Chapter 3: Basic Accounting Systems: Accrual Accounting

Accounting Cycle for Accrual Accounting:

1. Identify, analyze, and record the effects of each transaction on financial statements/use matching concept and revenue and expense recognition principle 2. Assemble adjustment data and record end-of-the period adjustments 3. Prepare financial statements

Adjusting Entries Rules:

1. No cash 2. Income statement/revenue or expense 3. Balance sheet/asset or liability (no equity)

Accounts Receivable

Amounts that are to be collected in the future that arise from normal operations/assets

Accounts Payable

Amounts to be paid in the future for goods or services already acquired.

Current Assets

Assets expected to be converted to cash or sold or used up within one year or less

Need for Accrual Basis by GAAP

Better predictor of the profitability of a company

Quick Assets

Cash and other assets that can be readily converted to cash such as receivables and market securities

Deferrals

Created by recording a transaction in a way that delays or defers the recognition of an expense or revenue/Prepaid or deferred expenses or unearned/deferred revenues

Accruals

Created when a revenue or expense has been earned or incurred but has not been recorded/Accrued expense/liabilities or accrued revenues/assets

Current Liabilities

Due within a short time and are to be paid out of current assets

Expense Recognition Principle

Expenses are recorded in the same period that they are generated

Accrued Expenses/Liabilities

Expenses that have been incurred but are not recorded in the accounts -Unpaid wages/utility expense

Quick Asset

Include cash and other assets that can be readily converted to cash

Long Term Liabilities

Not due for a long time

Accumulated Depreciation

Offsetting/contra asset account/Subtracted from fixed cost of asset and added to balance sheet to maintain a record of the original cost of a fixed asset

Fixed Assets

Physical Assets of a long-term nature

Classified Balance Sheet

Prepared with various sections, subsections, and captions

Quick Ratio

Quick assets/current liabilities

Prepaid/Deferred Expenses

Recorded as assets but become expenses overtime/prepaid insurance

Unearned Revenues/Deferred Revenues

Recorded as liabilities but become revenues over time/Unearned rent

Cash Basis of Accounting

Recording transactions only when cash is received or paid

Accrual Basis of Accounting

Records revenue as it is earned and matches expenses against the revenue they generate -Recorded as recognized or on account

Depreciation

Reduction in the ability of a fixed asset to provide service/Land is not depreciated

Matching Concept

Requires expenses to be recorded in the same period as the related revenues that they generate/ensures net income and net loss for the period is properly determined

Revenue Recognition Principle

Revenue is recorded when services have been provided or when a product has been delivered to a customer

Accrued Revenues/Assets

Revenues that have been earned but are not recorded in the accounts/interest on notes receivable -All adj. affect BS and IS -No adj. aaff SCF and cash

Intangible Assets

Rights of long term nature (goodwill, copy rights, patents)

Book Value

The cost of the fixed asset minus the balance of accumulated depreciation

Adjustment Process

The updating of accounting records prior to preparing financial statements (not needed with cash transactions)

Accrual Basis Accounting

The use of accrual concepts for recording transactions and preparing financial statements -Records revenue when it is earned and matches expenses against the revenue they generate -Revenue is recognized when services are provided -Liabilities are recognized when a business incurs the obligation

Accounts

Transactions that increase or decrease a financial statement element (Financial statement element)

Notes Recievable

Written claims against debtors who promise to pay the amount of the note and interest/Quick asset