Professional Documents
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CH 3
CH 3
Adjusting the
Accounts
3-1
3-2
Timing Issues
Accountants divide the economic life of a business into
artificial time periods (Time Period Assumption).
Jan.
3-3
Feb.
Mar.
Apr.
.....
Dec.
Timing Issues
Fiscal and Calendar Years
3-4
Timing Issues
Review
The time period assumption states that:
a. revenue should be recognized in the accounting
period in which it is earned.
b. expenses should be matched with revenues.
c. the economic life of a business can be divided into
artificial time periods.
d. the fiscal year should correspond with the calendar
year.
3-5
Timing Issues
Accrual- vs. Cash-Basis Accounting
Accrual-Basis Accounting
3-6
Timing Issues
Accrual- vs. Cash-Basis Accounting
Cash-Basis Accounting
3-7
Timing Issues
Recognizing Revenues and Expenses
Revenue Recognition Principle
Recognize revenue in the
accounting period in which it
is earned.
In a service enterprise,
revenue is considered to be
earned at the time the
service is performed.
3-8
Timing Issues
Recognizing Revenues and Expenses
Expense Recognition Principle
Match expenses with
revenues in the period
when the company makes
efforts to generate those
revenues.
Let the expenses follow
the revenues.
3-9
Timing Issues
Illustration 3-1
GAAP relationships in revenue
and expense recognition
3-10
Timing Issues
Review
One of the following statements about the accrual basis of
accounting is false. That statement is:
a. Events that change a companys financial statements
are recorded in the periods in which the events occur.
b. Revenue is recognized in the period in which it is
earned.
c. The accrual basis of accounting is in accord with
generally accepted accounting principles.
d. Revenue is recorded only when cash is received, and
expenses are recorded only when cash is paid.
3-11
3-12
3-14
Deferrals
Accruals
1. Prepaid Expenses.
Expenses paid in cash and
recorded as assets before
they are used or consumed.
3. Accrued Revenues.
Revenues earned but not yet
received in cash or
recorded.
2. Unearned Revenues.
Cash received and recorded
as liabilities before revenue
is earned.
4. Accrued Expenses.
Expenses incurred but not
yet paid in cash or recorded.
Illustration 3-3
3-15
Prepaid expenses
OR
3-16
Unearned revenues.
BEFORE
Expense Recorded
3-17
insurance
rent
supplies
equipment
advertising
buildings
Adjusting entry:
3-18
Supplies expense
Supplies
3-19
1,500
1,500
SO 5 Prepare adjusting entries for deferrals.
3-20
SO 5
Insurance expense
50
Prepaid insurance
3-21
50
3-22
SO 5
3-23
40
40
3-24
3-25
SO 5
3-26
Illustration 3-9
3-27
BEFORE
Revenue Recorded
3-28
Rent
Magazine subscriptions
Airline tickets
Customer deposits
3-29
3-30
400
400
3-31
SO 5
Illustration 3-12
3-32
Revenues earned
OR
Expenses incurred
3-33
Revenue Recorded
BEFORE
Cash Receipt
3-34
Rent
Interest
Services performed
Adjusting entry:
3-35
SO 6
200
Service revenue
200
Cash
200
Accounts receivable
3-36
200
3-37
SO 6
3-38
BEFORE
Cash Payment
3-39
Rent
Taxes
Interest
Salaries
Adjusting entry:
3-40
SO 6
Oct. 31
Interest expense
Interest payable
3-41
50
50
3-42
SO 6
3-43
3-44
SO 6
Illustration 3-21
3-45
3-46
3-47
Illustration 3-25
3-48
Balance
Sheet
3-50
Income
Statement
Owners
Equity
Statement
Illustration 3-26
3-51
SO 7
Illustration 3-27
3-52
SO 7
APPENDIX3A
Alternative Treatment of Prepaid Expenses
and Unearned Revenues
3-53
APPENDIX3A
Prepaid Expenses
Company may choose to debit (increase) an expense
account rather than an asset account. This alternative
treatment is simply more convenient.
Illustration 3A-2
3-54
APPENDIX3A
Unearned Revenues
Company may credit (increase) a revenue account when
they receive cash for future services.
Illustration 3A-5
3-55
APPENDIX3A
Summary of Additional Adjustment Relationships
Illustration 3A-7
3-56
IFRS
A Look at IFRS
Key Points
3-57
IFRS
A Look at IFRS
Key Points
3-58
GAAP has more than 100 rules dealing with revenue recognition.
Many of these rules are industry specific. In contrast, revenue
recognition under IFRS is determined primarily by a single
standard. Despite this large disparity in the amount of detailed
guidance devoted to revenue recognition, the general revenue
recognition principles required by GAAP that are used in this
textbook are similar to those under IFRS.
IFRS
A Look at IFRS
Key Points
3-59
IFRS
A Look at IFRS
Key Points
The terminology used for revenues and gains, and expenses and
losses, differs somewhat between IFRS and GAAP. For example,
income is defined as:
Increases in economic benefits during the accounting period in
the form of inflows or enhancements of assets or decreases of
liabilities that result in increases in equity, other than those
relating to contributions from shareholders.
Expenses are defined as:
Decreases in economic benefits during the accounting period in
the form of outflows or depletions of assets or incurrences of
liabilities that result in decreases in equity other than those
relating to distributions to shareholders.
3-60
IFRS
A Look at IFRS
3-61
IFRS
A Look at IFRS
GAAP:
a. provides very detailed, industry-specific guidance on
revenue recognition, compared to the general
guidance provided by IFRS.
b. provides only general guidance on revenue
recognition, compared to the detailed guidance
provided by IFRS.
c. allows revenue to be recognized when a customer
makes an order.
d. requires that revenue not be recognized until cash is
received.
3-62
IFRS
A Look at IFRS
3-63
IFRS
A Look at IFRS
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3-65