© PHI Learning, All rights reserved.1 Financial Accounting: A Managerial Perspective Third Edition Prepared by R. Narayanaswamy Indian Institute of Management Bangalore

© PHI Learning, All rights reserved.2 Measuring Income Chapter 3

© PHI Learning, All rights reserved.3 Income Measurement  Why measure income periodically?  What is income?  Net profit as income  Revenues  Gains  Expenses  Losses Chapter 3

© PHI Learning, All rights reserved.4 Accrual Accounting  Accrual basis and cash basis of accounting  Why is accrual a better measure of performance?  Accrual: Expected, not necessarily actual, cash receipts and payments  Realization principle: Revenue recognition  Matching principle: Comparing accomplishment with effort Chapter 3

© PHI Learning, All rights reserved.5 The Adjustment Process  What are adjusting entries?  Why are adjusting entries needed?  Deferral  Delaying the recognition of an expense already paid or of a revenue already received.  Accrual  Recognizing an expense that has not been paid or of a revenue that has not been received. Chapter 3

© PHI Learning, All rights reserved.6 Deferral  Apportioning recorded expenses  Prepaid expenses  Office supplies  Depreciation  Apportioning unearned revenues  Advance collection of rents, air tickets, magazine subscriptions, insurance premium, etc. Chapter 3

© PHI Learning, All rights reserved.7 Accrual  Recording accrued expenses  Expenses payable for services already used e.g., unpaid salaries, interest, and income tax  Recording accrued revenues  Revenue not received for services already provided e.g., professional fee revenue receivable, interest revenue receivable Chapter 3

© PHI Learning, All rights reserved.8 Preparing Financial Statements from the Adjusted Trial Balance  Adjusted trial balance  Adjustments columns  Extending balances to the adjusted trial balance columns  Preparing financial statements  Profit and loss account from the revenue and expense amounts  Balance sheet from the asset, liability and equity amounts Chapter 3

© PHI Learning, All rights reserved.9 Steps in the Accounting Cycle 1.Analyse transactions 2.Record transactions in the journal 3.Post journal entries to the ledger accounts 4.Prepare a trial balance 5.Journalise and post adjusting entries and prepare adjusted trial balance 6.Prepare financial statements 7.Journalise and post closing entries: temporary accounts 8.Carry forward the balance sheet accounts to the next accounting period: permanent accounts Chapter 3