1 Accrual Accounting Concepts Chapter 3 and Chapter 9 A200 Survey of Accounting University of Tennessee 2 Ch 3 Accrual Accounting Concepts Matching Revenue 1 Amounts earned by operating a business 2 Revenue is recognized recorded in the period it is earned whether or not cash is received at the same time 3 Revenue transactions increase equity through net income Expense 1 The cost of assets used or liabilities created in the process of generating revenue 2 Expenses are recognized recorded in the period they are incurred whether or not cash is paid at the same time 3 Expense transactions decrease equity through net income 3 Ch 3 Accrual Accounting Concepts Matching 1 2 Revenue is recorded in the same period as the Expenses that helped generate the revenue When revenue is earned increase a Revenue account and a increase the asset Cash when cash is received at the same time b increase the asset Accounts Receivable when cash will be received in the future Accrued Revenue c decrease the liability Unearned Revenue when cash was previously received Deferred Revenue Note See slide 9 4 Ch 3 Accrual Accounting Concepts Matching 1 Expenses are recorded in the same period as the Revenue they helped generate 2 When expense is incurred increase an Expense account and a decrease the asset Cash when cash is paid at the same time b increase the liability Accounts Payable when cash will be paid in the future Accrued Expense c decrease the asset Prepaid Expense when cash was previously paid Deferred Expense 5 Ch 3 Recording Transactions Transaction 1 Future Corporation began business on September 1 2012 by issuing capital stock to investors for 50 000 cash STATEMENT OF CASH FLOWS explains the change in the asset Cash INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET explains the change in the equity Retained Earnings 50 000 Cash in Financing Assets Cash 50 000 Liabilities Equity Capital Stock 50 000 6 Ch 3 Recording Transactions Transaction 2 During September Future Corporation purchased land for 20 000 by issuing a note payable to the seller STATEMENT OF CASH FLOWS explains the change in the asset Cash INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET explains the change in the equity Retained Earnings Assets Land Liabilities Note Payable 20 000 20 000 Equity 7 Ch 3 Recording Transactions Transaction 3 During September Future Corporation rendered services to clients for 12 000 cash STATEMENT OF CASH FLOWS explains the change in the asset Cash INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET explains the change in the equity Retained Earnings 12 000 Cash in Operating Assets Cash 12 000 Liabilities Equity Retained Earnings 12 000 12 000 Fees Revenue Revenue earned at the same time cash is received no accrual or deferral 8 Ch 3 Recording Transactions Transaction 4 During September Future Corporation rendered services to clients and billed them for 3 000 STATEMENT OF CASH FLOWS explains the change in the asset Cash INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET explains the change in the equity Retained Earnings Assets Accounts Receivable 3 000 Liabilities Equity Retained Earnings 3 000 Revenue earned before cash is received Accrued Revenue 3 000 Fees Revenue 9 Ch 3 Recording Transactions Transaction 5 During September Future received 4 500 cash in advance from Zone Company for six months rent on a vacant office in Future s building STATEMENT OF CASH FLOWS explains the change in the asset Cash INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET explains the change in the equity Retained Earnings 4 500 Cash in Operating Assets Cash Liabilities Unearned Rent Revenue 4 500 4 500 Equity Revenue earned after cash is received Deferred Revenue Remember that Unearned Revenue is ALWAYS a liability The liability account is not reduced until a company earns the revenue See Slide 16 10 Ch 3 Recording Transactions Transaction 6 During September Future Corporation paid a 1 700 utility bill for the month STATEMENT OF CASH FLOWS explains the change in the asset Cash INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET explains the change in the equity Retained Earnings 1 700 Cash out Operating Assets Cash 1 700 Liabilities Equity Retained Earnings 1 700 1 700 Utilities Expense Cash paid at the same time expense is incurred no accrual or deferral 11 Ch 3 Recording Transactions Transaction 7 During September Future Corporation hired a cleaning company to clean its offices for the month but has not yet paid the invoice of 600 STATEMENT OF CASH FLOWS explains the change in the asset Cash INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET explains the change in the equity Retained Earnings Assets Liabilities Accounts Payable 600 Equity Retained Earnings 600 Expense incurred before cash is paid Accrued Expense 600 Cleaning Expense 12 Ch 3 Recording Transactions Transaction 8 Future paid a 2 400 premium on a 1 year general business insurance policy STATEMENT OF CASH FLOWS explains the change in the asset Cash BALANCE SHEET Assets 2 400 Cash out Operating INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS Cash Prepaid Insurance 2 400 2 400 Liabilities explains the change in the equity Retained Earnings Equity Expense will be incurred after cash is paid Deferred Expense or Prepaid Expense Remember that we do not record the expense until we use the insurance See slide 18 13 Summarize account balances at the end of September before adjustments STATEMENT OF CASH FLOWS Assets Cash Accounts Receivable 0 Beg 0 0 1 50 000 F 50 000 Prepaid Insurance Land 0 20 000 12 000 O 12 000 4 3 000 0 TA 87 800 2 400 50 000 1 700 1 700 E 600 600 E 12 700 12 700 NI 4 500 600 20 000 3 000 R 3 000 0 3 000 2 400 0 1 700 7 20 000 1 700 O 62 400 0 Retained Earnings 12 000 R 6 62 400 0 Capital Stock 12 000 End Unearned Rent 4 500 2 400 Note Payable Equity 4 500 O 2 400 O Accounts Payable 5 8 Liabilities 2 3 INCOME STATEMENT AND STATEMENT OF RETAINED EARNINGS BALANCE SHEET 600 20 000 4 500 TL TSE 87 800 These are ending balances before EOP adjustments 50 000 14 Ch 3 Accrual Accounting Concepts End of Period Adjustments At the end of the accounting period the business adjusts accounts to assure that all revenue and all expenses of the period have been recorded Adjustments always involved the recording of an expense or revenue End of Period EOP adjustments are necessary to properly match revenue with expense because 1 Revenue can be earned before