Chapter Income Measurement and Accrual Accounting Recognition and Measurement in Financial Statements  Recognition: process of recording an item as an asset, a liability, a revenue, an expense, or the like  Measurement: requires two choices to be made  Choice 1: The attribute to be measured • Historical cost • Current value  Choice 2: The unit of measure—yardstick • Money LO Exhibit 4.1—Recognition and Measurement in Financial Statements Cash and Accrual Bases of Accounting  Cash basis: revenues are recognized when cash is received and expenses are recognized when cash is paid  Accrual basis: revenues are recognized when earned and expenses are recognized when incurred LO Example 4.1—Comparing the Cash and Accrual Bases of Accounting Exhibit 4.2—Comparing the Cash and Accrual Bases of Accounting The Revenue Recognition Principle  Recognized in the income statement when they are realized, or realizable, and earned  Revenues: Inflows of assets or settlements of liabilities  Delivering or producing goods  Rendering services  Conducting other activities LO Expense Recognition and the Matching Principle  Association of revenue of a period with all of the costs necessary to generate that revenue  Direct matching: associate revenues of a period with their costs  Indirect matching: associate costs with a particular period • Example: depreciation on building  Expenses incurred in two different ways:  From the use of an asset  From the recognition of a liability LO Example 4.3—Comparing Three Methods for Matching Costs with Revenue Adjusting Entries Made at the end of an accounting period  internal transactions and not affect the Cash account  Adjustment of either an asset or a liability with a corresponding change in revenue or expense  Types of adjusting entries:  Deferred expense  Deferred revenue  Accrued liability  Accrued asset  LO Deferred Revenue  Cash received before revenue is earned  Example:  Insurance collected in advance  Subscriptions collected in advance  Gift certificates  Initially recorded as liabilities (unearned or refundable receipts) and recorded as revenues in future periods when earned Example 4.6—Adjusting a Deferred Revenue Account Accrued Liability  Cash is paid after an expense is actually incurred rather than before its incurrence  Examples:  Payroll  Taxes  Utilities Example 4.8—Recording an Accrued Liability for Wages Accrued Asset  Revenue earned before the receipt of cash  Example: Rent and interest are earned with the passage of time and require an adjustment if cash has not yet been received  Whenever a company records revenue before cash is received, receivable is increased and revenue is also increased Example 4.10—Recording an Accrued Asset 30 adjustment to recognize insurance expense: Accruals and Deferrals 30 adjustment to recognize insurance expense: The Accounting Cycle Series of steps performed each period and culminating with the preparation of a set of financial statements 30 adjustment to recognize insurance expense: LO Exhibit 4.5—Steps in the Accounting Cycle Work sheet Device used at the end of the period to gather the information needed to prepare financial statements without actually recording and posting adjusting entries 30 adjustment to recognize insurance expense: Closing Entries  Made at the end of an accounting period  Return the balance in all nominal accounts to zero  Transfer the net income or net loss and the dividends of the period to the Retained Earnings account Real and Nominal accounts  Real accounts: balance sheet accounts  Permanent in nature  Not closed at the end of the period  Nominal accounts: revenue, expense, and dividend accounts  Temporary in nature  Closed at the end of the period Closing Process  All revenue accounts is credited to Income Summary—single entry is made  All expense accounts is credited to Income Summary—single entry is made  Credit balance in the Income Summary account is transferred to Retained Earnings  A credit is made to close the Dividends account with an offsetting debit to Retained Earnings Interim Financial Statements Financial Statements prepared monthly, quarterly or at other intervals less than a year in duration  Prepared for internal use 30 adjustment to recognize insurance expense: End of Chapter [...]... used at the end of the period to gather the information needed to prepare financial statements without actually recording and posting adjusting entries 30 adjustment to recognize insurance expense: Closing Entries  Made at the end of an accounting period  Return the balance in all nominal accounts to zero  Transfer the net income or net loss and the dividends of the period to the Retained Earnings... Example 4. 10—Recording an Accrued Asset 30 adjustment to recognize insurance expense: Accruals and Deferrals 30 adjustment to recognize insurance expense: The Accounting Cycle Series of steps performed each period and culminating with the preparation of a set of financial statements 30 adjustment to recognize insurance expense: LO 6 Exhibit 4. 5—Steps in the Accounting Cycle Work sheet Device used at the. .. transferred to Retained Earnings  A credit is made to close the Dividends account with an offsetting debit to Retained Earnings Interim Financial Statements Financial Statements prepared monthly, quarterly or at other intervals less than a year in duration  Prepared for internal use 30 adjustment to recognize insurance expense: End of Chapter 4 ... accounts  Permanent in nature  Not closed at the end of the period  Nominal accounts: revenue, expense, and dividend accounts  Temporary in nature  Closed at the end of the period Closing Process  All revenue accounts is credited to Income Summary—single entry is made  All expense accounts is credited to Income Summary—single entry is made  Credit balance in the Income Summary account is transferred... replaced with an expense as the costs expire Example 4. 4—Adjusting a Deferred Expense Account Deferred Revenue  Cash received before revenue is earned  Example:  Insurance collected in advance  Subscriptions collected in advance  Gift certificates  Initially recorded as liabilities (unearned or refundable receipts) and recorded as revenues in future periods when earned Example 4. 6—Adjusting a Deferred... Revenue Account Accrued Liability  Cash is paid after an expense is actually incurred rather than before its incurrence  Examples:  Payroll  Taxes  Utilities Example 4. 8—Recording an Accrued Liability for Wages Accrued Asset  Revenue earned before the receipt of cash  Example: Rent and interest are earned with the passage of time and require an adjustment if cash has not yet been received  Whenever ... LO Example 4. 1—Comparing the Cash and Accrual Bases of Accounting Exhibit 4. 2—Comparing the Cash and Accrual Bases of Accounting The Revenue Recognition Principle  Recognized in the income statement... culminating with the preparation of a set of financial statements 30 adjustment to recognize insurance expense: LO Exhibit 4. 5—Steps in the Accounting Cycle Work sheet Device used at the end of the period... period • Example: depreciation on building  Expenses incurred in two different ways:  From the use of an asset  From the recognition of a liability LO Example 4. 3—Comparing Three Methods for