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Lecture 3

COMMERCE 1AA3 Lecture Notes - Lecture 3: Fiscal Year, Gross Profit, Retained Earnings

Course Code
Firat Sayin

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Chapter 3: Accrual Accounting and
Accrual and Cash-Basis Accounting
Accrual Accounting
Records the impact of transactions when they occur
o Revenues when earned/ acquiring an asset
o Expenses when incurred/ taken a liability
Both cash and non-cash transactions
o Even if the business receives or pays no cash
Receipt or payment of cash is irrelevant
o Required by IFRS and ASPE
Cash-Basis Accounting
Only records cash transactions
o Cash receipts (treated as revenues)
o Cash payments (treated as expenses)
Ignores other business transactions
o Results in incomplete financial statements
Not permitted by IFRS or ASPE
o Only used by small businesses
Accrual Accounting
Cash transactions
o Collecting payments from customers
o Receiving interest earned
o Borrowing money
o Paying expenses
o Paying off loans
o Issuing stock
Noncash transactions
o Sales on account
o Purchases on account
o Accrual of expenses not yet paid
o Depreciation expense
o Usage of prepaid expenses
o Earning of revenue when cash was collected in advance
Going out of business
o Shut down, Sell assets, Pay liabilities, Return leftover cash to owners
o Only way for business to know how well they performed

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Time Period Concept
Ensures accounting information is reported at regular intervals
o Basic accounting period is 1 year
Time periods
o Calendar year Jan 1st - Dec 31st
o Fiscal year 12 month period not ending on Dec 31st
o Interim periods Month/ Quarter/ Semi-annual (6 months)
Revenue and Expense Recognition Principles
Revenue Recognition Principle
When to record revenue (make journal entry)
o After revenue is earned
o Usually when good is delivered to customer
Amount of revenue to record
o Cash value of goods transferred to customer
Expense Recognition Principle
Identify expenses incurred
o During the accounting period
Measure the expenses
o Then recognise them with related revenues earned
o Means subtract expenses from revenue

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Adjusting the Accounts
Financial Statements are issued at the end of the period
o Begins with the Trial Balance
Unadjusted because some accounts are not ready
o E.g. Accounts receivable/payable, supplies, prepaid rent
Need to be brought up to date
o Because Certain transactions have not be recorded
Categories of Adjustment
Adjustment for items businesses have paid/received cash in advance
o E.g. Use of supply in operations. Becomes expenses
o Unearned Revenue Still owe them the service (Pre-orders)
Allocates cost of Plant Assets to expenses over its useful life
o Represents wear-and-tear and obsolescence
Opposite of a deferral
o E.g. Employees have worked. Don’t pay salary until later
Prepaid Expense (Asset)
o Asset when purchased
o Expense when used
Unearned Revenue (Liability)
o Liability when payment is received
o Revenue when good is delivered
Plant Assets
Long lived tangible assets
o E.g. Buildings, Equipment, Furniture, Land
o Exception Land doesn’t decline in usefulness
Accrued Expenses
o Records expense before paying cash
o E.g. Salaries, interest, income taxes
Accrued Revenues
o Records revenue before collecting cash
o Earned and will collect next period
o Debits a receivable and credits a revenue
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