INSTRUCTOR MANUAL
Instructor’s Manual for Principles of Finance
03/21/22 1
, Instructor’s Manual for Principles of Finance
Chapter 4
Accrual Accounti ng Process
Chapter Summary
This chapter breaks out into three major sections:
Cash versus accrual accounting
Double-entry bookkeeping and transaction analysis
Expenditure capitalization and depreciation expense
Lecture Notes
4.1 Cash versus Accrual Accounting
Cash accounting looks to completion of a cash transaction (i.e., receipt or payment of cash) to
define whether the firm has revenues or expenses.
In contrast, accrual accounting only recognizes a sale when goods or services are delivered or
performed and only recognizes expenses that were incurred to generate those revenues—the
latter is the so-called matching principle requiring that “expenses follow the revenues.”
In summary, accrual accounting ignores the cash transaction and focuses on the delivery of
goods or the performance of a service to determine whether there are revenues or expenses to
report.
The result of this difference in approach is that an accrual-basis income statement will not
reflect the cash flow of a firm.
US Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting
Standards (IFRS) both use accrual accounting as the required standard. Large public companies
in the United States are obligated to follow US GAAP, and accrual accounting is, therefore,
required for them. Private companies are more likely to use cash accounting, as it is intuitive to
most business owners and no accounting training is required to create a cash accounting
income statement.
The Internal Revenue Service does not burden small business owners with the requirement that
they file their annual income tax declaration on an accrual basis. Because of the number of
small businesses, cash accounting is the most commonly used accounting standard.
The enforcement of an accrual accounting standard allows for a uniform approach to
interpretation and analysis of financial statements.
4.2 Economic Basis for Accrual Accounting
The Accounting Equation is the framework for recording transactions:
Assets=Liabilities+Owner ’ s Equity
Transaction reporting maintains the balance between left and right sides by design.
03/21/22 2
Instructor’s Manual for Principles of Finance
03/21/22 1
, Instructor’s Manual for Principles of Finance
Chapter 4
Accrual Accounti ng Process
Chapter Summary
This chapter breaks out into three major sections:
Cash versus accrual accounting
Double-entry bookkeeping and transaction analysis
Expenditure capitalization and depreciation expense
Lecture Notes
4.1 Cash versus Accrual Accounting
Cash accounting looks to completion of a cash transaction (i.e., receipt or payment of cash) to
define whether the firm has revenues or expenses.
In contrast, accrual accounting only recognizes a sale when goods or services are delivered or
performed and only recognizes expenses that were incurred to generate those revenues—the
latter is the so-called matching principle requiring that “expenses follow the revenues.”
In summary, accrual accounting ignores the cash transaction and focuses on the delivery of
goods or the performance of a service to determine whether there are revenues or expenses to
report.
The result of this difference in approach is that an accrual-basis income statement will not
reflect the cash flow of a firm.
US Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting
Standards (IFRS) both use accrual accounting as the required standard. Large public companies
in the United States are obligated to follow US GAAP, and accrual accounting is, therefore,
required for them. Private companies are more likely to use cash accounting, as it is intuitive to
most business owners and no accounting training is required to create a cash accounting
income statement.
The Internal Revenue Service does not burden small business owners with the requirement that
they file their annual income tax declaration on an accrual basis. Because of the number of
small businesses, cash accounting is the most commonly used accounting standard.
The enforcement of an accrual accounting standard allows for a uniform approach to
interpretation and analysis of financial statements.
4.2 Economic Basis for Accrual Accounting
The Accounting Equation is the framework for recording transactions:
Assets=Liabilities+Owner ’ s Equity
Transaction reporting maintains the balance between left and right sides by design.
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