Accrual Accounting Concepts
Chapter 3
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Learning Objectives
After studying this chapter, you should be able to:
•
Describe basic accrual accounting concepts, including the
matching concept
•
Use accrual concepts of accounting to analyze, record, and
summarize transactions
•
Describe and illustrate the end-of-period adjustment process
•
Prepare financial statements using accrual concepts of
accounting, including a classified balance sheet
•
Describe how the accrual basis of accounting enhances the
interpretation of financial statements
•
Financial Analysis: Describe and illustrate the use of working
capital, the current ratio, and the quick ratio in assessing a
company’s liquidity
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Learning Objective 1
Describe the basic accrual accounting
concepts, including the matching concept
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Why is Accrual Accounting Needed?
Revenue
earned
Cash received
or paid
Expense
incurred
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Accruing Revenue
Service provided
Customer invoiced
Cash received
______
Recognized
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Accruing Expenses
Materials purchased
Receive invoice
for purchase
Invoice paid
______
Recognized
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Matching Principle
Records ________ as it is earned
and matches ________ against the
___________ they generate
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Learning Objective 2
Use accrual concepts of accounting to
analyze, record, and summarize
transactions
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Accrual Concepts – Family Health Care
Transactions
• Services are provided to patients
• Insurance is filed, payment to be
received in the future
• Revenue is earned when the service
is provided to the patient
• Expenses are incurred for items such
as supplies where payment may be
made in the future
• Expenses are recorded as they are
incurred, not as they are paid
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Family Health Care – Rent Received in
Advance
• Family Health Care, P.C. received $1,800 from
ILS Company as rent for use of its land
Amount received is reported as a
_____ until the revenue is actually
earned
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Family Health Care – Prepaid
Expenses
• Family Health Care, P.C. buys a two-year
business insurance policy and pays $2,400 in
cash
Amount paid is reported as _________ until the
insurance is actually used up
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Family Health Care – Prepaid
Expenses
• Family Health Care, P.C. buys a six-month
medical malpractice insurance policy and pays a
premium in cash of $6,000
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Family Health Care – Additional Capital
Investment
• Dr. Landry invests an additional $5,000 in the
business in exchange for capital stock
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Family Health Care – Purchase on
Account
• Family Health Care, P.C. purchases $240 of
supplies on account
Amount purchased is reported as an asset
until the supplies are used in operations
Amount purchased is
reported as a liability
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Family Health Care – Purchase of
Equipment
• Purchased office equipment by making a $1,700
cash down payment and having five additional
monthly installments of $1,360
Cash down payment
Total Asset Value
Remaining balance due
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Family Health Care – Services
Provided on Account
• Provided services of $6,100 to patients on
account
_____ is recorded when service is provided
and invoiced
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Family Health Care – Services
Provided for Cash
• Performed services to patients who paid with
cash in the amount of $5,500
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Family Health Care – Collection of
Accounts Receivable
• Received $4,200 in cash payments from
patients’ insurance companies for prior services
performed.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Family Health Care – Payment of
Accounts Payable
• Paid $100 for supplies previously purchased on
account
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Family Health Care – Expenses Paid in
Cash
• Incurred expenses for the month of November
and paid cash for a total of $4,690
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Family Health Care – Dividends
Paid in Cash
• Family Health Care, P.C. paid dividends of
$1,200
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Learning Objective 3
Describe and illustrate the end-of-period
adjustment process
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Summary of Accruals and
Deferrals
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Deferrals and Accruals
Deferrals
____________
__________
Deferrals
______________
_____________
____________
Accruals
____________
__________
Accruals
______________
_____________
____________
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Deferred Expenses – Prepaid
Insurance
• As prepaid insurance expires, the asset, Prepaid
Insurance, decreases
Adjustments affect both the ____ ____ account
and the ____ ____ account
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Deferred Expenses – Supplies
• During November, $150 of supplies was used in
operations leaving a balance of $90
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Fixed Assets and Depreciation
Equipment
purchased
Equipment used to
generate
revenue over time
_____________
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Deferred Expenses – Depreciation
• The depreciation on Office Equipment for Family
Health Care is assumed to be $160 per month.
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Deferred Revenue – Unearned Rent
• On November 1, Family Health Care had
received $1,800 from ILS for rental of land for
five months. The portion of revenue earned by
the end of November is to be recorded.
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Pay Day
Accrued Expenses – Wages Owed
Wages earned
End of month
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Accrued Expenses – Wages Owed
• The amount owed for wages not paid is $220
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Accrued Revenues – Patient Services
• Family Health Care provides services worth
$750 to patients and have not billed for these
services at the end of the month
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Learning Objective 4
Prepare financial statements using
accrual concepts of accounting, including
a classified balance sheet
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Summary of Transactions for Family Health Care
• Family Health
Care, P.C. prepares
the four required
financial
statements to
summarize
November activity
after adjustments
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Income Statement
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Retained Earnings Statement
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Balance Sheet
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Statement of Cash Flows
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How the Financial Statements Integrate
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Learning Objective 5
Describe how the accrual basis of
accounting enhances the interpretation of
financial statements
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Cash vs. Accrual Accounting
Cash Basis
Accrual Basis
Revenue is recorded
When cash is _____
When revenue is _____
Expense is recorded
When cash is _____
When expense is _____ in
generating income
Adjusting entries
Not required
Required in order to
prepare _____ _____
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Importance of Accrual Accounting
• ____________ accounting provides a more
accurate measure of company performance
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Accrual Accounting and the Accounting
Cycle
________
Transactions
Record
___________
Record
__________
Prepare
________
_________
The Accounting Cycle
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Learning Objective 6
Financial Analysis: Describe and
illustrate the use of working capital, the
current ratio, and the quick ratio in
assessing a company’s liquidity
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Financial Analysis
• A company’s liquidity is its ability to convert _____ to
_____
• Measures to assess a company’s liquidity
• _____ _____
• _____ _____
• _____ _____
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Working Capital
Working Capital = _____ _____ − _____ _____
• Current assets: Cash and other assets that are
expected to be converted to cash, sold, or used
up within one year or less through normal
operations
• The larger the amount of working capital, the
more likely a company will be able to pay its
current liabilities
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Current Ratio
Current ratio =
• Measures a relationship among amounts, and
hence facilitates comparisons among companies
of different sizes
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Quick Ratio
Quick ratio =
•Quick assets: Cash and other current assets such as
receivables and short-term investments that can be
easily (and quickly) converted to cash
•
•
Inventories are excluded because the inventory must
first be sold and when sold on account, a receivable
must then be collected
Prepaid assets are excluded because most of the
times they are non-refundable or only partially
refundable after cancellation notices are processed
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Working Capital,
Current Ratio, and Quick Ratio
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End of Chapter 3
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