life of a business into time periods

• Year, quarter, month

• One year period is known as the fiscal year

• Shorter periods are known as interim periods

• Many transactions affect more than one time period

 

Accrual Basis Accounting

• Transactions affecting a company's financial statements are recorded in the period the events occur, rather than when cash is received or paid

• Revenue is recorded when earned, even if the cash has not been received

• Expenses are recorded when goods or services are consumed or used rather than when cash is paid

 

Cash Basis Accounting

• Revenue is recorded only when cash is received

• Expenses are recorded only when cash is padi

• Can lead to misleading info decision-making

• Timeing differences between the occurance of the actual event and its related cash flows

• Revenue and expenses can be manipulated by timing the receipt and payment for cash

 

 

Revenue Recognition

• Revenue

1. Increase in assets or settlements of liabilities

2. Results from a company's ordinary activities

• In general revenue is recognized

1. Ina merchandising company when merchansidse is sold and delivered point of sale

2. Ina  service company when the service is performed

• Under ASPE revenue can be recognized when

1. Services have been proided or the risks and rewards of ownership of the goods have been transferred to the buyer

2. Revenue can be reliably measured

3. Collection is reaonably certain

• Under IFRS revenues are recognized whena company satisfies a performance obligation

• Five step process to measure and report revenue

1. Identity the contract with the cilent or customer

2. Identify the perfomance obligations in the contract

3. Determine the transaction price

4. Allocate the transaction price to the performance obligaiton in the contract]

5. Recognize revenue when or as the company satisfies the performance obligation

 

Expense Recognition

• Expenses are recognized recorded when a decrease in economic rsrouces occurs

• Assets are consumed they decrease or libailites are incurred they increase

• Due to a company ordinary revenue genrating actilites

• Tied to changes in assets and liabilites

• Often coincides with revenue recognition

• Recognized whenever possible in the period in which effort is made to generate revenue

• Sometimes known as matching

 

Need for Adjusting entires

• Entries made at the end of the accounting period to update accounts and produce up-to-date relevant financial info

• Required because the trail balance may be not complete and up to date

• Some events are recorded daily

• Some costs are not included during the accounting period as they expire due to the passage of time

• Some times may be unrecorded because their amounts are not known

 

Types of Adjusting Entries

• Prepayments

• Preaid expenses

• Deferred revenues

• Accurals

• Accrued expenses

• Accrued revenues

 

Prepaid Expenses

• When expenses are paid before they are used or consumed, an asset is recorded

• When expenses are prepaid , an asset(prepaid expenses) is increased, debited to shows the future service or benefit and cash is decreased, credited

• Expire with the passage of time or though use

• Not practical to record is expiration on a daily basis, so done periodically, usually when statements are prepared

• Adjusting entry increases (debits) an expense account and decreases( credits) the asset, prepaid account

 

Deferred Revenues

• Cash received from customers before goods or services are provided to them

• Revenues not recorded as it has not yet been earned

• Recorded as a liability to recognize the performance obligations

• When the cash is received, cash is increased (debited) and a liability account (deferred revenue) is increased (credited)

• The opposite of prepaid expenses

• Ajusting entry decreases the liability (deferred revenue) accounting and increases a revenue accounting to record revenue earned

 

Accrued Expenses

• Any expeses that have been incrred that have not yet been recorded during the accounting period

• Adjustments make for accrued expnnses to record obligations that exist at the end of th eperiod and to recognize expenses that have been incurred during the current accounting period

• Adjusting entry results in an increase (debit) to an expense account and n increase (credit) to a liability (payable) account

 

Accrued Revenues

• Revenues that have been earned but not yet recorded at the end of an accounting period

• Adjustment is required to record the receivable that exists at the end of the period and to record the revenue that has been earned during the period

• Adjusting entry results in an increase (debit) to an asset accounting and an increase (credit) to a revenue account

 

 

 

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Adjusted Trail Balance

• Prepared after alladjusing entries have been recorded and posted

• Shows the balcnes of all acounting at the end of the accounting period, cluding those accounting that have been adjusted

• Proves total debit balances and total credit balances are equal after the adjusting entires have been made

• The main source for prep of financial statements

 

Financial statements

• Prepared in the following order

1. Statement of income is prepped first using revenue and expense accounts

2. Statement of changes in equity using equity accounting and net income from the income statement

3. Statement of financial position is prepared third, using asset, liability and equity accounts

 

Closing Entries

• Revenue, Expense and dividends declared accounts are components of retained earning

• Considered to be temp accounts

• Statement of financial position accounting carry forward into the future

• Considered to be perma accounts

• Closing entries

• Temp accounting balances transferred to retained earnigns

• Produce a zero balance in the temp accounts to prepare them for the next period's activity

 

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The Closing Process

1. Close all revenue accounts

1. Debit each revenue account for its balance and credit income

2. Summary for total revenue amount

2. Close all expense accounts

1. Debit income summary for the total expense amount and credit each expense account for its balance

3. Close income summary

1. Debit or credit income summary for the balance in the account and credit (debit) retained earnings

4. Close Dividends declared account

1. Debit retained earning and credit dividends declared account for the balance

 

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Post-closing trail balance

• Lists all perma accounts and their balances after all closing entreis are jounalized and posted

• Proves that total debit balances and total credit balances are equal after the closing entries have been jounalized and posted