2. Accrual Accounting Concepts
Chapter 4
Accrual Accounting Concepts

3. Time Period Assumption
Divides the economic life of a business into artificial time periods
Interim period (month, quarter)
Year (fiscal, calendar)
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4. Revenue Recognition Principle
Dictates that revenue be recognized in the accounting period in which it is earned
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5. Revenue Recognition Principle
Merchandising company
Revenue is earned when the merchandise is sold (normally at the point of sale)
Service company
Revenue is considered earned at the time the service is performed
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6. Discussion Questions
Discuss how revenue might be recognized for a construction company?
Compare this to how revenue might be recorded for a small convenience store.
Discussion points:
For Question 1 there is no need to describe percentage of completion vs. completed contract in great detail. Introduce the idea of there being different points for revenue recognition.
For question 2 note how the point at which revenue is earned is more distinct.
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7. Matching Principle
Requires that expenses be recorded in the same period in which the revenues they helped produce are recorded
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8. Discussion Question
Identify some expenses that can be easily matched to revenue and some that aren’t as easily directly matched to the revenue they help produce.
Discussion points:
Easily matched expenses: cost of goods sold, some salaries expense (e.g., direct labour)
Less easily matched expenses: some salaries expense (e.g., administrative salaries), depreciation expense, utilities expense
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9. Cash Basis of Accounting
Revenue is recorded only when cash is received
Expenses are recorded only when cash is paid
Not in accordance with GAAP
Violates revenue recognition and matching principles
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10. Accrual Basis Accounting
Revenue is recorded when earned, rather than when cash is received
Expenses are recorded when incurred, rather than when cash is paid
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11. Adjusting Entries
Adjusting entries are made to adjust or update accounts at the end of the accounting period
Adjusting entries can be categorized as
Prepayments
Accruals
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12. Types of Adjusting Entries
Prepayments
Prepaid expenses
Unearned revenues
Accruals
Accrued revenues
Accrued expenses
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13. Prepayments
Cash has been spent but the item acquired has not been used or consumed (prepaid expenses)
Cash has been collected but the revenue has not been earned (unearned revenues)
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14. Discussion Question Why are prepaid expenses a current asset?
Why are unearned revenues a current liability?
Discussion Points:
For prepaid assets use prepaid insurance as an example (future economic benefits)
For unearned revenues use deposits from customers as an example.
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15. Accruals Revenue has been earned, but not collected (accrued revenues)
Expenses were incurred, but not yet paid (accrued expenses)
Note: Entry has not yet been recorded!
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16. Adjusted Trial Balance
Proves the equality of total debit balances and total credit balances after the adjusting entries have been made
Financial statements can be easily prepared from the adjusted trial balance
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17. Closing the Books Closing entries
Transfer the temporary account balances to update the retained earnings account
Reduce the balances in the temporary accounts to zero to prepare for the next period’s postings
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18. All liability accounts
Temporary Permanent
All revenue accounts
All asset accounts
All expense accounts
All liability accounts
Dividends account
Shareholders’ equity
accounts
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19. Retained Earnings is a permanent account; the others shown here
are temporary
Individual Expenses
Retained Earnings
Income Summary
Individual Revenues
Dividends 1 3 4 2
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20. Post-Closing Trial Balance
Proves the equality of total debit balances and total credit balances after the closing entries have been made
Should contain only permanent accounts
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21. Required Steps in the Accounting Cycle
Analyze business transactions
Journalize the transactions
Post to general ledger accounts
Prepare a trial balance
Journalize and post adjusting entries (prepayments and accruals)
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22. Required Steps in the Accounting Cycle
Prepare an adjusted trial balance
Prepare financial statements
Journalize and post closing entries
Prepare a post-closing trial balance
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23. Copyright Notice
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