4-1 Accrual Accounting Concepts Kimmel ● Weygandt ● Kieso Financial Accounting, Eighth Edition 4-2 CHAPTER OUTLINE LEARNING OBJECTIVES 4-3 Explain the accrual basis of accounting and the reasons for adjusting entries Prepare adjusting entries for deferrals Prepare adjusting entries for accruals Prepare an adjusted trial balance and closing entries LEARNING OBJECTIVE Explain the accrual basis of accounting and the reasons for adjusting entries Accountants divide the economic life of a business into artificial time periods (Periodicity Assumption) Jan Feb Mar Generally a month, a quarter, or a year Fiscal year vs calendar year Apr Dec ▼ HELPFUL HINT An accounting time period that is one year long is called a fiscal year 4-4 LO Periodicity Assumption Review Question What is the periodicity assumption? 4-5 a Companies should recognize revenue in the accounting period in which it is earned b Companies should match expenses 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 LO REVENUE RECOGNITION PRINCIPLE Companies recognize revenue in the accounting period in which the performance obligation is satisfied 4-6 LO REVENUE RECOGNITION PRINCIPLE Illustration: Assume Conrad Dry Cleaners cleans clothing on June 30, but customers not claim and pay for their clothes until the first week of July The journal entries for June and July would be: 4-7 LO EXPENSE RECOGNITION PRINCIPLE ILLUSTRATION 4-1 “Let the expenses follow the revenues.” 4-8 LO EXPENSE RECOGNITION PRINCIPLE ILLUSTRATION 4-1 GAAP relationships in revenue and expense recognition 4-9 LO INVESTOR INSIGHT Apple Inc Reporting Revenue Accurately The Until recently, electronics manufacturer Apple was required to spread the revenues from iPhone sales over the two-year period following the sale of the phone Accounting standards required this because Apple was obligated to provide software updates after the phone was sold Since Apple had service obligations after the initial date of sale, it was forced to spread the revenue over a two-year period As a result, the rapid growth of iPhone sales was not fully reflected in the revenue amounts reported in Apple’s income statement A new accounting standard now enables Apple to report much more of its iPhone revenue at the point of sale It was estimated that under the new rule revenues would have been about 17% higher and earnings per share almost 50% higher 4-10 LO KEEPING AN EYE ON CASH The difference for Sierra is $2,840 ($5,700 - $2,860) The following summary shows the causes of this difference 4-90 LO 4b DO IT! Closing Entries Hancock Company has the following balances in selected accounts of its adjusted trial balance Accounts Payable $27,000 Dividends $15,000 Service Revenue 98,000 Retained Earnings 42,000 Rent Expense 22,000 Accounts Receivable 38,000 Salaries and Wages Expense 51,000 Supplies Expense 7,000 Prepare the entries to close the revenue and expense accounts SOLUTION Service Revenue 98,000 Income Summary Income Summary 98,000 80,000 Salaries and Wages Expense 4-91 Rent Expense 22,000 Supplies Expense 7,000 51,000 LO 4b DO IT! Closing Entries Hancock Company has the following balances in selected accounts of its adjusted trial balance Accounts Payable $27,000 Dividends $15,000 Service Revenue 98,000 Retained Earnings 42,000 Rent Expense 22,000 Accounts Receivable 38,000 Salaries and Wages Expense 51,000 Supplies Expense 7,000 Prepare the entries to close income summary and dividends SOLUTION Income Summary 18,000 Retained Earnings Retained Earnings Dividends 4-92 18,000 15,000 15,000 LO LEARNING OBJECTIVE *5 APPENDIX 4A: Describe the purpose and the basic form of a worksheet Worksheet A multiple-column form that may be used in the adjustment process and in preparing financial statements 4-93 Manual or computer spreadsheet A working tool, not a permanent accounting record Neither a journal nor a part of the general ledger LO SIERRA CORPORATION Worksheet ILLUSTRATION 4A-1 Form and procedure for a worksheet For the Month Ended October 31, 2017 4-94 LO SIERRA CORPORATION Worksheet ILLUSTRATION 4A-1 Form and procedure for a worksheet For the Month Ended October 31, 2017 (a) (b) (d) (d) (e) (g) (a) (b) (c) (c) (e) (f) (f) (g) 4-95 LO A Look at IFRS LEARNING OBJECTIVE Compare the procedures for adjusting entries under GAAP and IFRS KEY POINTS Similarities Companies applying IFRS also use accrual-basis accounting to ensure that they record transactions that change a company’s financial statements in the period in which events occur 4-96 Similar to GAAP, cash-basis accounting is not in accordance with IFRS LO A Look at IFRS KEY POINTS Similarities IFRS also divides the economic life of companies into artificial time periods Under both GAAP and IFRS, this is referred to as the periodicity assumption The general revenue recognition principle required by GAAP that is used in this textbook is similar to that used under IFRS Revenue recognition fraud is a major issue in U.S financial reporting The same situation occurs in other countries, as evidenced by revenue recognition breakdowns at Dutch software company Baan NV, Japanese electronics giant NEC, and Dutch grocer Ahold NV 4-97 LO A Look at IFRS KEY POINTS Differences Under IFRS, revaluation (using fair value) of items such as land and buildings is permitted IFRS allows depreciation based on revaluation of assets, which is not permitted under GAAP The terminology used for revenues and gains, and expenses and losses, differs somewhat between IFRS and GAAP For example, income under IFRS includes both revenues, which arise during the normal course of operating activities, and gains, which arise from activities outside of the normal sales of goods and services 4-98 LO A Look at IFRS KEY POINTS Differences Under IFRS, expenses include both those costs incurred in the normal course of operations as well as losses that are not part of normal operations This is in contrast to GAAP, which defines each separately 4-99 LO A Look at IFRS LOOKING TO THE FUTURE The IASB and FASB are completing a joint project on revenue recognition The purpose of this project is to develop comprehensive guidance on when to recognize revenue It is hoped that this approach will lead to more consistent accounting in this area For more on this topic, see www.fasb.org/project/revenue_recognition.shtml 4-100 LO A Look at IFRS IFRS Practice IFRS: 4-101 a) uses accrual accounting b) uses cash-basis accounting c) allows revenue to be recognized when a customer makes an order d) requires that revenue not be recognized until cash is received LO A Look at IFRS IFRS Practice Which of the following statements is false? 4-102 a) IFRS employs the periodicity assumption b) IFRS employs accrual accounting c) IFRS requires that revenues and costs must be capable of being measured reliably d) IFRS uses the cash basis of accounting LO A Look at IFRS IFRS Practice Accrual-basis accounting: a) is optional under IFRS b) results in companies recording transactions that change a company’s financial statements in the period in which events occur 4-103 c) has been eliminated as a result of the IASB/FASB joint project on revenue recognition d) is not consistent with the IASB conceptual framework LO COPYRIGHT “Copyright © 2016 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” 4-104 ... Accrual Accounting Concepts Kimmel ● Weygandt ● Kieso Financial Accounting, Eighth Edition 4-2 CHAPTER OUTLINE LEARNING OBJECTIVES 4-3 Explain the accrual basis of accounting and the reasons for. .. and recorded as assets before they are used or consumed Unearned revenues: Cash received before service are performed Accruals: Accrued revenues: Revenues for services performed but not yet received... ILLUSTRATION 4-10 Accounting for prepaid expenses 4-30 LO UNEARNED REVENUES Receipt of cash recorded as a liability before services are performed Cash Cash Receipt Receipt BEFORE Revenue Revenue