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Chapter 3

COMMERCE 1AA3 Chapter Notes - Chapter 3: Accrual, Financial Statement, Trial Balance

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Aadil Merali Juma

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Chapter 3
Explain How Accural Accounting Differs From Cash-Basis Accounting
Accounting information can be prepared using cash basis or accrual basis of accounting
Cash Basis Accounting
Record only business transactions involving the receipt or payment of cash
o All other business transactions are ignored
Businesses who use this method would have incomplete information about the
company’s financial position and results of operations, which would likely lead them to
make poor business decisions
Inconsistent with the conceptual framework of accounting, it is not permitted by IFRS or
Accrual Accounting
Receipt or payment of cash is irrelevant to deciding whether a business transaction
should be recorded
Is the business has acquired an asset, earned revenue, taken on a liability or incurred an
expense, the transaction is recorded in the accounting records
Apply the Revenue and Expense Recognition Principles
Consists of amounts earned by a company in the course of its ordinary business
activities, mostly through the sale of goods and services
IFRS definition
o The gross inflow of economic benefits during the period arising in the course of
the ordinary activities of an entity when those inflows result in increases in
equity, other than increases relating to contributions from equity participants”
Revenue Recognition
1. The ownership or control and benefits of the goods have been transferred to the
customer, or the services have been provided to the customer
2. The amount of revenue can be reliably to the customer
3. It is probable that the business will receive the economic benefits associated with the
transaction, which usually come in the form of cash receipts
New IFRS Revenue Recognition
Standard is based on the idea that all business transactions involve contracts that
exchange goods or services for cash or claims to receive cash
The business selling the good or service must:
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o Identify the contract with the customer
o Identify the separate performance obligations in the contract
o Determine the transaction price
o Allocate the transaction price to the separate performance obligations in the
o Recognize revenue when the entity satisfies each performance obligation
The Expense Recognition Principle
before an expense can be recognized:
o there must be a decrease in future economic benefits caused by a decrease in an
asset or an increase in a liability
o the expense can be reliably measured
Record Adjusting Journal Entries
important to record all assets and liabilities at period end and all revenues earned and
expenses incurred during the period have been included in the accounts
Types of Adjusting Entries
3 main types:
o Deferrals
Adjusting entry must be recorded when a company receives (pays) cash
in advance of providing the related good or service that has been paid for
Results in the deferral of the recognition of the related revenue
9expense) until the future period in until the economic benefit is
o Depreciation
Adjusting entry must be recorded to reflect that the future economic
benefits of a tangible asset decline with age
Special form of deferral
Results in the depreciation of the value of the asset over its useful life by
expensing the portion of the asset’s economic benefits that has been
used up during an accounting period
o Accruals
Adjusting entry must be recorded when a company delivers
(or receives) a good or service in advance of it being billed and paid for
Results in the accrual of the related revenue (expense) in the period in
which the good or service is actually provided
Prepaid Expense
An expense a company has paid for in advance of actually using the benefit
Recorded as an asset when the cash payment is made because it will provide an
economic benefit
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