Chapter Appendix 4 - Reporting financial performance. After studying this appendix, you should be able to explain the differences between the cash basis of accounting and the accrual basis of accounting. | 1 CHAPTER 4: REPORTING FINANCIAL PERFORMANCE 2 2 Chapter 4: Reporting Financial Performance After studying Appendix 4A, you should be able to: Explain the differences between the cash basis of accounting and the accrual basis of accounting 3 3 Reporting Financial Performance 4 4 Appendix 4A – Cash Basis versus Accrual Basis Most companies use accrual basis of accounting Recognize revenue in the period it is earned and expenses in the period when they are incurred. Cash received does not play a factor in recognizing the transaction Small companies may use the cash basis of accounting Recognize revenue only when the cash is received, and expenses are recorded only when the cash is paid Income is determined based solely on the actual collection of cash and the payment of expenses. Cash basis financial statements do not conform with GAAP 5 5 LO10 Appendix 4A – Conversion from Cash Basis to Accrual Basis Service Revenue Calculation The changes in accounts receivable and unearned revenues during the year must be considered Accounts Receivable: Represents amounts that were earned last year but collected this year Unearned Revenue: Represents amounts that were collected last year but have not been earned until this year 6 6 LO10 7 Appendix 4A – Conversion from Cash Basis to Accrual Basis 7 Appendix 4A – Conversion from Cash Basis to Accrual Basis Operating Expense Calculation The changes in prepaid expenses and accrued liabilities during the year must be considered Prepaid Expenses: Beginning prepaid expenses balance is added to cash paid for operating expenses to arrive at operating expense on an accrual basis Accrued Liabilities: Beginning accrued liabilities are deducted and ending accrued liabilities are added to cash paid for expenses to arrive at expenses on an accrual basis 8 8 LO10 9 Appendix 4A – Conversion from Cash Basis to Accrual Basis 9 10 Appendix 4A – Conversion from Cash Basis to Accrual Basis 10 . | 1 CHAPTER 4: REPORTING FINANCIAL PERFORMANCE 2 2 Chapter 4: Reporting Financial Performance After studying Appendix 4A, you should be able to: Explain the differences between the cash basis of accounting and the accrual basis of accounting 3 3 Reporting Financial Performance 4 4 Appendix 4A – Cash Basis versus Accrual Basis Most companies use accrual basis of accounting Recognize revenue in the period it is earned and expenses in the period when they are incurred. Cash received does not play a factor in recognizing the transaction Small companies may use the cash basis of accounting Recognize revenue only when the cash is received, and expenses are recorded only when the cash is paid Income is determined based solely on the actual collection of cash and the payment of expenses. Cash basis financial statements do not conform with GAAP 5 5 LO10 Appendix 4A – Conversion from Cash Basis to Accrual Basis Service Revenue Calculation The changes in accounts receivable and unearned revenues .
