Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 3 Accrual Accounting Concepts 123

The increase in prepaid insurance represents an $8,400 payment of cash for insur-

ance premiums. During November, only $1,100 of the premiums is deducted in arriv-

ing at net income. Therefore, the remaining $7,300 (the increase in prepaid insurance)

is deducted in arriving at cash flows from operations. Similarly, the increase in sup-

plies of $90 is deducted.

You may have noticed a pattern in how we reconciled net income to net cash flows

from operations. First, depreciation expense was added. Next, increases in current as-

sets related to operations were deducted, while increases in current liabilities related

to operations were added. The increase in the current liability for notes payable of

$6,800 was not included in the reconciliation. This is because the notes payable is re-

lated to the purchase of office equipment, which, in the statement of cash flows, is an

investing activity rather than an operating activity.

During November, all the current asset and liability accruals and deferrals related

to operations were increases. This was because Family Health Care used the cash ba-

sis during October, so there were no deferrals or accruals at the beginning of November.

In future periods, there would be both increases and decreases in these items. These

increases and decreases would be added or subtracted to arrive at cash flows from op-

erations, as shown in Exhibit 11.

SUMMARY OF LEARNING GOALS

Net income $XXX

Add:

Depreciation expense $XXX

Increases in current liabilities from operations XXX

Decreases in current assets from operations XXX XXX

Deduct:

Increases in current assets from operations $XXX

Decreases in current liabilities from operations XXX XXX

Net cash flows from operations $XXX

Exhibit 11

Reconciling Items

Describe basic accrual accounting concepts,
including the matching concept.Under accrual
concepts of accounting, revenue is recognized when it is
earned. When revenues are earned and recorded, all
expenses incurred in generating the revenues are recorded
so that revenues and expenses are properly matched in
determining the net income or loss for the period. Liabilities
are recorded at the time a business incurs the obligation to
pay for the services or goods purchased.

Use accrual concepts of accounting to analyze, record,
and summarize transactions.Using the integrated
financial statement framework, November transactions for
Family Health Care are recorded. Family Health Care’s

November transactions involve accrual accounting

transactions.

Describe and illustrate the end-of-the-period adjustment

process.The accrual concepts of accounting require the

accounting records to be updated prior to preparing financial

statements. This updating process, called the adjustment

process, is necessary to match revenues and expenses. The

adjustment process involves two types of adjustments—

deferrals and accruals. Adjustments for deferrals may involve

deferred expenses or deferred revenues. Adjustments for

accruals may involve accrued expenses or accrued revenues.

Prepare financial statements using accrual concepts of

accounting, including a classified balance sheet.

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For example, a decrease in accounts receivable implies that cash was collected and

thus would be added. In contrast, a decrease in accounts payable implies that cash was

paid and thus would be deducted.