1. Gary A. Porter and Curtis L. Norton
Using Financial Accounting Information: The Alternative to Debits and Credits Fifth Edition
Gary A. Porter and Curtis L. Norton
Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

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

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

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

5. Revenue Recognition Principle
Revenue is recognized when realized and earned—usually at point of sale
Exceptions:
Long-term contracts
Franchises
Commodities
Installment sales
Rent and interest
LO3

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

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

8. Types of Adjusting Entries
Deferred
expense
Accrued
liability
ALL RECOGNIZE REVENUE OR EXPENSES
BEFORE OR AFTER CASH IS EXCHANGED
Accrued
asset
Deferred
revenue
LO5

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

10. Deferred Expense Example
Prepay $2,400 for insurance for one year on Sept 1
To record payment:
Balance Sheet Income Statement
Assets = Liabilities + Stockholders’ Revenues - Expenses Equity
Prepaid Ins 2, Cash (2,400)
Monthly adjustment:
Prepaid Ins (200) Insurance Expense (200)
($2,400 annual × 1/12 = $200 per month for 12 months)

11. Deferred Expense Example
Purchase furniture on January 1 for $5,000. Estimated useful life is 7 years (84 months); estimated salvage value is $800
Purchase of furniture:
Balance Sheet Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity
Furniture 5,000
Cash (5,000)
Monthly adjustment:
Accumulated Depreciation Expense
depreciation (50) (50)
($5,000 – $800) × 1/84 = $50 per month for 84 months)

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

13. Deferred Revenue Example
Received $2,400 for an insurance policy in advance on
September 1
To record collection:
Balance Sheet Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity
Cash = Insurance collected
2, in Advance 2,400
Monthly adjusting journal entry:
Insurance collected Insurance expense in Advance (200) (200)
($2,400 annual × 1/12 = $200 per month for 12 months)
Deferred Revenue Example

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

15. Accrued Liability Example
Pay biweekly wages of $28,000
At end of month, between pay periods:
Balance Sheet Income Statement
Assets = Liabilities + Stockholders’ Revenues - Expenses Equity
Wages payable Wages expense
4, (4,000)
Next payday:
Cash = Wages payable Wages expense
(28,000) (4,000) (24,000)

16. Accrued Liability Example
On March 1, assume a 9%, 90-day, $20,000 loan is taken out with a bank
To record borrowing:
Balance Sheet Income Statement
Assets = Liabilities + Stockholders’ Revenues - Expenses Equity
Cash = Notes Payable
20, ,000
Monthly adjustment:
Interest Payable Interest Expense (150)
($20,000 principal × 9% × 3/12 = $450 for 3 months or
$450/3 = $150 per month)

17. Accrued Asset Revenue earned before cash is received
Examples:
Rent
Interest
Record revenue (and corresponding receivable) in period earned; receive payment in a future period

18. Accrued Asset Example First of the month:
Rent payment of $2,500 due within first 10 days of month
First of the month:
Balance Sheet Income Statement
Assets = Liabilities + Stockholders’ Revenues - Expenses Equity
Rent receivable Rent revenue
2, = ,500
Upon receipt of cash:
Cash 2,500
Rent receivable
(2,500)

19. Steps in the Accounting Cycle
1. Collect and
analyze info
7. Close the
accounts
2. Journalize
transactions
6. Record and
post
adjustments
3. Post
transactions to
general ledger
5. Prepare
financial
statements
4. Prepare
work sheet
LO6

20. Net income (or net loss)
Nominal Accounts
Serve 2 important purposes:
Zero out
nominal accounts
to start accumulation
of next period’s
results
Transfer
Net income (or net loss)
and dividends to the
Retained Earnings
account

21. End of Chapter 4