Chapter 3: Measuring and reporting financial performance

When should a business recognise revenue?

1. Physical possession passes to the customer

2. The business has the right to demand payment for the goods or services.

3. The customer has accepted the goods or services.

4. Legal title passes to the customer.

5. Significant risks and rewards of ownership passes to the customer.

How is revenue recognised if the purchase is used on credit?

It is usually recognised when the customer has accepted the goods/services and acquires the legal title.

What is the matching convention?

It is an accounting convention that holds that when measuring income, expenses should be matched to revenue, which they helped generate.

What is an accrued expense?

An expense that is unpaid at the end of a reporting period. It will be treated as a current liability.

1. Amount paid plus the amount outstanding will be shown in the income statement.

2. The amount outstanding will be represented as a current liability in the balance sheet.

3. The amount paid will reduce the cash account.

What is a prepaid expense?

An expense that has been paid in advance at the end of a reporting period. It will be treated as a current asset.

1. The full expense is recorded in the income statement.

2. The amount paid in advance will be written as prepaid expense a/c in the balance sheet.

3. The total amount paid will be reduced from the cash account.

What is the accruals convention?

An accounting convention that asserts profit is the excess of revenue over expense.

What are the two depreciation methods?

1. Straight-line method

2. Reducing-balance method

What is the perpetual inventory system?

• Used by most large entities.

• The system allows management to have better control over inventory by providing immediate and up-to-date information about inventory on hand/

• The balance of inventory account increases every time goods are purchases and decreases as the goods are sold.

• In theory, the balance on the inventory account reflects the cost of inventory on hand.

What is the periodic inventory system?

• This system is more suitable to smaller entities that do not have large numbers of purchase and sale transactions.

• When this system is used, inventory purchased is recorded in a temporary account, referred to as a purchases account.

• The purchases account only reflects the purchase of goods for resale and is not reduced when goods are sold.

• In addition to the purchases account. an inventory account is also used, but this is only updated at the end of the period.

Under this system, the balance of inventory will not reflect the value of inventory in hand.