Fa ch3

Financial Accounting
Belverd E. Needles, Jr.

Marian Powers
-----------
Multimedia Slides by:
Dr. Howard A. Kanter, CPA
DePaul University
Milton M. Pressley
University of New Orleans
Copyright©2001 by Houghton Miffli 1

n Company. All rights reserved.
Chapter 3
Measuring Business Income
Belverd E. Needles, Jr.

Marian Powers
-----------
Multimedia Slides by:
Dr. Howard A. Kanter, CPA
DePaul University
Milton M. Pressley
University of New Orleans

LEARNING OBJECTIVES
1. Define net income and its two major

components, revenues and expenses.
2. Explain the difficulties of income
measurement caused by:
(a) the accounting period issue,
(b) the continuity issue,
(c) the matching issue.
3. Define accrual accounting and explain
two broad ways of accomplishing it.

LEARNING OBJECTIVES
(continued)
4.State four principal situations that

require adjusting entries.
5.Prepare typical adjusting entries.
6.Prepare financial statements from

an adjusted trial balance.

Supplemental Objectives
Analyze cash flows from accrual-

based information.

Profitability Measurement:
The Role of Business Income
Objective 1
Define net income and its two
major components, revenues
and expenses.

Profitability Measurement: The Role
of Business Income
 Profitability and liquidity are the two
major goals of a business.
 To survive, a business must earn a profit.
 Profit, as a word, may be ambiguous.
 Net income is the preferred term because
it can be defined more precisely from an
accounting point of view.

Net Income
 Net income is the net increase in

stockholders’ equity that results from
the operations of a company.
 Net income is accumulated in the
Retained Earnings account.
 Net Income = Revenues - Expenses.

R > E, net profit.

R < E, net loss.

Revenues
 Revenues are increases in SE resulting from

selling goods or providing services.
 Revenue for a given period equals:
Cash + Receivables from goods and
services provided.
 Liabilities are generally not affected by
revenues.
 Stockholders’ investments increase SE but
are not revenues.

Expenses
 Expenses are decreases in SE resulting from

the costs of selling goods, rendering services,
or performing other business activities.
 Expenses are the costs of doing business.
 Not all cash payments are expenses.
 Prepaid expenses are recorded as assets. As
they expire, they become expenses.
 Not all decreases in SE arise from expenses.
 Dividends are not expenses.

The Accounting Period Issue
Objective 2a
Explain the difficulties of
income measurement caused
by the accounting period
issue.

The Accounting Period Issue
 The difficulty of assigning revenues and expenses to a

short period of time.
 Not all transactions can easily be assigned to a time
period.
 The accountant makes an assumption about periodicity.

The net income for any period of time less than the
life of the business, although tentative, is still a useful
estimate of the net income for the period.

Time periods are usually of equal length for
comparability.

The Measurement of
Business Income
 Financial statements may be prepared for any time period,
usually a calendar year.
 Accounting periods of less than one year are called interim
periods.
 The fiscal year is the twelve-month accounting period used
by a company.

Can be the same as the calendar year.

Can be different from the calendar year as the needs of
the business dictate.

The Continuity Issue
Objective 2b
income measurement caused by
the continuity issue.

The Continuity Issue
 The measurement of business income requires
that certain expenses and revenues be allocated
over several accounting periods.
 The continuity issue relates to the estimated
number of accounting periods in the business
entity’s life.
 The accountant assumes that an entity is a going
concern, that the entity will continue indefinitely.
 If a firm is not a going concern, financial
statements may be prepared on the basis of the
liquidation value of the assets -- that is, what
they will bring in cash.
The Matching Issue
Objective 2c
income measurement
caused by the matching
issue.

The Matching Issue
 The cash basis of accounting recognizes revenues when
received in cash and expenses when paid in cash.
 Cash basis accounting has matching problems.
 To adequately measure net income, revenues and
expenses must be assigned to the appropriate
accounting period.
 The matching rule states that:
 Revenues must be assigned to the accounting period
in which the goods are sold or services performed.
 Expenses must be assigned to the accounting period
in which they are used to produce revenue.

Accrual Accounting
Objective 3
Define accrual accounting and
explain two broad ways of
accomplishing it.

Accrual Accounting
 Accrual accounting “attempts to record the

financial effects on an enterprise of
transactions and other events and
circumstances . . . in the periods in which
those transactions, events, and circumstances
occur rather than only in the periods in which
cash is received or paid by the enterprise.”
 Accrual accounting is an application of the
matching rule.

Implementation of
Accrual Accounting
 Accrual accounting is done in two ways.
1. By recording revenues when earned
and expenses when incurred.
 When a sale is made on credit, revenue is
recorded before the cash is received in the
Accounts Receivable account.
 When an expense is incurred on credit, an
expense is recorded before the cash is paid in
the Accounts Payable account.

2. By adjusting the accounts.
 Those transactions that span the cutoff
period must be allocated to the proper
accounting period.
 A prepayment of 6 months’ office rent
must be adjusted on a monthly basis if
accurate monthly financial statements
are to be prepared.

The Adjustment Process
Objective 4
State four principal situations that

The Adjustment Process
 Adjusting entries are used to apply accrual

accounting to transactions that span more than
one accounting period.
 Adjusting entries involve at least one balance
sheet account and at least one income statement
account.
 Adjusting entries never involve the Cash account.

Four Types of Adjusting Entries
1. Costs have been recorded that must be allocated
between two or more accounting periods.
2. Expenses have been incurred but are not yet
recorded.
3. Revenues have been recorded that must be allocated
between two or more accounting periods.
4. Revenues have been earned but not yet recorded.

Deferrals
 A deferral is the postponement of:

 The recognition of an expense
already paid (Type 1 adjustment),
or
 A revenue received in advance
(Type 3 adjustment).

Accruals
 An accrual is the recognition of a

revenue (Type 4 adjustment) or
expense (Type 2 adjustment) that has
arisen but has not yet been recorded.

Allocating Recorded Costs Between
Two or More Accounting Periods
Objective 5
Prepare typical adjusting entries.

Type 1: Allocating Deferred Expenses
Prepaid Expenses: Rent Expense
Dr. Cr.
Jan. 31 Rent Expense 400
Prepaid Rent 400
Prepaid Rent
•Transaction
Jan. 2 800 Jan. 31 400
•Analysis
Rent Expense •Rules

Jan. 31 400
•Entry
Prepaid Expenses: Insurance Expense
Dr. Cr.
Jan. 31 Insurance Expense 40
Prepaid Insurance 40
Prepaid Insurance
•Transaction
Jan. 8 480 Jan. 31 40
•Analysis
Insurance Expense
•Rules
Jan. 31 40
•Entry
Prepaid Expenses: Art Supplies Expense
Dr. Cr.
Jan. 31 Art Supplies Expense 500
Art Supplies 500
Art Supplies
•Transaction
Jan. 6 1,800 Jan. 31 500
•Analysis
Art Supplies Expense •Rules
Jan. 31 500
•Entry
Prepaid Expenses: Office Supplies
Dr. Cr.
Jan. 31 Office Supplies Expense 200
Office Supplies 200
Office Supplies
•Transaction
Jan. 6 800 Jan. 31 200
•Analysis
Office Supplies Expense •Rules
Jan. 31 200
•Entry
Adjustment for Prepaid (Deferred) Expenses

Depreciation of PP&E: Art Equipment
Dr. Cr.
Jan. 31 Depreciation Expense, Art Equipment 70
Accumulated Depreciation, Art Equipment 70
Accumulated Deprn, Art Equipment

•Transaction
Jan. 31 70
•Analysis
Depreciation Expense, Art Equipment •Rules

Jan. 31 70
•Entry
Depreciation of PP&E: Office Equipment
Dr. Cr.
Jan. 31 Depreciation Expense, Office Equipment 50
Accumulated Depreciation, Office Equipment 50
Accumulated Deprn, Office Equipment

•Transaction
Jan. 31 50
•Analysis
Depreciation Expense, Office Equipment •Rules

Jan. 31 50
•Entry

Adjustment for Depreciation

Type 2: Recognizing Unrecorded (Accrued)
Expenses
Accrued Expenses: Accrued Wages
Dr. Cr.
Jan. 31 Wages Expense 180
Wages Payable 180
Wages Payable
•Transaction
Jan. 31 180
•Analysis
Wages Expense
Jan. 12 600 •Rules
26 600
31 180 •Entry
Expenses
Accrued Expenses: Estimated Income Taxes
Dr. Cr.
Jan. 31 Income Taxes Expense 400
Income Taxes Payable 400
Income Taxes Payable

•Transaction
Jan. 31 400
•Analysis
Income Taxes Expense •Rules

Jan. 31 400
•Entry

Adjustment for Unrecorded (Accrued) Expenses

Type 3: Allocating Deferred Revenues
Deferred Revenues: Unearned Fees
Dr. Cr.
Jan. 31 Unearned Art Fees 400
Art Fees Earned 400
Unearned Art Fees

•Transaction
Jan. 31 400 Jan. 15 1,000
•Analysis
Art Fees Earned •Rules

Jan. 31 400
•Entry

Adjustment for Unearned (Deferred) Revenues

Revenues
Accrued Revenues: Advertising Fees
Dr. Cr.
Jan. 31 Fees Receivable 200
Advertising Fees Earned 200
Fees Receivable
•Transaction
Jan. 31 200
•Analysis
Advertising Fees Earned •Rules

Jan. 10 1,400
19 2,800 •Entry
31 200
Adjustment for Unrecorded (Accrued) Revenues

Using the Adjusted Trial Balance to
Prepare Financial Statements
Objective 6
Prepare financial statements
from an adjusted trial
balance.

The Adjusted Trial Balance (ATB)
 The ATB is prepared after adjusting
entries have been recorded and posted.
 The ATB is a listing of all accounts and
their balances.
 The ATB should have equal debits and
credits.
 Financial statements are prepared from
the ATB by copying the appropriate
accounts to the appropriate financial
statement.

Cash Flows, Accrual Accounting,
and Management Objectives
Supplemental Objective 7
Analyze cash flows from
accrual-based information.

Cash Flows from Accrual-Based
Information
1. Management has a liquidity

goal, which is measured by cash
flow.

2. Every revenue or expense account on the
income statement has one or more related
accounts on the balance sheet.
Supplies is related to Supplies Expense.
Wages Expense is related to Wages Payable.
3. Cash flows generated or paid by company
operations may also be determined by
analyzing these relationships.
4. The following rules may be applied to
determine cash flow.

Prepaid Expense
Ending balance + Expense for the period -
Beginning balance = Cash payments
for expenses.
Unearned Revenue
Ending balance + Revenue for the period -
Beginning balance = Cash receipts
from revenues.

Accrued Expense
Beginning balance + Expense for the period
- Ending balance = Cash payments for
expenses.
Accrued Revenue
Beginning balance + Revenue for period
- Ending balance = Cash receipts from
revenues.

OKAY, LET’S REVIEW...
1. Define net income and its two major

components, revenues and
expenses.
2. Explain the difficulties of income
measurement caused by:
(a) the accounting period issue,
(b) the continuity issue,
(c) the matching issue.
3. Define accrual accounting and
explain two broad ways of
accomplishing it.

AND FINALLY...
4. State four principal situations that

5. Prepare typical adjusting entries.
6. Prepare financial statements from
an adjusted trial balance.
7. Analyze cash flows from accrual-
based information.


Fa ch3

Uploaded by

Copyright:

Available Formats

You might also like

Fa ch3

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Fa ch3

Uploaded by

Copyright:

Available Formats

Financial Accounting

Belverd E. Needles, Jr.

Copyright©2001 by Houghton Miffli 1

Belverd E. Needles, Jr.

Copyright©2001 by Houghton Miffli 2

1. Define net income and its two major

Copyright©2001 by Houghton Miffli 3

4.State four principal situations that

5.Prepare typical adjusting entries.

6.Prepare financial statements from

Copyright©2001 by Houghton Miffli 4

Analyze cash flows from accrual-

Copyright©2001 by Houghton Miffli 5

Copyright©2001 by Houghton Miffli 6

Copyright©2001 by Houghton Miffli 7

 Net income is the net increase in

Copyright©2001 by Houghton Miffli 8

 Revenues are increases in SE resulting from

Copyright©2001 by Houghton Miffli 9

 Expenses are decreases in SE resulting from

Copyright©2001 by Houghton Miffli 10

Copyright©2001 by Houghton Miffli 11

 The difficulty of assigning revenues and expenses to a

Copyright©2001 by Houghton Miffli 12

Copyright©2001 by Houghton Miffli 13

Copyright©2001 by Houghton Miffli 14

Copyright©2001 by Houghton Miffli 16

Copyright©2001 by Houghton Miffli 17

Copyright©2001 by Houghton Miffli 18

 Accrual accounting “attempts to record the

Copyright©2001 by Houghton Miffli 19

Copyright©2001 by Houghton Miffli 20

Copyright©2001 by Houghton Miffli 21

Copyright©2001 by Houghton Miffli 22

 Adjusting entries are used to apply accrual

Copyright©2001 by Houghton Miffli 23

Copyright©2001 by Houghton Miffli 24

 A deferral is the postponement of:

Copyright©2001 by Houghton Miffli 25

 An accrual is the recognition of a

Copyright©2001 by Houghton Miffli 26

Copyright©2001 by Houghton Miffli 27

Rent Expense •Rules

Copyright©2001 by Houghton Miffli 32

Accumulated Deprn, Art Equipment

Depreciation Expense, Art Equipment •Rules

Accumulated Deprn, Office Equipment

Depreciation Expense, Office Equipment •Rules

Copyright©2001 by Houghton Miffli 34

Copyright©2001 by Houghton Miffli 35

Income Taxes Payable

Income Taxes Expense •Rules

Copyright©2001 by Houghton Miffli 37

Copyright©2001 by Houghton Miffli 38

Unearned Art Fees

Art Fees Earned •Rules

Copyright©2001 by Houghton Miffli 39

Copyright©2001 by Houghton Miffli 40