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Chapter 4
Income Measurement andAccrual Accounting
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Recognition and Measurementin Financial Statements
Recognition: process of recording an item as an asset, a liability, a revenue, an expense, or the like
Measurement: requires two choices to be made Choice 1: The attribute to be measured• Historical cost• Current value
Choice 2: The unit of measure—yardstick• Money
LO 1
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Exhibit 4.1—Recognition and Measurement in Financial Statements
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Cash and Accrual Bases of Accounting
Cash basis: revenues are recognized when cash is received and expenses are recognized when cash is paid
Accrual basis: revenues are recognized when earned and expenses are recognized when incurred
LO 2
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Example 4.1—Comparing the Cash and Accrual Bases of Accounting
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Exhibit 4.2—Comparing the Cash and Accrual Bases of Accounting
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The Revenue Recognition Principle
Recognized in the income statement when they are realized, or realizable, and earned
Revenues: Inflows of assets or settlements of liabilities Delivering or producing goods Rendering services Conducting other activities
LO 3
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Expense Recognition and theMatching Principle
Association of revenue of a period with all of the costs necessary to generate that revenue Direct matching: associate revenues of a period with
their costs Indirect matching: associate costs with a particular
period• Example: depreciation on building
Expenses incurred in two different ways: From the use of an asset From the recognition of a liability
LO 4
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Example 4.3—Comparing Three Methods for Matching Costs with Revenue
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Adjusting Entries Made at the end of an accounting period internal transactions and do not affect the Cash
account Adjustment of either an asset or a liability with a
corresponding change in revenue or expense Types of adjusting entries:
Deferred expense Deferred revenue Accrued liability Accrued asset
LO 5
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Deferred Expense
Cash paid before expense is incurred Example:
Prepaid rent Prepaid insurance Office supplies Property and equipment
Unexpired costs are assets Written off and replaced with an expense as the
costs expire
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Example 4.4—Adjusting a Deferred Expense Account
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Deferred Revenue
Cash received before revenue is earned Example:
Insurance collected in advance Subscriptions collected in advance Gift certificates
Initially recorded as liabilities (unearned or refundable receipts) and recorded as revenues in future periods when earned
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Example 4.6—Adjusting a Deferred Revenue Account
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Accrued Liability
Cash is paid after an expense is actually incurred rather than before its incurrence
Examples: Payroll Taxes Utilities
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Example 4.8—Recording an Accrued Liability for Wages
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Accrued Asset
Revenue earned before the receipt of cash Example: Rent and interest are earned with the
passage of time and require an adjustment if cash has not yet been received
Whenever a company records revenue before cash is received, receivable is increased and revenue is also increased
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Example 4.10—Recording an Accrued Asset
30 adjustment to recognize insurance expense:
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Accruals and Deferrals
30 adjustment to recognize insurance expense:
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The Accounting Cycle30 adjustment to recognize insurance expense: Series of steps performed each period and
culminating with the preparation of a set of financial statements
LO 6
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Exhibit 4.5—Steps in the Accounting Cycle
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Work sheet30 adjustment to recognize insurance expense: Device used at the end of the period to gather
the information needed to prepare financial statements without actually recording and posting adjusting entries
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Closing Entries
Made at the end of an accounting period Return the balance in all nominal accounts to
zero Transfer the net income or net loss and the
dividends of the period to the Retained Earnings account
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Real and Nominal accounts
Real accounts: balance sheet accounts Permanent in nature Not closed at the end of the period
Nominal accounts: revenue, expense, and dividend accounts Temporary in nature Closed at the end of the period
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Closing Process
All revenue accounts is credited to Income Summary—single entry is made
All expense accounts is credited to Income Summary—single entry is made
Credit balance in the Income Summary account is transferred to Retained Earnings
A credit is made to close the Dividends account with an offsetting debit to Retained Earnings
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Interim Financial Statements30 adjustment to recognize insurance expense: Financial Statements prepared monthly,
quarterly or at other intervals less than a year in duration
Prepared for internal use
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End of Chapter 4