Chapter 3 Accrual Accounting

Learning Objectives 1.Understand the concept and principles under accrual –basis accounting The time- period concept The accrual basis principle The revenue principle The matching principle Capital expenditure and revenue expenditure 2.Complete the accounting cycle The adjustment process Prepare the financial statements Understand how to close the books 3.Use the C/R and D/R to evaluate a business

一、 The concept and principles under accrual –basis accounting 1.Review the time- period concept Slice the time into small segment. To ensure the financial statement is reported at regular intervals. Produce the periodic accounting elements

2.The accrual –basis principle Used for measuring the profit(Rev.,Exp.) Record the transaction when it occurs. ---Record revenues as they are earned. ---Record expenses as they are incurred. Record both cash and noncash transactions. It’s the combination of revenue and matching principles.

3.The revenue principle (1)When to record revenue. The business has finished the earning process(earn): --- has delivered the good or performed the service to the customer, ---meanwhile has the right to collected the cash ---no matter whether the cash is received. (2) What amount of revenue should be recorded. The amount of revenue recorded should be equal to the cash value of the goods or services transferred to the customer. Exhibit 3-3

(3) 3 types of revenue earned Sale on cash +cash, +revenue Sale on credit +A/R, +revenue Collect cash in advance +cash, +unearned revenue +revenue, - unearned revenue

4.The matching principle (1)It’s the principle for recording expenses (2)When to record the expenses. Get benefit from the transaction. Have the responsibility to pay for the it.

(3)The meaning of match Related expenses and revenues should be recognized at the same period. If there’s cause-and-effect relationship, and subtract the expenses from the revenues that created the expenses. If not, the expenses should be associated with a time period.

(4) 3 types of expense occurred Benefit and pay at the same time +expense, -cash Pay first,benefit later---Prepaid +prepaid, -cash +expense, -prepaid Benefit first,pay later---accrued +expense, +liability - cash, -liability

5 、 Capital expenditure and revenue expenditure (1)Capital expenditure is referred to the expenditure that create revenue for several periods(recorded as asset)..(2)Revenue expenditure is referred to the expenditure that create revenue for current period(recorded as expense).

二. Complete the accounting cycle ( 四 )Adjusting the accounts to update the F.S. 1.Features of adjustments Based on the accrual basis Adjust the revenues,expenses(NI). Also adjust the related asset and liability accounts. Irrelevant with cash Made at the end of accounting period Without source documents

2.Category of adjustment Exhibit3-10,3-11 (1) deferrals: cash transactions occur before the recognition of Rev & Exp. Prepaid expenses: +expenses,-assets Unearned revenues: +revenues,-liabilities (2)Accruals: Rev & Exp occur before cash transactions. Accrued expenses: + expenses,+liabilities Accrued revenues: +revenues, +assets

3. The steps of adjusting process Make the adjusting entries Post the adjustment to ledger

( 五 )Preparing the adjusted trial balance It’s made after the adjustments. To check the final balances of all accounts Exhibit

( 六 )Preparing the Financial Statements from the adjusted trial balance Exhibit3-14, 3-15, 3-15, 3-17 Summary problem P126

( 七 )Closing the Books(Accounts) 1. Temporary(normal )accounts Revenue accounts Expense accounts Income summary accounts Dividend accounts The balances of these accounts should be closed and have a zero balance to begin the next accounting period.

2. Closing entries perform two functions Set the balances of temporary accounts to zero, and to prepare the accounts for the next period’s transactions. Transfer the balances of temporary accounts into retained earnings.

3.Permanent (real)accounts Assets Liability Owners’equity The balances of permanent accounts are carrying to the next period, need not be closed.

4. Steps of closing process (1)Make the closing entries Debit each revenue account for the amount of its credit balance; Credit income summary account. Credit each expense account for the amount of its dedit balance; Debit income summary account. Debit(credit) income summary account for the for the amount of its credit (debit)balance; Credit(debit) R.E Credit dividend account; Debit R.E

(2)Post the closing entries to accounts

5 、 The relationship of temporary accounts Revenue Income summary Expense R. E. Dividends

三、 Financial Statement Analysis 1.Current Ratio Total current assets/Total current liabilities Represents the amount of current assets for $1 current liabilities. Measures the company’s ability to pay current liabilities with current assets.

2.Debt Ratio Total liabilities/total assets Indicate the proportion of a company’s assets that is financed with debt. Measures a company’s ability to pay total liabilities.

P141 Summary Problem