PRINCIPLE OF ACCOUNTING 2 nd Semester DBA Prepared By: Kamran (Lecturer) Specialization (Accounting) Kardan Institute of Higher Education

Accounting Period Assumption... 2 Divides the economic life of a business into artificial time periods. WHY? To provide immediate feedback on how the business is doing.

Time Period (Periodicity) Concept  Periodicity: divides the life of a business into short, even time periods, usually one year  Short periods keeps reporting timely and information updated.  Periods of equal length are comparable  An accounting time period that starts on January 1 and ends December 31 is called a calendar year.  An accounting time period that is one year long is called fiscal year. ©Kimberly Lyons 3

REVENUE RECOGNITION PRINCIPLE AND MATCHING PRINCIPLE 4

Revenue Recognition Principle...  Dictates that revenue be recognized in the accounting period in which it is earned.  Revenue is considered earned when the service has been provided or when the goods are delivered. 5

Matching Principle... Expenses should be matched with the revenues they generate in any specific accounting period. 6

Accrual VS Cash Accounting 10/21/2015 7

Cash-Basis Accounting  Revenue and expenses are recognized only when cash is received or payments are made.  Mainly used by small businesses.  Not an accurate picture of true profitability.  Revenue and expenses are recognized only when cash is received or payments are made.  Mainly used by small businesses.  Not an accurate picture of true profitability.

Cash Basis in not GAAP 9 GAAP

Accrual Basis Accounting 10 Subject to the:  Revenue Recognition Principle  Matching Principle

Accrual Accounting  A system of accounting in which revenues and expenses are recorded as they are earned and incurred, not when cash is received or paid.  Provides a more accurate picture of a company’s profitability.

Cash-Basis Accounting VS Accrual basis Accounting  Example: Bo Jovian Co. purchases inventory in December of 2008 for $10,000 and sells the inventory in January of 2009 for $13,000. Bo Jovian has a December 31 st year-end.  Compare net income for Bo Jovian for the two years under both accrual and cash basis accounting 12

Cash versus Accrual-Basis Net Income Cash Basis: Revenues Revenues $ 0 $13,000 - Expenses (10,000)0 = Net Income (loss) (10,000)$13,000 Accrual Basis: Revenues Revenues $ 0 $13,000 - Expenses 0(10,000) = Net Income (loss) $ 0 $ 3,000 13

Adjusting Entries Adjusting entries are required at the end of each accounting period for accrual-basis accounting, prior to preparing the financial statements.  To bring balance sheet accounts current.  To reflect proper amounts of revenues and expenses on the Income Statement.  To bring balance sheet accounts current.  To reflect proper amounts of revenues and expenses on the Income Statement.

Adjusting Entries Tips Each adjusting entry always involves at least One Income Statement Account  and  One Balance Sheet Account. Each adjusting entry always involves at least One Income Statement Account  and  One Balance Sheet Account. Adjusting entries never involve cash.

Common Adjusting Entries Prepaid Expenses Un-earned Revenues Unrecorded Revenues Unrecorded Expenses Prepaid Expenses Un-earned Revenues Unrecorded Revenues Unrecorded Expenses Payments made in advance for items charged to expense, to show the partial using-up of an asset. Amounts received before the actual earnings of revenues (the unearned revenues are liabilities). Revenues earned but not yet recorded by period’s end. Expenses incurred but not yet recorded by period’s end. Payments made in advance for items charged to expense, to show the partial using-up of an asset. Amounts received before the actual earnings of revenues (the unearned revenues are liabilities). Revenues earned but not yet recorded by period’s end. Expenses incurred but not yet recorded by period’s end.

14 PREPAID EXPENSES Prepaid Expenses are characterized by a previous transaction which must be adjusted because it is now the end of the period (time period assumption). The transaction is not yet complete at the end of the period. e.g. Shop supplies, Depreciation, prepaid Rent, prepaid Advertisement, Insurance premium. Example: Prepaid expenses expense. Information: You are a tenant renting office space for $2,000 per month. On Jan 1 st 2010, you prepay six months of rent or $12,000 to your landlord. The original entry may have been : 1/1/2010 Prepaid Rent 12,000 Cash 12,000

15 Adjusting Entries (Prepayments) Suppose it is now Feb 28 th 2010, two months later. The previous entry must be adjusted. The adjusting entry would be: Note: You had to refer back to the original entry to prepare the correct adjusting entry. To adjust: 2/28/2010 Rent Expense 4,000 Prepaid Rent 4,000

Shop Supplies (Prepayments) Suppose on Dec,4 Shop supplies were purchased of amount $4000. These supplies are expected to last for three or four months so it will be treated as Asset and recorded as: 19 To adjust: 12/4 Shop Supplies 4,000 Cash 4,000

Shop Supplies Suppose during December amount $2000 supplies are consumed. The utilized shop supplies will be treated as expense and need adjustment. 20 To adjust: 12/4 Supplies Expense 2,000 Shop Supplies 2,000

The allocation of the cost of a fixed assets to expense in the periods in which services are received from the asset. Cost of fixed assets Balance Sheet Assets: Plant and equipment Assets: Plant and equipment Income Statement Revenues: Expenses: Depreciation Revenues: Expenses: Depreciation as the services are received Depreciation

 Book Value  Cost – Accumulated Depreciation  Accumulated Depreciation  The sum of depreciation over a number of years is called acc.depreciation.  Causes of Depreciation  Physical deterioration  Obsolescence

Cost - Residual Value Years of Useful Life Depreciation Expense per Year = Depreciation

On January 1, 2003, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2003 using the straight-line method. Depreciation

Bass Co. will record $4,200 depreciation each year for five years. Total depreciation over the estimated useful life of the boat is: Salvage Value Depreciation

Adjusting Entries – “Unearned Revenues” Receipt of cash that is recorded as a liability because the revenue has not been earned. Rent Airline tickets School tuition fee Cash Receipt Revenue Earned BEFORE Advertisement Unearned revenues often occur in regard to:

Example: On Nov. 1 st, Phoenix Corp. received $24,000 from Arcadia High School for 3 months rent in advance. Show the journal entry to record the receipt on Nov. 1 st. Unearned rent revenue24,000 Cash24,000 Nov. 1 DebitCredit Cash 24,00024,000 DebitCredit Unearned Rent Revenue Adjusting Entries – “Unearned Revenues”

Example: On Nov. 1 st, Phoenix Corp. received $24,000 from Arcadia High School for 3 months rent in advance. Show the adjusting journal entry required on Nov. 30 th. Rent revenue 8,000 Unearned rent revenue 8,000 Nov. 30 Debit Credit Rent Revenue 8,00024,000 Debit Credit Unearned Rent Revenue Adjusting Entries – “Unearned Revenues” 8,000 16,000

Adjusting Entries – “Accrued Revenues” Revenues earned but not yet received in cash or recorded. Rent Interest Services performed BEFORE Accrued revenues often occur in regard to: Cash Receipt Revenue Recorded Adjusting entry results in:

Example: On January 1 st, Phoenix Corp. deposited $100,000 in a bank that return 12% interest per year. Show the journal entry to record the deposit on January 1 st. Cash100,000 Investments100,000January 1 DebitCredit Investments 100,000100,000 DebitCredit Cash Adjusting Entries – “Accrued Revenues”

Example: On January 1 st, Phoenix Corp. deposited $100,000 in a bank that return 12% interest per year. Show the adjusting journal entry required on January 31 st. Interest revenue1,000 Interest receivable1,000 January 31 Debit Credit Interest Receivable 1,0001,000 Debit Credit Interest Revenue Adjusting Entries – “Accrued Revenues”

Adjusting Entries – “Accrued Expenses” Expenses incurred but not yet paid in cash or recorded. Rent Taxes BEFORE Accrued expenses often occur in regard to: Cash Payment Expense Recorded Salaries Interest Adjusting entry results in:

Notes payable 200,000 Cash200,000 Feb. 2 DebitCredit Cash 200,000200,000 DebitCredit Notes Payable Adjusting Entries – “Accrued Expenses” Example:On Feb. 2 nd, Phoenix Corp. borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the journal entry to record the borrowing on Feb. 2 nd. Example: On Feb. 2 nd, Phoenix Corp. borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the journal entry to record the borrowing on Feb. 2 nd.

Example: On Feb. 2 nd, Phoenix Corp. borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the adjusting journal entry required on Feb. 28 th. Interest payable1,500 Interest expense1,500Feb. 28 DebitCredit Interest Expense 1,5001,500 DebitCredit Interest Payable Adjusting Entries – “Accrued Expenses”

1.Naqeeb paid rent $ 60,000 for 6 months of a buliding on November 1,2010.He is preparing financial statements on 31 st December, prepare adjusting entries. 2.Salman received 20,000 on 31 st September 2006 in advance for 4 months as advertisemnent charges, he is maintaining his books of accounts on 31 st December. Record adjusting entries for salman. 3.Saleem purchased a building on $50,000. its useful life is 12 years and residual value is $ 2000.Pass the original and adjusting entry at the end of 1 st year. 4.You have purchased shop supplies of $ At the end of period you have $6000 shop supplies,pass the necessary journal entries. 10/21/

Qs?Qs? 10/21/