chapter 4 Flashcards
Measurement of Profit
Cash basis
- Income is recorded when cash is received - Expenses are recorded when cash is paid
• Accrual basis
- Income recognised when the anticipated inflow of economic benefit can be reliably measured - Expenses recognised when the consumption of benefits can be reliably measured
Income
increases in economic benefits during the period in the form of inflows or enhancements of assets or decreases in liabilities
- Results in increases in equity - Not contributions by owners
Income = Revenue + Gains
- Recognised at the fair value of assets received
Expense:
decreases in economic benefits during the period in the form of outflows or depletions of assets or incurrences of liabilities
Results in decreases in equity
- Not distributions to the owners (i.e. ‘drawings’ and ‘dividends’ not expenses)
- Expenses are recognised in the period in which the consumption of costs can be measured
Temporary (Nominal) Accounts
Income statement accounts (i.e. income and expense accounts)
- Reduced to zero balance at end of each accounting period (closed)
Permanent (Real) Accounts
Balance sheet accounts (i.e. assets, liabilities, equity)
- Ending balances carried forward to next accounting period
Adjusting entries:
journal entries made at the end of an accounting period to update or correct the account balances
Need for adjusting entries
- > Often period in which cash is paid or received does not coincide with period in which expense/income recognised
- Some accounts must be adjusted on last day of accounting period to correctly recognise income and expenses not reflected in cash receipts or payments
- Occurs in order for statements to reflect consumption of benefits and what has in fact been earned during period
Deferrals:
assets that represent expenses paid in advance, and revenues received in advance that represent liabilities until the revenues can be recognised as earned
Accruals:
expenses that have been incurred but not recorded,
or revenues that have been earned but not recorded
Two rules for adjusting entries:
One side of the entry affects an income statement (expense of income/revenue) account and the other side
affects an account reported in the balance sheet (assets or liability)
• Cash account is never adjusted (cash flows occur either before or after the end of the reporting period)
Preparation of financial statements
Income statement
- Prepared first to determine profit or loss
- Reflects entity’s performance for the period
Statement of changes in equity
- Profit/loss must be added to/subtracted from equity
- Capital contributions and drawings/dividends also recorded - Shows details of movements in equity
- Equity balance reported in balance sheet
Balance sheet
- Reflect entity’s financial position at the end of the period - Facilitate evaluation of financial data
Current assets/liabilites
- Assets/liabilities that will be used up/paid off within a single operating cycle (usually 12 months)
Non-current assets
Investments - shares and debentures and other long-term financial assets, land held for speculation, and cash or other assets set aside for specific long-term purposes
- Property, plant and equipment - assets of a physical nature (tangible) that are used in the normal activities of the entity to produce goods, sell goods or provide services to customers
- Intangible assets - assets that usually do not have a physical substance but is expected to provide future benefits to the entity
- Other assets - assets that do not readily fit into one of categories described previously
Worksheet
Important functions of the worksheet:
• Assembles all information needed to adjust the accounts and prepare financial statements
- Aids in the preparation of interim financial statements when adjusting and closing entries are not required
- Contains information needed to close off profit and loss accounts for the period if required
