1. Income Measurement and Accrual Accounting
Chapter 4
Income Measurement and
Accrual Accounting

2. Recognition and Measurement in Financial Statements
Recognition: process of recording an item as an asset, a liability, a revenue, an expense, or the like
Measurement: requires two choices to be made
Choice 1: The attribute to be measured
Historical cost
Current value
Choice 2: The unit of measure—yardstick
Money
LO 1

3. Exhibit 4.1—Recognition and Measurement in Financial Statements

4. Cash and Accrual Bases of Accounting
Cash basis: revenues are recognized when cash is received and expenses are recognized when cash is paid
Accrual basis: revenues are recognized when earned and expenses are recognized when incurred
LO 2

5. Example 4.1—Comparing the Cash and Accrual Bases of Accounting

6. Exhibit 4.2—Comparing the Cash and Accrual Bases of Accounting

7. The Revenue Recognition Principle
Recognized in the income statement when they are realized, or realizable, and earned
Revenues: Inflows of assets or settlements of liabilities
Delivering or producing goods
Rendering services
Conducting other activities
LO 3

8. Expense Recognition and the Matching Principle
Association of revenue of a period with all of the costs necessary to generate that revenue
Direct matching: associate revenues of a period with their costs
Indirect matching: associate costs with a particular period
Example: depreciation on building
Expenses incurred in two different ways:
From the use of an asset
From the recognition of a liability
LO 4

9. Example 4.3—Comparing Three Methods for Matching Costs with Revenue

10. Adjusting Entries Made at the end of an accounting period
internal transactions and do not affect the Cash account
Adjustment of either an asset or a liability with a corresponding change in revenue or expense
Types of adjusting entries:
Deferred expense
Deferred revenue
Accrued liability
Accrued asset
LO 5

11. Deferred Expense Cash paid before expense is incurred Example:
Prepaid rent
Prepaid insurance
Office supplies
Property and equipment
Unexpired costs are assets
Written off and replaced with an expense as the costs expire

12. Example 4.4—Adjusting a Deferred Expense Account

13. Deferred Revenue Cash received before revenue is earned Example:
Insurance collected in advance
Subscriptions collected in advance
Gift certificates
Initially recorded as liabilities (unearned or refundable receipts) and recorded as revenues in future periods when earned

14. Example 4.6—Adjusting a Deferred Revenue Account

15. Accrued Liability
Cash is paid after an expense is actually incurred rather than before its incurrence
Examples:
Payroll
Taxes
Utilities

16. Example 4.8—Recording an Accrued Liability for Wages

17. Accrued Asset Revenue earned before the receipt of cash
Example: Rent and interest are earned with the passage of time and require an adjustment if cash has not yet been received
Whenever a company records revenue before cash is received, receivable is increased and revenue is also increased

18. Example 4.10—Recording an Accrued Asset
30 adjustment to recognize insurance expense:

19. Accruals and Deferrals
30 adjustment to recognize insurance expense:

20. The Accounting Cycle
30 adjustment to recognize insurance expense:
Series of steps performed each period and culminating with the preparation of a set of financial statements
LO 6

21. Exhibit 4.5—Steps in the Accounting Cycle

22. Work sheet
30 adjustment to recognize insurance expense:
Device used at the end of the period to gather the information needed to prepare financial statements without actually recording and posting adjusting entries

23. Closing Entries Made at the end of an accounting period
Return the balance in all nominal accounts to zero
Transfer the net income or net loss and the dividends of the period to the Retained Earnings account

24. Real and Nominal accounts
Real accounts: balance sheet accounts
Permanent in nature
Not closed at the end of the period
Nominal accounts: revenue, expense, and dividend accounts
Temporary in nature
Closed at the end of the period

25. Closing Process
All revenue accounts is credited to Income Summary—single entry is made
All expense accounts is credited to Income Summary—single entry is made
Credit balance in the Income Summary account is transferred to Retained Earnings
A credit is made to close the Dividends account with an offsetting debit to Retained Earnings

26. Interim Financial Statements
30 adjustment to recognize insurance expense:
Financial Statements prepared monthly, quarterly or at other intervals less than a year in duration
Prepared for internal use

27. End of Chapter 4