Lecture 3 - Accrual Accounting and Presentation of Financial Statements Flashcards
Describe when revenue and expenses are reported in respectively in Cash vs. Accrual accounting
Cash basis:
Revenue: Reported when cash received
Expenses: Reported when paid
Accrual basis:
Revenue: Recorded when earned
Expenses: Recorded when incurred
What are the implications of using Cash Based Accounting instead of Accrual Accounting?
- Accrual accounting is required by IFRS
-Cash-basis accounting fails to capture the underlying economic phenomenon
-Which results in incomplete financial statements
-Therefore only used by businesses that do not follow accounting standards
What does the Time-Period Concept indicate?
-Accounting information is reported at regular intervals
-Basic accounting period is one year
-Companies also prepare financial statements for interim periods
What 2 issues does the Revenue Recognition Principle deal with and what are the answers to these?
1) When to record/recognize revenue.
-Should be recognized when an entity has satisfied its performance obligations(…)
2) What amount of revenue to recognize.
-(…)for an amount that reflects what the entity expects to receive in exchange for providing goods or services to costumers.
*Based on contracts the entity has with outsiders.
Explain the 5 step process to revenue recognition
1) Identify the contract(s) with a costumer
2) Identify the separate performance obligations in the contract
3) Determine the transaction price
4) Allocate the transaction price to the separate performance obligations
5) Recognize revenue when (or as) the entity satisfy a performance obligation
Explain the 2 steps of the Matching Principle (in terms of the Expense Recognition Principle)
1) Identity all expenses incurred during the period.
2) Measure the expenses and recognize them in the same period in which any related revenues are earned.
- To recognize an expense along with related revenues means to subtract expenses from related revenues to compute net income or net loss.
Name the 3 categories of adjusting entries (when adjusting the accounts)
1) Deferrals
2) Accruals
3) Depreciation
Explain what a Deferral is and mention 3 types of Deferrals.
-An adjustment for an item for which the business paid or received cash in advance. (First cash is received, then later revenue is recognized - the opposite of accruals).
1) Prepaid expense (asset because it provides a future benefit for the entity)
2) Unearned service revenue (Received cash before obligation has been performed: This is a liability)
3) Depreciation of PPEs
What is Depreciation?
-Process of allocation the cost of PPE to expense over the assets useful life.
*Decline in usefulness due to wear and tear
Explain Accumulated Depreciation
-Shows the sum of all depreciation expense from using an asset
-The balance increases over the asset’s life
-An asset account with a normal credit balance - as it is a contra account to PPE
-A accumulated depreciation account is carried for each class of depreciable assets
Mention 2 types of accruals and explain them
1) Accrued expenses
-An expense that has been incurred but not paid
-Not recorded daily nor weekly but rather at the end of the period as an adjusting entry.
2) Accrued revenue
-A revenue that has been earned but not yet paid
Mention the 2 purposes of the Adjusting Process
1) Measure Income (affected by revenue and expenses)
2) Update the Balance Sheet (affected by assets and liabilities)
What does the Adjusted Trial Balance present?
-It summarizes all accounts and their final balances after all adjusting entries have been journalized and posted. Then the financial statements can be prepared based on the Adjusted Trial Balance.
What is the point of ‘closing the books’ and which accounts are closed?
-It is to prepare the accounts for the next period
-Temporary accounts are closed: Income, expenses, dividends
-Permanent accounts are not closed: Assets, liabilities, share capital, retained earnings
What are the 3 steps to Closing the Books?
1) Debit each income for the amount of its credit balance –> Credit retained earnings for the sum of all income
2) Credit each expense account for the amount of its debit –> Debit retained earnings for the sum of all expenses
3) Credit the dividends account for the same as its debit balance –> Debit retained earnings for the same amount
