Ch.4 Income Measurement & Accrual Accounting

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Ch.4Income Measurement Accrual Accounting
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Recognition and Measurement
I know I need to record this...
Recognition formally recording an item in the
financial statements of an entity
LO1
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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
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• Cash basis
• statement

Accrual basis statement
Statement of Cash Flows
Cash flows from operating activities (4,000)
What accounts for the difference?
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Revenue Recognition Principle
Revenue is recognized when realized and
earnedusually at point of sale
LO3
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Expense Recognition
Income Statement
Balance Sheet
PPE Intangibles

ASSETS
EXPENSES
when sold
Cost of goods sold
Inventory
Supplies Prepaid assets
Supplies expense Insurance expense Rent expense
as used
over period they provide benefits
Depreciation expense Amortization expense
Other expenses (as incurred)
LO4
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Matching Principle
Match expenses with associated revenues

Directly
e.g. Inventory
e.g. Buildings
e.g. Utilities
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Types of Adjusting Entries
Deferred expense
Accrued liability
ALL RECOGNIZE REVENUE OR EXPENSES BEFORE OR
AFTER CASH IS EXCHANGED
Accrued asset
Deferred revenue
LO5
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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

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Deferred Expense Example 1

• Prepay rent on office space for one year on
  September 1
• Initial journal entry
• 9/1 Prepaid Rent 2,400
• Cash 2,400
• Monthly adjusting journal entry
• 9/30 Rent Expense 200
• Prepaid Rent 200
• (2,400 annual 1/12 200 per month
  for 12 months)

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Deferred Expense Example 2
Purchase treadmill on January 1 for 5,000.
Estimated useful life is 7 years (84 months)
estimated salvage value is 800

• Initial journal entry
• 1/1 Fitness equipment 5,000
• Cash 5,000
• Monthly adjusting journal entry
• 1/31 Depreciation Expense 50
• Accumulated Depreciation 50
• (5,000 800) 1/84 50 per month
  for 84 months)

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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

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Deferred Revenue Example

• Received 2,400 for an insurance policy in
  advance on September 1
• Initial journal entry
• 9/1 Cash 2,400
• Insurance Collected in Advance 2,400
• Monthly adjusting journal entry
• 9/30 Insurance Collected in Advance 200
• Rent Revenue 200
• (2,400 annual 1/12 200 per month for 12
  months)

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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

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Accrued Liability Example 1
Pay biweekly wages of 28,000

• At end of month, between pay periods
• Wages Expense 4,000
• Wages Payable 4,000
• Next payday
• Wages Payable 4,000
• Wages Expense 24,000
• Cash 28,000

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Accrued Liability Example 2
On March 1, assume a 9, 90-day, 20,000 loan is
taken out with a bank

• Initial journal entry
• 3/1 Cash 20,000
• Note Payable 20,000
• Monthly adjusting journal entry
• 3/31 Interest Expense 150
• Interest Payable 150
• (20,000 principal 9 3/12 450 for 3
  months or 450/3 150 per month)

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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

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Accrued Asset Example
Rent payment of 2,500 due within first 10 days
of month

• First day of the month
• Rent Receivable 2,500
• Rent Revenue 2,500
• Upon receipt of cash
• Cash 2,500
• Rent Receivable 2,500