Chapter 4, Slide #1 Ch.4 Income Measurement & Accrual Accounting

Chapter 4, Slide #2 Recognition: formally recording an item in the financial statements of an entity Recognition and Measurement I know I need to record this... Measurement: quantification of the economic effects of the item on the entity...but at current value or historical cost? LO1

Chapter 4, Slide #3 Cash vs. Accrual Basis Cash basis: revenues and expenses are recorded only when cash is received or paid Accrual basis : revenues are recognized when earned; expenses are recognized when incurred LO2

Chapter 4, Slide #4 Cash basis statement Accrual basis statement Statement of Cash Flows Cash flows from operating activities : $(4,000) Income Statement Net income: $ 7,000 What accounts for the difference?

Chapter 4, Slide #5 Revenue Recognition Principle Revenue is recognized when realized and earned—usually at point of sale LO3

Chapter 4, Slide #6 Expense Recognition Income Statement PP&E Intangibles as used Balance Sheet when sold over period they provide benefits ASSETS:EXPENSES: Cost of goods sold Supplies expense Insurance expense Rent expense Depreciation expense Amortization expense Other expenses (as incurred) LO4 Inventory Supplies Prepaid assets

Chapter 4, Slide #7 Matching Principle Directly Indirectly over period they provide benefits Simultaneously upon their acquisition e.g. Inventory e.g. Buildings e.g. Utilities Match expenses with associated revenues

Chapter 4, Slide #8 Types of Adjusting Entries ALL RECOGNIZE REVENUE OR EXPENSES BEFORE OR AFTER CASH IS EXCHANGED Deferred expense Accrued liability Accrued asset Deferred revenue LO5

Chapter 4, Slide #9 Deferred Expense Cash paid before expense is incurred  Examples: Prepaid rent Prepaid insurance Office supplies Property and equipment  Costs are initially recorded as assets and allocated to expenses in future periods

Chapter 4, Slide #10 Prepay rent on office space for one year on September 1 Initial journal entry: 9/1Prepaid Rent2,400 Cash2,400 Monthly adjusting journal entry: 9/30Rent Expense 200 Prepaid Rent 200 ($2,400 annual × 1/12 = $200 per month for 12 months) Deferred Expense Example #1

Chapter 4, Slide #11 Deferred Expense Example #2 Initial journal entry: 1/1 Fitness equipment5,000 Cash 5,000 Monthly adjusting journal entry: 1/31 Depreciation Expense 50 Accumulated Depreciation 50 ($5,000 – $800) × 1/84 = $50 per month for 84 months) Purchase treadmill on January 1 for $5,000. Estimated useful life is 7 years (84 months); estimated salvage value is $800

Chapter 4, Slide #12 Deferred Revenue Cash received before revenue is earned  Examples: Insurance collected in advance Subscriptions collected in advance Gift certificates  Receipts are initially recorded as liabilities (unearned or refundable receipts) and recorded as revenues in future periods when earned

Chapter 4, Slide #13 Deferred Revenue Example Received $2,400 for an insurance policy in advance on September 1 Initial journal entry: 9/1 Cash 2,400 Insurance Collected in Advance 2,400 Monthly adjusting journal entry: 9/30Insurance Collected in Advance 200 Rent Revenue 200 ($2,400 annual × 1/12 = $200 per month for 12 months)

Chapter 4, Slide #14 Accrued Liability Expense incurred before cash is paid  Examples: Payroll Taxes Interest  Record expense (and corresponding liability) in period incurred; pay for it in a future period  No cash flow on recording, only when paid

Chapter 4, Slide #15 Accrued Liability Example #1 At end of month, between pay periods: Wages Expense 4,000 Wages Payable 4,000 Next payday: Wages Payable 4,000 Wages Expense 24,000 Cash 28,000 Pay biweekly wages of $28,000

Chapter 4, Slide #16 Accrued Liability Example #2 Initial journal entry: 3/1Cash 20,000 Note Payable 20,000 Monthly adjusting journal entry: 3/31Interest Expense 150 Interest Payable 150 ($20,000 principal × 9% × 3/12 = $450 for 3 months or $450/3 = $150 per month) On March 1, assume a 9%, 90-day, $20,000 loan is taken out with a bank

Chapter 4, Slide #17 Accrued Asset R evenue earned before cash is received  Examples: Rent Interest  Record revenue (and corresponding receivable) in period earned; receive payment in a future period Revenue

Chapter 4, Slide #18 Accrued Asset Example First day of the month: Rent Receivable 2,500 Rent Revenue 2,500 Upon receipt of cash: Cash 2,500 Rent Receivable 2,500 Rent payment of $2,500 due within first 10 days of month