Chapter 9: Cash vs Accrual

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To be GAAP complaint you must use Accrual method.

The cash method records sales when cash is received and expenses when cash is paid. This can distort the true situation, for example if a business prepays rent for the next 3 months then even though the situation hasn't changed an investor may think the profitability is not consistent.

The Accrual Method records revenue as soon as services are provided or good delivered, not when cash is received. Expenses are recorded when the goods or services are received and not when they are paid for -- accounts receivable are used to record unpaid balances.

5th August: Employee earns a commission of $93k
Journal Entry
Commissions Expense $93k
Commissions Payable $93k
1st September: You pay your employee
Journal Entry
Commissions Payable $93k
Cash $93k
1st Jan: You take out a loan for 3k for 6 months
Journal Entry
Cash $3k
Notes Payable $3k
End of each month of the 6 months: Pay $20 interest
Journal Entry
Interest Expense $20
Interest Payable $20
1st July: Pay off loan
Journal Entry
Notes Payable $3k
Interest Payable $20
Cash $3120
Prepaid Expenses
1st April: You prepay your $1500 rent for each quarter (3 months at a time)
Journal Entry
Prepaid Rent $4.5k
Cash $4.5k
End of each month of April, May, June record your rent expense
Journal Entry
Rent Expense $1.5k
Prepaid Rent $1.5k

By the end of 3 months the Prepaid Rent account (which is an asset account) will be zero

Unearned Revenue
1st April: Your tenant pays $1500 rent for each quarter (3 months at a time)
Journal Entry
Cash $4.5k
Unearned Rent $4.5k
End of each month of April, May, June record your revenue
Journal Entry
Unearned Rent $1.5k
Rental Income $1.5k

By the end of 3 months the Unearned Rent account (which is a liability account) will be zero

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  • 10 months ago by vince