1.Explain the revenue recognition principle and the expense recognition principle.2.Differentiate between the cash basis and the accrual basis of accounting.3.Explain why adjusting entries are needed, and identify the major types of adjusting entries.4.Prepare adjusting entries for deferrals.5.Prepare adjusting entries for accruals.6.Describe the nature and purpose of the adjusted trial balance.7.Explain the purpose of closing entries.8.Describe the required steps in the accounting cycle.Study Objectives
Cash-Basis Accounting•Revenues are recognized only when cash is received.•Expenses are recognized only when cash is paid. •Prohibitedunder GAAP.Accrual vs. Cash Basis of Accounting
Accrual-Basis Accounting•Required by GAAP.•Recognize (record) impact of transaction as it occurs.•Record transactions in period that events occur whether or not cash is involved.•Revenue recognized when earned.•Expenses recognized when incurred.Accrual vs. Cash Basis of Accounting
ExampleSuppose that Fresh Colors paints a large building in 2011. In 2011, it incurs and pays total expenses (salaries and paint costs) of $50,000. It bills the customer $80,000, but does not receive payment until 2012.20112012TotalCash Receipts0 80,00080,000Cash Payments50,000050,000Net Income (Loss)(50,000) 80,00030,000Prepare income statements using the cash basisPrepare income statements using the accrual basisSame in total:
Periodicity Assumption•Economic life of a business is divided into artificial time periods.•Fiscal year vs. calendar yearJan.Feb.Mar.Apr.Dec.. . . . .Timing IssuesRevenue Recognition Principle•Recognize revenue in the accounting period in which it is earned. •Record revenue in period service provided or goods delivered.•Doesn’t matter when cash is received.Expense Recognition Principle•Expenses are matched with revenues in the period the cost contributes to revenues. •Expenses follow Revenues.•Also called the Matching Principle.Record Revenue and Expenses when they happen.
Accrual Accounting: Reporting RevenueTimeCash can be received . . .Before or During or After . . . earning revenue• Company provides goods or services here. •Revenue is earned and recordedhere.•Does not matter when cash is received.Revenue is earned when:•Service provided•Goods delivered
Accrual Accounting: Reporting ExpensesTimeCash can be paid . . .Before or During or After . . . Incurring expenses• Company incurs cost to generate revenue here. •Expense is recordedhere.•Does not matter when cash is paidExpense is recognized when:•Cost is incurred•Assets are used or consumed•Passage of time