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Accounting for Revenue

and Expenses
–Accounting Bases
–Cash Basis
–Accrual Basis

–Recognition of Revenues
–Recognition of Expenses
–Matching of Revenues and Expenses
–Gross Profit Margin
–Net Profit Margin
Accounting Basis
Cash Basis of Accounting
Accrual Basis of Accounting
Cash Basis
Revenue is recorded only
when the cash is received
and an expense is recorded
only cash is paid.
The cash basis of accounting is not
accordance with
Generally Accepted Accounting
Principles(GAAP) –
violating the revenue recognition
concept.
Accrual Basis
An enterprise should prepare its financial
statements except for cash flow information
under accrual basis of accounting
The effects of transactions and other events
are recognised when they occur (not as
cash or its equivalents is received or paid)
and they are recorded in the accounting
records and reported in the financial
statements of the period to which they
relate
Illustration
Example:
Given below is the summary of transactions
of Salma Enterprise for the month of June
2005.
RM
Sales (70% on credit) 60,000
Advertising expenses (cash) 1,000
Rent expense (cash) 1,500
Depreciation Expense 1,200
Salary expense (unpaid) 18,000
Collection from customer
8,000
(from May credit sales)

Calculate the profit by using both accrual and


Accrual Basis:
Sales (total) 60,000
Less:
Advertising 1,000
Depreciation 1,200
Rent 1,500
Salary 18,000 (21,700)
Net Profit 38,300

Cash Basis:
Sales:Cash Collection 8,000
Cash Sales 18,000
Less:
Advertising 1,000
Rent 1,500 (2,500)
Net Profit 23,500
Recognition
The process of incorporating in the balance
sheet or income statement an item that meets
the definition of an element and satisfies the
following criteria for recognition:
it is probable that any future economic benefit
associated with the item will flow to or from
the entity; and
the item has a cost or value that can be
measured with reliability.
Revenue recognition

Sale of goods
Rendering of services
Revenue
The gross inflow of economic benefits
during the period arising in the course of
the ordinary activities of an entity when
those inflows result in increases in
equity, other than increases relating to
contributions from equity participants
Revenue recognition
Revenue is recognised when
it is probable that future economic
benefits will flow to the entity and
these benefits can be measured
reliably.
Revenue recognition
Goods includes goods produced by the
entity for the purpose of sale and goods
purchased for resale, such as
merchandise purchased by a retailer or
land and other property held for resale.
.
Recognition criteria: Sale of goods
Revenue from the sale of goods shall be recognised when
all the following conditions have been satisfied:

(a) the entity has transferred to the buyer the significant risks
and rewards of ownership of the goods;
(b) the entity retains neither continuing managerial
involvement to the degree usually associated with
ownership nor effective control over the goods sold;
(c) the amount of revenue can be measured reliably;
(d) it is probable that the economic benefits associated
with the transaction will flow to the entity; and
(e) the costs incurred or to be incurred in respect of the
transaction can be measured reliably.
Measurement of Revenue
Revenue shall be measured at the fair value
of the consideration received or receivable.*
Fair value is the amount for which an asset
could be exchanged, or a liability settled,
between knowledgeable, willing parties in an
arm’s length transaction
In most cases, the consideration is in the
form of cash or cash equivalents and the
amount of revenue is the amount of cash or
cash equivalents received or receivable.
Revenue recognition:
Rendering of services
When the outcome of a transaction involving
the rendering of services can be estimated
reliably, revenue associated with the
transaction shall be recognised by reference
to the stage of completion of the transaction
at the balance sheet date. The outcome of a
transaction can be estimated reliably when
all the following conditions are satisfied:
Revenue recognition:
Rendering of services (cont..)
(a) the amount of revenue can be measured reliably;
(b) it is probable that the economic benefits
associated with the transaction will flow to the
entity;
(c) the stage of completion of the transaction at the
balance sheet date can be measured reliably; and
(d) the costs incurred for the transaction and the
costs to complete the transaction can be measured
reliably. *
Rendering of services: methods to
determine stage of completion
The stage of completion of a transaction may be determined by a
variety of methods. An entity uses the method that measures reliably
the services performed. Depending on the nature of the transaction,
the methods may include:

(a) surveys of work performed;


(b) services performed to date as a percentage of total services to be
performed; or
(c) the proportion that costs incurred to date bear to the estimated
total costs of the transaction.
Only costs that reflect services performed to date are included in costs
incurred to date. Only costs that reflect services performed or to be
performed are included in the estimated total costs of the transaction.
Progress payments and advances received from customers often do
not reflect the services performed.
Expenses
Decrease in economic benefits during
the accounting period in the form of
outflows or depletions of assets or
incurrence of liabilities that result in
decreases in equity, other than those
relating to distributions to equity
participants
Expense recognition

An expense should be recognised


when and only when:
(b) It is probable that the
consumption or loss of future
economic benefits resulting in a
reduction in assets and/or an
increase in liabilities has
occurred; and
(c) The consumption or loss of
future economic benefits can be
measured reliably.
Expense recognition
Basis for recording expenses is the matching
principle
Expenses are the costs of operating a
business
Expenses are costs of assets that are used up
in the earning of revenue
Matching principle requires:
– Identify all expenses during the accounting period
– Measure the expenses
– Match the expenses against the revenues earned
during the same period
Matching of Revenues and
Expenses
Revenue and expenses that relate to the
same transaction or other events are
recognised simultaneously.

Example – If the company estimated


that sales commission paid to the
salesman must be at 10% of their total
sales example total sales
is RM1000.
Matching concept:
Expense: sales commission RM100
Revenue: Total sales RM1000.
Methods of matching
1) Cause and effect
Direct link between expense and
revenue. Eg services rendered by
employees (such as commission,
cost of goods sold).
2) Systematic and rational
allocation of cost eg depreciation
3) Immediate recognition eg
advertising expense
Gross Profit Margin
Net sales – Cost of sales
Net sales = Gross sales – sales
returns –sales discount
Cost of sales = cost of goods sold
Net Profit Margin
Gross Profit minus operating expenses
Operating expenses:
– Distribution expenses
– Selling expenses
– Administrative expenses
– Finance costs