accruals and deferrals
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Accruals and Deferrals:Accruals and Deferrals:Timing is Everything in AccountingTiming is Everything in Accounting
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JOIN KHALID AZIZJOIN KHALID AZIZ
ECONOMICSOFICMAP, ICAP, MA-ECONOMICS, B.COM.
FINANCIAL ACCOUNTINGOFICMAP STAGE 1,3,4 ICAPMODULE B, B.COM, BBA, MBA & PIPFA.
COST ACCOUNTINGOFICMAP STAGE 2,3 ICAP MODULED, BBA, MBA & PIPFA.
CONTACT:
0322-3385752
0312-2302870
0300-2540827
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,
KARACHI, PAKISTAN.
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JOIN KHALID AZIZJOIN KHALID AZIZ
FRESH CLASSES
ICAP MODULE B & D
FINANCIAL ACCOUNTING,BUSINESS ECONOMICS & COST
ACCOUNTING.
INDIVIDUAL & GROUPS
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JOIN KHALID AZIZJOIN KHALID AZIZ
FRESH CLASSES OF MAECONOMICS
EXTERNAL.GUESS PAPERS AND
PAST PAPERS OF1998-2009 ARE AVAILABLE.
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More About AccrualsMore About Accruals
Accrual Accounting: Recording thefinancial transactions of a business
in the period in which they occur,
rather than in the period in whichcash is exchanged.
The economic substance of the
transaction signals therecordingnot disbursing or
receiving cash.
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Examples of Accrual EventsExamples of Accrual Events
Sales made on account
Purchases made on credit
Wages expense for employees
when theyve worked but you havent yet paid
them
Interest on money borrowed or lent
when time has passed (so interest has been
earned by the lender) but the actual cash for the
interest has not changed hands
Income tax expense
when you owe it but havent yet paid the IRS
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Accounts Receivable:Accounts Receivable:
Amounts owed by customersAmounts owed by customers
for goods and services receivedfor goods and services received
RecognitionRecognition of eventof event versus realization ofrealization of
cashcash
recognizing a revenue or expense means torecord it in the accounting records so that it
shows up on the income statement
WhenWhen is revenue recognized?
when the amounts are earned (requiredactivities are complete)
Realization means you actually get the cash.
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Accounts Payable:Accounts Payable:
Amounts you owe creditorsAmounts you owe creditors
for the purchase of goods and servicesfor the purchase of goods and services
When are costs
recognized as
expenses? when the matching
revenue is
recognized, or
when the benefits ofthe expenditures are
received
INVOICE
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AccrualsAccruals that need to be made before thethat need to be made before thefinancial statements are preparedfinancial statements are prepared ----
adjustments to the booksadjustments to the books
1. Any revenue earned that has not been billed(no receivable has been recorded)
2. Any interest revenue that has been earnedon investments that has not been recorded
3. Any expense that has been incurred (used)but has not been recorded (a common one
is salary expense)4. Income tax expense incurred but not
recorded
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RevenueRevenue that needs to be accruedthat needs to be accrued
Work that has been
completed -- but nothing
has been recorded for
the financial statements. This situation arises when
a customer has not been
billed yet has not paid
Computerization of record-
keeping has made this
situation less frequent
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Example:Example:
1.1. Revenue to be accruedRevenue to be accrued
An employee of Maids-R-Usfinished cleaning a house
on January 31, but didnt get
the paperwork into the office
in time to get it included inthe January records.
An income statement for
January must include therevenue because it has
been earned.
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Accruing RevenueAccruing Revenue
Accruing revenue affects the accounting
equation in the following way:
Assets = Liab. + Cont. Cap. + Retained Earnings
+ A/R + Revenue
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Increases income
Increases equity
No effect on cash flows
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What happens when the customer pays?What happens when the customer pays?
When the customer pays,
the accounting equation
is affected on the asset
side only. A/R is decreased by the
amount of the payment
Cash is increased by the
amount of the payment
The revenue has already
been recognized.
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Interest RevenueInterest Revenue
You have a 6-month, Rs.100 CD that earns
12%, (always given as an annual rate), purchased onJanuary 1.
The natural recording of this interest revenuewill happen when you receive the money.
An income statement for January needs to
show the amount of interest revenue for
January.
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Accruing Interest RevenueAccruing Interest Revenue
Interest = principal x rate x time
Interest = Rs.100 x .12 x 1/12 =
Rs.1
Since the rate is per year, the time hasto be given in terms of a year.
Interest receivable and interest
revenue will each be Rs.1.
Show how that keeps theaccounting equation in balance.
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Accruing Interest RevenueAccruing Interest Revenue
Assets = Liab. + Cont. Cap. + Retained Earnings
+1 interest +1 interest
receivable revenue
Income Statement:
Statement of Changes in Equity:Statement of Cash Flows:
Increases income
Increases equityNo effect on cash flow
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3.3. An Expense to be AccruedAn Expense to be Accrued
Salary expense is a common expense thatneeds to be accrued before financial statements
are prepared.
Suppose employees work five days per week
and are paid every Friday, but January 31 falls
on a Tuesday.
The salary expense for the week from January
30 to February 3 will not be paid until Friday,
February 3.
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Accruing Salary ExpenseAccruing Salary Expense
The income statement
for January should
have the expense for
January 30 and 31,
while the February
income statement will
have the expense for
February 1, 2, and 3.
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JOIN KHALID AZIZJOIN KHALID AZIZ
ECONOMICSOFICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTINGOFICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
COST ACCOUNTINGOFICMAP STAGE 2,3 ICAP MODULED, BBA, MBA & PIPFA.
CONTACT: 0322-3385752
0312-2302870
0300-2540827
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,
KARACHI, PAK
ISTA
N.
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Accruing Salary ExpenseAccruing Salary Expense
Suppose a weeks payroll is Rs.5,000.
On January 31, the company should accrue
Rs.2,000 worth of salary expense.
i.e., 2 out of 5 days worth of the salary must bea January expense.
How is this reflected in the accounting
equation?
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Accruing Salary ExpenseAccruing Salary Expense
Assets = Liab. + Cont. Cap. + Retained Earnings
+ 2,000 salaries (2,000) salary
payable expense
Income Statement (Jan.):
Statement of Changes in Equity:
Statement of Cash Flows:
Decreases income
Decreases equity
No effect on cash flows
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Assets = Liab. + Cont. Cap. + Retained Earnings
(5,000) cash (2000) salaries (3000) salarypayable expense
What happens when the salaries areWhat happens when the salaries are
actually paid to the employees onactually paid to the employees on
Friday, February 3?Friday, February 3?
Income Statement (for Feb!):
Statement of Changes in Equity:Statement of Cash Flows:
Decreases income
Decreases equityOperating cash outflow
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4.4. Taxes to be accruedTaxes to be accrued
Tax expense is a common expense that needs
to be accrued when financial statements are
prepared.
The income statement for January needs toinclude the income taxes for January, even
though they will not be paid until several
months later.
WHY??
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What is a Deferral?What is a Deferral?
A deferral event occurs when
cash is received or paid before
revenue is earned or an
expense is incurred.
Deferral events are a part of
the accrual basis ofaccounting
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DeferredDeferred RevenueRevenue
Youve received payment for
something you have NOT yet
provided.
Dollars first, action later. Revenue is not recognized
until the service is performed or
the goods are delivered...but
you have to record the fact thatyou have received the cash.
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Example of deferred revenue:Example of deferred revenue:
A publishing company collects moneyfor magazine subscriptions before the
magazines are actually delivered.
What is exchanged? Cash is received
but the give part will come later.
In the meantime, the company has an
obligation--a liability. (The companygives a promise of future delivery of
magazines.)
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How does receiving a payment inHow does receiving a payment in
advance affect the accounting equation?advance affect the accounting equation?
Assets = Liab. + Cont. Cap. + RetainedEarnings
+ cash + unearnedrevenue
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
No effect
No effect
Operating cash flows
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What happens when the service is finallyWhat happens when the service is finally
performed or the goods are delivered?performed or the goods are delivered?
Assets = Liab. + Cont. Cap. + RetainedEarnings
+ cash - unearnedrevenue
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Increases income
Increases equity
No effect on cash flows
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Deferred ExpensesDeferred Expenses
Prepaid ExpensesRent
Insurance
Supplies
Youve paid the cash up-front but you havent
received the goods or services yet.
Remember: DEFER
means to postpone.
Here, we postpone
recognizing the expense
until we actually use the
goods or services.
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Deferred ExpensesDeferred Expenses
Depreciation
ofplantandequipment
Recognizing an expenditure
by spreading it over severalyears, allocating a part of the
expense to each of several
periods during which the asset
is used:
A special deferral--depreciation:
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PREPAID RENTPREPAID RENT
Often companies pay rent in advance.
When the cash is paid, the company
has purchased an asset called
prep
aidrent.
Dollars first--action later.
Whats the action that triggers
recognition of the expense?
Passing of the time to which the rentapplies.
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How does paying the rent in advanceHow does paying the rent in advance
affect the accounting equation?affect the accounting equation?
Assets = Liab. + Cont. Cap. + RetainedEarnings
+ prepaid rent
+ cash
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Decreases income
Decreases equity
Operating Cash Outflows
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The expense is recorded when the time of theThe expense is recorded when the time of the
rent has passedrent has passed when its been used up.when its been used up.U
sually its an adjustment, made when the financialU
sually its an adjustment, made when the financialstatements are being prepared.statements are being prepared.
Assets = Liab. + Cont. Cap. + RetainedEarnings
- Prepaid rent - rent expense
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Decreases income
Decreases equity
No effect on cash flow
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PREPAID INSURANCEPREPAID INSURANCE
Often companies pay insurance in
advance.
When the cash is paid, the company has
purchased an asset called prepaidinsurance.
Dollars first--action later.
Whats the action that triggers recognition
of the expense?
Passing of the time to which the insurance
applies.
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How does paying for the insurance inHow does paying for the insurance in
advance affect the accounting equation?advance affect the accounting equation?
Assets = Liab. + Cont. Cap. + Retained Earnings
+ prepaid insurance
- cash
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
No effect
No effect
Operating cash outflow
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The expense is recorded when the time toThe expense is recorded when the time to
which the insurance applies has passedwhich the insurance applies has passed----whenwhen
its been used up.its been used up.Usually its an adjustment, made when the financial statements are
being prepared.
Assets = Liab. + Cont. Cap. + Retained Earnings
- prepaid - insurance expense
insurance
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Decreases income
Decreases equity
No effect on cash flow
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BUYING SUPPLIESBUYING SUPPLIES
Companies purchase supplies to beused later.
When the cash is paid, the company
has purchased an asset called
supplies. Sometimes they are calledsupplies-on-hand to differentiate them
from supplies expense (used).
Dollars first--action later.
Whats the action that triggersrecognition of the expense?
Actually using the supplies.
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How does buying the supplies in advanceHow does buying the supplies in advance
affect the accounting equation?affect the accounting equation?
Assets = Liab. + Cont. Cap. + Retained Earnings
+ supplies
- cash
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
No effect
No effect
Operating cash outflow
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The expense is recorded whenThe expense is recorded when
supplies are used.supplies are used.
Assets = Liab. + Cont. Cap. + Retained Earnings
- supplies - supplies expense
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Decreases income
Decreases equity
No effect on cash flow
Usually, supplies-on-hand are counted at the end of theperiod, and an adjustment is made to get the amount of
the remaining asset correct for the balance sheet.
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DEPRECIATIONDEPRECIATION
When a company buys an
asset that is used up in the
business (i.e., they didnt buy
it to resell it) AND it will be
useful for more than one
year, GAAP says that the
expense must be spread
over the accounting periods
during the useful life of the
asset.
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DEPRECIATIONDEPRECIATION
The portion of the cost of an assetallocated to any one accounting period--
DEPRECIATION EXPENSE
Depreciation of an asset is
an allocation process--spreading
the cost of an asset that benefits more
than one accounting period over the
estimated useful life of the asset.
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Example of DepreciationExample of Depreciation
ABC Co. bought asatellite dish for
Rs.5,000. The asset is
expected to last five
years and have nosalvage value at the end
of its useful life. How
will the purchase and
use of the asset affectthe financial
statements?
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PurchasePurchase of the asset:of the asset:
How does it affect the financial statements?How does it affect the financial statements?
+5,000 satellite dish
(5,000) cash
Income Statement: no effect
Statement of Changes in Equity: no effect
Statement of Cash Flows: Rs.5,000
investing activity cash outflow
Assets = Liabilities + CC + RE
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We want to allocate the cost of the assetto the income statement as an expenseduring the time period we use the asset.
If we depreciate the asset using theSTRAIGHT LINE method, we will dividethe cost of the asset (minus anyestimated salvage value) by the usefullife: Rs.5,000/5 = Rs.1,000 each year.
USE OF THE ASSETUSE OF THE ASSET
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UseUse of the asset:of the asset:
How does it affect the financial statements?How does it affect the financial statements?
(1,000) (1,000)
reduces the asset expense
Assets = Liabilities + CC + RE
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Reduces income
Reduces equity
No effect on cash flow
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JOIN KHALID AZIZJOIN KHALID AZIZ
ECONOMICSOFICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTINGOFICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
COST ACCOUNTINGOFICMAP STAGE 2,3 ICAP MODULED, BBA, MBA & PIPFA.
CONTACT: 0322-3385752
0312-2302870
0300-2540827
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,KARACHI, PAKISTAN.
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