1. CHAPTER 4
Revenue and Expense Recognition

2. Accounting principles
Let’s Review
Accounting principles

3. Accounting Principles and Practices- Question
If you wish to pursue an accounting job with a focus on cost analysis and budget, you would pursue the path of a:
CPA (Certified Public Accountant)
CGA (Certified General Accountant)
CMA (Certified Management Accountant
CFO (Chief Financial Officer)

4. Accounting Principles and Practices- Question
The four characteristics of GAAP are:
Honesty, Trust, Fairness, Equality
Relevance, Reliability, Understandability, Comparability and Consistency
Relevance, Ethics, Understandability, Fairness
Reliability, Comparability and Consistency, Fairness, Honesty

5. Accounting Principles and Practices- Question
The following GAAP principle states that accounting for a business must be kept separate from the personal affairs of its owner.
Cost Principle
Conservatism Principle
Objectivity Principle
Economic Entity Principle

6. Accounting Principles and Practices- Question
Which of the following describes the consistency in the characteristic of Comparability and Consistency?
An expense must be recorded in the same accounting period in which it was used to generate revenue
All items must be capitalized except when they are not material
All information that affects the full understanding of financial statements must be included
Accounting methods can not be changed to manipulate figures

7. Accounting Principles and Practices- Question
True or False? The four fundamental characteristics are the same between GAAP and IFRS.
True
False

8. Checklist Chapter 4 Recognize Revenue Recognize Expenses
Purpose of Adjustments
Recording Adjustments

9. Revenue Recognition
Revenue must be recorded (recognized) whenever a service has been performed, not necessarily when cash is received.
When a business sells products or services, there are three ways to receive cash:
Customer pays cash when the service is performed
Customer pays cash after the service is performed
Customer pays cash before the service is performed
In all cases, revenue must be recognized when the service is performed or the product is sold.

10. Customer Pays When the Service is Performed
When a customer pays as soon as
the service is performed, two things
Must happen:
Cash must increase.
Equity must increase, which is
recorded as an increase to
service revenue.

11. Customer Pays After the Service is Performed
When a customer pays after
the service is provided, two things
must happen:
Accounts receivable must
increase.
Equity must increase, which is
recorded as an increase to
service revenue.

12. Accounts Receivable Accounts receivable is an asset.
It indicates that the customer owes the company money.
Services provided on “account” mean that the customer will pay later and an accounts receivable has been created.
At some point in the future, the customer will pay cash to reduce the amount owing.

13. Customer Pays After the Service is Performed
When a customer finally pays the amount
owing, two things must happen:
Accounts receivable must
decrease.
Cash must increase.
Revenue is not recorded since it was
recorded earlier, when the service was
provided.

14. Customer Pays Before the Service is Performed
Sometimes a customer will pay cash before services are provided.
If a business receives cash from a customer before services are provided, can they record service revenue at that time?
No, service revenue cannot be recorded because the business has not done anything to earn revenue.
The business owes services and must record the owed services as a liability called Unearned Revenue.

15. Unearned Revenue Unearned revenue is a liability.
The customer has provided a deposit for future services.
It indicates that the business owes the customer services at some point in the future.

16. Customer Pays Before the Service is Performed
When a customer pays before the service
is provided, two things must happen:
Cash must increase.
Unearned revenue must increase, which is
a liability.
Owner’s equity does not change, no work
has been done and no revenue is recorded.

17. Customer Pays Before the Service is Performed
When the service is finally performed,
two things must happen:
Unearned revenue must decrease.
Equity must increase, which is
recorded as an increase to
service revenue.
Cash does not change since the
customer already paid.

18. Revenue Recognition - Question
You provide services to a customer, who will pay later. How is that recorded?
Increase cash, increase service revenue
Increase accounts receivable, increase service revenue
Increase accounts receivable, increase unearned revenue
Decrease accounts receivable, increase service revenue

19. Revenue Recognition - Question
You receive cash from a customer as a deposit for future services. How is that recorded?
Increase cash, increase unearned revenue
Increase cash, increase service revenue
Decrease unearned revenue, increase service revenue
Increase cash, decrease unearned revenue

20. Revenue Recognition - Question
You provide services to a customer, who pays immediately. How is that recorded?
Increase cash, increase unearned revenue
Increase accounts receivable, increase service revenue
Decrease unearned revenue, increase service revenue
Increase cash, increase service revenue

21. Revenue Recognition - Question
A customer paid a deposit two months ago, and this month you now provide the services. How is that recorded?
Increase cash, increase unearned revenue
Increase accounts receivable, increase service revenue
Decrease unearned revenue, increase service revenue
Increase cash, increase service revenue

22. Revenue Recognition - Question
Last month you provided services to a customer on account, and this month you receive payment. How is that recorded?
Increase cash, increase unearned revenue
Increase cash, decrease accounts receivable
Increase cash, decrease unearned revenue
Increase cash, increase service revenue

23. Checklist Chapter 4 Recognize Revenue Recognize Expenses
Purpose of Adjustments
Recording Adjustments

24. Expense Recognition
Expenses must be recorded (recognized) whenever they have been incurred, not necessarily when cash is paid.
There are three possible ways to pay for an expense:
Cash is paid when the expense is incurred
Cash is paid after the expense has been incurred
Cash is paid before the expense is incurred

25. Cash Paid When Expense is Incurred
When cash is paid when an expense
is incurred, two things must
happen:
Cash must decrease.
Equity must decrease, which is
recorded as an increase to an
expense.

26. Cash Paid After Expense has been Incurred
When cash is paid after an expense
is incurred, two things must
happen:
Accounts payable must increase.
Equity must decrease, which is
recorded as an increase to an
expense.

27. Accounts Payable Accounts payable is a liability.
It indicates that the business owes a supplier money (has a debt).
Items or services purchase on “account” mean the business will pay later and an accounts payable has been created.
At some point in the future, the business will pay cash to reduce the debt.

28. Cash Paid After Expense has been Incurred
When the business finally pays the debt,
two things must happen:
Accounts payable must
decrease.
Cash must decrease.
Expenses are not recorded since they were
recorded earlier, when the expense was
incurred.

29. Cash Paid Before Expense is Incurred
Sometimes a business will pay cash before expenses occur.
If a business pays cash to a supplier before expenses occur, can they record expenses at that time?
No, expenses cannot be recorded because the business has not actually incurred the expenses yet.
The business owns the items or the service contract (i.e. insurance policy) and must record these as an asset called Prepaid Expenses.

30. Prepaid Expenses Prepaid expense is an asset.
Separate prepaid expense accounts would exist for items such as rent, insurance, office supplies, or any other item that is paid for before it is used.
It indicates that the business owns the item or service contract.
Eventually, the prepaid expense will be used and become an expense.

31. Cash Paid Before Expense is Incurred
When the business prepays for a one year
insurance policy, two things must happen:
Cash must decrease.
Prepaid insurance must increase.
Owner’s equity does not change, no
expenses have been incurred so no
expenses will be recorded.

32. Cash Paid Before Expense is Incurred
When the one month of insurance is
finally used, two things must happen:
Prepaid insurance must decrease.
Equity must decrease, which is
recorded as an increase to an
expense.
Cash does not change since the
expense has already been paid.

33. Expense Recognition - Question
You receive a bill for advertising and will pay the bill next month. How is this recorded?
Decrease cash, increase advertising expense
Increase accounts payable, increase advertising expense
Decrease cash, increase prepaid advertising
Decrease cash, decrease accounts payable

34. Expense Recognition - Question
You prepay six months worth of rent with cash. How is this recorded?
Decrease cash, increase prepaid rent
Decrease cash, increase rent expense
Decrease prepaid rent, increase rent expense
Increase accounts payable, increase prepaid rent

35. Expense Recognition - Question
You pay an employee’s salary with cash. How is this recorded?
Decrease cash, increase prepaid salary
Increase accounts payable, increase salary expense
Decrease prepaid salary, increase salary expense
Decrease cash, increase salary expense

36. Expense Recognition - Question
Last month you prepaid for six months of rent, and now you have used one month of rent. How is this recorded?
Decrease cash, increase prepaid rent
Increase accounts payable, increase rent expense
Decrease prepaid rent, increase rent expense
Decrease cash, increase rent expense

37. Expense Recognition - Question
Last month you receive an advertising bill, and this month you finally pay the bill. How is this recorded?
Decrease cash, increase prepaid advertising
Decrease cash, decrease accounts payable
Increase accounts payable, increase advertising expense
Decrease cash, increase advertising expense

38. Checklist Chapter 4 Recognize Revenue Recognize Expenses
Purpose of Adjustments
Recording Adjustments

39. Purpose of Adjustments
Adjustments are transactions that conform to accrual accounting. They:
Occur at the end of an accounting period.
Update assets and liabilities on the balance sheet.
Update revenue and expenses on the income statement.
Do not involve an exchange of cash, since adjustments are just rearranging values in the company.

40. Checklist Chapter 4 Recognize Revenue Recognize Expenses
Purpose of Adjustments
Recording Adjustments

41. Adjustments: Unearned Revenue
Unearned revenue represents
services that are owed.
At the end of the period, calculate
how much work was actually done
to fulfill the obligation.
The amount of work completed
is adjusted as a decrease to
unearned revenue and an
increase to service revenue.

42. Adjustments: Prepaid Expenses
Prepaid expenses represent
items or services paid for in
advance.
At the end of the period, calculate
how much of the prepaid item
was used.
The amount of the
prepaid item that was used
is adjusted as a decrease to
prepaid expenses and an increase
to an expense.

43. Adjustments: Accrued Expenses
Some expenses are incurred in a period but not recorded because nothing happens to trigger a transaction. They will be recorded at the end of the period.
Interest owed on a bank loan may not be paid until the following month, or paid when the bank loan is due.
Despite not paying the interest with cash during the month, the interest expense must still be recorded.
The amount of interest owed must also be recorded as a liability since the business will eventually have to pay the amount due.

44. Adjustments: Accrued Expenses
Accrued expenses represent
expenses incurred but not
yet paid.
At the end of the period, calculate
how much the expense
is worth.
The amount of the accrued
expense is adjusted as an increase
to a liability and an increase to
an expense.

45. Adjustments: Depreciation
Depreciation spreads the value of
property, plant and equipment over
several years. It effectively decreases
the value of these assets.
Depreciation expense is recorded
on the income statement.
Property, plant and equipment
will decrease in value.
Accounting records must show
the historical value (original price)
of the assets, yet still record a decrease in value.

46. Adjustments: Exercise
On March 1, 2013, Birch Company prepaid $4,000 for an eight month advertising contract. On March 31, 2013, Birch Company had used one month of the advertising contract. Record the transaction on March 31, 2013 using the appropriate T-accounts.
+ CASH -
INCREASE (DR) DECREASE (CR)
- ACCOUNTS PAYABLE +
DECREASE (DR) INCREASE (CR)
+ PREPAID ADVERTISING -
INCREASE (DR) DECREASE (CR)
+ ADVERTISING EXPENSE -
INCREASE (DR) DECREASE (CR)
$500
$500

47. Adjustments: Exercise
On May 25, 2013, Oak Company received $2,000 cash from a customer as a deposit for future services. On June 30, 2013, Oak Company had provided $1,500 worth of services for the customer. Record the transaction on June 30, 2013 using the appropriate T-accounts.
+ CASH -
INCREASE (DR) DECREASE (CR)
- UNEARNED REVENUE +
DECREASE (DR) INCREASE (CR)
$1,500
+ ACCOUNTS RECEIVABLE -
INCREASE (DR) DECREASE (CR)
- SERVICE REVENUE +
DECREASE (DR) INCREASE (CR)
$1,500

48. Checklist Chapter 4 Recognize Revenue Recognize Expenses
Purpose of Adjustments
Recording Adjustments

49. Complete the following exercise.

50. Review Exercise
Ash Company had the following transactions for the month of July Record each transaction in T-Accounts. July 2: Provided services to a customer and immediately received $1,200 cash.
+ CASH -
INCREASE (DR) DECREASE (CR)
- SERVICE REVENUE +
DECREASE (DR) INCREASE (CR)
$1,200
$1,200
July 3: Received a telephone bill for $350 which will be paid later.
- ACCOUNTS PAYABLE +
DECREASE (DR) INCREASE (CR)
+ TELEPHONE EXPENSE -
INCREASE (DR) DECREASE (CR)
$350
$350

51. Review Exercise
July 4: Prepaid a one year insurance policy for $1,800 cash.
+ CASH -
INCREASE (DR) DECREASE (CR)
+ PREPAID INSURANCE -
INCREASE (DR) DECREASE (CR)
$1,800
$1,800
July 8: Received $5,200 cash from a customer as a deposit for future work.
+ CASH -
INCREASE (DR) DECREASE (CR)
- UNEARNED REVENUE +
DECREASE (DR) INCREASE (CR)
$5,200
$5,200
July 15: Provided services to a customer who will pay $800 later.
+ ACCOUNTS RECEIVABLE -
INCREASE (DR) DECREASE (CR)
- SERVICE REVENUE +
DECREASE (DR) INCREASE (CR)
$800
$800

52. Review Exercise July 21: Paid the $350 telephone bill from July 3.
+ CASH -
INCREASE (DR) DECREASE (CR)
- ACCOUNTS PAYABLE +
DECREASE (DR) INCREASE (CR)
$350
$350
July 31: One month of the 12 month, $1,800 insurance policy was used.
+ PREPAID INSURANCE -
INCREASE (DR) DECREASE (CR)
+ INSURANCE EXPENSE -
INCREASE (DR) DECREASE (CR)
$150
$150
July 31: Completed $2,000 worth of work that was previously unearned.
- UNEARNED REVENUE +
DECREASE (DR) INCREASE (CR)
- SERVICE REVENUE +
DECREASE (DR) INCREASE (CR)
$2,000
$2,000

53. End of Chapter 4