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¦ FRESH CLASSES
¦ ICAP MODULE B & D
¦ FINANCIAL ACCOUNTING,
BUSINESS ECONOMICS & COST
ACCOUNTING.
¦ INDIVIDUAL & GROUPS

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¦FRESH CLASSES OF MA
ECONOMICS
EXTERNAL.
¦GUESS PAPERS AND
PAST PAPERS OF1998-
2009 ARE AVAILABLE.

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¦ Sales made ³on account´
¦ Purchases made ³on credit´
¦ Wages expense for employees
» when they¶ve worked but you haven¶t 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 haven¶t yet paid the IRS

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3


3

ƒ recognizing a revenue or expense means to
record it in the accounting records so that it
shows up on the income statement
¦ Ë
is revenue recognized?
Ë

ƒ when the amounts are earned (required
activities are complete)
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3 means you actually get the cash.

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When are costs


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as INVOICE

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ƒ when the ³matching´
revenue is
recognized, or
ƒ when the benefits of
the expenditures are
received


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5.67

1. Any revenue earned that has not been billed

(no receivable has been recorded)
2. Any interest revenue that has been earned
on 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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¦ Work that has been

completed -- but nothing
has been recorded for
the financial statements.
ƒ This situation arises when
a customer has not been
billed yet has not paid
ƒ Computerization of record-
keeping has made this
situation less frequent

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¦ An employee of Maids-R-Us
finished cleaning a house
on January 31, but didn¶t get
the paperwork into the office
in time to get it included in
the January records.
¦ An income statement for
January must include the
revenue because it has
been earned.

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¦ Accruing revenue affects the accounting

equation in the following way:

Assets = Liab. + Cont. Cap. + Retained Earnings

+ A/R + Revenue

¦ Income Statement: Increases income

¦ Statement of Changes in Equity: Increases equity
¦ Statement of Cash Flows: No effect on cash flows

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¦ When the customer pays,

the accounting equation
is affected on the asset
side only.
ƒ A/R is decreased by the
amount of the payment
ƒ Cash is increased by the
amount of the payment
¦ The revenue has already
been recognized.

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¦ The most common accrual is for interest--

the cost of borrowing money.
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ƒ If you borrowed the money, you¶d be dealing
with interest expense.

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¦ rou have a 6-month, Rs.100 CD that earns

12%, (always given as an annual rate), purchased on
January 1.
¦ The natural recording of this interest revenue
will 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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¦ Interest = principal x rate x time

¦ Interest = Rs.100 x .12 x 1/12 =
Rs.1
ƒ Since the rate is ³per year,´ the time has
to be given in terms of a year.
¦ Interest receivable and interest
revenue will each be Rs.1.
Show how that keeps the
accounting equation in balance.

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Assets = Liab. + Cont. Cap. + Retained Earnings

+1 interest +1 interest
receivable revenue

Income Statement: Increases income

Statement of Changes in Equity: Increases equity
Statement of Cash Flows: No effect on cash flow

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¦ Salary expense is a common expense that

needs 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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¦ 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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¦ Suppose a week¶s 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 be
a January expense.
¦ How is this reflected in the accounting
equation?

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Assets = Liab. + Cont. Cap. + Retained Earnings

+ 2,000 salaries (2,000) salary

payable expense

¦ Income Statement (Jan.): Decreases income

¦ Statement of Changes in Equity: Decreases equity
¦ Statement of Cash Flows: No effect on cash flows

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Assets = Liab. + Cont. Cap. + Retained Earnings

(5,000) cash (2000) salaries (3000) salary

payable expense

RIncome Statement (for Feb!): Decreases income

RStatement of Changes in Equity: Decreases equity
RStatement of Cash Flows: Operating cash outflow

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¦ Tax expense is a common expense that needs

to be accrued when financial statements are
prepared.
¦ The income statement for January needs to
include the income taxes for January, even
though they will not be paid until several
months later.
¦ WHr??

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 payment for
something you have NOT yet
provided.
¦ Dollars first, action later.
¦ Revenue is not

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until the service is performed or
the goods are delivered...but
you have to


 the fact that
you have received the cash.

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A publishing company collects money
for magazine subscriptions before the
magazines are actually delivered.

ƒ What is exchanged? Cash is received

but the á i part will come later.
ƒ In the meantime, the company has an
obligation--a liability. (The company
gives a promise of future delivery of
magazines.)

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Assets = Liab. + Cont. Cap. + Retained Earnings

+ cash + unearned
revenue

Income Statement: No effect

Statement of Changes in Equity: No effect

Statement of Cash Flows: Operating cash flows

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Assets = Liab. + Cont. Cap. + Retained Earnings

+ cash - unearned
revenue

Income Statement: Increases income

Statement of Changes in Equity: Increases equity

Statement of Cash Flows: No effect on cash flows

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You¶ve paid the cash ³up-front´ but you haven¶t

received the goods or services yet.
Remember: DEFER
Prepaid Expenses means to postpone.
[
 Here, we postpone


 recognizing the expense


  until we actually use the

goods or services.

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A special deferral--depreciation:
Recognizing an expenditure
by spreading it over several
years, allocating a part of the
expense to each of several
periods during which the asset
is used:

Depreciation
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¦ Often companies pay rent in advance.

¦ When the cash is paid, the company
has purchased an asset called
 eaid ent.
¦ Dollars first--action later.
¦ What¶s the action that triggers
recognition of the expense?
Passing of the time to which the rent
applies.

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Assets = Liab. + Cont. Cap. + Retained Earnings

+ prepaid rent
+ cash

Income Statement: Decreases income

Statement of Changes in Equity: Decreases equity

Statement of Cash Flows: Operating Cash Outflows

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Assets = Liab. + Cont. Cap. + Retained Earnings

- Prepaid rent - rent expense

Income Statement: Decreases income

Statement of Changes in Equity: Decreases equity

Statement of Cash Flows: No effect on cash flow

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¦ Often companies pay insurance in

advance.
¦ When the cash is paid, the company has
purchased an asset called  eaid
insu ance.
¦ Dollars first--action later.
¦ What¶s the action that triggers recognition
of the expense?
Passing of the time to which the insurance
applies.

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Assets = Liab. + Cont. Cap. + Retained Earnings

+ prepaid insurance
- cash

Income Statement: No effect

Statement of Changes in Equity: No effect

Statement of Cash Flows: Operating cash outflow

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Assets = Liab. + Cont. Cap. + Retained Earnings

- prepaid - insurance expense
insurance

Income Statement: Decreases income

Statement of Changes in Equity: Decreases equity

Statement of Cash Flows: No effect on cash flow

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¦ Companies purchase supplies to be
used later.
¦ When the cash is paid, the company
has purchased an asset called
su
ies. Sometimes they are called
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 to differentiate them
from supplies expense (used).
¦ Dollars first--action later.
¦ What¶s the action that triggers
recognition of the expense?
Actually using the supplies.

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Assets = Liab. + Cont. Cap. + Retained Earnings

+ supplies
- cash

Income Statement: No effect

Statement of Changes in Equity: No effect

Statement of Cash Flows: Operating cash outflow

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Assets = Liab. + Cont. Cap. + Retained Earnings

- supplies - supplies expense

Income Statement: Decreases income

Statement of Changes in Equity: Decreases equity

Statement of Cash Flows: No effect on cash flow

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¦ When a company buys an

asset that is used up in the
business (i.e., they didn¶t 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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¦ The portion of the cost of an asset

allocated to any one accounting period--
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¦ 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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¦ ABC Co. bought a

satellite dish for
Rs.5,000. The asset is
expected to last five
years and have no
salvage value at the end
of its useful life. How
will the purchase and
use of the asset affect
the financial
statements?

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(5,000) cash

6 Income Statement: no effect

6 Statement of Changes in Equity: no effect
6 Statement of Cash Flows: Rs.5,000
investing activity cash outflow

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¦ We want to „
„ the cost of the asset
to the income statement as an expense
during the time period we use the asset.
¦ If we depreciate the asset using the
STRAIGHT LINE method, we will divide
the cost of the asset (minus any
estimated salvage value) by the useful
life: Rs.5,000/5 = Rs.1,000 each year.

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(1,000) (1,000)
reduces the asset expense

Income Statement: Reduces income

Statement of Changes in Equity: Reduces equity

Statement of Cash Flows: No effect on cash flow

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8

6 Each year for five years, we will reduce the

asset¶s value on the balance sheet by Rs.1,000.
6 Each year for five years, we will have an expense
of Rs.1,000 on the income statement.
6 Instead of netting out the subtracted amount on the
balance sheet, we will always show the original
cost and then the amount of the total reduction.
That amount is called  

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6 The
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