1 PowerPointPresentation by PowerPoint Presentation by Gail B. Wright Professor of Accounting Bryant University © Copyright 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South-Western are trademarks used herein under license. FINANCIAL ACCOUNTING 2 ND EDITION BY DUCHAC, REEVE, & WARREN 3 Accrual Accounting Concepts

2 LEARNING GOALS When you finish this chapter, you should be able to

3 1.Describe basic accounting concepts including matching concept. 2.Use accrual concepts to analyze, record, & summarize transactions. 3.Describe, illustrate end-of-period adjustment process. LEARNING GOALS Continued

4 LEARNING GOALS 4.Prepare financial statements using accrual concepts. 5.Describe how accrual basis of accounting enhances interpretation. 6.Describe the accounting cycle for accruals. 7.Describe, illustrate common-sized financial statements.

5 WENDY’S INTERNATIONAL Wendy’s  Has over 4,000 restaurants  Succeeds through innovation  1 st Salad bar in fast food restaurant  Made-to-order sandwiches  Responsive to customers

6 LEARNING GOALS 1 Describe basic accounting concepts.

7 ACCRUAL CONCEPT LG 1 Transactions Are recorded as they occur Are recorded even if cash not received or paid Affect accounting equation (A = L + E)

8 ACCRUAL MEANS Revenue recognized (recorded) when earned Liabilities recognized when obligation incurred Revenue recognized (recorded) when earned Liabilities recognized when obligation incurred LG 1

9 MATCHING PRINCIPLE LG 1 Expenses recognized, recorded in same period as related revenue

10 MATCHING MEANS When revenue is recorded –Expenses incurred in generating revenues are Identified Recorded Matching subtracts expenses from revenue to determine net income or loss When revenue is recorded –Expenses incurred in generating revenues are Identified Recorded Matching subtracts expenses from revenue to determine net income or loss LG 1

11 LEARNING GOALS 2 Use accrual concepts to analyze, record, & summarize transactions.

12 FAMILY HEALTH CARE, PC Earns revenue when services provided to patients –Earnings process complete –Patient obligated to pay Incurs expenses to earn revenue –Recognize expenses according to matching principle LG 2

13 HEALTH CARE, PC Transactions for November Transactions include –Revenue Cash and on account –Acquiring insurance Incurring insurance expense –Buying equipment Recording depreciation expense –Other LG 2

14 TRANSACTION (a) Family Health Care, PC receives rent in advance. LG 2

15 Assets =Liabilities +Equity Cash + Land =Note + Unearned rev +Stock + Ret Earn Bal Oct7, ,000 =10,0006, ,320 Rent1,800 = 1,800 Bal 9, ,000 =10, ,8006, ,320 Cash Flows Balance Sheet Income Statement IFSF: Advance Rent (a) Operating 1,800 Family Health Care, PC receives rent in advance. LG 2

16 TRANSACTION (b) Family Health Care, PC buys a 2 year policy for general business insurance. LG 2

17 Assets =Liabilities +Equity Cash + Prepaid Ins + Land =Note + Unearned +Equity Balances 9, ,000=10, ,800 9,320 Insurance-2, ,400 = Balances 6, , ,000=10, ,800 +9,320 Cash Flows Balance Sheet Income Statement IFSF: Business Insurance (b) Operating -2,400 Family Health Care, PC buys 2 year business insurance policy LG 2

18 TRANSACTION (c) Family Health Care, PC buys a 6 month malpractice insurance policy. LG 2

19 Assets =Liabilities +Equity Cash + Prepaid Ins + Land =Note + Unearned +Equity Balances 6, , ,000=10, ,800 +9,320 Insurance-6, ,000 = Balances , ,000=10, ,800 +9,320 Cash Flows Balance Sheet Income Statement IFSF: Malpractice Insurance (c) Operating -6,000 Family Health Care, PC buys 6 mo. malpractice insurance policy LG 2

20 TRANSACTION (d) Dr. Landry invests an additional $5,000 in Family Health Care, PC. LG 2

21 Assets =Liabilities +Equity Cash + Other =Note + Unearned +Stock + Ret Earn Balances ,400 =10, ,800 +6, ,320 Issued stock 5,000 =5,000 Balances5, ,400 =10, , , ,320 Cash Flows Balance Sheet Income Statement IFSF: Stock (d) Financing 5,000 Dr. Landry invests in practice LG 2

22 TRANSACTION (e) Family Health Care, PC buys supplies on account. LG 2

23 Assets = Liabilities +Equity Cash + Supplies + Other =Acct Pay + OtherEquity Balances 5, ,400 = + 11, ,320 Supplies = 240 Balances5, ,400 = , ,320 Cash Flows Balance Sheet Income Statement IFSF: Supplies On Account (e) Family Health Care, PC purchased supplies on account. LG 2

24 TRANSACTION (f) Family Health Care, PC buys equipment with $1,700 down payment and a note for $6,800. LG 2

25 Assets = Liabilities +Equity Cash + Equip + Other =Note + OtherEquity Balances 5, ,640 =10, , ,320 Equipment-1, ,500 = 6,800 Balances4, , ,640 =16, , ,320 Cash Flows Balance Sheet Income Statement IFSF: Bought Equipment (f) Family Health Care, PC bought equipment. Investing -1,700 LG 2

26 TRANSACTION (g) Family Health Care, PC provides services to patients on account. LG 2

27 Assets =Liabilities +Equity Cash + Acct rec. + Other =Liabilities +Stock + Ret Earn Balances4, ,140 =18, , ,320 Fees 6,100 = 6,100 Balances4, , ,140 =18, , ,420 Cash Flows Balance Sheet Income Statement IFSF: Services On Account (g) Family Health Care, PC performed services on account. Revenue 6,100 LG 2

28 TRANSACTION (h) Family Health Care, PC provided services to patients and received $5,500 cash. LG 2

29 Assets =Liabilities +Equity Cash + Acct rec. + Other =Liabilities +Stock + Ret Earn Balances4, , ,140 =18, , ,420 Fees5,500 = 5,500 Balances9, , ,140 = 18, , ,920 Cash Flows Balance Sheet Income Statement IFSF: Services For Cash (h) Family Health Care, PC performed services for cash. Revenue 5,500 Operating 5,500 LG 2

30 TRANSACTION (i) Family Health Care, PC received $4,200 from insurance company payment. LG 2

31 LG 2 Assets =Liabilities +Equity Cash + Acct rec. + Other =Liabilities +Stock + Ret Earn Balances9, , ,140 = 18, , ,920 Payment4, ,200 = Balances13, , ,140 = 18, , ,920 Cash Flows Balance Sheet Income Statement IFSF: Received Insurance Payment (i) Family Health Care, PC received insurance payment on account. Operating 4,200

32 TRANSACTION (j) Family Health Care, PC paid money on account. LG 2

33 Assets =Liabilities +Equity Cash + Acct rec. + Other =Acct pay + OtherEquity Balances13, , ,140 = , ,920 Payment -100 = Balances13, , ,140 = , ,920 Cash Flows Balance Sheet Income Statement IFSF: Received Insurance Payment (j) Family Health Care, PC received insurance payment on account. Operating -100 LG 2

34 TRANSACTION (k) Family Health Care, PC provides services to patients on account. LG 2

35 Assets =Liabilities +Equity Cash + Acct rec. + Other =LiabilitiesStock + Ret Earn Balances13, , ,140 = 18, , ,920 Payment -4,690 = -4,690 Balances8, , ,140 = 18, , ,230 Cash Flows Balance Sheet Income Statement IFSF: Paid November Expenses (k) Family Health Care, PC paid November expenses. Operating -4,690 Expenses -4,690 LG 2

36 TRANSACTION (l) Family Health Care, PC paid dividend to Dr. Landry. LG 2

37 Assets =Liabilities +Equity Cash + Acct rec. + Other =LiabilitiesStock + Ret Earn Balances8, , ,140 = 18, , ,230 Payment-1,200 = -1,200 Balances7, , ,140 = 18, , ,030 Cash Flows Balance Sheet Income Statement IFSF: Paid Dividend (l) Family Health Care, PC paid dividend to Dr. Landry. Financing 1,200 LG 2

38 LEARNING GOALS 3 Prepare end of period adjustments.

39 ADJUSTMENT PROCESS Applies matching concept To complete balance sheet, income statement Applies matching concept To complete balance sheet, income statement LG 3

40 LG 3 EXHIBIT 1 1/1/200712/31/20081/1/200812/31/2008 Deferrals Revenue earned, expense incurred Cash received, paid

41 DEFERRALS Cash paid before expense incurred or cash received before revenue recognized Examples: –Prepaid expenses (insurance) –Unearned revenues LG 3

42 FAMILY HEALTH CARE, PC Deferrals Deferred expenses –Prepaid insurance expired, $1,100 –Supplied used, $150 –Depreciation on equipment, $160 Deferred revenues –Unearned rent revenue earned, $360 LG 3

43 Assets =LiabilitiesEquity Cash + Prepaid Ins+ Other =Liabilities+Stock + Ret Earn Balances7, , ,640 = 18, , ,030 Insurance expense - 1,100 = -1,100 Balances7, , ,640 = 18, , ,930 Cash Flows Balance Sheet Income Statement IFSF: Prepaid Insurance ( AJE 1) Family Health Care, PC recognized insurance used up. LG 3 Ins Exp - 1,100

44 Assets =Liabilities+Equity Cash + Supplies + Other =Liabilities+Stock + Ret Earn Balances7, ,700 = 18, , ,930 Supplies expense = -150 Balances7, ,700 = 18, , ,780 Cash Flows Balance Sheet Income Statement IFSF: Supplies ( AJE 2) Family Health Care, PC recognized supplies used up. LG 3 Supp Exp - 150

45 Assets =Liabilities+Equity Cash + Acc Dep + Other =Liabilities+Stock + Ret Earn Balances7, ,790 = 18, , ,780 Depreciation expense = -160 Balances7, ,790 = 18, , ,620 Cash Flows Balance Sheet Income Statement IFSF: Depreciation ( AJE 3) Family Health Care, PC recognized depreciation on equipment. LG 3 Dep Exp - 160

46 Assets =Liabilities+Equity Cash + Other =Unearned + Other +Stock + Ret Earn Balances7, ,630 = 1, , , ,620 Unearned rent = Balances7, ,630 = 1, , , ,980 Cash Flows Balance Sheet Income Statement IFSF: Unearned Rent ( AJE 4) Family Health Care, PC recognized rent revenue. LG 3 Rent Rev 360

47 LG 3 1/1/200712/31/20081/1/200812/31/2008 Accruals Cash received or paid Revenue earned, expense incurred EXHIBIT 1 (cont.)

48 ACCRUALS Recognize expense before cash is paid or recognize revenue before cash is received Examples: –Accrued expenses (interest expense) –Accrued revenues (for services provided but not billed) LG 3

49 FAMILY HEALTH CARE, PC Accruals Accrued expense –Wages owed but not paid, $220 Accrued revenues –Services provided, not billed, $750 LG 3

50 Assets =Liabilities+Equity Cash + Other =Wages pay + Other +Stock + Ret Earn Balances7, ,630 = 18,380+11, ,980 Wages Expense = Balances7, ,630 = , , ,760 Cash Flows Balance Sheet Income Statement IFSF: Wages Expense ( AJE 5) Family Health Care, PC incurred wages expense. LG 3 Wages exp - 220

51 Assets =Liabilities+Equity Cash + Acc Rec + Other =Liabilities+Stock + Ret Earn Balances7, , ,730 =18,60011, ,760 Fees earned 750 = 750 Balances7, , ,730 = 18, , ,510 Cash Flows Balance Sheet Income Statement IFSF: Fees Earned ( AJE 6) Family Health Care, PC earned revenue. LG 3 Fees earned 750

52 EXERCISE 3-6a Indicate whether the following are deferred (prepaid) expense. a)Fees earned, not received b)Tax owed, not paid c)Salary owed, not paid d)Supplies on hand e)Fees received, not earned LG 2 f)Utilities owed, not paid g)2-yr premium paid on insurance h)Subscriptions received in advance Click the button to skip this exercise

53 EXERCISE 3-6b Indicate whether the following are deferred (unearned) revenue. a)Fees earned, not received b)Tax owed, not paid c)Salary owed, not paid d)Supplies on hand e)Fees received, not earned LG 3 f)Utilities owed, not paid g)2-yr premium paid on insurance h)Subscriptions received in advance Click the button to skip this exercise

54 EXERCISE 3-6c Indicate whether the following are accrued expense (liability). a)Fees earned, not received b)Tax owed, not paid c)Salary owed, not paid d)Supplies on hand e)Fees received, not earned LG 3 f)Utilities owed, not paid g)2-yr premium paid on insurance h)Subscriptions received in advance Click the button to skip this exercise

55 EXERCISE 3-6d Indicate whether the following are accrued revenue (asset). a)Fees earned, not received b)Tax owed, not paid c)Salary owed, not paid d)Supplies on hand e)Fees received, not earned LG 3 f)Utilities owed, not paid g)2-yr premium paid on insurance h)Subscriptions received in advance Click the button to skip this exercise

56 LEARNING GOALS 4 Prepare financial statements using accrual concepts.

57 FINANCIAL STATEMENTS Health Care PC prepares financial statements to summarize financial activity for November after adjustments 4 Financial Statements are –Income statement –Retained earnings statement –Balance sheet –Cash flow statement LG 4

58 LG 4 EXHIBIT 3 Continued

59 LG 4 Continued

60 LG 4 Continued

61 LG 4

62 Statement of cash flows linked to cash on balance sheet Net income from income statement linked to retained earnings statement Retained earnings linked to balance sheet in stockholders’ equity INTEGRATED FINANCIAL STATEMENTS LG 4

63 LG 4 EXHIBIT 5

64 LEARNING GOALS 5 Describe how accrual basis of accounting enhances interpretation.

65 ACCRUAL ACCOUNTING Accrual accounting enhances interpretation –By following a standard set of rules (GAAP) for Recording Reporting –Is a better predictor of long-term profitability LG 5

66 LEARNING GOALS 6 Describe accounting cycle for accruals.

67 ACCOUNTING CYCLE Identify, analyze, record transactions Identify, analyze, record adjustment data Prepare financial statements Prepare accounting records for next period LG 6

68 LEARNING GOALS 7 Describe, illustrate common sized financial statements.

69 COMMON SIZED STATEMENTS Useful in comparing one company to another Use vertical analysis as basis for comparison LG 7

70 Income StatementWENDY’SMcDONALD’S Revenues100.0% Operating expenses Operating income6.2%18.6% Other expenses Income before tax5.0%16.8% Income taxes Net income1.4%12.0% LG 7 WENDY VS. McDONALD’S Common Size Income Statement

71 Wendy’s has higher operating expenses than McDonald’s McDonald’s has higher tax and other expense than Wendy’s Wendy’s earns significantly less (1.4%) profit on every dollar of sales than McDonald’s (12%) LG 7 ANALYSIS

72 AssetsWENDY’SMcDONALD’S Current assets14.3%10.3% Other long-term assets Property & equipment Total assets100.0% LG 7 WENDY VS. McDONALD’S Common Size Balance Sheet 1

73 Liabilities & Equity)WENDY’SMcDONALD’S Current liabilities21.5%12.6% Other liabilities Total stockholders’ equity Total liabilities& equity 100.0% LG 7 WENDY VS. McDONALD’S Common Size Balance Sheet 2

74 Wendy’s current assets and current liabilities are higher than McDonald’s McDonald’s has higher long term liabilities than Wendy’s Wendy’s uses slightly higher equity financing than McDonald’s LG 7 ANALYSIS

75 THE END CHAPTER 3