Using Financial
Accounting Information:
The Alternative to Debits and Credits
Fifth Edition
Gary A. Porter and Curtis L. Norton
Chapter 4, Slide #1
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Recognition and Measurement
Recognition: formally
recording an item in
the financial statements
of an entity
“...but at
current value
or historical
cost?”
Chapter 4, Slide #2
“I know I need
to record this...”
Measurement:
quantification of the
economic effects of
the item on the entity
LO1
Cash vs. Accrual Basis
Cash basis: revenues and
expenses are recorded only
when cash is received or paid
Accrual basis: revenues are recognized
when earned; expenses are recognized
when incurred
Chapter 4, Slide #3
LO2
Cash basis
statement
Accrual basis
statement
Statement of
Cash Flows
Income
Statement
Cash flows
from operating
activities: $(4,000)
Net income: $ 7,000
What accounts for
the difference?
Chapter 4, Slide #4
Revenue Recognition Principle
Revenue is recognized when realized and
earned—usually at point of sale
Exceptions:





Chapter 4, Slide #5
Long-term contracts
Franchises
Commodities
Installment sales
Rent and interest
LO3
Expense Recognition
Balance Sheet
ASSETS:
Inventory
Supplies
Prepaid assets
PP&E
Intangibles
Income Statement
EXPENSES:
when sold
Cost of goods sold
as used
Supplies expense
Insurance expense
Rent expense
over period they
provide benefits
Depreciation expense
Amortization expense
Other expenses
(as incurred)
Chapter 4, Slide #6
LO4
Matching Principle
Match expenses with associated revenues
Directly
Indirectly
over period they
provide benefits
e.g. Inventory
e.g. Buildings
Chapter 4, Slide #7
Simultaneously
upon their
acquisition
e.g. Utilities
Types of Adjusting Entries
Deferred
expense
Accrued
asset
Chapter 4, Slide #8
ALL RECOGNIZE
REVENUE OR
EXPENSES
BEFORE OR
AFTER CASH IS
EXCHANGED
Accrued
liability
Deferred
revenue
LO5
Deferred Expense
Cash paid before expense is incurred
 Examples:
•
•
•
•
Prepaid rent
Prepaid insurance
Office supplies
Property and equipment
 Costs are initially recorded as
assets and allocated to expenses in
future periods
Chapter 4, Slide #9
Deferred Expense Example
Prepay $2,400 for insurance for one year on Sept 1
To record payment:
Balance Sheet
Income Statement
Assets = Liabilities + Stockholders’ +
Equity
Prepaid Ins 2,400
Cash (2,400)
Revenues - Expenses
Monthly adjustment:
Prepaid Ins (200)
Insurance Expense (200)
($2,400 annual × 1/12 = $200 per month for 12 months)
Chapter 4, Slide #10
Deferred Expense Example
Purchase furniture on January 1 for $5,000. Estimated useful
life is 7 years (84 months); estimated salvage value is $800
Purchase of furniture:
Balance Sheet
Income Statement
Assets =
Liabilities + Stockholders’ + Revenues - Expenses
Equity
Furniture 5,000
Cash (5,000)
Monthly adjustment:
Accumulated
depreciation (50)
Depreciation Expense
(50)
($5,000 – $800) × 1/84 = $50 per month for 84 months)
Chapter 4, Slide #11
Deferred Revenue
Cash received before revenue is earned
 Examples:
• Insurance collected in advance
• Subscriptions collected in advance
• Gift certificates
 Receipts are initially recorded as liabilities
(unearned or refundable receipts) and recorded as
revenues in future periods when earned
Chapter 4, Slide #12
Deferred Revenue Example
Received $2,400 for an insurance policy in advance on
September 1
To record collection:
Balance Sheet
Assets
Cash
2,400
Income Statement
= Liabilities + Stockholders’ + Revenues - Expenses
Equity
= Insurance collected
in Advance 2,400
Monthly adjusting journal entry:
Insurance collected
in Advance (200)
Insurance expense
(200)
($2,400 annual × 1/12 = $200 per month for 12 months)
Chapter 4, Slide #13
Accrued Liability
Expense incurred before cash is paid
 Examples:
• Payroll
• Taxes
• Interest
 Record expense (and corresponding
liability) in period incurred; pay for
it in a future period
 No cash flow on recording, only
when paid
Chapter 4, Slide #14
Accrued Liability Example
Pay biweekly wages of $28,000
At end of month, between pay periods:
Balance Sheet
Income Statement
Assets
=
Liabilities + Stockholders’ +
Equity
Wages payable
+
4,000
Revenues - Expenses
Wages expense
(4,000)
Next payday:
Cash
= Wages payable
(28,000)
Chapter 4, Slide #15
(4,000)
+
Wages expense
(24,000)
Accrued Liability Example
On March 1, assume a 9%, 90-day, $20,000
loan is taken out with a bank
To record borrowing:
Balance Sheet
Income Statement
Assets = Liabilities + Stockholders’ +
Equity
Cash
=
Revenues - Expenses
Notes Payable
20,000
20,000
Monthly adjustment:
Interest Payable
150
+
Interest Expense
(150)
($20,000 principal × 9% × 3/12 = $450 for 3 months or
$450/3 = $150 per month)
Chapter 4, Slide #16
Accrued Asset
Revenue earned before cash is received
 Examples:
• Rent
• Interest
 Record revenue (and
corresponding receivable) in
period earned; receive
payment in a future period
Chapter 4, Slide #17
Accrued Asset Example
Rent payment of $2,500 due within first 10 days of
month
First of the month:
Balance Sheet
Assets
= Liabilities + Stockholders’ +
Equity
Rent receivable
2,500
=
Upon receipt of cash:
Cash 2,500
Rent receivable
(2,500)
Chapter 4, Slide #18
Income Statement
Revenues - Expenses
Rent revenue
2,500
Steps in the Accounting Cycle
1. Collect and
analyze info
7. Close the
accounts
2. Journalize
transactions
6. Record and
post
adjustments
5. Prepare
financial
statements
Chapter 4, Slide #19
3. Post
transactions to
general ledger
4. Prepare
work sheet
LO6
Nominal Accounts
Serve 2 important purposes:
Zero out
nominal accounts
to start accumulation
of next period’s
results
Chapter 4, Slide #20
Transfer
Net income (or net loss)
and dividends to the
Retained Earnings
account
End of Chapter 4
Chapter 4, Slide #21