Accounting Fundamentals Chapter 3

Questions and Answers

What is the definition of the operating cycle?

The time it takes for a company to pay cash to suppliers, sell those goods and services to customers, and collect cash from customers.

What are the elements on the statement of earnings?

Revenues

Expenses

Gains

Losses

All of the above (correct)

The cash basis of accounting recognizes revenue when cash is paid.

False

What does the revenue principle state?

Revenue should be recognized when ownership is passed, not necessarily when cash is received. Signup and view all the answers

What is the expense principle?

Expenses should be recognized when they are incurred, not necessarily when cash is paid. Signup and view all the answers

What happens when cash is received before revenue is earned?

A liability account called Deferred Revenue is recorded. Signup and view all the answers

What is the matching principle?

Resources consumed to earn revenues in an accounting period should be recorded in that period, regardless of when cash is paid. Signup and view all the answers

Study Notes

Learning Objectives

Understand the business operating cycle and the relevance of the periodicity assumption.
Identify business activities impacting the statement of earnings elements.
Grasp the accrual basis of accounting and the principles for recognizing revenue and expenses.
Prepare a multistep statement of earnings.
Differentiate between net earnings and cash flow from operations.

Operating Cycle

The operating cycle (cash-to-cash cycle) measures the time from cash payment to suppliers, to selling goods/services, to cash collection from customers.
Stages include purchasing/manufacturing, delivering services/products, and receiving payment.

Elements of the Statement of Earnings

Revenues: Increases in assets or decreases in liabilities from ongoing operations.
Expenses: Decreases in assets or increases in liabilities from ongoing operations.
Gains: Increases in assets or decreases in liabilities from non-operational transactions.
Losses: Decreases in assets or increases in liabilities from non-operational transactions.

Operating Activities Recognition and Measurement

Cash Basis Accounting:
- Revenue recognized when cash is received.
- Expenses recognized when cash is paid.
Accrual Accounting:
- Revenues and expenses recognized when transactions occur, independent of cash flow.

Accounting Standards

Accrual accounting is mandated by International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP).

Principles for Preparing the Statement of Earnings

Revenue Principle: Revenue recognized upon transfer of ownership, not solely cash receipt.
Expense Principle: Expenses recognized when incurred, regardless of cash payment.
Matching Principle: Costs incurred to generate revenue must be recorded in the same accounting period.

Revenue Principle Example

In cases where cash is received before goods/services delivery:
- A liability termed "Deferred Revenue" is recognized.
- Entries made: Cash (+A) and Deferred Revenue (+L).