Notes:

Chapter 4 Income Measurement And Accrual Accounting

RecognitionandMeasurement
Recognition:formally
recordinganiteminthe
financialstatementsof
anentity
...butat
currentvalue
orhistorical
cost?

IknowI
needto
record
this...

Measurement:
quantificationofthe
economiceffectsof
theitemontheentity
LO1

Cashvs.AccrualBasis
Cashbasis:revenuesandexpensesare
recordedonlywhencashisreceivedorpaid
Accrualbasis: revenuesarerecognizedwhen
earned;expensesarerecognizedwhenincurred

LO2

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Notes:

Chapter 4 Income Measurement And Accrual Accounting

Accrualbasis
statement

Cashbasis
statement
Statementof
CashFlows

Income
Statement
Netincome:

Cashflowsfrom
operatingactivities:

$7,000

$(4,000)
Whataccountsfor
thedifference?

RevenueRecognitionPrinciple
Revenueisrecognizedwhenrealizedand
earnedusuallyattimeofsale
Exceptions:
Longtermcontracts
Franchises
Commodities
Installmentsales
Rentandinterest
LO3

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Notes:

Chapter 4 Income Measurement And Accrual Accounting

MatchingPrinciple
Matchexpenseswithassociatedrevenues

Directly

Indirectlyover
periodthey
providebenefits

e.g.,Inventory

e.g.,Buildings

Simultaneously
upontheir
acquisition
e.g.,Utilities
LO4

ExpenseRecognition
IncomeStatement

BalanceSheet

EXPENSES:

ASSETS:
Inventory
Supplies
Prepaidassets
PP&E
Intangibles

whensold

Costofgoodssold

asused

Suppliesexpense
Insuranceexpense
Rentexpense

overperiodthey
providebenefits
l

Depreciationexpense
Amortizationexpense
Otherexpenses
(asincurred)

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Notes:

Chapter 4 Income Measurement And Accrual Accounting

TypesofAdjustingEntries
Deferred
expense

Accrued
asset

RECOGNIZE
REVENUEOR
EXPENSES
BEFOREORAFTER
CASHIS
EXCHANGED

Accrued
liability

Deferred
revenue
LO5

DeferredExpense
Cashpaidbeforeexpenseisincurred
Examples:

Prepaidrent
Prepaidinsurance
Officesupplies
Propertyandequipment

Costsareinitiallyrecordedasassetsand

allocatedtoexpensesinfutureperiods

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Notes:

Chapter 4 Income Measurement And Accrual Accounting

DeferredExpenseExample#1
PrepayrentonofficespaceforoneyearonSeptember1
Initialjournalentry:
9/1
PrepaidInsurance
2,400
Cash
2,400
Monthlyadjustingjournalentry:
9/30 InsuranceExpense
200
PrepaidInsurance
200
($2,400annual 1/12=$200permonthfor12months)

DeferredExpenseExample#2
PurchasenewstorefixturesonJanuary1for$5,000.
Estimatedusefullifeis5years(60months);estimated
salvagevalueis$500
Initialjournalentry:
1/1 Storefixtures
5,000
Cash
5,000
Monthlyadjustingjournalentry:
1/31DepreciationExpense
75
AccumulatedDepreciation75
($5,000 $500) 1/60=$75permonthfor60months)

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Notes:

Chapter 4 Income Measurement And Accrual Accounting

DeferredRevenue
Cashreceivedbeforerevenueisearned
Examples:
Insurancecollectedinadvance
Subscriptionscollectedinadvance
Giftcertificates

Receiptsareinitiallyrecordedasliabilities
(unearnedorrefundablereceipts)andrecordedas
revenuesinfutureperiodswhenearned

DeferredRevenueExample
Received$2,400foraninsurancepolicyinadvanceon
September1
Initialjournalentry:
9/1 Cash
2,400
InsuranceCollectedinAdvance

2,400

Monthlyadjustingjournalentry:
9/30 InsuranceCollectedinAdvance
200
InsuranceRevenue
200
($2,400annual 1/12=$200permonthfor12months)

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Notes:

Chapter 4 Income Measurement And Accrual Accounting

AccruedLiability
Expenseincurredbeforecashispaid
Examples:
Payroll
Taxes
Interest

Recordexpense(andcorresponding

liability)inperiodincurred;payforitina
futureperiod
Nocashflowonrecording,onlywhenpaid

AccruedLiabilityExample#1
Paybiweeklywagesof$280,000
Atendofmonth,betweenpayperiods:
WagesExpense
40,000
WagesPayable

40,000

Nextpayday:
WagesPayable
40,000
WagesExpense240,000
Cash

280,000

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Notes:

Chapter 4 Income Measurement And Accrual Accounting

AccruedLiabilityExample#2
OnMarch1,assumea9%,90day,$20,000
loanistakenoutwithabank
Initialjournalentry:
3/1 Cash
20,000
NotesPayable
20,000
Monthlyadjustingjournalentry:
3/31 InterestExpense
150
InterestPayable
150
($20,000principal 9% 3/12=$450for3
monthsor$450/3=$150permonth)

AccruedLiabilityExample#2
(continued)
Torecordpaymentofa9%,90day,$20,000loanwith
interestdueonMay30
5/30 InterestPayable
InterestExpense
NotesPayable
Cash

300
150
20,000
20,450

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Notes:

Chapter 4 Income Measurement And Accrual Accounting

AccruedAsset
Revenueearnedbeforecashisreceived
Examples:
Rent
Interest

Recordrevenue(andcorresponding

receivable)inperiodearned;receivepayment
inafutureperiod

AccruedAssetExample
Rentpaymentof$2,500duewithinfirst10
daysofmonth

Firstdayofthemonth:
RentReceivable2,500
RentRevenue
2,500
Uponreceiptofcash:
Cash2,500
RentReceivable
2,500

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Notes:

Chapter 4 Income Measurement And Accrual Accounting

AdjustingEntrySummary
Examples:
DeferredExpense
cashreceivedbeforeexpenseisincurred

DeferredRevenue
cashreceivedbeforerevenueisearned

AccruedLiability
expenseincurredbeforecashispaid

AccruedAsset
revenueisearnedbeforecashisreceived

StepsintheAccountingCycle
7.Closethe
accounts

1.Collectand
analyzeinfo

6.Recordand
postadjusting
entries
5.Prepare
financial
statements

2.Journalize
transactions
3.Post
transactionsto
generalledger

4.Prepare
worksheet
LO6

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Notes:

Chapter 4 Income Measurement And Accrual Accounting

TheClosingProcess
Purpose:
Toreturnthebalanceofrevenue,
expense,anddividendaccountsto
zerotobeginthenextperiod
totransferthenetincomeofthe
periodtoRetainedEarnings

NominalAccounts
Revenues

Expenses

Closeto
Income
Summary

Normal
balance

Normal
balance

Closeto
Income
Summary

$XX

$XX

$XX

$XX

Dividends
Normal
balance

Closeto
Retained
Earnings

$XX

$XX

Zeroout
nominalaccounts
tostartaccumulation
ofnextperiods
results
LO7

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Notes:

Chapter 4 Income Measurement And Accrual Accounting

ClosingEntries
IncomeSummary
$XX
fromexpense
accounts

$XX
fromrevenue
accounts

(Netloss)ornetincome
closedtoRetainedEarnings

What Should You Understand After

Today
WhatisAccounting?
Whatarethe4financialstatements
Temporaryvs.PermanentAccounts
StockvsFlow
Howfinancialstatementsconnecttoeachother
Theaccountingcycleisaprocessthatcreatesfinancialstatements
Cashvs.AccrualAccounting
Creditshavetoequaldebits
BalancesheetmustalwaysBALANCE!!!!!!

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