Chapter 4 Income Measurement and Accrual Accounting PDF

Chapter 4 Income Measurement and Accrual Accounting © 2019 Cengage. All rights reserved. Recognition and Measurement in Financial Statements Recognition: process of recording an item as an asset, a liability, a revenue, an expense, or the like Measurement: re...

Chapter 4 Income Measurement and Accrual Accounting © 2019 Cengage. All rights reserved. Recognition and Measurement in Financial Statements Recognition: process of recording an item as an asset, a liability, a revenue, an expense, or the like Measurement: requires two choices to be made – Choice 1: The attribute to be measured  Historical cost  Current value – Choice 2: The unit of measure—yardstick  Money Introduction toCengage. © 2019 Cost management All rights reserved. Exhibit 4.1—Recognition and Measurement in Financial Statements © 2019 Cengage. All rights reserved.  Cash and Accrual Bases of Accounting Cash basis: revenues are recognized when cash is received and expenses are recognized when cash is paid Accrual basis: revenues are recognized when earned and expenses are recognized when incurred Introduction toCengage. © 2019 Cost management All rights reserved. Example 4.1—Comparing the Cash and Accrual Bases of Accounting © 2019 Cengage. All rights reserved. Exhibit 4.2—Comparing the Cash and Accrual Bases of Accounting © 2019 Cengage. All rights reserved.  Revenue Recognition Principle Recognized in the income statement when they are realized, or realizable, and earned Revenues: Inflows of assets or settlements of liabilities – Delivering or producing goods – Rendering services – Conducting other activities Introduction toCengage. © 2019 Cost management All rights reserved.  Expense Recognition and the Matching Principle Association of revenue of a period with all of the costs necessary to generate that revenue – Direct matching: associate revenues of a period with their costs – Indirect matching: associate costs with a particular period  Example: depreciation on building Introduction toCengage. © 2019 Cost management All rights reserved. Example 4.3—Comparing Three Methods for Matching Costs with Revenue © 2019 Cengage. All rights reserved.  Adjusting Entries Made at the end of an accounting period internal transactions and do not affect the Cash account Adjustment of either an asset or a liability with a corresponding change in revenue or expense Types of adjusting entries: – Deferred expense – Deferred revenue – Accrued liability – Accrued asset Introduction toCengage. © 2019 Cost management All rights reserved.  Deferred Expense Cash paid before expense is incurred Examples: – Prepaid rent – Prepaid insurance – Office supplies – Property and equipment Unexpired costs are assets – Written off and replaced with an expense as the costs expire Introduction toCengage. © 2019 Cost management All rights reserved. Example 4.4—Adjusting a Deferred Expense Account © 2019 Cengage. All rights reserved.  Deferred Revenue Cash received before revenue is earned Example: – Insurance collected in advance – Subscriptions collected in advance – Gift certificates Initially recorded as liabilities (unearned or refundable receipts) and recorded as revenues in future periods when earned Introduction toCengage. © 2019 Cost management All rights reserved. Example 4.6—Adjusting a Deferred Revenue Account © 2019 Cengage. All rights reserved.  Accrued Liability Cash is paid after an expense is actually incurred rather than before its incurrence Examples: – Payroll – Taxes – Utilities Introduction toCengage. © 2019 Cost management All rights reserved. Example 4.8—Recording an Accrued Liability for Wages © 2019 Cengage. All rights reserved.  Accrued Asset Revenue earned before the receipt of cash Example: Rent and interest are earned with the passage of time and require an adjustment if cash has not yet been received Whenever a company records revenue before cash is received, receivable is increased and revenue is also increased Introduction toCengage. © 2019 Cost management All rights reserved. Example 4.9—Recording an Accrued Asset © 2019 Cengage. All rights reserved. Exhibit 4.3—Accruals and Deferrals © 2019 Cengage. All rights reserved. Exhibit 4.4—Unadjusted Trial Balance © 2019 Cengage. All rights reserved. Exhibit 4.5—Adjusted Trial Balance © 2019 Cengage. All rights reserved.  The Accounting Cycle Series of steps performed each period and culminating with the preparation of a set of financial statements Introduction toCengage. © 2019 Cost management All rights reserved. Exhibit 4.6—Steps in the Accounting Cycle © 2019 Cengage. All rights reserved.  Closing Entries Made at the end of an accounting period Return the balance in all nominal accounts to zero Transfer the net income or loss and the dividends to Retained Earnings Introduction toCengage. © 2019 Cost management All rights reserved.  Real and Nominal accounts Real accounts: balance sheet accounts – Permanent in nature – Not closed at the end of the period Nominal accounts: revenue, expense, and dividend accounts – Temporary in nature – Closed at the end of the period Introduction toCengage. © 2019 Cost management All rights reserved.  The Use of a Work Sheet Device used at the end of the period to gather the information needed to prepare financial statements without actually recording and posting adjusting entries Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Tools: Work Sheets a useful device to aid in preparation of the statements at the end of a period Step 1: The Unadjusted Trial Balance Columns Step 2: The Adjusting Entries Columns Step 3: The Adjusted Trial Balance Columns Step 4: The Income Statement Columns Step 5: The Balance Sheet Columns Introduction toCengage. © 2019 Cost management All rights reserved. Example 4.13—Preparing a Work Sheet © 2019 Cengage. All rights reserved.