1. Chapter 3 Measuring Revenues and Expenses

2. Chapter 3 Measuring Revenues and Expense Accrual accounting determines when to record revenues and expenses. Accrual accounting determines when to record revenues and expenses. Accrual accounting is based on two principals Accrual accounting is based on two principals Revenue Recognition Principle: recognize revenues when they are earned (when the product or service is provided to the customer) Revenue Recognition Principle: recognize revenues when they are earned (when the product or service is provided to the customer) Matching Principle: recognize expenses as they are incurred in order to match them to related revenues. Matching Principle: recognize expenses as they are incurred in order to match them to related revenues.

3. Chapter 3 Measuring Revenues and Expense Revenues can be recognized Revenues can be recognized When cash is received When cash is received Before cash is received (Accrual) Before cash is received (Accrual) Accounts Receivable: an asset account that increases when goods are sold on credit Accounts Receivable: an asset account that increases when goods are sold on credit After cash is received (Deferral) After cash is received (Deferral) Unearned Revenue: a liability account that results when a company receives cash from a customer for goods or services to be provided in the future Unearned Revenue: a liability account that results when a company receives cash from a customer for goods or services to be provided in the future

4. Revenue Recognition and Cash Flows Exhibit 3 TimingFirstSecondLinking TimingFirstSecondLinking EffectPeriodPeriodAccount EffectPeriodPeriodAccount TimingFirstSecondLinking TimingFirstSecondLinking EffectPeriodPeriodAccount EffectPeriodPeriodAccount No Accrual orRevenue EarnedNone Deferral NeededCash Received Accrued RevenueRevenue EarnedCash ReceivedAccounts Receivable Deferred Cash ReceivedRevenue EarnedUnearnedRevenue No Accrual orRevenue EarnedNone Deferral NeededCash Received Accrued RevenueRevenue EarnedCash ReceivedAccounts Receivable Deferred Cash ReceivedRevenue EarnedUnearnedRevenue

5. Chapter 3 Measuring Revenues and Expense Expenses can be recognized Expenses can be recognized When cash is paid When cash is paid Before cash is paid (Accrual) Before cash is paid (Accrual) Salaries Payable: a liability account that identifies an obligation to pay employees in the near future Salaries Payable: a liability account that identifies an obligation to pay employees in the near future After cash is paid (Deferral) After cash is paid (Deferral) Prepaid Expense: an asset account that identifies a resource that has been paid for but has not been used Prepaid Expense: an asset account that identifies a resource that has been paid for but has not been used

6. Expense Recognition and Cash Flows Exhibit 6

7. REQUIRED STEPS IN THE ACCOUNTING CYCLE Analyze business transactions. Analyze business transactions. Journalize the transactions. Journalize the transactions. Post to ledger accounts. Post to ledger accounts. Prepare a trial balance. Prepare a trial balance. Journalize and post adjusting entries-- prepayments and accruals. Journalize and post adjusting entries-- prepayments and accruals. Prepare an adjusting trial balance. Prepare an adjusting trial balance. Prepare financial statements: Prepare financial statements: Income statement Income statement Retained earnings statement Retained earnings statement Balance sheet Balance sheet Statement of Cash Flow Statement of Cash Flow Journalize and post closing entries. Journalize and post closing entries. Prepare post-closing trial balance. Prepare post-closing trial balance.

8. Chapter 3 Measuring Revenues and Expense Journals Journals A chronological record of a company’s transactions. A chronological record of a company’s transactions. General Journal General Journal Special Journal Special Journal Sales Journal Sales Journal Purchase Journal Purchase Journal Ledgers Ledgers A file in which each of a company’s accounts and balances of those accounts are maintained. General Ledger Subsidiary Ledger Control Accounts Accounts Receivable Accounts Payable

9. Chapter 3 Measuring Revenues and Expense Adjusting Entries Adjusting Entries Completed each accounting period prior to producing financial statements Completed each accounting period prior to producing financial statements Adjust the balances of assets, liabilities, revenue, and expense accounts Adjust the balances of assets, liabilities, revenue, and expense accounts Two Rules Two Rules Never use the Cash account in an adjusting entry. Never use the Cash account in an adjusting entry. Always use one balance sheet account and one income statement account in each adjusting entry. Always use one balance sheet account and one income statement account in each adjusting entry.

10. Transactions for Mom’s Cookie Co. Exhibit 8

11. Chapter 3 Measuring Revenues and Expense Closing Entries Closing Entries Completed each accounting period after producing financial statements Completed each accounting period after producing financial statements Zero out the balance of all temporary accounts Zero out the balance of all temporary accounts Temporary accounts are revenues, expenses, and dividend (withdrawal) accounts Temporary accounts are revenues, expenses, and dividend (withdrawal) accounts Prepare for the next accounting period by separating the current period earnings from future earnings Prepare for the next accounting period by separating the current period earnings from future earnings Adjust the balance of retained earnings to meet its definition Adjust the balance of retained earnings to meet its definition All past earnings that have not been paid out in the form of dividends. All past earnings that have not been paid out in the form of dividends.

12. Chapter 3 Measuring Revenues and Expense Closing Entries Closing Entries Three Closing entries Three Closing entries Debit all Revenues & Gains then Credit Retained Earnings Debit all Revenues & Gains then Credit Retained Earnings Credit all Expenses & Losses then Debit Retained Earnings Credit all Expenses & Losses then Debit Retained Earnings Credit Dividends (Withdrawals) then Debit Retained Earnings Credit Dividends (Withdrawals) then Debit Retained Earnings After closing entries, only permanent (balance sheet) accounts have balances. After closing entries, only permanent (balance sheet) accounts have balances.

13. Closing Entries for January for Mom’s Cookie Company Exhibit 11

14. Effect of Closing Entries on Revenue and Expense Account Balances Exhibit 12 See following two slides for larger images of individual accounts

15. Chapter 3 Measuring Revenues and Expense 2. Post transaction to ledger. 3. Prepare and post adjusting entries. 4. Prepare summary of account balances. 5. Prepare Financial Statements. 6. Close temporary accounts to retained earnings. 7. Prepare post-closing summary of account balances. 1.Record transactions in journal.