-Accrual Accounting: method that records revenues when earned and expenses when incurred without
regard to when cash is exchanged.
-they must be accurate and up to date to be considered useful
-to ensure that financial statements are up to date, GAAP requires the use of accrual accounting.
-Time Period Concept:transactions of a company are broken down into distinct periods of time and are
reported for those periods
-following accrual accounting allows companies to match expenses with revenues in specified periods
-the basic accounting period = one year
-a company can report for a calendar year (Jan. 1 – Dec. 31)
-Or another 12 month period that does not end on Dec. 31
-Public reports are quarterly and annually
Accounting Cycle
For every accounting period, the
company goes through the accounting
cycle
Adjusting Entries
-two main categories of adjustments:
accruals and deferrals
-Accruals: record revenues and
expenses before cash is received or
paid
-Deferrals: record revenues and
expenses after cash has been received
or paid
-4 types of adjusting entries: Accrued
Revenues and Expenses, Deferred
Revenues and Expenses
Deferred Revenues (Unearned Revenues)
-receiving cash from a customer before earning it creates a liability = unearned revenue
-Unearned revenue is a liability because the company owes a product or service to the customer
-Upfront could relate to unearned revenues
Deferred Expenses:
-Prepaid expenses (deferred expenses) represent items that are paid for before they are used.
-Prepaid expenses = assets
-Supplies receive the same treatment as prepaid expenses
-Depreciation expense= an adjusting entry that falls into the category of adjusting for a prepaid expense
Accrual Accounting and Income : Chapter 3
-Depreciation= the allocation of the cost of a long-term fixed asset to expenses over its useful life.
-Land is not depreciated
•Straight-line depreciation:
-Cost of Asset, Useful Life (UL), and Salvage value (SV) also called residual value – this can also be $0
-Formula for Depreciation Expense (per year):
(Cost of Asset -Salvage Value of Asset) / (Useful Life of Asset)
-Monthly Depreciation = Annual Depr. / 12
Example:
Cost of Equipment: $10,800 The Depreciation Expense (per year)
Useful life: 4 years $10,800 - $0 / 4 = $2,700
Salvage Value: $0 Per Month: $2,700 / 12 = $225
-Accumulated Depreciation Equipment is a contra-account.
-contra-account = linked to your fixed assets account, reported in the financial statements with the
account it is linked to, has a normal balance opposite of the account it is linked to
-The balance of the contra-account is subtracted from the balance of the account it is linked to in order
to calculate the net value of the two accounts
Reporting a Contra-Account and Book Value of a Long-Term Asset:
Cost - accumulated depreciation= book (or carrying) value
Adjusted Trial Balance and Financial Statements
-After all the adjustments have been made, the Adjusted Trial Balance can be prepared
-ensures total debits equal total credits after the adjusting entries
-facilitates the preparation of financial statements
Closing Process
1.Debit each revenue account for the amount of its credit balance and then Credit Retained Earnings for
the total amount of the debits
2.Credit each expense account for the amount of its debit balance and then Debit Retained Earnings for
the total amount of the credits
3.Credit the Dividends account for the amount of its debit balance and then Debit Retained Earnings for
the amount
Classifying Assets and Liabilities
-Liquidity measures how quickly an asset can be converted to cash and used to pay off liabilities due
within the next year
-cash is the most liquid asset
Multi-Step Income Statement
-A multi-step income statement calculates net income in multiple steps
-it provides various subtotals (profit measurements) before the final calculation for net income
Note card
Net Sales – COGS = Gross Profit
Gross Profit – Operating Expenses = Operating Income
Operating Income + Other Revenues – Other Expenses =
Income Before Income Taxes
Income before income taxes – Income tax expense = Net Income
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