4-1
ACCRUAL
ACCOUNTING
CONCEPTS
4-2
Financial Accounting, Seventh Edition
Learning Objectives
After studying this chapter, you should be able to:
4-3
1.
Explain the revenue recognition principle and the expense recognition
principle.
2.
Differentiate between the cash basis and the accrual basis of
accounting.
3.
Explain why adjusting entries are needed, and identify the major types of
adjusting entries.
4.
Prepare adjusting entries for deferrals.
5.
Prepare adjusting entries for accruals.
6.
Describe the nature and purpose of the adjusted trial balance.
7.
Explain the purpose of closing entries.
8.
Describe the required steps in the accounting cycle.
9.
Understand the causes of differences between net income and cash
provided by operating activities.
Preview of Chapter 4
Financial Accounting
Seventh Edition
Kimmel Weygandt Kieso
4-4
Timing Issues
Accountants divide the economic life of a business into
artificial time periods (Periodicity Assumption).
.....
Jan.
4-5
Feb.
Mar.
Apr.
Generally a month, a quarter, or a year.
Fiscal year vs. calendar year
Dec.
LO 1 Explain the revenue recognition principle
and the expense recognition principle.
Timing Issues
Review Question
What is the periodicity assumption?
a. Companies should recognize revenue in the
accounting period in which it is earned.
b. Companies should match expenses with revenues.
c. The economic life of a business can be divided into
artificial time periods.
d. The fiscal year should correspond with the calendar
year.
4-6
LO 1 Explain the revenue recognition principle
and the expense recognition principle.
Timing Issues
The Revenue Recognition Principle
Companies recognize
revenue in the accounting
period in which the
performance obligation is
satisfied.
4-7
LO 1 Explain the revenue recognition principle
and the expense recognition principle.
Timing Issues
Illustration: Assume Conrad Dry Cleaners cleans clothing
on June 30, but customers do not claim and pay for their
clothes until the first week of July. The journal entries for
June and July would be:
4-8
LO 1 Explain the revenue recognition principle
and the expense recognition principle.
Timing Issues
Illustration 4-1 (Partial)
“Let the expenses follow the revenues.”
4-9
LO 1 Explain the revenue recognition principle
and the expense recognition principle.
Timing Issues
Illustration 4-1 GAAP
relationships in revenue
and expense recognition
4-10
LO 1 Explain the revenue recognition principle
and the expense recognition principle.
4-11
Timing Issues
Accrual versus Cash Basis of Accounting
Accrual-Basis Accounting
► Transactions recorded in the periods in which the
events occur.
► Revenues are recognized when services performed,
even if cash was not received.
► Expenses are recognized when incurred, even if cash
was not paid.
4-12
LO 2 Differentiate between the cash basis
and the accrual basis of accounting.
Timing Issues
Accrual versus Cash Basis of Accounting
Cash-Basis Accounting
► Revenues are recognized only when cash is received.
► Expenses are recognized only when cash is paid.
► Prohibited under generally accepted accounting
principles (GAAP).
4-13
LO 2 Differentiate between the cash basis
and the accrual basis of accounting.
Timing Issues
Illustration: Suppose that Fresh Colors paints a large
building in 2013. In 2013, it incurs and pays total expenses
(salaries and paint costs) of $50,000. It bills the customer
$80,000, but does not receive payment until 2014.
Illustration 4-2 (Partial)
2013
4-14
2014
LO 2 Differentiate between the cash basis
and the accrual basis of accounting.
Timing Issues
Review Question
Which one of these statements about the accrual basis of
accounting is false?
4-15
a.
Companies record events that change their financial
statements in the period in which events occur, even if cash
was not exchanged.
b.
Companies recognize revenue in the period in which the
performance obligation is satisfied.
c.
This basis is in accord with generally accepted accounting
principles.
d.
Companies record revenue only when they receive cash, and
record expense only when they pay out cash.
LO 2 Differentiate between the cash basis
and the accrual basis of accounting.
4-16
The Basics of Adjusting Entries
Adjusting entries
ensure that the revenue recognition and expense
recognition principles are followed.
are required every time a company prepares financial
statements.
includes one income statement account and one
balance sheet account.
4-17
never include cash.
LO 3 Explain why adjusting entries are needed, and
identify the major types of adjusting entries
The Basics of Adjusting Entries
Review Question
Adjusting entries are made to ensure that:
4-18
a.
expenses are recognized in the period in which they
are incurred.
b.
revenues are recognized in the period in which the
performance obligation is satisfied.
c.
balance sheet and income statement accounts have
correct balances at the end of an accounting period.
d.
All of the above.
LO 3 Explain why adjusting entries are needed, and
identify the major types of adjusting entries
Types of Adjusting Entries
Deferrals:
Illustration 4-3
Categories of adjusting entries
1.
Prepaid expenses: Expenses paid in cash and recorded as
assets before they are used or consumed.
2.
Unearned revenues: Cash received before service are
performed.
Accruals:
4-19
1.
Accrued revenues: Revenues for services performed but not
yet received in cash or recorded.
2.
Accrued expenses: Expenses incurred but not yet paid in
cash or recorded.
LO 3 Explain why adjusting entries are needed, and
identify the major types of adjusting entries
Types of Adjusting Entries
Trial Balance –
Each account is
analyzed to
determine
whether it is
complete and upto-date.
Illustration 4-4
4-20
LO 3 Explain why adjusting entries are needed, and
identify the major types of adjusting entries
Adjusting Entries for Deferrals
Deferrals are either:
Prepaid expenses
OR
4-21
Unearned revenues.
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Prepaid Expenses”
Payment of cash, that is recorded as an asset because
service or benefit will be received in the future.
Cash Payment
BEFORE
Expense Recorded
Prepayments often occur in regard to:
4-22
insurance
rent
supplies
equipment
advertising
buildings
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Prepaid Expenses”
Prepaid Expenses
Costs that expire either with the passage of time or
through use.
Adjusting entry results in an increase (a debit) to an
expense account and a decrease (a credit) to an asset
account.
4-23
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Prepaid Expenses”
Adjusting entries for prepaid expenses
Illustration 4-5
4-24
Increases (debits) an expense account and
Decreases (credits) an asset account.
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Prepaid Expenses”
Illustration: Sierra Corporation purchased supplies costing $2,500
on October 5. Sierra recorded the purchase by increasing (debiting)
the asset Supplies. This account shows a balance of $2,500 in the
October 31 trial balance. An inventory count at the close of business
on October 31 reveals that $1,000 of supplies are still on hand.
Oct. 31
Supplies Expense
Supplies
1,500
1,500
($2,500 – 1,000 = $1,500)
Illustration 4-6 (Partial)
4-25
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Prepaid Expenses”
Illustration: On October 4, Sierra Corporation paid $600 for a oneyear fire insurance policy. Coverage began on October 1. Sierra
recorded the payment by increasing (debiting) Prepaid Insurance.
This account shows a balance of $600 in the October 31 trial balance.
Insurance of $50 ($600 ÷ 12) expires each month.
Oct. 31
Insurance Expense
50
Prepaid Insurance
50
Illustration 4-7 (Partial)
4-26
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Prepaid Expenses”
Depreciation
Buildings, equipment, and motor vehicles (long-lived
assets) are recorded as assets, rather than an expense,
in the year acquired.
Companies report a portion of the cost of a long-lived
asset as an expense (depreciation) during each period of
the asset’s useful life.
4-27
Depreciation does not attempt to report the actual
change in the value of the asset.
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Prepaid Expenses”
Illustration: For Sierra Corporation, assume that depreciation on
the office equipment is $480 a year, or $40 per month.
Oct. 31
Depreciation Expense
40
Accumulated Depreciation-Equipment
40
Illustration 4-8 (Partial)
4-28
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Prepaid Expenses”
Statement Presentation
Accumulated DepreciationEquipment is a contra asset
account.
Appears just after the account it
offsets (Equipment) on the
balance sheet.
Illustration 4-9
4-29
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Prepaid Expenses”
Summary
Illustration 4-10
4-30
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Unearned Revenues”
Receipt of cash recorded as a liability before services are
performed.
Cash Receipt
BEFORE
Revenue Recorded
Unearned revenues often occur in regard to:
4-31
rent
magazine subscriptions
airline tickets
customer deposits
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Unearned Revenues”
Unearned Revenues
Adjusting entry to record the revenue that has been
earned and to show the liability that remains.
Adjusting entry results in a decrease (a debit) to a
liability account and an increase (a credit) to a revenue
account.
4-32
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Unearned Revenues”
Adjusting entries for unearned revenues
Illustration 4-11
4-33
Decrease (a debit) to a liability account and
Increase (a credit) to a revenue account.
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Unearned Revenues”
Illustration: Sierra Corporation received $1,200 on October 2 from
R. Knox for guide services for multi-day trips expected to be
completed by December 31. Unearned Service Revenue shows a
balance of $1,200 in the October 31 trial balance. From an evaluation
of the service Sierra performed for Knox during October, the company
determines that it has earned $400 in October.
Oct. 31
Unearned Service Revenue
Service Revenue
400
400
Illustration 4-12 (Partial)
4-34
LO 4 Prepare adjusting entries for deferrals.
Adjusting Entries for “Unearned Revenues”
Summary
Illustration 4-13
ACCOUNTING FOR UNEARNED REVENUES
Examples
Rent, magazine
subscriptions,
customer deposits
for future service
4-35
Reason for
Adjustment
Accounts Before
Adjustment
Adjusting
Entry
Unearned
Revenues recorded
in liability
accounts are now
recognized as
revenue for
services performed
Liabilities overstated.
Revenues understated.
Dr. Liabilities
Cr. Revenues
LO 4 Prepare adjusting entries for deferrals.
4-36
Adjusting Entries for Accruals
Made to record:
Revenues earned and
OR
Expenses incurred
in the current accounting period that have not been
recognized through daily entries.
4-37
LO 5 Prepare adjusting entries for accruals.
Adjusting Entries for “Accrued Revenues”
Revenues for services performed but not yet received in
cash or recorded.
Adjusting entry results in:
Revenue Recorded
BEFORE
Cash Receipt
Accrued revenues often occur in regard to:
4-38
rent
interest
services performed
LO 5 Prepare adjusting entries for accruals.
Adjusting Entries for “Accrued Revenues”
Accrued Revenues
An adjusting entry serves two purposes:
(1) Shows the receivable that exists, and
(2) Records the revenues for services performed.
4-39
LO 5 Prepare adjusting entries for accruals.
Adjusting Entries for “Accrued Revenues”
Adjusting entries for accrued revenues
Illustration 4-14
4-40
Increases (debits) an asset account and
Increases (credits) a revenue account.
LO 5 Prepare adjusting entries for accruals.
Adjusting Entries for “Accrued Revenues”
Illustration: In October, Sierra Corporation performed guide
services for $200 that were not billed to clients before October
31.
Oct. 31
Accounts Receivable
Service Revenue
200
200
Illustration 4-15
4-41
LO 5 Prepare adjusting entries for accruals.
Adjusting Entries for “Accrued Revenues”
Summary
Illustration
Illustration 4-16
4-16
ACCOUNTING FOR ACCRUED REVENUES
4-42
Examples
Reason for
Adjustment
Accounts Before
Adjustment
Adjusting
Entry
Interest, rent,
services performed
but not collected
Services performed
but not yet received
in cash or recorded
Assets understated.
Revenues understated.
Dr. Assets
Cr. Revenues
LO 5 Prepare adjusting entries for accruals.
Adjusting Entries for “Accrued Expenses”
Expenses incurred but not yet paid in cash or recorded.
Adjusting entry results in:
Expense Recorded
BEFORE
Cash Payment
Accrued expenses often occur in regard to:
4-43
rent
taxes
interest
salaries
LO 5 Prepare adjusting entries for accruals.
Adjusting Entries for “Accrued Expenses”
Accrued Expenses
An adjusting entry serves two purposes:
(1) Records the obligations, and
(2) Recognizes the expenses.
4-44
LO 5 Prepare adjusting entries for accruals.
Adjusting Entries for “Accrued Expenses”
Adjusting entries for accrued expenses
Illustration 4-17
4-45
Increases (debits) an expense account and
Increases (credits) a liability account.
LO 5 Prepare adjusting entries for accruals.
Adjusting Entries for “Accrued Expenses”
Illustration: Sierra Corporation signed a three-month note
payable in the amount of $5,000 on October 1. The note
requires Sierra to pay interest at an annual rate of 12%.
Illustration 4-18
Oct. 31
Interest Expense
50
Interest Payable
50
Illustration 4-19 (Partial)
4-46
LO 5 Prepare adjusting entries for accruals.
4-47
Adjusting Entries for “Accrued Expenses”
Illustration: Sierra Corporation last paid salaries on October 26;
the next payment of salaries will not occur until November 9. The
employees receive total salaries of $2,000 for a five-day work
week, or $400 per day. Thus, accrued salaries at October 31 are
$1,200 ($400 × 3 days).
Illustration 4-20
4-48
LO 5 Prepare adjusting entries for accruals.
Adjusting Entries for “Accrued Expenses”
Illustration: Sierra Corporation last paid salaries on October 26;
the next payment of salaries will not occur until November 9. The
employees receive total salaries of $2,000 for a five-day work
week, or $400 per day. Thus, accrued salaries at October 31 are
$1,200 ($400 x 3 days).
Oct. 31
Salaries and Wages Expense
Salaries and Wages Payable
1,200
1,200
Illustration 4-21
4-49
LO 5 Prepare adjusting entries for accruals.
Adjusting Entries for “Accrued Expenses”
Summary
Illustration 4-22
4-50
LO 5 Prepare adjusting entries for accruals.
Summary of Basic Relationships
Illustration 4-23
Summary of adjusting
entries
4-51
LO 5 Prepare adjusting entries for accruals.
The Adjusted Trial Balance
After all adjusting entries are journalized and posted the
company prepares another trial balance from the ledger
accounts (Adjusted Trial Balance).
The adjusted trial balance’s purpose is to prove the equality of
debit balances and credit balances in the ledger.
The adjusted trial balance is the primary basis for the
preparation of the financial statements.
4-52
LO 6 Describe the nature and purpose of the adjusted trial balance.
The Adjusted Trial Balance
Illustration 4-26
Adjusted trial balance
4-53
LO 6
The Adjusted Trial Balance
Review Question
Which of the following statements is incorrect concerning the
adjusted trial balance?
a. An adjusted trial balance proves the equality of the total
debit balances and the total credit balances in the ledger
after all adjustments are made.
b. The adjusted trial balance provides the primary basis for the
preparation of financial statements.
c. The adjusted trial balance lists the account balances
segregated by assets and liabilities.
d. The adjusted trial balance is prepared after the adjusting
entries have been journalized and posted.
4-54
LO 6 Describe the nature and purpose of the adjusted trial balance.
Preparing Financial Statements
Financial statements are prepared directly from the
Adjusted Trial Balance.
Income
Statement
4-55
Retained
Earnings
Statement
Balance
Sheet
LO 6 Describe the nature and purpose of the adjusted trial balance.
Preparing Financial Statements
Illustration 4-27
4-56
Preparing Financial Statements
4-57
Illustration 4-28
Quality of Earnings
Quality of Earnings – company provides full and transparent
information.
Earnings Management - the planned timing of revenues,
expenses, gains, and losses to smooth out bumps in net income.
Companies may manage earnings by:
one-time items to prop up earnings numbers.
inflate revenue numbers in the short-run.
improper adjusting entries.
As a result of the Sarbanes-Oxley Act, many companies are trying to
improve the quality of their financial reporting.
4-58
LO 6 Describe the nature and purpose of the adjusted trial balance.
Closing the Books
At the end of the accounting period, companies transfer the
temporary account balances to the permanent stockholders’
equity account—Retained Earnings.
Illustration 4-29
4-59
LO 7 Explain the purpose of closing entries.
Closing the Books
In addition to updating Retained Earnings to its correct ending
balance, closing entries produce a zero balance in each
temporary account.
Illustration 4-30
4-60
LO 7 Explain the purpose of closing entries.
Closing the Books
2014
Illustration 4-31
4-61
Closing the Books
Illustration 4-32
Posting of
closing entries
4-62
LO 7 Explain the purpose of closing entries.
Preparing a Post-Closing Trial Balance
The purpose of the post-closing trial balance is to prove
the equality of the permanent account balances that the
company carries forward into the next accounting period.
All temporary accounts will have zero balances.
4-63
LO 7 Explain the purpose of closing entries.
Summary of the Accounting Cycle
1. Analyze business transactions
4-64
Illustration 4-33
Required steps in the
accounting cycle
9. Prepare a post-closing
trial balance
2. Journalize the
transactions
8. Journalize and post
closing entries
3. Post to ledger accounts
7. Prepare financial
statements
4. Prepare a trial balance
6. Prepare an adjusted trial
balance
5. Journalize and post
adjusting entries:
Deferrals/Accruals
LO 8 Describe the required steps in the accounting cycle.
Keep an Eye on Cash
Sierra Corporation’s income statement shows net income of
$2,860. Net income and net cash provided by operating
activities often differ.
Net income on a cash basis is
referred to as “Net cash
provided by operating
activities.”
The statement of cash flows,
reports net cash provided by
operating activities.
Illustration 4-27
4-65
LO 9 Understand the causes of differences between net
income and cash provided by operating activities.
Keep an Eye on Cash
The difference for Sierra is $2,840 ($5,700 - $2,860). The
following summary shows the causes of this difference.
4-66
LO 9
Appendix 4A
Adjusting Entries in an Automated World— Using a
Worksheet
Trial Balance –
Each account is
analyzed to
determine whether
it is complete and
up-to-date.
Illustration 4-4
4-67
Steps in Preparing a Worksheet
1. Prepare a Trial Balance on the Worksheet
Cash
Supplies
Prepaid Insurance
Equipment
Notes Payable
Accounts Payable
Unearned Service Revenue
Common Stock
Dividends
Service Revenue
Trial Balance
Dr.
Cr.
15,200
2,500
600
5,000
5,000
2,500
1,200
10,000
500
10,000
Salaries & Wages Exp.
Rent Expense
Totals
4,000
900
28,700
Account Titles
4-68
Adjustments
Dr.
Cr.
Adjusted
Trial Balance
Dr.
Cr.
Income
Statement
Dr.
Cr.
Illustration 4A-1
Balance Sheet
Dr.
Cr.
28,700
LO 10 Describe the purpose and the basic form of a worksheet.
Steps in Preparing a Worksheet
1. Prepare a Trial Balance on the Worksheet
Cash
Supplies
Prepaid Insurance
Equipment
Notes Payable
Accounts Payable
Unearned Service Revenue
Common Stock
Dividends
Service Revenue
Trial Balance
Dr.
Cr.
15,200
2,500
600
5,000
5,000
2,500
1,200
10,000
500
10,000
Salaries & Wages Exp.
Rent Expense
Totals
4,000
900
28,700
Account Titles
Adjustments
Dr.
Cr.
Adjusted
Trial Balance
Dr.
Cr.
Income
Statement
Dr.
Cr.
Illustration 4A-1
Balance Sheet
Dr.
Cr.
28,700
Trial balance amounts come
directly from ledger accounts.
Include all accounts
with balances.
4-69
LO 10 Describe the purpose and the basic form of a worksheet.
Using a Worksheet
Illustration 4-24
General journal
showing adjusting
entries
Adjusting
Journal
Entries
4-70
2012
Steps in Preparing a Worksheet
2. Enter the Adjustments in the Adjustments Columns
Account Titles
Cash
Supplies
Prepaid Insurance
Equipment
Notes Payable
Accounts Payable
Unearned Service Revenue
Common Stock
Dividends
Service Revenue
Salaries & Wages Exp.
Rent Expense
Totals
Supplies Expense
Insurance Expense
Accumulated Depreciation
Depreciation Expense
Accounts Receivable
Interest Expense
Interest Payable
Salaries and Wages Payable
Totals
Trial Balance
Adjustments
Dr.
Cr.
Dr.
Cr.
15,200
(a) 1,500
2,500
(b)
600
50
5,000
5,000
2,500
1,200 (d) 400
10,000
500
(d) 400
10,000
(e) 200
(g)
4,000
1,200
900
28,700
28,700
(a) 1,500
(b) 50
(c)
40
(c) 40
(e)
200
(f)
50
(f)
50
(g)
1,200
3,440
3,440
Add additional accounts as needed.
4-71
Adjusted
Trial Balance
Dr.
Cr.
Income
Statement
Dr.
Cr.
Balance Sheet
Dr.
Cr.
Adjustments Key:
(a) Supplies Used.
(b) Insurance Expired.
(c) Depreciation Expensed.
(d) Service Revenue Earned.
(e) Service Revenue Accrued.
(f) Interest Accrued.
(g) Salaries Accrued.
Enter adjustment amounts, total
adjustments columns,
and check for equality.
LO 10 Describe the purpose and the
basic form of a worksheet.
Steps in Preparing a Worksheet
3. Complete the Adjusted Trial Balance Columns
Account Titles
Cash
Supplies
Prepaid Insurance
Equipment
Notes Payable
Accounts Payable
Unearned Service Revenue
Common Stock
Dividends
Service Revenue
Salaries & Wages Exp.
Rent Expense
Totals
Supplies Expense
Insurance Expense
Accumulated Depreciation
Depreciation Expense
Accounts Receivable
Interest Expense
Interest Payable
Salaries and Wages Payable
Totals
4-72
Trial Balance
Adjustments
Dr.
Cr.
Dr.
Cr.
15,200
(a) 1,500
2,500
(b)
600
50
5,000
5,000
2,500
1,200 (d) 400
10,000
500
(d) 400
10,000
(e) 200
(g)
4,000
1,200
900
28,700
28,700
(a) 1,500
(b) 50
(c)
40
(c) 40
(e)
200
(f)
50
(f)
50
(g)
1,200
3,440
3,440
Total the adjusted trial balance
columns and check for equality.
Adjusted
Trial Balance
Dr.
Cr.
15,200
1,000
550
5,000
5,000
2,500
800
10,000
500
10,600
Income
Statement
Dr.
Cr.
Balance Sheet
Dr.
Cr.
5,200
900
1,500
50
40
40
200
50
30,190
50
1,200
30,190
LO 10 Describe the purpose and the
basic form of a worksheet.
Steps in Preparing a Worksheet
4. Extend Amounts to Financial Statement Columns
Account Titles
Cash
Supplies
Prepaid Insurance
Equipment
Notes Payable
Accounts Payable
Unearned Service Revenue
Common Stock
Dividends
Service Revenue
Salaries & Wages Exp.
Rent Expense
Totals
Supplies Expense
Insurance Expense
Accumulated Depreciation
Depreciation Expense
Accounts Receivable
Interest Expense
Interest Payable
Salaries and Wages Payable
Totals
4-73
Trial Balance
Adjustments
Dr.
Cr.
Dr.
Cr.
15,200
(a) 1,500
2,500
(b)
600
50
5,000
5,000
2,500
1,200 (d) 400
10,000
500
(d) 400
10,000
(e) 200
(g)
4,000
1,200
900
28,700
28,700
(a) 1,500
(b) 50
(c)
40
(c) 40
(e)
200
(f)
50
(f)
50
(g)
1,200
3,440
3,440
Adjusted
Trial Balance
Dr.
Cr.
15,200
1,000
550
5,000
5,000
2,500
800
10,000
500
10,600
Income
Statement
Dr.
Cr.
Balance Sheet
Dr.
Cr.
10,600
5,200
900
5,200
900
1,500
50
1,500
50
40
40
200
50
30,190
Extend all revenue and expense account
balances to the income statement columns.
40
50
50
1,200
30,190
7,740
10,600
LO 10
Steps in Preparing a Worksheet
5. Total Columns, Compute Net Income (Loss)
Account Titles
Cash
Supplies
Prepaid Insurance
Equipment
Notes Payable
Accounts Payable
Unearned Service Revenue
Common Stock
Dividends
Service Revenue
Salaries & Wages Exp.
Rent Expense
Totals
Supplies Expense
Insurance Expense
Accumulated Depreciation
Depreciation Expense
Accounts Receivable
Interest Expense
Interest Payable
Salaries and Wages Payable
Totals
Net Income
Totals
4-74
Trial Balance
Adjustments
Dr.
Cr.
Dr.
Cr.
15,200
(a) 1,500
2,500
(b)
600
50
5,000
5,000
2,500
1,200 (d) 400
10,000
500
(d) 400
10,000
(e) 200
(g)
4,000
1,200
900
28,700
28,700
(a) 1,500
(b) 50
(c)
40
(c) 40
(e)
200
(f)
50
(f)
50
(g)
1,200
3,440
3,440
Adjusted
Trial Balance
Dr.
Cr.
15,200
1,000
550
5,000
5,000
2,500
800
10,000
500
10,600
Income
Statement
Dr.
Cr.
Balance Sheet
Dr.
Cr.
15,200
1,000
550
5,000
5,000
2,500
800
10,000
500
10,600
5,200
900
5,200
900
1,500
50
1,500
50
40
40
200
50
30,190
Compute Net Income or Net Loss.
40
40
200
50
50
1,200
30,190
7,740
2,860
10,600
10,600
22,450
10,600
22,450
50
1,200
19,590
2,860
22,450
LO 10
Key Points
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Companies applying IFRS use accrual-basis accounting.
Similar to GAAP, cash-basis accounting is not in accordance with
IFRS.
IFRS also divides the economic life of companies into artificial time
periods. Under both GAAP and IFRS, this is referred to as the
periodicity assumption.
IFRS requires that companies present a complete set of financial
statements, including comparative information annually.
LO 11 Compare the procedures for revenue recognition under GAAP and IFRS.
Key Points
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GAAP has more than 100 rules dealing with revenue recognition.
In contrast, revenue recognition under IFRS is determined primarily
by a single standard.
Revenue recognition fraud is a major issue in U.S. financial
reporting. The same situation occurs in other countries, as
evidenced by revenue recognition breakdowns at Dutch software
company Baan NV, Japanese electronics giant NEC, and Dutch
grocer AHold NV.
LO 11 Compare the procedures for revenue recognition under GAAP and IFRS.
Key Points
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A specific standard exists for revenue recognition under IFRS (IAS
18). In general, the standard is based on the probability that the
economic benefits associated with the transaction will flow to the
company selling the goods, providing the service, or receiving
investment income. In addition, the revenues and costs must be
capable of being measured reliably. GAAP uses concepts such as
realized, realizable (that is, it is received, or expected to be
received), and earned as a basis for revenue recognition.
Under IFRS, revaluation of items such as land and buildings is
permitted. IFRS allows depreciation based on revaluation of
assets, which is not permitted under GAAP.
LO 11 Compare the procedures for revenue recognition under GAAP and IFRS.
Key Points
The terminology used for revenues and gains, and expenses and
losses, differs somewhat between IFRS and GAAP. For example,
income is defined as:
Increases in economic benefits during the accounting period in
the form of inflows or enhancements of assets or decreases of
liabilities that result in increases in equity, other than those
relating to contributions from shareholders.
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LO 11 Compare the procedures for revenue recognition under GAAP and IFRS.
Key Points
4-79
Income includes both revenues, which arise during the normal
course of operating activities, and gains, which arise from activities
outside of the normal sales of goods and services. Instead, under
GAAP income refers to the net difference between revenues and
expenses. Expenses are defined as: Decreases in economic
benefits during the accounting period in the form of outflows or
depletions of assets or incurrences of liabilities that result in
decreases in equity other than those relating to distributions to
shareholders.
Procedures of the closing process are applicable to all companies
whether they are using IFRS or GAAP.
LO 11 Compare the procedures for revenue recognition under GAAP and IFRS.
Looking to the Future
The IASB and FASB are now involved in a joint project on revenue
recognition. The purpose of this project is to develop comprehensive
guidance on when to recognize revenue. Presently, the Boards are
considering an approach that focuses on changes in assets and
liabilities (rather than on earned and realized) as the basis for revenue
recognition. It is hoped that this approach will lead to more consistent
accounting in this area. For more on this topic, see
www.fasb.org/project/revenue_recognition.shtml.
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LO 11 Compare the procedures for revenue recognition under GAAP and IFRS.
IFRS Practice
Which of the following statements is false?
a) IFRS employs the periodicity assumption.
b) IFRS employs accrual accounting.
c) IFRS requires that revenues and costs must be capable of
being measured reliably.
d) IFRS uses the cash basis of accounting.
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LO 11 Compare the procedures for revenue recognition under GAAP and IFRS.
IFRS Practice
As a result of the revenue recognition project being undertaken by
the FASB and IASB:
a) revenue recognition will place more emphasis on when
revenue is earned.
b) revenue recognition will place more emphasis on when
revenue is realized.
c) revenue recognition will place more emphasis on when
changes occur in assets and liabilities.
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d) revenue will no longer be recorded unless cash has been
received.
LO 11
IFRS Practice
Accrual-basis accounting:
a) is optional under IFRS.
b) results in companies recording transactions that change a
company’s financial statements in the period in which events
occur.
c) will likely be eliminated as a result of the IASB/FASB joint
project on revenue recognition.
d) is not consistent with the IASB conceptual framework.
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LO 11 Compare the procedures for revenue recognition under GAAP and IFRS.
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4-84
