Recognition & Measurement in Financial Statements
1) Recognition
• The process of including an item in the financial statements.
• Recognized with Words (Cash, Land), and Numbers (amount)
2) Measurement
a. The Attribute to be Measured – recording the cost of the assets
• Historical cost (verifiable) – the amount paid for an assets and used as a basis for recognizing it on the balance sheet. (reliability)
• Realizable value (estimate selling price) – the estimate of cash that could be received by selling assets currently. (relevance)
• Trade-off between reliability and relevance
b. The Unit of Measure – the units of money used
• A decline in purchasing power of the dollar = continuing rise in the general level of prices. Ex: First year, you could have spent $1000 on other goods/services instead of land. Second year, the same $1000 might better buy the land instead of other goods/services.
• Inflation – rise in the general level of prices, results in a decrease in purchasing power. II.
The Accrual Basis of Accounting
Cash basis – revenues are recognized when cash is received and expenses are paid.
Accrual basis – revenues are recognized and when expenses when incurred.
Cash Basis
Accrual Basis
Revenue is recognized When Received When Earned
Expense is recognized
When Paid
When Incurred
• Time period assumption
Ø Conflict – earning income is a process that takes place over a period of time.
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III.
Accrual Accounting and Adjusting Entries
Adjusting entries – journal entries made at the end of the period by a company using the accrual basis of accounting
1) Types of Adjusting Entries
a. Prepaid Expense (Cash Paid before Expense is Incurred)
Sept 1
Prepaid Rent (Insurance)
$2,400
Cash
$2,400
Sept 30
Rent Expense
$200
Prepaid Rent
$200
b. Depreciation – the process of allocating the cost of a long-term tangible assets over its useful life.
Straight-line method – the assignment of an equal amount of depreciation to each period. Jan 1
Delivery Truck
$21,000
Cash
$21000
Jan 31
Depreciation Expense
$300
Accumulated Depreciation
$300
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