Presentation on theme: "Accrual Accounting and the Financial Statements"— Presentation transcript:
1 Accrual Accounting and the Financial Statements Chapter 3
2 Learning Objective 1Relate accrual accounting and cash flows.
3 Accrual Accounting vs Cash Basis Accounting Accrual Accounting - records the impact of a business event as it occursCash Basis – records only transactions in which cash is received or paid
4 The Time-Period Concept Financial statements are prepared for specific periods and at regular intervals.
5 Learning Objective 2Apply the revenue and matching principles.
6 Revenue Principle Revenue is recorded when it is earned. The amount of revenue to record is the cash value of goods transferred to customer.
7 The Matching Principle Record all expenses incurred during the accounting periodMatch expenses against revenues earned
8 Learning Objective 3Update the financial statements by adjusting the accounts.
9 Air & Sea Unadjusted Trial Balance April 30, 20x3
10 Categories of Accounting Adjustments DeferralsDepreciationAccruals
11 Prepaid Expenses: Rent On April 1, 20x3, Air & Sea Travel prepays three months office rent.3,000Prepaid RentCash
12 Prepaid Expenses: Rent What is the adjusting entry on April 30?April 30 Rent Expense 1,000Prepaid Rent 1,000To record rent expense ($3,000 x 1/3)
13 Prepaid Expenses: Supplies On April 2, 20x3, Air & Sea Travel paid cash of $700 for office supplies.700SuppliesCash
14 Prepaid Expenses: Supplies An inventory at month end indicated that $400 in office supplies remained.4/2 700Supplies4/Bal. 400Supplies Expense4/30 300Bal. 300
15 DepreciationAllocation of the cost of a plant asset to expense over the asset’s useful life
16 Depreciation of Plant Assets On April 3, the business purchased furniture on account for $16,500. The furniture is expected to last 5 years.16,500FurnitureAccounts Payable
17 Depreciation of Plant Assets Straight-line method of depreciation allocates equal amounts each accounting period.$16,000 ÷ 5 years = $3,300 per year$3,300 ÷12 months = $275 per month
18 Depreciation of Plant Assets What is the adjusting entry on April 30?April 30 Depreciation Expense, Furniture 275Accumulated Depreciation, Furniture 275To record depreciation
19 Book ValueThe net amount of a plant asset (cost minus accumulated depreciation)
20 Accrued ExpenseA liability that arises from an expense that has not yet been paid.Air & Sea Travel pays its employees a monthly salary of $1,900, half on the 15th and half on the last day of the month. If a payday falls on the weekend, Air & Sea pays the employee on the following Monday.
22 Accrued RevenueA revenue that has been earned but not received in cash.Bank One hires Air & Sea Travel on April 15 to arrange travel services on a monthly basis. Bank One will pay the travel agency $500 monthly, with the first payment on May 15.
23 Accrued Revenues Adjusting entry: April 30 Accounts Receivable 250 Service Revenue 250To accrue service revenue
24 Unearned RevenueAn obligation arising from receiving cash before providing a service.Plantation Foods engages Air & Sea Travel agreeing to pay the agency $450 monthly, beginning immediately. Air & Sea Travel collects the first amount on April 20 and earns one-third the last 10 days.
25 Unearned Revenues April 20 Cash 450 Unearned Revenue 450 Received advanced paymentApril 30 Unearned Revenue 150Revenue 150To record revenue earned($450 x 1/3)
27 Learning Objective 4Prepare the financial statements.
28 Air & Sea Travel, Inc. Income Statement Month Ended April 30, 20x5 Revenue:Service revenue $7,400Expenses:Salary expense $1,900Rent expense 1,000Utilities expense 400Supplies expense 300Depreciation expense ,875Income before tax $3,525Income tax expenseNet income $2,985
29 Air & Sea Travel, Inc. Statement of Retained Earnings Month Ended April 30, 20x5 Retained earnings, April 1, 20x5 $11,250Add: Net income ,958$14,235Less: Dividends ( 3,200)Retained earnings, April 30, 20x5 $11,035
36 Classifying Assets and Liabilities List assets and liabilities in order of their relative liquidity.Liquidity - how quickly an item can be converted to cash.
37 Classifying Assets and Liabilities Current assetsLong-term assetsCurrent liabilitiesLong-term liabilities
38 Learning Objective 6Use the current ratio and the debt ratio to evaluate a business.
39 Total current liabilities Current RatioMeasures company’s ability to pay current liabilities with current assetsTotal current assetsTotal current liabilitiesRule of thumb: A strong current ratio is 2.00
40 A low debt ratio is safer than a high debt ratio. The proportion of assets that is financed with debt.Measures business’s ability to pay total liabilitiesTotal liabilitiesTotal assetsA low debt ratio is safer than a high debt ratio.