Financial Accounting, IFRS PDF

Financial Accounting 1st year Global BBA Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Financial Accounting, IFRS Twelfth Edition Global Edition Chapter 3 Accrual Accoun...

Financial Accounting 1st year Global BBA Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Financial Accounting, IFRS Twelfth Edition Global Edition Chapter 3 Accrual Accounting Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Learning Objectives 3.1 Explain how accrual accounting differs from cash-basis accounting 3.2 Apply the revenue and expense recognition principles 3.3 Adjust the accounts 3.4 Prepare updated financial statements 3.5 Close the books Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Learning Objective 3.1 Explain how accrual accounting differs from cash-basis accounting Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Explain How Accrual Accounting Differs From Cash-Basis Accounting (1 of 4) Accrual Accounting Records impact of transactions when they occur Records: – Income when earned – Expenses when incurred Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Explain How Accrual Accounting Differs From Cash-Basis Accounting (2 of 4) Cash-Basis Accounting Records only cash transactions – Cash receipts – Cash payments Fails to capture the underlying economic phenomenon Results in incomplete financial statements Only used by businesses that do not follow accounting standards Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Explain How Accrual Accounting Differs From Cash-Basis Accounting (3 of 4) Accrual accounting records cash transactions, such as: – Collecting cash from customers – Receiving cash from interest earned – Paying salaries, rent, and other expenses – Borrowing money – Paying off loans – Issuing shares Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Explain How Accrual Accounting Differs From Cash-Basis Accounting (4 of 4) The Time-Period Concept – Accounting information is reported at regular intervals – Basic accounting period is one year – Companies also prepare financial statements for interim periods Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Learning Objective 3.2 Apply the revenue and expense recognition principles Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Apply the Revenue and Expense Recognition Principles (1 of 4) The Revenue Principle Deals with two issues: – When to record (recognize) revenue – What amount of revenue to record Revenue is recognized when: – risks and rewards of ownership of the goods has transferred to the buyer – the entity retains neither continuing managerial involvement usually associated with ownership nor effective control over goods sold Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Apply the Revenue and Expense Recognition Principles (2 of 4) The Revenue Principle Revenue is recognized when: – the amount of revenue can be measured reliably – it is probable that the economic benefits associated with the transaction will flow to the entity – the costs incurred or to be incurred in respect of the transaction can be measured reliably Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Apply the Revenue and Expense Recognition Principles (3 of 4) The Expense Recognition Principle Includes two steps: – Identify all expenses incurred during the period – Measure the expenses and recognize them in the same period in which any related revenues are earned To recognize an expense along with related revenues means to subtract expenses from related revenues to compute net income or net loss. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Apply the Revenue and Expense Recognition Principles (4 of 4) The Matching Concept explains the relationship between expenses and revenues Includes two steps: – Identify all expenses incurred during the period – Measure the expenses and recognize them in the same period in which any related income is earned The change in assets and liabilities determines profit or loss, not the application of a matching concept. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Exhibit 3-4 The Matching Concept Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Learning Objective 3.3 Adjust the accounts Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Exhibit 3-6 Unadjusted Trial Balance Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Categories of Adjusting Entries Deferrals – An adjustment for payment of an item or receipt of cash in advance. Accruals – The opposite of a deferral. Depreciation – Allocates the cost of Property, Plant and Equipment (PPE) to expense over the asset’s useful life. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Adjust the Accounts (1 of 6) Prepaid Expenses An expense paid in advance. Prepaid expenses are assets because they provide a future benefit for the owner. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Prepaid Expenses (1 of 4) Prepaid Rent: Suppose RedLotus’ Travel Inc., prepays three months’ store rent ($3,000) on June 1. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Prepaid Expenses (2 of 4) Prepaid Rent. Throughout June, Prepaid Rent carries the balance of $3,000. At June 30, an adjusting entry is required to transfer $1,000 ($3,000 ÷ 3) from Prepaid Rent to Rent Expense. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Prepaid Expenses (3 of 4) Supplies. On June 2, RedLotus paid cash of $700 for cleaning supplies. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Prepaid Expenses (4 of 4) Supplies. A count at June 30 indicates that $400 of supplies remain on hand. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Adjust the Accounts (2 of 6) Unearned Service Revenue Receipt of cash before earning the revenue creates a liability Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Unearned Service Revenue (1 of 2) Suppose another hotel chain engages RedLotus Security, paying them commissions in advance to make 10 bookings within 30 days. Assume RedLotus collects $400 on June 15. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Unearned Service Revenue (2 of 2) During the last 15 days of the month, RedLotus books five clients into the hotel to earn ½ of the $400. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Adjust the Accounts (3 of 6) Accrued Expenses A liability that arises from an expense that has not yet been paid Not recorded daily or weekly, but rather at the end of the period as an adjusting entry Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Accrued Expenses (1 of 4) Accrued Salary Expense. Suppose RedLotus Security pays its employee a monthly salary of $1,800, half on the 15th and half on the last day of the month. The following calendar for June has the paydays circled: Assume that if a payday falls on a Sunday, RedLotus’ pays the employee on the following Monday. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Accrued Expenses (2 of 3) The second half-month amount of $900 will be paid on Monday, July 1. At June 30, therefore, RedLotus Security makes the adjusting entry. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Adjust the Accounts (4 of 6) Accrued Revenues A revenue that has been earned but not yet collected. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Accrued Revenues (3 of 3) Assume that on June 15 a hotel agrees to pay RedLotus a commission of $30 per booking into its hotel over the next 30 days. RedLotus books 10 clients in June and earns $300, for work done in June. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Exhibit 3-7 Prepaid and Accrual Adjustments Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Adjust the Accounts (5 of 6) Depreciation of Property, Plant and Equipment Plant assets are long-lived tangible assets, such as land, buildings, furniture, and equipment. Depreciation is the process of allocating cost to expense for a long-term plant asset. – Decline in usefulness – Spread the cost of the plant asset over its useful life – Exception: Land – does not decline in usefulness Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Depreciation of Plant Assets (1 of 4) Equipment. Suppose that on June 2 RedLotus purchased equipment on account for $24,000 Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Depreciation of Plant Assets (2 of 4) Straight-line depreciation method: Divide cost of the asset by its useful life RedLotus Security Equipment: Cost: $24,000 Useful life: 5 years 24,000 Annual depreciation = year = 4,800 per year 5 4,800 Monthly depreciation = months = 400 per year 12 Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Depreciation of Plant Assets (3 of 4) Depreciation expense for June is recorded as follows: Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Depreciation of Plant Assets (4 of 4) Accumulated Depreciation Shows the sum of all depreciation expense The balance increases over the asset’s life Contra asset account, a normal credit balance. A contra account has two distinguishing characteristics: – Always has a companion account – Normal balance is opposite that of the companion account Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Exhibit 3-8 PPE on the Balance Sheet of RedLotus Security Book Value: Cost of the plant asset minus accumulated depreciation Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Income Tax Accrual RedLotus Security would make an additional adjusting entry to accrue income tax expense of $600 and the related income tax payable as the final adjusting entry of the period. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Summary of the Adjusting Process Two purposes of the adjusting process are to – measure income, and – update the balance sheet. Therefore, every adjusting entry affects both of the following: – Revenue or expense—to measure income – Asset or liability—to update the balance sheet Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Exhibit 3-10 Summary of Adjusting Entries Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Exhibit 3-11 The Adjusting Process of RedLotus (1 of 2) Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Exhibit 3-11 The Adjusting Process of RedLotus (2 of 2) Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Adjust the Accounts (6 of 6) The Adjusted Trial Balance Summarizes all accounts and their final balances after all adjusting entries have been journalized and posted Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Exhibit 3-12 Adjusted Trial Balance Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Learning Objective 3.4 Prepare updated financial statements Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Construct the Financial Statements The June financial statements of RedLotus Security can be prepared from the adjusted trial balance. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Exhibit 3-13 Income Statement Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Exhibit 3-14 Statement of Changes in Equity Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Exhibit 3-15 Balance Sheet Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Learning Objective 3.5 Close the books Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Close the Books (1 of 3) Prepares the accounts for the next period Close temporary accounts: accounts related to a limited period of time – Income – Expenses – Dividends Do NOT close permanent accounts – Assets – Liabilities – Shareholders’ equity Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Close the Books (2 of 3) Steps to close the books: 1. Debit each income for the amount of its credit balance. Credit Retained Earnings for the sum of all revenues. 2. Credit each expense account for the amount of its debit balance. Debit Retained Earnings for the sum of all expenses. 3. Credit the Dividends account for the amount of its debit balance. Debit Retained Earnings for the same amount. Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Exhibit 3-16 Journalizing and Posting the Closing Entries (1 of 2) Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Exhibit 3-16 Journalizing and Posting the Closing Entries (2 of 2) Copyright © 2024 Pearson Education Ltd. All Rights Reserved. Close the Books (3 of 3) Copyright © 2024 Pearson Education Ltd. All Rights Reserved.