3-1 Measuring Revenues and Expenses Electronic Presentation by Douglas Cloud Pepperdine University Chapter F3

3-2 1.Explain the concept of accrual accounting and why it is used. 2.Record revenue transactions using accrual accounting. 3.Record expense transactions using accrual accounting. 4.Identify and record adjusting entries at the end of a fiscal period. ObjectivesObjectives Once you have completed this chapter, you should be able to: ContinuedContinued

3-3 5.Prepare closing entries and financial statements at the end of a fiscal period. 6.Identify steps in the accounting cycle. ObjectivesObjectives

3-41 ObjectiveObjective Explain the concept of accrual accounting and why it is used.

3-5 Accrual accounting is a form of accounting in which revenues are recognize when they are earned and expenses are recognized when they are incurred.

Record revenue transactions using accrual accounting. ObjectiveObjective

3-7 Revenue Transactions On February 12, 2004, Mom’s Cookie Company sold boxes of cookies (cost $400) to a customer for $600 on credit. Mom’s

3-8 Revenue Transactions ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 2/12Accts. Receivable600 Sales Revenue600 Accounts Receivable is an asset account that increases when good are sold on credit.

3-9 Revenue Transactions ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 2/12Accts. Receivable600 Sales Revenue600 2/12Cost of Goods Sold–400 Merchandise Inv. –400 The second entry records the cost of the cookies and reduces the inventory.

3-10 Revenue Transactions This sale transaction is linked to a second transaction that occurs on March 10 when the customer pays for the goods.

3-11 Revenue Transactions ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 3/10Cash600 Accts. Receivable–600 Revenue is not recognized at the time cash is received because it has already been recognized when goods were sold.

3-12 Linking Revenues and Cash through Accounts Receivable Accounts Sales Accounts Sales Date Cash Receivable Revenue Date Cash Receivable Revenue Accounts Sales Accounts Sales Date Cash Receivable Revenue Date Cash Receivable Revenue Feb Mar –600 Net results Feb Mar –600 Net results Exhibit 1

3-13 Revenue Transactions On February 24, a customer paid $3,000 for an order in advance of receiving the cookies.

3-14 Revenue Transactions ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 2/14Cash3,000 Unearned Revenue3,000 Unearned Revenue is a liability account that results when a company receives cash in advance.

3-15 Revenue Transactions The sales transaction is recorded when the goods are delivered to the customer on March 3. Mom’s

3-16 Revenue Transactions ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 3/3Unearned Revenue–3,000 Sales Revenue3,000 3/3Cost of Goods Sold–2,000 Merchandise Inv.–2,000

3-17 Unearned Sales Unearned Sales Date Cash Revenue Revenue Date Cash Revenue Revenue Unearned Sales Unearned Sales Date Cash Revenue Revenue Date Cash Revenue Revenue Feb. 243,0003,000 Mar. 3–3,0003,000 Net results3,00003,000 Feb. 243,0003,000 Mar. 3–3,0003,000 Net results3,00003,000 Linking Cash and Revenues through Unearned Revenue Exhibit 2

3-18 Revenue Transactions LEARNING NOTE Account titles vary in practice. For example, Unearned Revenue might appear as Customer Deposits, Prepaid Subscriptions, or Deferred Revenues.

3-19 TimingFirstSecondLinking TimingFirstSecondLinking EffectPeriodPeriodAccount EffectPeriodPeriodAccount TimingFirstSecondLinking TimingFirstSecondLinking EffectPeriodPeriodAccount EffectPeriodPeriodAccount No Accrual orRevenue EarnedNone Deferral NeededCash Received Accrued RevenueRevenue EarnedCash ReceivedAccounts Receivable Deferred Cash ReceivedRevenue EarnedUnearnedRevenue No Accrual orRevenue EarnedNone Deferral NeededCash Received Accrued RevenueRevenue EarnedCash ReceivedAccounts Receivable Deferred Cash ReceivedRevenue EarnedUnearnedRevenue Revenue Recognition and Cash Flows Exhibit 3

3-20 Accrued revenue is revenue recognized prior to the receipt of cash. Deferred revenue is revenue recognized after cash has been received. Revenue Transactions

Record expense transactions using accrual accounting. ObjectiveObjective

3-22 Expense Transactions Accrued expenses result when expenses are recognized prior to the payment of cash. A deferred expense is an expense recognized after the payment of cash.

3-23 On February 16, Mom’s Cookie Company purchased $400 of supplies on credit. Expense Transactions

3-24 Expense Transactions Accounts Payable is a liability account that identifies an obligation to pay a supplier in the near future. ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 2/16Supplies400 Accounts Payable400

3-25 By February 28 the company has consumed all of these supplies. Expense Transactions

3-26 Expense Transactions This transaction records the expense in the fiscal period in which resources were consumed. ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 2/28Supplies Expense–400 Supplies–400

3-27 On March 15, Mom’s Cookie Company sends a check for $400 to the supplier. Expense Transactions

3-28 Expense Transactions ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 3/15Accounts Payable–400 Cash –400

3-29 Linking Expense and Cash through Accounts Payable Exhibit 4 AccountsSupplies AccountsSupplies DateCashSuppliesPayableExpense AccountsSupplies AccountsSupplies DateCashSuppliesPayableExpense Feb Feb. 28–400–400 Mar. 15–400–400 Net result–40000–400 Feb Feb. 28–400–400 Mar. 15–400–400 Net result–40000–400

3-30 On February 26, Mom’s Cookie Company sends a check for $600 for rent of a building for March. Expense Transactions Mom’s Cookie Co.

3-31 Expense Transactions ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 2/26Prepaid Rent600 Cash–600 Prepaid Rent is an example of a prepaid expense, which is an asset account that identifies resources that have been paid for but not used.

3-32 By the end of March the rental service has been consumed and an expense needs to be recorded. Expense Transactions

3-33 Expense Transactions ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 3/31Rent Expense–600 Prepaid Rent–600

3-34 The matching principle requires companies to recognize the expenses used to generate revenue in the same accounting period in which the revenues are recognized.

3-35 Expense Recognition and Cash Flows Exhibit 6

Identify and record adjusting entries at the end of a fiscal period. ObjectiveObjective

3-37 Mom’s Cookie Co. Adjusting Account Balances In mid-February, Mom’s Cookie Company decides to move to a new building on March 1. The rent for the new building is $600 per month. On February 24 rent is paid for March and April. Mom’s Cookie Co.

3-38 Adjusting Account Balances ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 2/24Prepaid Rent1,200 Cash–1,200

3-39 Adjusting Account Balances At the end of March and April, Mom’s Cookie Company must record an expense for rent.

3-40 Adjusting Account Balances ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 3/31Rent Expense–600 Prepaid Rent–600 4/30Rent Expense–600 Prepaid Rent–600 An adjusting entry is a transaction recorded in the accounting system to ensure the correct account balances are reported for a particular fiscal period.

3-41 Adjusting Account Balances The company borrowed a total of $30,000 in January. The bank charges $200 of interest each month.

3-42 Adjusting Account Balances ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 1/31Interest Expense–200 Interest Payable200 2/28Interest Expense–200 Interest Payable200 3/31Interest Expense–200 Interest Payable200

3-43 Every adjusting entry includes at least one balance sheet and at least one income statement account.

3-44 The interest is to be paid the day after the end of each quarter. Thus, the first interest payment is due on April 1. Adjusting Account Balances

3-45 Adjusting Account Balances ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 4/1Interest Payable–600 Cash–600

3-46 The company purchased equipment in January at a total cost of $31,000. The usage of this equipment should be recognized over a number of fiscal periods. Adjusting Account Balances Mom’s Mom’s Cookie Company expenses its equipment at the rate of $520 per month. Entries are made on January 31 and February 28 for $520.

3-47 Adjusting Account Balances ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 1/31Depreciation Exp.–520 Accum. Deprec.–520 2/28Depreciation Exp.–520 Accum. Deprec.–520 Depreciation is the allocation of the cost of assets to the fiscal periods that benefit from the assets’ use. Accumulated Depreciation is a contra-asset account used to identify the total amount of depreciation recorded for a company’s assets.

3-48 Ledger Accounts A journal is a chronological record of a company’s transactions.

3-49 Ledger Accounts A ledger is a file in which each of a company’s accounts and the balances of those accounts are maintained. Posting is the process of transferring transactions to specific accounts in a company’s ledger.

3-50 Posting Transactions to the Ledger Ledger Accumulated Depreciation Date Amount Balance Jan. 31–520–520 Feb. 28–520–1,040 ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 1/31Depreciation Exp.–520 Accum. Deprec.–520 2/28Depreciation Exp.–520 Accum. Deprec.–520

3-51 Ledger Accounts The primary ledger a company uses to record its account balances is referred to as the general ledger.

Prepare closing entries and financial statements at the end of a fiscal period. ObjectiveObjective

3-53 Mom’s Cookie Company Account Balances January 31, 2004 Account Balance Assets: Cash9,300 Merchandise Inventory1,400 Equipment31,000 Accumulated Depreciation (520) Total Assets41,180 Liabilities: Interest Payable200 Notes Payable30,000 Total Liabilities30,200 ContinuedContinued Exhibit 9

3-54 Owners’ Equity: Contributed Capital10,000 Sales Revenue11,400 Cost of Goods Sold(7,600) Wages Expense(1,000) Rent Expense(600) Depreciation Expense(520) Supplies Expense(300) Utilities Expense(200) Interest Expense (200) Total Owners’ Equity10,980

3-55 Mom’s Cookie Company Income Statement For the Month Ended January 31, 2004 Sales revenue$11,400 Cost of goods sold(7,600) Wages expense(1,000) Rent expense(600) Depreciation expense(520) Supplies expense(300) Utilities expense(200) Interest expense (200) Net income$ 980 Exhibit 10

3-56 Closing Entries Revenue accounts are closed by transferring their balances to Retained Earnings.

3-57 Expense accounts are closed by transferring their balances to Retained Earnings. Closing Entries Closing entries reset the balances of revenue and expense accounts to zero.

3-58 ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 1/31Retained Earnings11,400 Sales Revenue–11,400 1/31Retained Earnings–10,420 Cost of Good Sold7,600 Wages Expense1,000 Rent Expense600 Depr. Expense520 Supplies Expense300 Utilities Expense200 Interest Expense200 Closing Entries for January Exhibit 11

3-59 Retained Earnings Cost of Goods Sold Rent Expense Supplies Expense Interest Expense Sales Revenue ContinuedContinued Effect of Closing Entries Exhibit 12

3-60 Wage Expense Depreciation Expense Utilities Expense Effect of Closing Entries Exhibit 12

3-61 Payments to Owners Maria and Stan decide to withdraw $500 from Mom’s Cookie Company on January 31. Maria and Stan decide to withdraw $500 from Mom’s Cookie Company on January 31.

3-62 Ledger Retained Earnings Date Amount Balance Jan. 31– ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 1/31Retained Earnings–500 Cash–500

3-63 Ledger ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 1/31Retained Earnings–500 Cash–500 Cash Date Amount Balance Jan. 31–5008,800 9,300

3-64 Mom’s Cookie Company Post-Closing Summary of Account Balances January 31, 2004 Account Balance Assets: Cash8,800 Merchandise Inventory1,400 Equipment31,000 Accumulated Depreciation (520) Total Assets40,680 Liabilities: Interest Payable200 Notes Payable30,000 Total Liabilities30,200 ContinuedContinued Exhibit 13

3-65 Owners’ Equity: Contributed Capital10,000 Retained Earnings480 Sales Revenue0 Cost of Goods Sold0 Wages Expense0 Rent Expense0 Depreciation Expense0 Supplies Expense0 Utilities Expense0 Interest Expense 0 Total Owners’ Equity10,480

3-66 Mom’s Cookie Company Balance Sheet At January 31, 2004 Assets Cash$ 8,800 Merchandise inventory1,400 Equipment31,000 Accumulated depreciation (520) Total assets$40,680 Liabilities and Owners’ Equity Interest payable $ 200 Notes payable 30,000 Total liabilities30,200 Contribution by owners10,000 Retained earnings 480 Total liabilities and owners’ equity$40,680 Exhibit 14

3-67 Mom’s Cookie Company Statement of Cash Flows For the Month Ended January 31, 2004 Operating Activities Received from customers$11,400 Paid for merchandise(9,000) Paid for wages(1,000) Paid for rent(600) Paid for supplies(300) Paid for utilities (200) Net cash flow from operating activities$ 300 Investing Activities Paid for equipment(31,000) ContinuedContinued Exhibit 15

3-68 Financing Activities Received from creditors$30,000 Received from owners10,000 Paid to owners (500) Net cash flow from financing activities$39,500 Net cash flow for January8,800 Cash balance, January 1 0 Cash balance, January 31$ 8,800

Identify steps in the accounting cycle. ObjectiveObjective

3-70 The accounting cycle is the process of recording, summarizing, and reporting accounting information.

3-71 Exhibit 16 Steps in the Accounting Cycle

3-72 Accounting and Ethics An accounting system with adequate controls to ensure reliable information is expected by stakeholders of most companies. An accounting system is a legal requirement for companies that sell shares of stock to the public and for many other companies that are regulated by state and local authorities.

3-73 Good accounting is the first line of defense against unethical behavior in business. Accounting and Ethics

3-74 T HE E ND C HAPTER F3

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