Introduction to Accounting Preparing for a User’s Perspective Accrual Accounting: Revenue Recognition and the Matching Principle Debits and Credits Trainer By Kevin C. Kimball, CPA with support from www.canvas.net Free Jan. 2014 Available on the Google Play Store

Lenders and investors rely heavily on a company’s reported Net Income to make lending and investing decisions. Reported Net Income will be misstated IF either Revenues or Expenses are: 1) reported at the wrong amounts $ OR 2) are reported in the wrong periods.

Revenue recognition principle ACCRUAL ACCOUNTING helps management avoid Net Income misstatements of amount $ and timing Revenue recognition principle REVENUES Matching principle EXPENSES

Revenue Recognition Principle Recognize revenues in the accounting period when they become realized (or realizable) and are earned. Deliver a good or service Receive cash or claims to cash or assets that can be readily converted to cash. You owe me. Substantially complete or deliver the promised goods or services. Matching Principle Recognize expenses in the same accounting period as the revenues that they helped generate. Revenues Expenses

Three Common Revenue Recognition Situations 12/31/X1 12/31/X2 12/31/X3 Easy NO adjustments needed. 1) Cash is received at the SAME time as the revenue is recognized. Yes, adjustments needed. 2) Cash is received BEFORE the revenue is recognized. Deferred Revenue Yes, adjustments needed. 3) Cash is received AFTER the revenue is recognized. Accrued Revenue Revenue recognition: AMOUNT $ and TIMING of REVENUES

1) Cash is received at the SAME time as the revenue is recognized. Background: Jones Co. is an independent sales agent for Bob Co. Jones Co. is paid a 5% commission on all sales it helps Bob Co. make. Example: In 20X2, Jones Co. received a $100 sales commission from Bob Co. related to a sale made in 20X2. FTYE 12/31/X1 FTYE 12/31/X2 FTYE 12/31/X3 Cash $100 Revenues $100 EASY: No adjusting entries and no other accounts are needed.

2) Cash is received BEFORE the revenue is recognized. Example: In 20X1 Jones Co. received $100 cash in advance from Bob Co. for sales commissions he expected to earn in 20X2. In 20X2 Jones Co. did earn the $100 in sales commissions as expected. FTYE 12/31/X1 FTYE 12/31/X2 FTYE 12/31/X3 Cash $100 Un. Revenues $100 Unearned Revenues $100 Revenues $100 NOT SO EASY: Unearned Revenue account is used to “defer” revenue recognition until 20X2 when the Revenue IS recognized.

3) Cash is received AFTER the revenue is recognized. Example: In 20X2 Jones Co. earned $100 in sales commissions from Bob Co., but Jones Co. didn’t receive the commission payment until 20X3. FTYE 12/31/X1 FTYE 12/31/X2 FTYE 12/31/X3 Acct. Receivable $100 Cash $100 Revenues $100 Acct. Receivable $100 NOT SO EASY: The Account Receivable account is used to “accrue” Revenue until 20X3 when the Cash IS finally received.

Three Common Matching Principle Situations 12/31/X1 12/31/X2 12/31/X3 Easy NO adjustments needed. 1) Cash is paid at the SAME time as the benefit received. 2) Cash is paid BEFORE the benefit is received Yes, adjustments needed. Deferred expenses and the expense is recognized. Yes, adjustments needed. 3) Cash is paid AFTER the benefit is received Accrued expenses and the expense is recognized. Matching principle: AMOUNT $ and TIMING of EXPENSES

1) Cash is paid at the SAME time as the benefit received. Example: In 20X2, Bob Co. made a $2,000 cash sale and incurred AND paid Jones Co. a $100 commission. FTYE 12/31/X1 FTYE 12/31/X2 FTYE 12/31/X3 Cash $2,000 Selling expenses are properly MATCHED to Sales Revenues in the same year. Sales Revenues $2,000 Selling Expenses $100 Cash $100 EASY: No adjusting entries and no other accounts are needed.

2) Cash is paid BEFORE the benefit is received. Example: In 20X1 Bob Co. paid Jones Co. $100 cash in advance for an anticipated sales commission that it expects to incur in 20X2. In 20X2, Bob Co. made a $2,000 cash sale and incurred the $100 commission to Jones Co. as expected. FTYE 12/31/X1 FTYE 12/31/X2 FTYE 12/31/X3 Cash $2,000 Selling expenses are properly MATCHED to Sales Revenues in the same year. Sales Revenues $2,000 Prep. Expense $100 Selling Expenses $100 Cash $100 Prep. Expense $100 NOT SO EASY: Prepaid expense account is used to “defer” expense recognition until 20X2 when the Expense IS recognized.

3) Cash is paid AFTER the benefit is received. Example: In 20X2, Bob Co. made a $2,000 cash sale and incurred a $100 sales commission to Jones Co. Bob Co. has decided not to pay the commission until 20X3. FTYE 12/31/X1 FTYE 12/31/X2 FTYE 12/31/X3 Cash $2,000 Selling expenses are properly MATCHED to Sales Revenues in the same year. Sales Revenues $2,000 Selling Expenses $100 Accts. Payable $100 Accts. Payable $100 Cash $100 NOT SO EASY: Accounts payable account is used to “accrue” expenses into the current period allowing later payment.

Assets = Liabilities + Equity Many transactions do not affect Revenues (revenue recognition principle) or Expenses (matching principle), but they still must be recorded. Assets = Liabilities + Equity Receive a $1 asset by giving up a $1 asset $1 $1 Receive a $1 asset by increasing a $1 liability. $1 $1 Receive a $1 asset by issuing $1 of capital stock. $1 $1 Pay a $1 dividend by giving up a $1 asset. $1 $1

Revenue Recognition Principle Recognize revenues in the accounting period when they become realized (or realizable) and are earned. Deliver a good or service Receive cash or claims to cash or assets that can be readily converted to cash. You owe me. Substantially complete or deliver the promised goods or services. Matching Principle Recognize expenses in the same accounting period as the revenues that they helped generate. Revenues Expenses

Introduction to Accounting Preparing for a User’s Perspective Accrual Accounting: Revenue Recognition and the Matching Principle Debits and Credits Trainer By Kevin C. Kimball, CPA with support from www.canvas.net Free Jan. 2014 Available on the Google Play Store