Accrual Accounting Concepts - In Depth Notes

Accrual Accounting Concepts

Overview of Accrual Accounting
  • Need for Immediate Feedback: Companies seek prompt information on performance.
  • Time Periods in Accounting: Economic life divided into intervals:
    • Interim Period: Months, quarters.
    • Yearly: Fiscal or calendar.
  • Impact of Transactions on Multiple Periods: Transactions often affect more than one accounting period.
  • Importance of Accuracy: Preparing financial reports monthly or quarterly requires precision.
Revenue Recognition Principles

  • Definition of Revenue: An increase in assets or settlement of liabilities stemming from ordinary activities.

  • General Recognition Guidelines:

    • Merchandising Companies: Revenue recognized at point of sale (when merchandise is sold and delivered).
    • Service Companies: Recognized when services are performed.

  • Recognition under ASPE (Accounting Standards for Private Enterprises): Revenue can be acknowledged when:

    • Performance obligation is substantially complete.
    • Revenue is measurable with reliability.
    • Collection is reasonably certain.

  • Recognition under IFRS (International Financial Reporting Standards): Revenue is recognized upon satisfying a performance obligation, involving a five-step process:

    1. Identify the contract with the customer.
    2. Identify performance obligations within the contract.
    3. Determine the transaction price.
    4. Allocate the transaction price to performance obligations.
    5. Recognize revenue when the obligation is satisfied.
Conditions for Revenue Recognition
  • Recognized when:
    • Sales or services are substantially complete.
    • The amount is determinable.
    • Collection is assured.
Expense Recognition Principles
  • Definition of Expenses: Recognized when a decrease in future economic benefits occurs, often linked with revenues they helped generate.
Basis of Accounting

  • Cash Basis Accounting:

    • Revenue recorded only when cash is received.
    • Expenses recorded only when cash is paid.
    • Risks of misleading financial statements due to cash timing manipulations.

  • Accrual Basis Accounting:

    • Revenue recorded when earned, regardless of cash receipt.
    • Expenses recorded when incurred, regardless of cash payment.
Adjusting Entries

  • Purpose: Adjust or update accounts at period's end, crucial for representing accurate financial data.

  • Causes for Adjusting Entries:

    • Daily unreconciled items.
    • Unrecorded costs during the period.

  • Categories of Adjusting Entries:

    • Prepayments:
    • Prepaid Expenses: Cash spent but not yet used.
    • Unearned Revenues: Cash received for services or goods not yet delivered.
    • Accruals:
    • Accrued Revenues: Revenue earned but not yet collected.
    • Accrued Expenses: Expenses incurred but not yet paid.
Adjusted Trial Balance
  • Prepared after journalizing and posting all adjusting entries.
  • Shows all accounts' balances post-adjustment, ensuring total debits and credits are balanced, facilitating financial statement preparation.
Closing Entries

  • Purpose of Closing Entries:

    • Reset temporary accounts (revenues, expenses, dividends) to zero.
    • Transfer balances to retained earnings for the upcoming period.

  • Temporary vs. Permanent Accounts:

    • Temporary Accounts: Include all revenue and expense accounts and the dividends account.
    • Permanent Accounts: Include all asset, liability, and equity accounts.
Other Comprehensive Income (OCI)
  • Applicable to companies reporting under IFRS, consisting of complex items influencing OCI rather than net income.
  • Comprehensive Income: Sum of OCI items and net income.
Post-Closing Trial Balance
  • Contains only permanent accounts, evidencing the equality of their total debit and credit balances following closing entries confirmation.