Week 4 Flashcards
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 the owners
income = revenue + gains
Expense
Decreases in economic benefits during the period in the form of outflows or depletion’s of assets or incurrences of liabilities. Result in decreases in equity. Not distributions to the owners.
Expenses are recognised in the period in which the consumption of costs can be measured
Current assets vs current liabilities
Current assets will be used with a single operating cycle (usually 12 months.)
Current liabilities paid off within a single operating cycle
Non-current assets vs non-current liabilities
Non current assets will not be used up within a single operating cycle (usually 12 months)
Non current liabilities will not be paid off within a single operating cycle
Measurement of profit
Cash basis
Accrual basis
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
Accrual and cash bases accounting
The main difference between the accrual and cash bases of accounting is the timing of when revenues and expenses are recorded. The generally accepted accounting principles require the accrual basis, income statements report accrual-based profit or loss. Cash basis information is also useful in understanding the financial condition of a company. A company that generates accrual income but never generates cash is a company that will soon fail
Cash basis
Record revenue when
Record expenses when
Cash is received
Cash is paid
Accrual basis
Record revenue when
Record expenses when
Revenue is earned
Expense is incurred
The need for adjusting journal entries
In many cases the period in which cash is paid or received does not coincide with period in which expense and income are recognised
Therefore, some accounts must be adjusted on the last day of the accoutring period to correctly recognise income and expenses not reflected in cash receipts or payments.
Classifcation of adjusting entires
Deferrals (prepayments)
Accruals
Deferrals
Prepaid expense
Unearned revenue
Accruals
Accrued expense
Accrued revenue
Prepaid expense
Costs/expenses paid before they are consumed
Unearned revenue
Revenues that are collected or received but not yet earned
Accrued expense
Expenses incurred but not yet paid & unrecorded
Accrued revenue
Revenue earned but not yet received & unrecorded
Classification of adjusting entires
When a company receives cash before it provides the service, it has a deferred revenue (unearned revenue)
When a company pays for a resource before it uses or consumes it, the company has a deferred expense (prepaid)
When a company earned revenue but not yet received in cash or entered in the records, it has an accrued revenue.
When a company consumed service but not yet paid in cash or entered in the records, it has an accrued expense
The rule of adjustment entires
Attempting to account for the timing difference between receipt/payment of cash and recognition of income/expense.
One side of the entry affects and income statement account (that is revenue or expense)
The other side of the entry affects an account reported in the balance sheet (That is asset or liability)
Cash is never adjusted
Depreciation
Allocation of the historic cost of an asset (less any residual) over the useful life of that asset
Adjusted trial balance
Same accounting process applied
Unadjusted trial balance used as starting point
Adjusting entires are posted to the general ledger
An adjusted trial balance can then be prepared
Debits must still equal credits
Adjusting entires always affect and income statement and a balance sheet account
