Chapter 4: Accrual Accounting Concepts
Time period Assumption:
Divides the economic life of a business into artificial time periods. Ex: Interim
period (month, quarter) or Year (Fiscal, Calendar)
Revenue Recognition Principle:
Dictates that revenue be recognized in the accounting period in which it is earned.
Merchandising Company: revenue is earned when the merchandise is sold
(normally at point of sale)
Service company: revenue is considered earned at the time the service is
Requires that expenses be recorded in the same time period in which the revenues
they helped produce are recorded.
The practice of expense recognition is referred to as the matching principle
Cash Basis of Accounting:
Revenue is recorded only when cash is received.
Expenses are recorded only when cash is paid
Can lead to misleading financial statements – fails to record revenue that has
been earned if the cash hasn’t been received and fails to match expenses with
earned revenues, can give the impression that a company is not as profitable as it
was for the period.
Not in accordance with GAAP: violates revenue recognition and matching
Accrual Basis Accounting:
Means transactions that affect a company’s financial statements are recorded in
the periods in which the events occur, rather than when the company actually
receives or pays cash
Revenue is recorded when earned, rather than when cash is received
Expenses are recorded when incurred, rather than when cash is paid.
Adjusting entries are made to adjust or update accounts at the END of the