Module 3 - Accrual Accounting and Income

Module 3 - Accrual Accounting and Income - MODULE 3 ACCRUAL...

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Prepared by: Ms Rahayu Abdull Razak & Edited by: Rohaya Shaari Page 1 MODULE 3: ACCRUAL ACCOUNTING AND INCOME Learning outcomes: Differentiate between cash and accrual system Define and apply the accounting period concept, revenue and matching principles Explain why Adjusting entries are needed Journalize and post Adjusting entries Explain the purpose of and prepare an adjusted trial balance ACCRUAL VERSUS CASH BASIS ACCOUNTING There are two ways to do accounting:- 1. Accrual accounting records the effect of each transaction as it occur - that is revenues are recorded when earned and expenses are recorded when incurred. 2. Cash basis accounting record revenue only when cash is received and expenses are recorded only when cash is paid. EXAMPLE: Illustration: Fresh Colors Company is providing painting services. Suppose that fresh colors paint a large building in 2011 worth $80,000. Company receives the amount due in 2012. In 2011, company also incurs and pays total expenses of $50,000. Under accrual, the following will be recorded: DATE ACCOUNT TITLE DEBIT CREDIT
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Prepared by: Ms Rahayu Abdull Razak & Edited by: Rohaya Shaari Page 2 Under cash basis, the following will be recorded DATE ACCOUNT TITLE DEBIT CREDIT TIMING ISSUES Most business needs immediate feedback about how well they are doing. Accrual accounting becomes complicated because of the following three principles:- Three principles are used as guidelines:- 1. Time period assumption : business activity can be divided into measurement intervals, such as months, quarters and years. Accounting implications: accounting must divide the continuous business process, and produce periodic reports. An annual reporting period may follow the calendar year by running from January 1 through December 31 . Annual periods are usually further divided into quarterly periods containing activity for three months 2. The revenue principle tells the accountant when to record revenue and the amount of revenue to record. The revenue recognition principles requires that companies recognize revenue in the accounting period in which it is earned. In a service company, revenue is considered to be earned at the time the service is performed. Example:- Assume Conrad Dry Cleaners cleans clothing on June 30, but customers do not claim and pay for their clothes until the first week of July. When to record the revenue? 3. The matching principles (expenses recognition principle) guides accounting for expenses. It measures all the expenses incurred during the period and matches the expenses against the revenue of the period. Example: salary of worker to clean cloth at ABC laundry should be recorded at the same time as the revenue earned.
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Prepared by: Ms Rahayu Abdull Razak & Edited by: Rohaya Shaari Page 3 ADJUSTING ENTRIES Adjusting entries is the end of period process to adjust the books so that revenue can be allocated to the period when they are earned and expenses to the period they are incurred.
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