3 Accrual
Accounting Concepts
FINANCIAL
ACCOUNTING
2ND
EDITION
BY
DUCHAC, REEVE, & WARREN
PowerPoint Presentation by
Gail B. Wright
Professor of Accounting
Bryant University
© Copyright 2007 Thomson South-Western, a part
of The Thomson Corporation. Thomson, the Star
Logo, and South-Western are trademarks used
herein under license.
1
LEARNING GOALS
When you finish this
chapter, you should be
able to
2
LEARNING GOALS
1. Describe basic accounting concepts
including matching concept.
2. Use accrual concepts to analyze, record, &
summarize transactions.
3. Describe, illustrate end-of-period
adjustment process.
Continued
3
LEARNING GOALS
4. Prepare financial statements using accrual
concepts.
5. Describe how accrual basis of accounting
enhances interpretation.
6. Describe the accounting cycle for accruals.
7. Describe, illustrate common-sized financial
statements.
4
WENDY’S INTERNATIONAL
Wendy’s
Has over 4,000 restaurants
Succeeds through innovation
1st Salad bar in fast food restaurant
Made-to-order sandwiches
Responsive to customers
5
LEARNING GOALS
1
Describe basic
accounting
concepts.
6
LG 1
ACCRUAL CONCEPT
Transactions
•Are recorded as they occur
•Are recorded even if cash not received or paid
•Affect accounting equation (A = L + E)
7
LG 1
ACCRUAL MEANS
• Revenue recognized (recorded)
when earned
• Liabilities recognized when
obligation incurred
8
LG 1
MATCHING PRINCIPLE
Expenses recognized, recorded in same
period as related revenue
9
LG 1
MATCHING MEANS
• When revenue is recorded
– Expenses incurred in generating revenues are
• Identified
• Recorded
• Matching subtracts expenses from revenue
to determine net income or loss
10
LEARNING GOALS
2
Use accrual concepts to
analyze, record, &
summarize transactions.
11
LG 2
FAMILY HEALTH CARE, PC
• Earns revenue when services provided to
patients
– Earnings process complete
– Patient obligated to pay
• Incurs expenses to earn revenue
– Recognize expenses according to matching
principle
12
LG 2
HEALTH CARE, PC
Transactions for November
• Transactions include
– Revenue
• Cash and on account
– Acquiring insurance
• Incurring insurance expense
– Buying equipment
• Recording depreciation expense
– Other
13
LG 2
TRANSACTION (a)
Family Health Care, PC receives
rent in advance.
14
LG 2
IFSF: Advance Rent (a)
Cash
Flows
Income
Statement
Balance Sheet
Assets
= Liabilities
+
Equity
Cash + Land = Note + Unearned rev + Stock + Ret Earn
Bal Oct
7,320 + 12,000 = 10,000
Rent
1,800
Bal
9,120 + 12,000 = 10,000 +
=
6,000 +
3,320
6,000 +
3,320
1,800
1,800
Family Health Care, PC
receives rent in advance.
Operating 1,800
15
LG 2
TRANSACTION (b)
Family Health Care, PC buys a 2
year policy for general business
insurance.
16
LG 2
IFSF: Business Insurance (b)
Cash
Flows
Balance Sheet
Assets
Balances
= Liabilities
+
Equity
Cash + Prepaid Ins + Land = Note + Unearned +
Equity
9,120
+ 12,000= 10,000 +
Insurance -2,400 + 2,400
Balances
Income
Statement
6,720 + 2,400
=
0
+
+ 12,000= 10,000 +
1,800
0
1,800 +
9,320
0
9,320
Family Health Care, PC buys 2
year business insurance policy
Operating -2,400
17
LG 2
TRANSACTION (c)
Family Health Care, PC buys a 6
month malpractice insurance policy.
18
LG 2
IFSF: Malpractice Insurance (c)
Cash
Flows
Balance Sheet
Assets
Balances
= Liabilities
+
Equity
Cash + Prepaid Ins + Land = Note + Unearned +
Equity
6,720 + 2,400
Insurance -6,000 + 6,000
Balances
Income
Statement
720 + 8,400
+ 12,000= 10,000 +
=
0
+
+ 12,000= 10,000 +
1,800 +
0
9,320
+
0
1,800 +
9,320
Family Health Care, PC buys 6
mo. malpractice insurance policy
Operating -6,000
19
LG 2
TRANSACTION (d)
Dr. Landry invests an additional
$5,000 in Family Health Care, PC.
20
LG 2
IFSF: Stock (d)
Cash
Flows
Balance Sheet
Assets
Balances
Income
Statement
= Liabilities
+
Equity
Cash + Other = Note + Unearned +
Stock + Ret Earn
720 + 20,400 = 10,000 +
Issued
stock
5,000
Balances
5,720 + 20,400 = 10,000 +
1,800 +
=
6,000
+ 3,320
5,000
1,800 +
11,000 +
3,320
Dr. Landry invests in practice
Financing 5,000
21
LG 2
TRANSACTION (e)
Family Health Care, PC buys
supplies on account.
22
LG 2
IFSF: Supplies On Account (e)
Cash
Flows
Balance Sheet
Assets
=
Cash + Supplies + Other =
Balances
Income
Statement
5,720
Liabilities
Acct Pay +
+ 20,400 =
Supplies
+ 240
=
240
Balances
5,720 + 240
+ 20,400 =
240
+
Equity
Other
Equity
+
11,800 +
14,320
+
11,800 +
14,320
Family Health Care, PC
purchased supplies on account.
23
LG 2
TRANSACTION (f)
Family Health Care, PC buys
equipment with $1,700 down
payment and a note for $6,800.
24
LG 2
IFSF: Bought Equipment (f)
Cash
Flows
Income
Statement
Balance Sheet
Assets
=
Liabilities
Cash + Equip + Other =
Note
Balances
5,720
10,000 + 2,040
Equipment
-1,700 + 8,500
Balances
4,020 + 8,500 + 20,640 =
+ 20,640 =
=
+
+
Other
Equity
Equity
+
14,320
+
14,320
6,800
16,800 + 2,040
Family Health Care, PC
bought equipment.
Investing -1,700
25
LG 2
TRANSACTION (g)
Family Health Care, PC provides
services to patients on account.
26
LG 2
IFSF: Services On Account (g)
Cash
Flows
Income
Statement
Balance Sheet
Assets
= Liabilities +
Equity
Cash + Acct rec. + Other = Liabilities + Stock + Ret Earn
Balances
Fees
Balances
4,020
+ 29,140 = 18,840
6,100
+
11,000 +
=
4,020 + 6,100 + 29,140 = 18,840
3,320
6,100
+ 11,000 +
9,420
Family Health Care, PC performed
services on account.
Revenue 6,100
27
LG 2
TRANSACTION (h)
Family Health Care, PC provided
services to patients and received
$5,500 cash.
28
LG 2
IFSF: Services For Cash (h)
Cash
Flows
Income
Statement
Balance Sheet
Assets
= Liabilities +
Equity
Cash + Acct rec. + Other = Liabilities + Stock + Ret Earn
Balances
4,020 + 6,100
+ 29,140 = 18,840
Fees
5,500
Balances
9,520 + 6,100 + 29,140 =
+
11,000 +
=
9,420
5,500
18,840 +
11,000 + 14,920
Family Health Care, PC performed
services for cash.
Operating 5,500
Revenue 5,500
29
LG 2
TRANSACTION (i)
Family Health Care, PC received
$4,200 from insurance company
payment.
30
LG 2
IFSF: Received Insurance Payment (i)
Cash
Flows
Income
Statement
Balance Sheet
Assets
= Liabilities +
Equity
Cash + Acct rec. + Other = Liabilities + Stock + Ret Earn
Balances
9,520 + 6,100 + 29,140 =
Payment
4,200 - 4,200
Balances
13,720 + 1,900 + 29,140 =
=
18,840
0
18,840 +
+ 11,000 + 14,920
+
0
+
0
11,000 + 14,920
Family Health Care, PC received
insurance payment on account.
Operating 4,200
31
LG 2
TRANSACTION (j)
Family Health Care, PC paid money
on account.
32
LG 2
IFSF: Received Insurance Payment (j)
Cash
Flows
Balance Sheet
Assets
Balances
Payment
Balances
Income
Statement
= Liabilities +
Equity
Cash + Acct rec. + Other = Acct pay + Other
Equity
13,720 + 1,900 + 29,140 =
+ 18,600 +
25,920
+ 18,600 +
25,920
-100
240
=
- 100
13,620 + 1,900 + 29,140 =
140
Family Health Care, PC received
insurance payment on account.
Operating
-100
33
LG 2
TRANSACTION (k)
Family Health Care, PC provides
services to patients on account.
34
LG 2
IFSF: Paid November Expenses (k)
Cash
Flows
Income
Statement
Balance Sheet
Assets
= Liabilities +
Cash + Acct rec. + Other = Liabilities
Balances
13,620 + 1,900 + 29,140 =
Payment
-4,690
Balances
8,930 + 1,900 + 29,140 =
18,740
Equity
Stock + Ret Earn
+ 11,000 + 14,920
=
-4,690
18,740
+ 11,000 + 10,230
Family Health Care, PC paid
November expenses.
Operating -4,690
Expenses -4,690
35
LG 2
TRANSACTION (l)
Family Health Care, PC paid
dividend to Dr. Landry.
36
LG 2
IFSF: Paid Dividend (l)
Cash
Flows
Income
Statement
Balance Sheet
Assets
= Liabilities +
Cash + Acct rec. + Other = Liabilities
Balances
8,930 + 1,900 + 29,140 =
Payment
-1,200
Balances
7,730 + 1,900 + 29,140 =
18,740
Equity
Stock + Ret Earn
+ 11,000 + 10,230
=
-1,200
18,740
+ 11,000 +
9,030
Family Health Care, PC paid
dividend to Dr. Landry.
Financing 1,200
37
LEARNING GOALS
3
Prepare end of period
adjustments.
38
LG 3
ADJUSTMENT PROCESS
• Applies matching concept
• To complete balance sheet, income
statement
39
LG 3
EXHIBIT 1
1/1/2007
12/31/2008
Cash received,
paid
1/1/2008
Deferrals
12/31/2008
Revenue earned,
expense incurred
40
LG 3
DEFERRALS
• Cash paid before expense incurred or cash
received before revenue recognized
• Examples:
– Prepaid expenses (insurance)
– Unearned revenues
41
LG 3
FAMILY HEALTH CARE, PC
Deferrals
• Deferred expenses
– Prepaid insurance expired, $1,100
– Supplied used, $150
– Depreciation on equipment, $160
• Deferred revenues
– Unearned rent revenue earned, $360
42
LG 3
IFSF: Prepaid Insurance (AJE 1)
Cash
Flows
Balance Sheet
Assets
=
Liabilities
Income
Statement
Equity
Cash + Prepaid Ins+ Other =
Liabilities+ Stock + Ret Earn
Balances
7,730 + 8,400
+ 22,640 =
18,740 + 11,000 + 9,030
Insurance
expense
- 1,100
=
-1,100
Balances
7,730 + 7,300
+ 22,640 =
18,740 + 11,000 + 7,930
Family Health Care, PC recognized
insurance used up.
Ins Exp - 1,100
43
LG 3
IFSF: Supplies (AJE 2)
Cash
Flows
Balance Sheet
Income
Statement
Assets
=
Liabilities+
Equity
Cash + Supplies + Other
=
Liabilities+ Stock + Ret Earn
Balances
7,730 +
240
+ 29,700 =
18,740 + 11,000 + 7,930
Supplies
expense
-
150
=
-150
Balances
7,730 +
90 + 29,700 =
18,740 + 11,000 + 7,780
Family Health Care, PC recognized
supplies used up.
Supp Exp - 150
44
LG 3
IFSF: Depreciation (AJE 3)
Cash
Flows
Balances
Depreciation
expense
Balances
Balance Sheet
Income
Statement
Assets
= Liabilities+
Cash + Acc Dep + Other
= Liabilities+ Stock + Ret Earn
7,730 +
0
Equity
+ 29,790 =
18,740 + 11,000 + 7,780
-
160
=
-160
7,730 -
160
+ 29,790 =
18,740 + 11,000 + 7,620
Family Health Care, PC recognized
depreciation on equipment.
Dep Exp - 160
45
LG 3
IFSF: Unearned Rent (AJE 4)
Cash
Flows
Balances
Unearned
rent
Balances
Balance Sheet
Assets
=
Cash + Other
= Unearned + Other + Stock + Ret Earn
7,730 + 29,630 =
Liabilities+
Income
Statement
Equity
1,800
+ 16,940 + 11,000 + 7,620
=
-360
360
7,730 + 29,630 =
1,440
+ 16,940 + 11,000 + 7,980
0
+
0
Family Health Care, PC recognized
rent revenue.
Rent Rev
46
360
LG 3
EXHIBIT 1 (cont.)
1/1/2007
12/31/2008
Revenue earned,
expense incurred
Accruals
1/1/2008
12/31/2008
Cash received or
paid
47
LG 3
ACCRUALS
• Recognize expense before cash is paid or
recognize revenue before cash is received
Examples:
– Accrued expenses (interest expense)
– Accrued revenues (for services provided but
not billed)
48
LG 3
FAMILY HEALTH CARE, PC
Accruals
• Accrued expense
– Wages owed but not paid, $220
• Accrued revenues
– Services provided, not billed, $750
49
LG 3
IFSF: Wages Expense (AJE 5)
Cash
Flows
Balance Sheet
Assets
Balances
Wages
Expense
Balances
=
Liabilities+
Income
Statement
Equity
Cash + Other =
Wages pay + Other + Stock + Ret Earn
7,730 + 29,630 =
18,380+ 11,000 + 7,980
0
+
0
=
220
-220
7,730 + 29,630 =
220
+ 18,380 + 11,000 + 7,760
Family Health Care, PC incurred
wages expense.
Wages exp - 220
50
LG 3
IFSF: Fees Earned (AJE 6)
Cash
Flows
Balance Sheet
Assets
Balances
Fees earned
Balances
Income
Statement
=
Liabilities+
Equity
Cash + Acc Rec + Other =
Liabilities+
Stock + Ret Earn
7,730 + 1,900 + 27,730 =
18,600
11,000 + 7,760
750
=
7,730 + 2,650 + 27,730 =
750
18,600 +
11,000 + 8,510
Family Health Care, PC earned
revenue.
Fees earned 750
51
LG 2
EXERCISE 3-6a
Indicate whether the following are deferred (prepaid)
expense.
a) Fees earned, not
received
b) Tax owed, not paid
c) Salary owed, not paid
d) Supplies on hand
e) Fees received, not
earned
f)
Utilities owed, not
paid
g) 2-yr premium paid
on insurance
h) Subscriptions
received in advance
Click the
button to
skip this
exercise
52
LG 3
EXERCISE 3-6b
Indicate whether the following are deferred (unearned)
revenue.
a) Fees earned, not
received
b) Tax owed, not paid
c) Salary owed, not paid
d) Supplies on hand
e) Fees received, not
earned
f)
Utilities owed, not
paid
g) 2-yr premium paid on
insurance
h) Subscriptions
received in advance
Click the
button to
skip this
exercise
53
LG 3
EXERCISE 3-6c
Indicate whether the following are accrued expense
(liability).
a) Fees earned, not
received
b) Tax owed, not paid
c) Salary owed, not paid
d) Supplies on hand
e) Fees received, not
earned
f)
Utilities owed, not
paid
g) 2-yr premium paid on
insurance
h) Subscriptions
received in advance
Click the
button to
skip this
exercise
54
LG 3
EXERCISE 3-6d
Indicate whether the following are accrued revenue
(asset).
a) Fees earned, not
received
b) Tax owed, not paid
c) Salary owed, not paid
d) Supplies on hand
e) Fees received, not
earned
f)
Utilities owed, not
paid
g) 2-yr premium paid
on insurance
h) Subscriptions
received in advance
Click the
button to
skip this
exercise
55
LEARNING GOALS
4
Prepare financial
statements using accrual
concepts.
56
LG 4
FINANCIAL STATEMENTS
• Health Care PC prepares financial
statements to summarize financial activity
for November after adjustments
• 4 Financial Statements are
–
–
–
–
Income statement
Retained earnings statement
Balance sheet
Cash flow statement
57
LG 4
EXHIBIT 3
Continued
58
LG 4
Continued
59
LG 4
Continued
60
LG 4
61
LG 4
INTEGRATED FINANCIAL
STATEMENTS
• Statement of cash flows linked to cash on
balance sheet
• Net income from income statement linked
to retained earnings statement
• Retained earnings linked to balance sheet in
stockholders’ equity
62
LG 4
EXHIBIT 5
63
LEARNING GOALS
5
Describe how accrual
basis of accounting
enhances interpretation.
64
LG 5
ACCRUAL ACCOUNTING
• Accrual accounting enhances interpretation
– By following a standard set of rules (GAAP)
for
• Recording
• Reporting
– Is a better predictor of long-term profitability
65
LEARNING GOALS
6
Describe accounting
cycle for accruals.
66
LG 6
ACCOUNTING CYCLE
•
•
•
•
Identify, analyze, record transactions
Identify, analyze, record adjustment data
Prepare financial statements
Prepare accounting records for next period
67
LEARNING GOALS
7
Describe, illustrate
common sized financial
statements.
68
LG 7
COMMON SIZED
STATEMENTS
Useful in comparing one
company to another
Use vertical analysis as basis for
comparison
69
LG 7
WENDY VS. McDONALD’S
Common Size Income Statement
Income Statement
Revenues
WENDY’S McDONALD’S
100.0%
100.0%
93.8
6.2%
81.4
18.6%
1.2
1.8
Income before tax
Income taxes
5.0%
3.6
16.8%
4.8
Net income
1.4%
12.0%
Operating expenses
Operating income
Other expenses
70
LG 7
ANALYSIS
Wendy’s has higher operating expenses than
McDonald’s
McDonald’s has higher tax and other expense than
Wendy’s
Wendy’s earns significantly less (1.4%) profit on
every dollar of sales than McDonald’s (12%)
71
LG 7
WENDY VS. McDONALD’S
Common Size Balance Sheet 1
Assets
Current assets
Other long-term assets
Property & equipment
Total assets
WENDY’S McDONALD’S
14.3%
10.3%
12.2
73.5
15.4
74.3
100.0%
100.0%
72
LG 7
WENDY VS. McDONALD’S
Common Size Balance Sheet 2
Liabilities & Equity)
Current liabilities
Other liabilities
Total stockholders’
equity
Total liabilities&
equity
WENDY’S McDONALD’S
21.5%
12.6%
24.8
36.3
53.7
51.1
100.0%
100.0%
73
LG 7
ANALYSIS
Wendy’s current assets and current liabilities are
higher than McDonald’s
McDonald’s has higher long term liabilities than
Wendy’s
Wendy’s uses slightly higher equity financing than
McDonald’s
74
CHAPTER 3
THE END
75