1. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Accrual Accounting Concepts Chapter 3

2. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Learning Objectives After studying this chapter, you should be able to: Describe basic accrual accounting concepts, including the matching concept Use accrual concepts of accounting to analyze, record, and summarize transactions Describe and illustrate the end-of-period adjustment process Prepare financial statements using accrual concepts of accounting, including a classified balance sheet Describe how the accrual basis of accounting enhances the interpretation of financial statements Financial Analysis: Describe and illustrate the use of working capital, the current ratio, and the quick ratio in assessing a company’s liquidity

3. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Describe the basic accrual accounting concepts, including the matching concept Learning Objective 1

4. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Why is Accrual Accounting Needed? Expense incurred Cash received or paid Revenue earned

5. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Accruing Revenue ______ Recognized ______ Recognized Service provided Customer invoiced Cash received

6. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Accruing Expenses Receive invoice for purchase Materials purchased Invoice paid ______ Recognized ______ Recognized

7. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Matching Principle Records ________ as it is earned and matches ________ against the ___________ they generate Records ________ as it is earned and matches ________ against the ___________ they generate

8. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Use accrual concepts of accounting to analyze, record, and summarize transactions Learning Objective 2

9. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Accrual Concepts – Family Health Care Transactions Services are provided to patients Insurance is filed, payment to be received in the future Revenue is earned when the service is provided to the patient Expenses are incurred for items such as supplies where payment may be made in the future Expenses are recorded as they are incurred, not as they are paid

10. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Family Health Care – Rent Received in Advance Family Health Care, P.C. received $1,800 from ILS Company as rent for use of its land Amount received is reported as a _____ until the revenue is actually earned

11. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Family Health Care – Prepaid Expenses Family Health Care, P.C. buys a two-year business insurance policy and pays $2,400 in cash Amount paid is reported as _________ until the insurance is actually used up

12. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Family Health Care – Prepaid Expenses Family Health Care, P.C. buys a six-month medical malpractice insurance policy and pays a premium in cash of $6,000

13. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Family Health Care – Additional Capital Investment Dr. Landry invests an additional $5,000 in the business in exchange for capital stock

14. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Family Health Care – Purchase on Account Family Health Care, P.C. purchases $240 of supplies on account Amount purchased is reported as an asset until the supplies are used in operations Amount purchased is reported as a liability

15. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Family Health Care – Purchase of Equipment Purchased office equipment by making a $1,700 cash down payment and having five additional monthly installments of $1,360 Cash down payment Remaining balance due Total Asset Value

16. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Family Health Care – Services Provided on Account Provided services of $6,100 to patients on account _____ is recorded when service is provided and invoiced

17. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Family Health Care – Services Provided for Cash Performed services to patients who paid with cash in the amount of $5,500

18. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Family Health Care – Collection of Accounts Receivable Received $4,200 in cash payments from patients’ insurance companies for prior services performed.

19. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Family Health Care – Payment of Accounts Payable Paid $100 for supplies previously purchased on account

20. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Family Health Care – Expenses Paid in Cash Incurred expenses for the month of November and paid cash for a total of $4,690

21. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Family Health Care – Dividends Paid in Cash Family Health Care, P.C. paid dividends of $1,200

22. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Describe and illustrate the end-of-period adjustment process Learning Objective 3

23. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Summary of Accruals and Deferrals

24. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Deferrals ____________ __________ ____________ __________ ______________ _____________ ____________ ______________ _____________ ____________ Deferrals Accruals ____________ __________ ____________ __________ ______________ _____________ ____________ ______________ _____________ ____________ Accruals Deferrals and Accruals

25. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Deferred Expenses – Prepaid Insurance As prepaid insurance expires, the asset, Prepaid Insurance, decreases Adjustments affect both the ____ ____ account and the ____ ____ account

26. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Deferred Expenses – Supplies During November, $150 of supplies was used in operations leaving a balance of $90

27. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Fixed Assets and Depreciation Equipment used to generate revenue over time Equipment used to generate revenue over time Equipment purchased Equipment purchased _____________

28. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Deferred Expenses – Depreciation The depreciation on Office Equipment for Family Health Care is assumed to be $160 per month.

29. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Deferred Revenue – Unearned Rent On November 1, Family Health Care had received $1,800 from ILS for rental of land for five months. The portion of revenue earned by the end of November is to be recorded.

30. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Accrued Expenses – Wages Owed Wages earned End of month Pay Day

31. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Accrued Expenses – Wages Owed The amount owed for wages not paid is $220

32. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Accrued Revenues – Patient Services Family Health Care provides services worth $750 to patients and have not billed for these services at the end of the month

33. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Prepare financial statements using accrual concepts of accounting, including a classified balance sheet Learning Objective 4

34. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Summary of Transactions for Family Health Care Family Health Care, P.C. prepares the four required financial statements to summarize November activity after adjustments

35. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Income Statement

36. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Retained Earnings Statement

37. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Balance Sheet

38. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Statement of Cash Flows

39. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. How the Financial Statements Integrate

40. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Describe how the accrual basis of accounting enhances the interpretation of financial statements Learning Objective 5

41. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Cash vs. Accrual Accounting Cash BasisAccrual Basis Revenue is recordedWhen cash is _____When revenue is _____ Expense is recordedWhen cash is _____When expense is _____ in generating income Adjusting entriesNot requiredRequired in order to prepare _____ _____

42. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Importance of Accrual Accounting ____________ accounting provides a more accurate measure of company performance

43. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Accrual Accounting and the Accounting Cycle The Accounting Cycle ________ Transactions ________ Transactions Prepare ________ _________ Prepare ________ _________ Record ___________ Record ___________ Record __________ Record __________

44. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Financial Analysis: Describe and illustrate the use of working capital, the current ratio, and the quick ratio in assessing a company’s liquidity Learning Objective 6

45. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Financial Analysis A company’s liquidity is its ability to convert _____ to _____ Measures to assess a company’s liquidity _____ _____

46. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Working Capital Working Capital = _____ _____ − _____ _____ Current assets: Cash and other assets that are expected to be converted to cash, sold, or used up within one year or less through normal operations The larger the amount of working capital, the more likely a company will be able to pay its current liabilities

47. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Current Ratio Measures a relationship among amounts, and hence facilitates comparisons among companies of different sizes Current ratio =

48. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Quick Ratio Quick assets: Cash and other current assets such as receivables and short-term investments that can be easily (and quickly) converted to cash Inventories are excluded because the inventory must first be sold and when sold on account, a receivable must then be collected Prepaid assets are excluded because most of the times they are non-refundable or only partially refundable after cancellation notices are processed Quick ratio =

49. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Working Capital, Current Ratio, and Quick Ratio

50. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. End of Chapter 3