Question

Chapter 3 &4

accounting

• Understand the revenue and expense recognition principles
• Understand differences between a classified balance sheet vs. a traditional balance sheet and an multi-step income statement vs. a single-step
• Know the difference between cash basis accounting and accrual basis accounting

Answer 1

Revenue Recognition Principle
This requires that revenues from the business to be recorded in its books of account when it is earned (i.e when goods are transferred or services rendered),
which is not necessarily when cash is received.
Example: Products are sold at $5,000 on Nov 8th, 2019 and cash is received on Dec 8th 2019.
	8th Nov	8th Dec
	Revenue is recognized.	Cash is received.
The business records the sale on November 8th when the sale occurred and the customer received the product even though the cash is not received until Dec 8th.
Expenses Recognition Principle
This requires that expenses be reported as and when incurred, which is not necessarily when cash has been paid. Sometimes referred to as the Matching principle.
Because expense recognition principle states that expenses should be recognized in the same period as the revenues to which they relate.
Example: Supplies were purchased on march 5th for $1000. they will be recorded as an asset on march 5th and expensed as they are used.
Some expenses are difficult to correlate with revenue, such as administrative salaries, rent, and utilities.
These expenses are designated as period costs, and are charged to expense in the period with which they are associated. This usually means that they are charged to expense as incurred.
The matching principle’s main goal is to match revenues and expenses in the correct accounting period.
Both Revenue and Expenses recognition principle is important in accrual basis of accounting.
Under the accrual basis accounting, revenues and expenses are recognized as follows:
Revenue recognition: Revenue is recognized when both of the following conditions are met:
a. Revenue is earned.
b. Revenue is realized or realizable.
Revenue is earned when products are delivered or services are provided.
Realized means cash is received.
Realizable means it is reasonable to expect that cash will be received in the future.
Expense recognition: Expense is recognized in the period in which related revenue is recognized (Matching Principle).
Under the cash basis accounting, revenues and expenses are recognized as follows:
Revenue recognition: Revenue is recognized when cash is received.
Expense recognition: Expense is recognized when cash is paid.

2.

Classified Balance sheet

Traditional Balance Sheet

A classified balance sheet separates the assets and liabilities of your company into current and long-term classes. The classification process provides additional details about the net worth and liquidity of your business. Your liquidity position is enhanced when the value of assets that are easy to liquidate exceeds the amount of liabilities your business owes.

An unclassified balance sheet reports your assets and liabilities, but does not separate the items into classes. The total values of your assets and debt equal the same amount, regardless of whether your balance sheet is classified or unclassified. An unclassified sheet is simpler to produce, but may warrant additional questions from investors or outside parties about the character of your net worth or liquidity position.

CLASSIFIED BALANCE SHEET PURPOSE CLASSIFICATION Classified Balance Sheet shows various information under different subcategories. ASSETS: o Current Assets o Long-term Investments o Property, Plant and Equipment o Intangible Assets o Other Assets OBJECTIVES • Easily to understand and analyze • Ascertain the amount and nature of the liabilities easily. Easily ascertain the position of assets • Understand changing trends • Easily understand profit and Loss • Understand unpaid LIABILITIES: o Current Liability o Long Term Liability Large organizations and businesses who want their balance sheet to be more detailed go for classified balance sheets. • EQUITY: o Capital Account o Partner's Capital Account o Share Capital o Retained Earnings

Traditional Balance sheet

Dec. 31, 2015 $233,000 136,530 Dec 31, 2014 $220,000 138,000 103,770 2,500 b. C. $ $101,270 Cash Accounts receivable (net) Available-for-sale investments (at cost) — Note 1 Less valuation allowance for available for sale investments Available-for-sale investments (fair value) Interest receivable Investment in Jolly Roger Co.stock-Note 2 Office equipment (net) Total assets Accounts payable Common stock Excess of issue price over par Retained earnings Unrealized gain (Loss) on available-for-sale investments Total liabilities and stockholders' equity 115,000 $ 69,400 70,000 225,000 $ 77,000 130,000 $666,270 $ 60,000 70,000 225,000 308,770 2,500 $666,270

Classified Balance Sheet

Davidson Groceries Balance Sheet, December 31, 2XX4 $22,000 24,000 103,000 12,000 $161,000 Assets Current Assets Cash Accounts Receivable Inventory Prepaid Rent Total Current Assets Noncurrent Assets Land Equipment (net) Buildings (net) Total Noncurrent Assets Total Assets Liabilities and Stockholders' Equity Liabilities Current Liabilities Accounts Payable Salaries Payable Insurance Payable Total Current Liabilities 210,000 155,000 680,000 1,045,000 $1,206.000 $33,000 9,000 15,000 $57,000 300,000 220,000 520,000 $577,000 Noncurrent Liabilities Note Payable-Third National Bank Note Payable-State Bank Total Current Liabilities Total Liabilities Stockholders' Equity Capital Stock Retained Earnings Total Stockholders' Equity Total Liabilities and Stockholders' Equity $179,000 450,000 $629,000 $1,206,000

3. Difference Between Cash Basis of Accounting AND Accrual Basis of Accounting

	Cash basis of accounting	Accrual basis of accounting
1	Recognizes revenue when cash has been received	Recognizes revenue when it’s earned (eg. when the project is complete)
2	Recognizes expenses when cash has been spent	Recognizes expenses when they’re billed (eg. when you’ve received an invoice)
3	Taxes are not paid on money that hasn’t been received yet	Taxes paid on money that you’re still owed
4	Mostly used by small businesses and sole proprietors with no inventory	Required for medium and large size businesses with more revenue.
5	Under this, there may be prepaid or outstanding expenses and accrued and unearned incomes in the Balance Sheet.	Under this system, there is no prepaid or outstanding expenses or accrued or unearned incomes.
6	Example: Products are sold at $5,000 on Nov 8th, 2019 and cash is received on Dec 8th 2019. in cash basis of accounting revenue is recognized on Dec 8th when cash is received.	Example: Products are sold at $5,000 on Nov 8th, 2019 and cash is received on Dec 8th 2019. in Accrual basis of accounting revenue is recognized on Nov 8th when products are actually sold to customer.