Topic 2Accounting for Accruals

When to Record Revenue?

Assume that an accountant provided tax advice to a client on December 1, 20X3, but agreed to wait until January 15, 20X4 to be paid.

Q: Should the accountant “recognize” (record) this revenue, in 20X3 or 20X4?

A:

What is Accrual Accounting

• Accrual accounting attempts to record the effects of accounting events in the period that such events occur, regardless of when cash is received. (textbook)

• Cash information is important!• Cash information is on the Statement of Cash Flows

Examples of Accrual Events

• Sales made “on account”• Purchases made “on account”• Wages expense for employees• Interest on money borrowed or lent• Income tax expense

Computing Interest on Debt: Some Rules to Remember

• “Principal” is the amount originally borrowed• Quoted interest rates are usually “annual”

rates• even if the “term” of the loan is less than one year

• Often, interest is paid at the time principal is repaid if the term of the loan is < one year.

Computing Interest on Debt:the Formula

• Principal of the loan• x Annual interest rate• x Portion of a year in question• = Interest cost for the period in

question

Computing Interest on Debt:an Example

• Assume that on July 1, 20X1 Young Co. borrowed $10,000 from the bank at 12% interest rate and agrees to repay the interest on December 31, 20X1. How much interest will be owed?

• $• $10,000 x .12 x 6/12 = $ .

Transaction AnalysisIncluded in the lecture on Chapter 1 were six examples

of transaction analysis. After these events the account balances of “Our Company” were:o Cash 1,700o Land 3,500o Note payable 2,000o Common stock 3,000o Retained earnings 200

The eight events that follow are a continuation of the activities for Our Co. These events occurred in 20X2.

Transaction Analysis: ex. 1

• Provided services to customers for $2,000, on account.

• Assets = Liab. + C. Stock + Ret. Earn.

• Income Statement: • Statement of Changes in Equity: • Statement of Cash Flows:

Transaction Analysis: ex. 2

• Incurred expenses of $1,200, on account.• Assets = Liab. + C. Stock + Ret. Earn.•

• Income Statement: • Statement of Changes in Equity: • Statement of Cash Flows:

Transaction Analysis: ex. 3

• Collected $1,500 cash from account receivable.

• Assets = Liab. + C. Stock + Ret. Earn.

• Income Statement: • Statement of Changes in Equity: • Statement of Cash Flows:

Transaction Analysis: ex. 4• On April 30, 20X2, repaid the $2,000 that was

borrowed in 20X1, plus interest. The money was borrowed on Dec. 31, 20X1 at a rate of 9%.

• Assets = Liab. + C. Stock + Ret. Earn.

• Income Statement: • Statement of Changes in Equity: • Statement of Cash Flows:

Transaction Analysis: ex. 5

• Paid $1,000, on accounts payable.• Assets = Liab. + C. Stock + Ret. Earn.

• Income Statement:• Statement of Changes in Equity: • Statement of Cash Flows:

Transaction Analysis: ex. 6• On Oct. 1, 20X2, borrowed $1,500 at a rate of 8%,

by issuing a Note Payable. The loan, plus interest, is to be repaid on March 31, 20X3.

• Assets = Liab. + C. Stock + Ret. Earn.

• Income Statement: • Statement of Changes in Equity: • Statement of Cash Flows:

Transaction Analysis: ex. 7

• Distributed $100, to owners.• Assets = Liab. + C. Stock + Ret. Earn.

• Income Statement: • Statement of Changes in Equity: • Statement of Cash Flows:

Transaction Analysis: ex. 8

• On Dec. 31, accrued interest on the Oct. 1, Note Payable.

• Assets = Liab. + C. Stock + Ret. Earn.•

• Income Statement: • Statement of Changes in Equity: • Statement of Cash Flows:

Transaction Analysis: Summary for 20X2

Assets = Liab. + C. Stock + Ret. Earn. 5,200 = 2,000 3,000 200+ 2,000 (A/R) n/a n/a + 2,000 n/a + 1,200 (A/P) n/a - 1,200- 1,500 (A/R)) + 1,500 (cash) n/a n/a n/a- 2,060 (cash) - 2,000 (N/P) n/a - 60- 1,000 (cash) - 1,000 (A/P) n/a n/a+ 1,500 (cash) + 1,500 (N/P) n/a n/a- 100 (cash) n/a n/a - 100 n/a + 30 (I/P) n/a - 30+ 5,540 = + 1,730 + 3,000 + 810

Income Statement

Revenues $2,000- Expenses (1,290)Net income $ 710

Statement of Changes in Equity

Beginning common stock $3,000Plus: Investments 0Ending common stock $3,000

Beginning retained earnings 200Plus: Net income 710Less: dividends (100)Ending retained earnings 810Total equity $3,810

Balance Sheet Assets:

Cash $1,540Accounts receivable 500Land 3,500

Total assets $5,540Liabilities:

Accounts payable $ 200Interest payable 30 Note payable 1,500

Total liabilities $1,730Equity:

Common stock 3,000Retained earnings 810

Total equity 3,810Total liabilities and equity $5,540

Statement of Cash FlowsCash flows from operating activities:

Cash receipts from revenues $1,500Cash payments for expenses (1,060)

Net cash flow from oper. activs. $ 440

Cash flows from investing activities:

Cash flows from financing activities:Cash receipts from bank loan 1,500Cash payment for bank loan (2,000)Cash payment for dividend (100)

Net cash flow from fin. activs. (600)Net decrease in cash $ (160)