Introductory Financial Accounting I
Class 3 | Operating Decisions and the Accounting System
Professor Andrea Down
Fall 2024
Let’s Start with a Laugh ☺
Announcements
▪ Midterm Exam: Wednesday, October 16th @ 17:00 – 19:00
• More details closer to exam
• Last class before exam will be review
Announcements
▪ Accounting Orientation Day (see details on Quercus)
• Registration has now started; deadline = October 11 @ 11:59PM
• This is a mandatory event for all accounting students
• You will receive 1 bonus mark for one of the accounting courses you are taking this
term
• You can access to the registration via Quercus under the course shell 'Accounting
Events 2024 Fall – Years ½ and Years ¾’
• The form is listed under the module 'Accounting Orientation Day'
Recap
▪ Two things in this class will ALWAYS be true:
1. Assets = Liabilities + Owners’ Equity
2. Debits = Credits
Recap: Balance Sheet
Assets
LIABILITIES
ASSETS
OWNERS’ EQUITY
Liabilities or
Owners’ Equity
Recap: Balance Sheet
Recap: Journal Entries
⬜ ASSET = LIABILITIES + OWNERS’ EQUITY
⬜ DEBITS = CREDITS
Agenda
▪
▪
▪
▪
Operating cycle
Cash basis and accrual accounting
Revenue recognition
Matching process
The Operating Cycle
▪ The operating cycle (or cash-to-cash) cycle is the time it takes for a company to pay
cash to suppliers, sell those goods and services to customers, and collect cash from
customers
The Periodicity Assumption
▪ To provide timely information for decision makers, we report financial information for
relative short periods (e.g., monthly, quarterly, annually)
▪ Two types of issues arise when reporting periodic net earnings:
• Recognition issues: When should the transactions be recognized, classified, and
recorded?
• Measurement issues: What amounts should be recognized and recorded for the
transactions?
Classified Statement of Earnings
▪ The statement of earnings includes a number of sections and subtotals to aid the
user in identifying the company’s earnings from operations for the year, and to
highlight the effect of other items on net earnings
Classified Statement of Earnings
Net sales
− Cost of sales
= Gross profit
− Operating expenses
= Earnings from operations
+/− Non-operating revenues/expenses and gains/losses
= Earnings before income taxes
− Income tax expense
= Earnings from continuing operations
+/− Earnings/loss from discontinued operations
= Net earnings
Classified Statement of Earnings
Example: Dollarama
Classified Statement of Earnings
Income Statement T-Accounts
Revenues and Gains
Expenses and Losses
(many accounts)
(many accounts)
-
+
+
-
DEBIT
CREDIT
DEBIT
CREDIT
Income Statement T-Accounts
Revenues and Gains
Expenses and Losses
+ with Credits
+ with Debits
Accounts have
CREDIT balances
Accounts have
DEBIT balances
Balance Sheet
Assets
LIABILITIES
ASSETS
CONTRIBUTED CAPITAL
RETAINED EARNINGS
Liabilities or
Owners’ Equity
Cash Basis Accounting
▪ Some small businesses use cash basis accounting
▪ Revenues are recorded when cash is received and expenses are recorded when
cash is paid
▪ The cash basis also does not necessarily reflect all assets and liabilities of a
company on a particular date
▪ A cash basis is often adequate for small businesses, which usually do not have to
report to external users
Accrual Accounting
▪ Required by IFRS and ASPE
▪ Revenues and expenses are recognized when the transaction that causes them
occurs, not necessarily when cash is received or paid
▪ Revenues are recognized when they are earned and expenses when they are
incurred
▪ The revenue recognition principle and the matching process determine when
revenues and expenses are to be recorded under accrual basis accounting
Revenue Recognition Principle
▪ Specifies both the timing and amount of revenue to be recognized during an
accounting period
▪ It requires that a company recognize revenue when goods and services are
transferred to customers in an amount it expects to receive
▪ Revenue is earned when the business delivers goods or services, although cash
can be received from customers
• In a period before delivery
• In the same period as delivery
• In a period after delivery
Example 1: Revenue Recognition
▪ Cash is received before the goods or services are delivered
Debit
Credit
On receipt of $1,000 cash deposit
Cash
1,000
Deferred revenue
1,000
On delivery of ordered goods
Deferred revenue
Sales revenue
1,000
1,000
Example 2: Revenue Recognition
▪ Cash is received in the same period as the goods or services are delivered
Debit
Credit
On delivery of purchased goods for $300 cash
Cash
Sales revenue
300
300
Example 3: Revenue Recognition
▪ Cash is received after the goods or serviced are delivered
Debit
Credit
On delivery of purchased goods for $500 on account
Accounts receivable
500
Sales revenue
500
On receipt of cash after delivery
Cash
Accounts receivable
500
500
The Matching Process
▪ Requires that expenses be recorded when incurred in earning revenue
▪ All of the resources consumed in earning revenues during a specific period must be
recognized in that same period
▪ A matching of costs with benefits
Recording Expenses vs Cash Payments
▪ As with revenues and cash receipts, expenses are recorded as incurred, regardless
of when cash is paid
▪ Cash may be paid before, during, or after an expense is incurred
▪ An entry is made on the date the expense is incurred and another one on the date of
the cash payment, if at different times
Example 1: The Matching Process
▪ Cash is paid before the expense is incurred to generate revenue
Debit
Credit
On payment of $200 for office supplies
Office supplies
200
Cash
200
On subsequent use of half of the supplies
Supplies expense
Office supplies
100
100
Example 2: The Matching Process
▪ Cash is paid in the same period as the expense is incurred to generate revenue
Debit
Credit
On payment of $500 for using a repair service
Repairs expense
Cash
500
500
Example 3: The Matching Process
▪ Cash is paid after the cost is incurred to generate revenue
Debit
Credit
On the use of $4,000 of employees’ services during the period
Salaries expense
4,000
Salaries payable
4,000
On payment of cash after using employees’ services
Salaries payable
Cash
4,000
4,000
Key Takeaways
▪ Most companies use accrual accounting
▪ We recognize revenues when goods and services are transferred to customers
• Cash payment could occur before, at the same time, or after
▪ We record expenses when they are incurred
• Cash payment could occur before, at the same time, or after
▪ Revenue accounts have credit balances
▪ Expense accounts have debit balances