Chapter 3: Financial Accounting
Accrual vs. Cash-Based Accounting
Ashton Converse
Objectives/Schedule

 Welcome: Hope you all had a relaxing holiday!
 Opening Look: Why Companies Research?
 Review Session
 Share about Interview Results
 Discussion Accrual vs. Cash Based Accounting
 Term and Notes
 www.accountingcoach.com
 Current Ratio and Debt Ratio: Evaluating the Business
Question to Get Going

 Why do companies spend millions of
dollars/yuan/etc. on research to discover more
about products and their customers?
 Companies such as the following:
 Callaway does research on golf clubs
 Wilson does research on tennis rackets and sports
equipment
 Apple on customers and top technology
 McDonalds on customers and communities
 Starbucks on communities, customers, and service
Review to Know and
Remember

 What are debit and credit usually recorded in?
 The chronological accounting record of an entity’s
transactions is called what?
 What is a trial balance?
 In the field of accounting, what is a ledger?
 What does posting mean in accounting?
 Name the first 3 steps to the flow of accounting?
 Name the last 3 steps to the flow of accounting?
 Why does I like the month of October?
Interview Results

 We are going to take around 20 minutes and have
some of you share what you found and learned
through your interviews.
 If you volunteer or are chosen to speak, cover one of
the following:
 Why is accounting so important for a successful
business?
 How to keep employees motivated and encouraged?
 What did you learn?
 What could they improve on?
Accrual vs. Cash Based
Accounting

 Accrual Accounting
 Records the impact of a business event as it occurs
 Cash does not need to be affected/changed
 Cash-basis Accounting
 Records on transactions in which cash is received or
paid
 Only records when cash is affected/changed
Accrual vs. Cash Basis

 Why is it important to know the difference?
 Scenario:
 If you own a business and your business makes sales
on account, are you going to use cash-basis accounting
or accrual accounting?
 WHY?
 Cash basis does not record the sale because you
received no cash.
What Happens?

 If we use Cash Basis Accounting:
 Then we will fail to record a sale on account (Balance Sheet)
 THIS IS BAD because the receivable is a real asset
 Without the truth, then investors cannot value the business
realistically
 Ignoring the sale robs investors of information about the true
revenue (Income Statement)
 Investors now are unable to value the business realistically
Cash Flows

Accrual Accounting is more complex-and more
complete-than cash-basis accounting.
Cash Transactions
 Collecting from Customers
 Borrowing Money
 Paying off Loans
 Issuing Stock
 Receiving cash from
interest earned
 Paying salaries, rent, and
other
Noncash Transactions
 Purchases of inventory on
account
 Sales on account
 Depreciation Expense
 Accrual of expenses
incurred but not yet paid
 Usage of prepaid rent,
insurance, and supplies
Name this Concept/Principle

 Makes sure that accounting information is reported
at regularly (intervals)
 Time-Period Concept
 The basis of recording expenses, helps accounts
identify all expenses during a period
 Matching Principle
 The basis for recording revenues; helps accountants
know when to record revenues
 Revenue Principle
Converse about Concepts

 The basic accounting period is usually 1 year.
 However, different periods can be annually, semiannually, monthly, or quarterly.
 The Revenue Principle helps govern 2 things:
 When to record revenue (make a journal entry)
 The amount of revenue to record
 The Matching Principle includes 2 steps:
 Identify all expenses
 Measure the expenses, and match expenses against
revenue
Converse about Concepts
 Deferral

 An adjustment for which the business paid or received
cash in advance
 Examples:
 PREPAID RENT, PREPAID INSURANCE, SUPPLIES
 What does depreciation mean?
 Expense associated with spreading (allocating) the cost
of a plant asset over its useful life
 Most common long-term deferral
 Comes from long-life assets: buildings, equipment, etc.
Converse about Concepts

 Accruals
 An expense or a revenue that occurs before the
business pays or receives cash.
 Remember: an accrual is the opposite of a deferral
 Review Term
 What is a Prepaid Expense?
 Random assets that typically expire or get used up in the
near future.
 What are some examples?
 Prepaid insurance, prepaid rent, supplies
 This means one asset increases while the other decreases
Term Diving

 What does the word accumulated mean?
 What does depreciation mean?
 So, accumulated depreciation is the cumulative sum of
all depreciation expense from the date of acquiring a plant
asset.
 Book Value
 The asset’s cost minus accumulated depreciation
 If a building cost $250,000 and the accumulated
depreciation is 35,000 over the years, what is the book
value?
 $215,000 is correct!
Week 6: Day 2 Objectives

 Welcome! Lets Learn
 Quick Review of Concepts and Terms
 Adventure into new Terms and Jargon
 Ratios: Debt and Current
 Finish Chapter 3
 Start Looking at Chapter 4
 Internal Control
 Financial and Management Plans
Quick Review

 What is the difference between accrual accounting
and cash-basis accounting?
 What is depreciation?
 Why do companies spend millions of dollars on
research?
 What 2 things does the revenue principle govern?
 What is the book value of this equipment if I bought
it all for $12,000, keeping in mind that accumulated
depreciation is $3,000?
 What is a deferral?
 What is accumulated depreciation?
Term Diving

 Accrued Expense
 A liability that arises from an expense that has not yet
been paid.
 Accounts Payable
 Accrued Revenue
 A revenue that has been earned, but not yet received
in cash.
 Accounts Receivable
 Unearned Revenue
 A liability created when a business collects cash from
its customers in advance of earning the revenue.
Jargon Used by Accountants
 Closing the Books

 Prepare the accounts for the next period
 Close the old journals and books and open up the next
periods transactions
 Closing Entries
 Set the revenue and expense balances back to zero at
the end of the period.
 To help prepare for the upcoming period.
 Temporary Account vs. Permanent Account
 Permanent are the long-life assets that will always be
used and will not be closed out like the temporary
accounts
End Chapter Terms

 Liquidity: measure of how quickly an item can be
converted to cash (like an asset)
 Operating Cycle: time span during which cash is
paid for goods and services that are sold to
customers who pay the business in cash
 Classified balance sheet: a balance sheet that shows
current assets separate from fixed assets/liabilities
 Report Format: assets on top, then liabilities and
owners’ equity below (best and most basic)
 Account Format: assets on the left, then liabilities
and owners’ equity on the right
End Chapter Terms

Two Types of Steps for the Income Statement
1. Single-step Income Statement
1. Lists all revenues together under one heading (revenues)
2. Expenses are in a separate category (expenses)
2. Multi-step Income Statement
1. Similar to Single-step, but it adds important detials
2. Contains subtotals to highlight important relationships
between revenues and expenses
Summary Problem
Application

 Both of the Summary Problems should be viewed by
you before the next class.
 Read through each problem and see how they
answer the question.
 Especially focus on the Mid-Chapter Summary
Problem*
Accounting Coach

For Extra Outside of Class Help
 www.accountingcoach.com
 This is a neat website that has extra information as
well as helpful activities and tools that can help you
learn more about accounting and/or help you
review what we have discussed in class.
Ratios for Evaluating

Current Ratio
 This is one of the most commonly used ratios in accounting
 Equation:
Current Ratio = Total current assets/total current liabilities
 The current ratio measures the company’s ability to pay
current liabilities with current assets.
 So with the assets a company owns, they see if that can pay
off their liabilities
Ratios for Evaluating

Debt Ratio
 This is one of the second common ratios that helps
managers and accountants make decisions
 Equation:
Debt Ratio = Total liabilities/Total assets
 This shows the proportion of a company’s assets that
is financed with debt.
 Shows the companies ability to pay off both current
and long-term debt
Chapter 4 Learning Objectives

 Set-up an effective system of internal control
 Use a bank reconciliation as a control device
 Apply internal controls
 Use a budget to manage cash
 Look at ethical judgments in businesses
Discuss this Question

 What could happen when a company fails to
supervise their employee’s day-to-day activities?
 Talk with your neighbor for about 2-3 minutes
 Come up with a good list of ideas
 Lets hear what some of you think?
 Possible ideas you may have stated:
 People steal, do not work as hard, quality work
decreases, more mistakes occur, difficult issues arise,
ethical problems may happen, less motivation, and
limitless more.
Good Management

Internal Control
 An organizational plan and certain measures for the
better of the company
 Used/designed to do the following:




Safeguard assets
Encourage obedience to company policies
Promote operational efficiency
Ensure accurate and reliable accounting records
Good Management

Sarbanes-Oxley Act (SOX)
 Congress passed the SOX to help the public concern
 Revamped (improved) corporate governance in the
United States
 Had sweeping effects on the accounting profession
 Removed wrong actions and unethical situations
 Keeps people in accountability to be more truthful
 Better all around for accountants, companies, and the
government
System of Internal Control

Components of Designing a System of Internal Control
1.
2.
3.
4.
5.
6.
Competent, Reliable, and Ethical Personnel
Assignment of Responsibilities
Proper Authorization
Supervision of Employees
Separation of Duties*
Internal and External Audits
Organizational Chart of a Corporation (helpful tool, Exhibit 4-2)
Quick Check: Do you
Know

 DO YOU KNOW…What is a controller?
 The chief accounting officer of a business
 DO YOU KNOW…What is an audit?
 A periodic examination of a company’s finance
statements and the accounting systems, controls, and
records that produce them.
Story Time

 Each of you will write a small story that includes 3 of
the internal control areas.
 The story/news article you write must be some
problem in a company.
 Write a summary of the company issue and how
they could improve 3 different areas of internal
control to possibly fix the issue or issues.
 Should be about a ½ of page to a full page story.
 ENJOY AND HAVE FUN WITH THIS!