Ch.4
Income Measurement
& Accrual Accounting
Chapter 4, Slide #1
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
Chapter 4, Slide #5
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
Simultaneously
upon their
acquisition
e.g. Inventory
e.g. Buildings
e.g. Utilities
Chapter 4, Slide #7
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 #1
Prepay rent on office space for one year on September 1
Initial journal entry:
9/1
Prepaid Rent
2,400
Cash
2,400
Monthly adjusting journal entry:
9/30 Rent Expense
200
Prepaid Rent
200
($2,400 annual × 1/12 = $200 per month for 12
months)
Chapter 4, Slide #10
Deferred Expense Example #2
Purchase treadmill on January 1 for $5,000. Estimated useful
life is 7 years (84 months); estimated salvage value is $800
Initial journal entry:
1/1 Fitness equipment
5,000
Cash
5,000
Monthly adjusting journal entry:
1/31 Depreciation Expense
50
Accumulated Depreciation
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
Initial journal entry:
9/1 Cash
2,400
Insurance Collected in Advance
2,400
Monthly adjusting journal entry:
9/30 Insurance Collected in Advance
200
Rent Revenue
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 #1
Pay biweekly wages of $28,000
At end of month, between pay periods:
Wages Expense
4,000
Wages Payable
4,000
Next payday:
Wages Payable
Wages Expense
Cash
28,000
Chapter 4, Slide #15
4,000
24,000
Accrued Liability Example #2
On March 1, assume a 9%, 90-day, $20,000 loan is
taken out with a bank
Initial journal entry:
3/1 Cash
20,000
Note Payable
20,000
Monthly adjusting journal entry:
3/31 Interest Expense
150
Interest Payable
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:
Revenue
• 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 day of the month:
Rent Receivable
Rent Revenue
2,500
Upon receipt of cash:
Cash
Rent Receivable
2,500
Chapter 4, Slide #18
2,500
2,500