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Mgmt 200 Spring 2010 Chap 4 Accrual Accounting

Mgmt 200 Spring 2010 Chap 4 Accrual Accounting - Income...

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Income Measurement and Accrual Accounting Chapter 4
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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 Repeat for next period
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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. b. Purchased $334,000 of new sports equipment inventory; paid $90,000 in cash and owed the rest on account. c. 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. d. Paid $7,200 cash for utilities for the year. e. Received $21,000 from customers as deposits on orders of new winter sports equipment to be sold to the customers in January 2009. f. 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 3. Which basis of accounting (cash or accrual) provides more useful information to investors, creditors, and other users? Why?
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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) Rent/interest (continuously when earned) Non-performing loans
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The Accounting Cycle • A 1 = L 1 + CC 1 +RE 1 Start of year balance sheet • A 2 = L 2 + CC 2 +RE 1 + Rev* 2 – Exp* 2 - Div 2 After this year’s transactions have been processed • A 2 = L 2 + CC 2 +RE 1 + Rev 2 – Exp 2 - Div 2 After adjusting entries to “correct” revenues and expenses • A 2 = L 2 + CC 2 +RE 2 After closing entries to close temporary accounts and update retained earnings Start of year balance sheet for next year – repeat cycle
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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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