1. Chapter 4
Introduction

2. Financial Statement Assumptions
Economic
Entity
Cost
Principle
Time
Period
Going
Concern
Monetary
Unit 20 20

3. Economic Entity Concept
Each entity has its own books, records and financial statements that are separate from owners
No intermingling of personal and business assets and liabilities or income and expenses
Owners’
Books &
Records
Business
Books &
Records 21 21

4. Cost Principle
Record assets at cost paid to acquire them – their historical cost
Continue to value assets at historical cost until sold
More objective than market value 22 22

5. Going Concern
Assume business will continue indefinitely into the foreseeable future
Justifies use of historical cost 23 23

6. Monetary Unit
How we measure (e.g. U.S. dollar, Japanese yen, Mexican peso, etc.)
Assumes economic measure is relatively stable; no adjustment for inflation made in financial statements 24 24

7. Time Period Assumption
Assumes it is possible to break up an entity’s earnings in discrete time periods (a month, quarter, year)
Necessary to provide users with financial results on a timely basis
Requires use of estimates 25 25

8. 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
We use the Accrual based approach as required by Generally Accepted Accounting Principles.
LO2

9. Revenue Recognition Principle
Revenue is recognized when realized or realizable and earned—when we have provided the goods or services.
LO3

10. Expense Recognition and The Matching Principal
Balance Sheet
Income Statement
PP&E
Intangibles
ASSETS:
EXPENSES:
when sold
Cost of goods sold
Inventory
Supplies
Prepaid assets
as used
Supplies expense
Insurance expense
Rent expense
over period they
provide benefits
Depreciation expense
Amortization expense
Other expenses
(as incurred)
LO4

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

12. Types of Adjusting Entries
Deferred
expense
Accrued
liability
ALL RECOGNIZE REVENUE OR EXPENSES
BEFORE OR AFTER CASH IS EXCHANGED
Accrued
asset
Deferred
revenue
LO5

13. 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

14. Deferred Expense Example #1
We pay rent for our office space one year in advance on September 1
Initial journal entry:
9/1 Prepaid Rent 2,400
Cash 2,400
Monthly adjusting journal entry:
9/30 Rent Expense
Prepaid Rent
($2,400 annual × 1/12 = $200 per month for months)

15. Deferred Expense Example #2
Purchase treadmill on January 1 for $5,000. Estimated useful life is 7 years (84 months); estimated salvage value is $800
Initial journal entry:
1/1 Fitness equipment 5,000
Cash 5,000
Monthly adjusting journal entry:
1/31 Depreciation Expense
Accumulated Depreciation
($5,000 – $800) × 1/84 = $50 per month for 84 months)

16. 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

17. Deferred Revenue Example
On September 1, we received $2,400 in advance for a 12-month subscription to our monthly magazine.
Initial journal entry:
9/1 Cash ,400
Unearned Subscription Revenue (liability) ,400
Monthly adjusting journal entry:
9/30 Unearned Revenue
Subscription Revenue
($2400 * 1/12 = 200

18. 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

19. Accrued Liability Example #1
Pay biweekly wages of $28,000
At end of month, between pay periods:
Wages Expense ,000
Wages Payable 4,000
Next payday:
Wages Payable ,000
Wages Expense ,000
Cash 28,000

20. Accrued Liability Example #2
On March 1, assume a 9%, 90-day, $20,000 loan is taken out with a bank
Initial journal entry:
3/1 Cash ,000
Note Payable ,000
Monthly adjusting journal entry:
3/31 Interest Expense
Interest Payable
($20,000 principal × 9% × 3/12 = $450 for 3 months or $450/3 = $150 per month)

21. 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

22. Accrued Asset Example First day of the month: Rent Receivable 2,500
Rent payment of $2,500 due within first 10 days of month
First day of the month:
Rent Receivable ,500
Rent Revenue ,500
Upon receipt of cash:
Cash ,500
Rent Receivable ,500