Unit 4 Recording business transactions (part 2) Flashcards
Accrual accounting
Including the impact of transactions on the financial statements in the time periods where revenues and expenses occur rather than when the cash is received or paid
Cash accounting
Accounting for revenues and expenses when cash is paid or received
Unearned revenue?
Cash received before earned (Liability)
Prepayment?
Cash paid before incurred (Asset)
Accrued revenue?
Cash received after earned (Asset)
Accrued expense?
Cash paid after incurred (Liability)
When does unearned revenue (L) become revenue?
When goods or services owing are provided
Examples of unearned revenue
Insurance premiums
Magazine subscriptions
Rent received in advance
Examples of prepayment
Prepaid insurance
Prepaid rend
Office supplies
Important questions to ask when accounting for a transaction
What was the original transaction and how was it recorded?
What accrual adjusting entries are required?
Is the revenue correctly earned?
Have the expenses been incurred?
Examples of accrued revenue
Commissions earned but not yet received
Interest earned but not yet received
Examples of accrued expense
Wages earned by employees but not paid after end of financial period
Interest payable on outstanding loan
Summary of Cash vs Accrual profit
The earning of a revenue is not necessarily accompanied by an inflow of cash in the same period
The incurrence of an expense is not necessarily accompanied by an outflow of cash in the same period. Accrual profit is not the same as cash profit
Recognition after cash flow
Deferral
Revenue adjustment: unearned revenue (L)
Expense adjustment: prepayment (A)
Recognition before cash flow
Accrual
Revenue adjustment: Interest receivable (A)
Expense adjustment: Wages owing (L)
What are T accounts?
A useful account format in accounting to present accounts and work through transactions (journal/ledger) and balance accordingly
Bal b/d
Balance brought down
Bal c/d
Balance carried down
Earnings management?
The use of accounting techniques to produce financial statements that present an overly positive view of a company’s business activities and financial position
What does earnings management suggest?
The information contained in the financial statements can be manipulated to give an inaccurate picture of a company’s financial performance/position
When does earnings management happen?
When managers take advantage of how accounting rules are applied and create financial statements that “inflate” or “smooth” earnings (revenue or profitability)
AASB
Australian Accounting Standards Board
The framework
For the preparation and presentation of financial statements
Some additional accounting rules
ASX listing requirements
Corporations law
What does the framework set out?
The concepts underlying the preparation of financial reports for external users
The framework including coverage of?
A. Objectives of financial reports
B. Assumptions underlying financial reports
C. Qualitative characteristics of financial information
D. Definition of elements of financial statements
E. Recognition and measurement of those elements
Motivations to manage earnings (revenue and profitability)
Market pressure to meet financial expectations
Bonus dependent on certain revenue or profitability
Stock options increase when profitability increases
Senior management pressuring individual managers to improve
performance
Culture of company demands ‘high-growth’
Common approaches to managing earnings
Improper recognition of revenue Recording fictitious revenue Channel stuffing (Credit sales) Improper management estimates Improper capitalization of expenses Improper expense recognition
