Accrual- versus Cash-Basis Accounting
Accrual-Basis Accounting
u Transactions recorded in the periods in which the events occur.
u Companies recognize revenues when they perform services
rather than when they receive cash.
u Expenses are recognized when incurred (rather than when paid).
u In accordance with International financial reporting standard
(IFRS).
LO 1
Accrual- versus Cash-Basis Accounting
Cash-Basis Accounting
u Revenues recognized when cash is received.
u Expenses recognized when cash is paid.
u Cash-basis accounting is not in accordance with international
financial reporting standard).
LO 1
Recognizing Revenues and Expenses
REVENUE RECOGNITION PRINCIPLE
• Recognize revenue in the accounting period in which the performance
obligation is satisfied.
EXPENSE RECOGNITION PRINCIPLE
• Match expenses with revenues in the period when the company makes
efforts that generate those revenues.
LO 1
Adjusting Entries
u Ensure that the revenue recognition and expense recognition
principles are followed.
u Necessary because the trial balance may not contain up-to-
date and complete data.
u Required every time a company prepares financial statements.
u Will include one income statement account and one balance
sheet account.
LO 1
Types of Adjusting Entries
Deferrals Accruals
1. Prepaid Expenses. 1. Accrued Revenues.
Expenses paid in cash Revenues for services
before they are used or performed but not yet
consumed. received in cash or
recorded.
2. Unearned Revenues. 2. Accrued Expenses.
Cash received before Expenses incurred but not
services are performed. yet paid in cash or
recorded.
LO 1
• Deferrals are expenses or revenues that are recognized at a date
later than the point when cash was originally exchanged.
• There are two types:
u Prepaid expenses
u Unearned revenues
LO 2
• Payment of cash, that is recorded as an asset to show the
service or benefit the company will receive in the future.
Cash Payment BEFORE Expense Recorded
Prepayments often occur in regard to:
u insurance u rent
u supplies u equipment
u advertising u buildings
LO 2
u Expire either with the passage of time or through use.
u Adjusting entry:
► Increase (debit) to an expense account and
► Decrease (credit) to an asset account.
LO 2
• Receipt of cash that is recorded as a liability because the service has
not been performed.
Cash Receipt BEFORE Revenue Recorded
Unearned revenues often occur in regard to:
u Rent u Magazine subscriptions
u Airline tickets u Customer deposits
LO 2
u Adjusting entry is made to record the revenue for services
performed during the period and to show the liability that remains
at the end of the period.
u Results in a decrease (debit) to a liability account and an increase
(credit) to a revenue account.
LO 2
Accruals are made to record
u Revenues for services performed but not yet recorded at the
statement date.
u Expenses incurred but not yet paid or recorded at the statement
date.
LO 3
• Revenues for services performed but not yet received in cash or
recorded.
Revenue Recorded BEFORE Cash Receipt
Accrued revenues often occur in regard to:
u Rent
u Interest
u Services
LO 3
u Adjusting entry shows the receivable that exists and records the
revenues for services performed.
u Adjusting entry:
► Increases (debits) an asset account and
► Increases (credits) a revenue account.
LO 3
Expenses incurred but not yet paid in cash or recorded.
Expense Recorded BEFORE Cash Payment
Accrued expenses often occur in regard to:
u Rent u Taxes
u Interest u Salaries
LO 3
u Adjusting entry records the obligation and recognizes the expense.
u Adjusting entry:
► Increase (debit) an expense account and
► Increase (credit) a liability account.
LO 3
LO 3
Worksheet
u Multiple-column form used in preparing financial
statements.
u Not a permanent accounting record.
u May be a computerized worksheet using an
electronic spreadsheet program such as Excel.
u Prepared using a five step process.
u Use of worksheet is optional.
LO 1
u Income statement is prepared from the income
statement columns.
u Balance sheet and owner’s equity statement are
prepared from the balance sheet columns.
u Companies can prepare financial statements
before they journalize and post adjusting entries.
LO 1
u Adjusting entries are prepared from the
adjustments columns of the worksheet.
u Journalizing and posting of adjusting entries
follows the preparation of financial statements
when a worksheet is used.
LO 1
At the end of the accounting period, the company makes the accounts
ready for the next period.
LO 2
Closing entries formally recognize in the ledger the transfer of
u net income (or net loss) and
u owner’s drawings to owner’s capital.
Companies generally journalize and post closing entries only at the end of
the annual accounting period.
Closing entries produce a zero balance in each temporary account.
LO 2
Preparing Closing Entries
Illustration 4-9
Diagram of closing
process—
proprietorship
Owner’s Capital is a
permanent account.
All other accounts are
temporary accounts.
LO 2
Preparing Closing Entries
CLOSING
ENTRIES
ILLUSTRATED
Illustration 4-
10
Closing entries
journalized
Posting
Closing
Entries
Illustration 4-11
LO 2
Preparing a Post-Closing Trial Balance
Purpose is to prove the equality of the permanent account
balances carried forward into the next accounting period.
Illustration 4-12
Post-closing trial
balance
LO 2
Explain the steps in the accounting
LEARNING
OBJECTIVE
6 cycle and how to prepare correcting
entries.
Illustration 4-
1. Analyze business transactions 15
9. Prepare a post-closing 2. Journalize the
trial balance transactions
8. Journalize and post
3. Post to ledger accounts
closing entries
7. Prepare financial
4. Prepare a trial balance
statements
6. Prepare an adjusted 5. Journalize and post
trial balance adjusting entries
LO 3