1. Recognition and Measurement
I know I need to record this...
Recognition: formally recording an item in the financial statements of an entity
Measurement:
quantification of the
economic effects of
the item on the entity
...but at
current value
or historical
cost?
LO1

2. Cash vs. Accrual Basis Cash basis: revenues and expenses are
recorded only when cash is received or paid
Accrual basis: revenues are recognized when
earned; expenses are recognized when incurred
LO2

3. Accrual basis statement
Cash basis
statement
Accrual basis statement
Income
Statement
Net income:
$ 7,000
Statement of
Cash Flows
Cash flows from
operating activities:
$(4,000)
What accounts for
the difference?

4. Revenue Recognition Principle
Revenue is recognized when realized and earned—usually at time of sale
Exceptions:
Long-term contracts
Franchises
Commodities
Installment sales
Rent and interest
LO3

5. Match expenses with associated revenues
Matching Principle
Match expenses with associated revenues
Directly
Indirectly over
period they
provide benefits
Simultaneously
upon their
acquisition
e.g. Inventory
e.g. Buildings
e.g. Utilities
LO4

6. Expense Recognition Balance Sheet Income Statement ASSETS: EXPENSES:
PP&E
Intangibles
ASSETS:
EXPENSES:
when sold
Cost of goods sold
Inventory
Supplies
Prepaid assets
as used
Supplies expense
Insurance expense
Rent expense
Depreciation expense
Amortization expense
over period they
provide benefits l
Other expenses
(as incurred)

7. RECOGNIZE REVENUE OR EXPENSES BEFORE OR AFTER CASH IS EXCHANGED
Types of Adjustments
Deferred
expense
Accrued
liability
RECOGNIZE REVENUE OR EXPENSES
BEFORE OR AFTER CASH IS EXCHANGED
Accrued
asset
Deferred
revenue
LO5

8. Deferred Expense Cash paid before expense is incurred
Examples:
Prepaid rent
Prepaid insurance
Office supplies
Property and equipment
Costs are initially recorded as assets and allocated to expenses in future periods

9. Deferred Expense Example
Prepay $2,400 for insurance for one year on September 1.

10. Deferred Expense Example
September 30 adjustment to recognize insurance expense:
$2,400 / 12 months = $200 /month

11. Deferred Revenue Cash received before revenue is earned
Examples:
Insurance collected in advance
Subscriptions collected in advance
Gift certificates
Receipts are initially recorded as liabilities (unearned or refundable receipts) and recorded as revenues in future periods when earned

12. Deferred Revenue Example
Received $2,400 for an insurance policy in advance:

13. Deferred Revenue Example
Monthly adjustment:
($2,400 annual × 1/12 = $200 per month for 12 months)

14. Accrued Liability Expense incurred before cash is paid
Examples:
Payroll
Taxes
Interest
Record expense (and corresponding liability) in period incurred; pay for it in a future period
No cash flow on recording, only when paid

15. Accrued Liability Example
Biweekly wages are $280,000

16. Accrued Liability Example
At end of month, between pay periods:

17. Accrued Liability Example
Next payday:

18. Accrued Asset Revenue earned before cash is received
Examples:
Rent
Interest
Record revenue (and corresponding receivable) in period earned; receive payment in a future period

19. Accrued Asset Example
Rent payment of $2,500 due within first 10 days of month

20. Accrued Asset Example
Upon receipt of cash:

21. Adjustments Summary Examples: Deferred Expense
cash received before expense is incurred
Deferred Revenue
cash received before revenue is earned
Accrued Liability
expense incurred before cash is paid
Accrued Asset
revenue is earned before cash is received
Adjustments Summary

22. Steps in the Accounting Cycle
1. Collect and
analyze info
7. Close the
accounts
2. Journalize
transactions
6. Record and
post adjusting
entries
3. Post
transactions to
general ledger
5. Prepare
financial
statements
4. Prepare
work sheet
LO6

23. The Closing Process Purpose: To return the balance of revenue,
expense, and dividend accounts to
zero to begin the next period
to transfer the net income (or loss) and dividends of the period to Retained Earnings

24. End of Chapter 4