Topic 3

• Cash v Accrual accounting

  1. Cash Basis: Profit = Cash Inflows from Income - Cash Outflows from Expenses

  2. Accrual Basis: Profit = Income Earned - Expenses Incurred
• Assumptions / Concepts

  Interaction of the accounting period assumption and going concern assumption: Accounting entity assumption – the assumption that a business entity is separate and distinct from its owners and from other business entities. Accrual accounting - attempts to match income to the period in which it is earned and expenses to the period in which they are incurred. Accounting period assumption - the life of the business is broken up into equal accounting periods. Going concern - in the absence of evidence to the contrary, the entity is assumed to have an indefinite life
• Introduction to adjusting entries

  Classification: Deferrals include items that have been prepaid. Accruals include expenses incurred but not yet paid and income earned not received
• Types of adjusting entries

  1. Deferrals

  2. Prepayments of expenses (Adjustment a)

  3. Pre-collection of income (Adjustment b)

  4. Stocks of supplies (Adjustment c)

  5. Depreciation (Adjustment d)
• Depreciation is a method which is used to _ _ _ _ _ _ _ _ the cost of the asset over the accounting periods in which it is used. The purpose of depreciation is _ _ _ _ _ _ _ _ _, _ _ _ _ _ _ _ _ _, _ _ _ _ _ _ _ _ _ _, _ _ _ _ _ _ _ _ _ _.
• Accumulated depreciation is a Contra Asset account
• Adjustment entries will always involve an Income Statement item and a Balance Sheet item
• Adjustment entries never adjust the cash account
• In AFB, Accounts Receivable or Accounts Payable are not adjusted as they are control accounts and are not covered in detail in this unit
• Assets are recorded at historic cost, which is the amount of cash or equivalents used to acquire them, while liabilities are recorded at the amount of cash or equivalents that will need to be paid out to satisfy them
• Why are adjusting entries necessary?

  To update all account balances before financial statements can be prepared
• When do you record revenue or expenses?

  Cash basis: when you pay or receive money

  Accrual basis: when you get a bill or raise an invoice