Finance and capital markets
Accrual basis of accounting
Simple example of accrual accounting. Created by Sal Khan.
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- what is income statement?(5 votes)
- It's a financial statement which present company financial performance over specific time. Like If we want to see the financial performance of "Apple Corporation" in year 2012 then we will consider checking it's income statement.(9 votes)
- What if I buy $200 in supplies this month for an event to be held and paid for by the customer next month? I don't believe this specific case is covered in the video. I understand that I would record the revenue next month, but is the $200 in expenses also matched to the event which occurs next month? Or is it recorded as an expense this month?(5 votes)
- Accrual basis of accounting always tries to match revenue with expenses.
Purchasing $200 in inventory that you will sell next month will result in a $200 increase in inventory and a $200 decrease in cash on the balance sheet.
When you sell the inventory, revenue and cost of goods sold (the expense) will be recognized on the income statement. The specific line items that are changed (tax expense, net income, cash flow from operations, cash, inventory, retained earnings) can get quite long to explain here, but I can break down specifically how the three statements are affected if you'd like.(5 votes)
- Video time4:04For my journal entry, I would have to "credit" Deferred revenue but what account would I "debit" to record the transaction under accrual basis?(2 votes)
- You would debit cash.
Deferred revenue is a liability, it is credited because you in "owe" the service of that amount, so you don't own that money received yet. You debit cash because your cash account is increasing.
Now on the flip side, once you provide the service, you would debit Deferred revenue (the liability account goes down - you no longer owe the service) and then credit the Revenue account.(3 votes)
- In month 2 the even cost you 200 and you and the customer agree that they will pay you 400 next months and so the 400 is recorded in the income statement in month 2 as revenue. But in month 3 when you get an advance from the customer of 200 why is this not recorded as revenue as well?(3 votes)
- How can cash have a negative balance, or is this something U.S related??
(Reference from U.K Accounting)
Thanks in advance
This may be a stupid question.(2 votes)
- If you owe someone money, that could look like a negative cash balance. It depends what exactly you are counting as "cash". Cash does not literally mean "bank notes". You have to read the notes to the financial statements.(2 votes)
- At3:35- how can a negative $100 be added to a positive $400 to become $500? It is no wonder I don't understand accrual accounting.(2 votes)
- The negative $100 is added to the positive $400 to make positive $300 that month. But the same month also has deferred revenue of positive $200 which adds up to become $500.(1 vote)
- Why did Month 2 accrual $400 REv to $400 AC Rec. and $200 exp= -$100 in profit? Shouldn't it be 0(2 votes)
- These videos are extremely high level. The ideas are accurate, but there are different standards for different types of business, stores, services, and manufacturers all use different types of journal entries. It's actually kind of difficult to explain the reasons for this, without spending a lot more time. Keep in mind that if you have a credit in one journal, there must be a corresponding debit to another journal, depending on what journal is being modified, the entries can sound counterintuitive.(1 vote)
- Can you clarify the dissimilarity between Accounts Receivable and Deferred Revenue to me, please ? As far as I can see, in Month 3 the person is paid $200 in advance in exchange for his obligation to cater an event for the customer in Month 4, which makes the $200 Deferred Revenue. But let's consider Month 2: he caters for the customer in that month at the expense of $200 so that he would receive $400 in Month 3. Isn't it his liability, in order to get paid $400 the next month, to hold an event for the customer with the price of $200 ?(2 votes)
- Accounts receivable is money that people owe you for something you sold them.
Deferred revenue is money that someone has already given to you but you haven't done what you are supposed to do for it yet, so you can't call it revenue.
For example, say someone pays you to provide some service for two months. They pay you $200, which is 100 for each month. In month 1, you are not allowed to say you have revenue of $200, because you haven't earned that second payment yet, even though they gave you the money (they might even have promised you the money rather than actually giving it to you, in which case your accounts receivable increased instead of your cash increasing). You book $100 as revenue and $100 as deferred revenue. In month 2, the deferred revenue is eliminated and recognized as current revenue.(1 vote)
- In month 3, why is the $200 in deferred revenue a liability?
Why is it not an asset?(2 votes)
- In month 2 why does the person have -$100 in cash, isn't it supposed to be -$200 in cash?(2 votes)
Let's now account for the same series of events, but instead of doing it on a cash basis, let's do it on an accrual basis. And the whole idea with accrual accounting is to match your revenues and expenses to when you actually perform the service. So it actually captures business activity, as opposed to just capturing when cash changes hands. So let's see what that actually means. So in month one, you cater an event where the cost to you was $100. The customer pays you $200 for your services. And what I'll do, I'll do the accrual accounting right here. So this is kind of the cash income statement. Let's do the accrual accounting income statement. So you actually provided the service of catering, you got $200 for your services. So I'll put $200 in for revenue. And the expenses associated with that service that you provided in month one is $100. And so your profit is $100. So at least for month one, the cash basis and accrual basis of accounting look exactly the same. And once again, you have $100 in cash. Now let's go to month two. You cater an event where the cost to you was $200. You and the customer agree that they can pay you $400 the next month. So now it gets interesting, because you performed the catering that month. And the catering that you performed that month is worth $400. So in the accrual basis of accounting, would say that you earned $400 of revenue, even though the customer did not pay you. They did not give you the cash. And the way that you account for that, is on your balance sheet you say that you are essentially owed $400. So this accounts receivable, this is essentially stuff that other people owe you. You need to receive this from other people. But it's an asset. Other people have an obligation to you. So you have an accounts receivable of $400. When they pay you the $400, it goes from accounts receivable to cash. And then the cost to you was $200. So here, all of a sudden, you performed the service, the revenues and expenses for that service are in that month. And now your profit here shows $200. So it is actually a better reflection of what you did it that month. Now, the reality is that you didn't get the cash for it, and you had to spend $200 of cash out of your pocket. So you're still, just like the cash accounting, you're still going to have negative $100 in cash. Now, let's go to month three. You get $400 from the customer the previous month. Now with cash basis, you would have added that to your revenue. But here we already accounted for it in the accounts receivable. We already took that revenue, but because you got the $400 in cash, it's going to just disappear from receivables and then go into cash, because you actually got it. You get $400 from the customer the previous month. You also get $200 in advance from a customer that you have to cater for the next month. So you did no catering in month three, and because you did no catering in month three, you have zero revenue in month three. And then you also have zero expenses. The way that you account for the $400 that you got, is that your accounts receivables goes to 0. And that goes to cash. So the negative $100, you add $400 to it, so it will become positive $300. And the way that you account for this $200 in advance from a customer, is you call that deferred revenue. You've got the cash there. So we went from negative $100, added $400 to $300. You get another $200 in cash, so that gives us $500 in cash again. But we didn't earn any revenue. That $200, that was a kind of a cash advance. So we put that right over here in deferred revenue. That's revenue that we're deferring to a future period. In the future, we will earn it. This is now a liability, because we are obligated to earn that revenue. And then in month four, we actually earn the revenue. So in month four, we can actually put it on our income statement at $200. And then we had $100 of expenses. So we have this $100 right over here. And so in month four, we earned $100. And once again, $100 went away from our cash balance. So we still have $400. So whether you do the cash basis or the accrual basis, you have the same exact amount of cash. But what's more interesting is how the profit relates in each of the periods. And I'll talk about that in a little bit more depth in the next video.