Tag Archives: Chapter 5

Accruals and Deferrals

Accruals
Accrued revenues and expenses are recognized before cash is received or paid.
Under accrual basis accounting, revenues are recognized when they are earned even if cash is not received yet. In this case, an accrued revenue is recognized.
Expenses that are recognized as they are incurred and cash is paid later are the accrued expenses.
Revenue recognized on credit sales is an example of an accrued revenue, because cash will be collected later.
Salaries expense recognized during the current period when the payment is made in the following period is an example of an accrued expense.
Deferrals
Deferred revenues and expenses are recognized after cash is received or paid. In the case of a deferred revenue, revenue recognition is deferred until revenue is earned even if cash has been received.
For a deferred expense, expense is recognized later while cash payment is made now. Unearned subscription revenue is an example of deferred revenue.
When subscribers to a magazine pay in advance for a year, the cash receipt is recorded as unearned subscription revenue, which is a liability account.
As each issue of magazine is sent to the subscriber, subscription revenue is recognized and the unearned subscription revenue account decreases.
Prepaid rent expense is an example of a deferred expense.
When then entity pays a one-year rent at the beginning of the lease period, the cash payment if recorded as prepaid rent expense, which is an asset account.
At the end of each month, rent expense is recognized and the prepaid rent expense account decreases.





 

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Accrual Basis Accounting

CASH BASIS ACCOUNTING
Under cash basis accounting, revenues are recognized when cash is received and expenses are recognized when cash is paid.
ACCRUAL BASIS ACCOUNTING
Under accrual basis accounting, revenues are recognized when revenues are earned regardless of cash receipt.
Revenues can be recognized before or after cash is received.
Expenses are recognized when related revenues are recognized. This is called the matching principle.
Financial statements are prepared using accrual basis accounting except for the statement of cash flows which is prepared by cash basis accounting.
Revenue Recognition
Revenue recognition under accrual basis accounting requires the following:
Revenue is earned
Revenue is earned when the goods are delivered or services are provided.
Revenue is realized or realizable
Realized means that cash is received from the customer. Revenue is realizable when the collection of cash is expected.
Expense Recognition
Expense recognition under accrual basis accounting is matched with when the related revenue is recognized.
The cost of goods sold is recognized in the same period when related sales revenue is recognized. Therefore, expense is matched with revenue under accrual basis accounting. This principle is named as matching principle.
Financial Statements
Generally accepted accounting principles require the application of accrual basis accounting when financial statements are prepared.
The only exception is the statement of cash flows.
To report the cash flows from operating, investing and financing activities, cash basis accounting is applied when the statement of cash flows is prepared.
Review Questions
1. Under cash basis accounting, when are revenues recognized?
Under cash basis accounting, revenues are recognized when cash is received.
2. Under cash basis accounting, when are expenses recognized?
Under cash basis accounting, expenses are recognized when cash is paid.
3. When are revenues recognized under accrual basis accounting?
Under accrual basis accounting, revenues are recognized when revenues are earned.
4. Under accrual basis accounting, when are expenses recognized?
Under accrual basis accounting, expenses are recognized when related revenues are recognized.
5. What is the name of principle that is applied when expenses are recognized under accrual basis accounting?
Matching principle


 

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