Chapter 4-1

Chapter 4-1 - Chapter 4: Income Measurement and Accrual...

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Chapter 4: Income Measurement and Accrual Accounting
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The Accounting Cycle During period Analyze transactions Record journal entries Post amounts to the general ledger At end of period Adjust revenues and expenses for unrecorded items Prepare financial statements Close revenue, expense, and dividend accounts and update the retained earnings account
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Accrual Accounting Revenue Recognition Principle Revenues recognized when (a) realized or realizable, and (b) earned. Matching Principle Expenses incurred to generate recognized revenue be recognized in the same period. Net income (revenue – expenses) is NOT cash flow from operations.
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Cash versus Accrual basis Cash basis net income Revenues and expenses recognized only when cash is received or paid. Treatment of long-term assets Equal to Cash Flow from Operations (CFO) Accrual basis net income Revenues are recognized when earned and expenses are recognized when incurred (Matching principle).
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Reporting Cash Basis versus Accrual Basis Income Ru’s Sports, Inc., sells sports equipment to customers. Its fiscal year ends on December 31. The following transactions occurred in 2008: a. Paid employees $54,200 in wages for the year; an additional $4,800 for 2008 wages will be paid in January 2009. c. Purchased $334,000 of new sports equipment inventory; paid $90,000 in cash and owed the rest on account. e. Sold sports equipment to customers for $410,000; received $340,000 in cash and the rest on account. The cost of the equipment was $287,000. g. Paid $7,200 cash for utilities for the year. i. Received $21,000 from customers as deposits on orders of new winter sports equipment to be sold to the customers in January 2009. k. Received a $680 bill for December 2008 utilities that will be paid in January 2009. Required: 1. Compute net income under the accrual basis. 2. Compute net income under the cash basis
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‘Cash’ income statement Revenue c) Sales Revenue 340,000 e) Sales Revenue 21,000 _______ 361,000 Less Expenses a) Wages 54,200 c) Inventory Purchases 90,000
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Revenue Recognition Principle Revenue Recognition Principle Revenues recognized when (a) realized or realizable, and (b) earned. This means revenue is typically measured at the point of sale. Issues/exceptions Sales returns FOB shipping vs. FOB destination Long-term contracts (over life of project) Commodities (point of production)
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The Accounting Cycle A1 = L1 + CC1 +RE1 Start of year balance sheet A2 = L2 + CC2 +RE1 + Rev*2 – Exp*2 - Div2 After this year’s transactions have been processed A2 = L2 + CC2 +RE1 + Rev2 – Exp2 - Div2 After adjusting entries to “correct” revenues and expenses A2 = L2 + CC2 +RE2 After closing entries to close temporary accounts and update retained earnings
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Adjusting entries Adjusting entries are necessary at the end of the period to measure revenues and expenses in compliance with accrual
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Chapter 4-1 - Chapter 4: Income Measurement and Accrual...

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