Accounting

Chapter 4
ACCRUAL
ACCOUNTING
CONCEPTS
2

Chapter 4
Accrual Accounting Concepts
• Explain the revenue recognition principle and the
matching principle.
• Differentiate between the cash basis and the
accrual basis of accounting.
• Explain why adjusting entries are needed and
identify the major types of adjusting entries.
• Prepare adjusting entries for prepayments.
3

Chapter 4
Accrual Accounting Concepts
Prepare adjusting entries for accruals.
• Describe the nature and purpose of the adjusted
trial balance.
• Explain the purpose of closing entries.
• Describe the required steps in the accounting cycle.
4

11
Time Period Assumption...
Divides the economic life of a
business into artificial time
periods
WHY
to provide immediate
feedback on how the
business is doing.
5

Time Period Assumption...
Generally a month, a quarter, or a year.
An accounting time period that is one year
long is called a fiscal year.
An accounting time period that starts on January 1 and
ends December 31 is called a calendar year.
6

Revenue Recognition Principle...
• Dictates that revenue be recognized in
the accounting period in which it is
earned.
• Is considered earned
• when the service has been provided or
• when the goods are delivered.
7

Matching Principle...
Requires that expenses be
recorded in the same period in
which the revenues they helped
produce are recorded.
8

Review
Which principle dictates that efforts (expenses)
be recorded with accomplishments (revenues)
a. Cost Principle.
b.Matching Principle
c. Periodicity Principle
d.Revenue Recognition Principle
10

Review
Which principle dictates that efforts (expenses)
be recorded with accomplishments (revenues)
a. Cost Principle.
b.Matching Principle
c. Periodicity Principle
d.Revenue Recognition Principle
11

Review
When would revenue be recorded for the
following scenario . . .
Ad agency is hired for a project in May,
does the work in June and is paid in
July
June
12

Review
When would expenses be recorded for this
companion scenario
The Ad agency on this project incurs
$1,500 of expenses in May, $3,000 in June,
and none in July
The answer is June! Matching
says the expenses should follow
the revenue.
13

Review
When would revenue be recorded for the
following scenario . . .
Sell plane ticket on September 1 for a
flight on October 15
The answer is October – when the
service is provided!
14

Review
When would expenses be recorded for the
following scenario . . .
The airline pays pilot salaries on October 7 th
for the week ended September 30th
The answer is September – the pilots
provided labor services for September
flights during that month.
15

211
Cash Basis
Revenue recorded only when cash is received.
Expense recorded only when cash is paid.
16

Accrual Basis Accounting
Adheres to the:
• Revenue Recognition Principle
Revenue recorded only when
earned, not when cash is
received
• Matching Principle
Expense recorded only when
incurred, not when cash paid
17

Accrual Basis adheres to...
•Generally
•Accepted
•Accounting
•Principles
18

Types of Adjusting Entries
• Prepayments:
• Prepaid expenses: Expenses paid in cash and recorded
as assets before they are used or consumed.
• Unearned Revenues: Cash received and recorded as
liabilities before revenue is earned.
• Accruals:
• Accrued revenues: Revenues earned but not yet
received in cash or recorded.
• Accrued expenses: Expenses incurred but not yet paid
in cash or recorded.
20

Prepayments
•PREPAID EXPENSES - Costs that
expire either with the passage of time
or through use.
•UNEARNED REVENUES- money has
been received before the goods or
services are provided.
21

You can start with the trial
balance to find information to
adjust prepayments.
22

Sierra Corporation
Trial Balance
October 31, 2007
Debit Credit
Cash $15,200
Advertising Supplies 2,500
Prepaid Insurance 600
Office Equipment 5,000
Notes Payable $ 5,000
Accounts Payable 2,500
Unearned Service Revenue 1,200
Common Stock 10,000
Dividends 500
Service Revenue 10,000
Salaries Expense 4,000
Rent Expense 900
$28,700 $28,700

Prepaid Expenses
Amount equals cost of goods or services
used up or expired
If not adjusted, expenses would be
understated and assets overstated
24

On October 5 the company paid $2,500
for advertising supplies.
Cash
Oct 5
2,500
Supplies
Oct 5
Advertising
Supplies
2,500
Advertising
Supplies
Expense
GENERAL JOURNAL Debit Credit
Oct 5 Supplies 2,500
Cash 2,500
Purchased advertising supplies

Supplies
An inventory on October 31 reveals that $1,000 of
supplies remain on hand; therefore $1,500 of supplies
have been used. ($2,500 - $1,000) =$ 1,500
Advertising
Advertising Supplies
Expense
Cash
Oct 5
2,500
Oct 5
Supplies
2,500
Oct 31 1,500
Oct 31
1,500
Bal. 1,000
GENERAL JOURNAL Debit Credit
Oct 5 Supplies Expense 1,500
Supplies 1,500
To record advertising supplies consumed

Supplies Expense
Oct
$1,500
Nov
$1,800
Dec
$1,410
Jan
$1,425
Feb
$1,601
Mar
$1,435
Apr
$1,510
May
$1,592
June
$1,652
July
$1,621
Aug
$1,427
Sept
$1,555
Supplies expense is based on usage... so
different amounts appear each month
27

Prepaid Expenses
On October 1 the company paid $600 for a 1-year
insurance policy. Coverage began October 1.
Cash
Oct 1
600
Prepaid
Insurance
Oct 1 600
Insurance
Expense
GENERAL JOURNAL Debit Credit
Oct 1 Prepaid Insurance 600
Cash 600
Purchased one-year policy effective October 1

Insurance Policy
Oct
$50
Nov
$50
Dec
$50
Jan
$50
Feb
$50
Mar
$50
Apr
$50
May
$50
June
$50
July
$50
Aug
$50
Sept
$50
1 Year $ 600
29

Prepaid Expenses
On October 31st, $50 ($600/12 months)
of the insurance was used-up or expired.
Cash
Oct 1
600
Oct 1
Prepaid
Insurance
600
550
Oct 31
50
Insurance
Expense
Oct 31 50
GENERAL JOURNAL Debit Credit
Oct 31 Insurance Expense 50
Prepaid Insurance 50
Record insurance expense for the month

Depreciation
How do you apply the Matching
Principle to the cost of a long lived
asset
31

Allocates the cost of an asset to expense
over its useful life – MATCHING
PRINCIPLE
Is an estimate
Depreciation
Depreciation is ALLOCATION of costnot
VALUATION(Current Replacement
Cost)
We’re not attempting to reflect the actual
change in value of an asset!
32

Office Equipment
Oct
$40
Nov
$40
Dec
$40
Jan
$40
Feb
$40
Mar
$40
Apr
$40
May
$40
June
$40
July
$40
Aug
$40
Sept
$40
Depreciation= $480/year
33

Office Equipment
Oct 2
5,000
Accumulated
Depreciation-
Office Equipment
Oct 31 40
Depreciation
Expense
Oct 31 40
GENERAL JOURNAL Debit Credit
Oct 31 Depreciation Expense 40
Accumulated Depreciation-Office Equip 40
To record monthly depreciation
Accumulated depreciation is a
contra asset account - an offset
against the fixed asset account.
34

Balance Sheet Presentation
Office equipment $ 5,000
Less : accumulated depreciation 40
$4,960
Book Value or
Carrying Value
35

511
Unearned Revenues
Received on Oct. 2 $1,200 for advertising
services expected to be completed by Dec 31.
Oct 2
Cash
1,200
Unearned Service
Revenue
Oct 2
1,200
Service
Revenue
GENERAL JOURNAL Debit Credit
Oct 2 Cash 1,200
Unearned Service Revenue 1,200
Collected money for work to be
performed by Dec 31.

Unearned Revenues
During October $400 of the revenue was earned.
Oct 2
Cash
1,200
Unearned Service
Revenue
Service
Revenue
Oct. 31 400 Oct 2 1,200
Oct. 31 400
Bal
800
GENERAL JOURNAL Debit Credit
Oct 31 Unearned Service Revenue 400
Service Revenue 400
To record revenue earned

511
Accruals
•Revenue has been earned, but not
collected.
•Expenses have been incurred, but
not yet paid.
38

Accrued Revenues
Revenues earned but not yet
received in cash or recorded at the
statement date.
39

Accrued Revenues
Earned $200 for advertising services to clients
in October, but they were not billed until after
October 31st.
Accounts
Receivable
Oct 31 200
Service
Revenue
Oct 31
200
GENERAL JOURNAL Debit Credit
Oct 31 Accounts Receivable 200
Service Revenue 200

Accrued Expenses
Expenses incurred but not yet paid
or recorded at the statement date.
41

Interest expense is the cost a
company incurs to use money:
Information needed to compute interest expense:
face value of note
interest rate (always expressed in annual rate)
the length of time note is outstanding
Formula for Computing Interest
Face Value
of Note
Annual
Interest
Rate
Time
in term of
One Year
Interest
$ 5,000 X 12% * 1/12 = $50

Accrued Interest
Interest Expense
Interest Payable
Oct 31 50 Oct 31 50
GENERAL JOURNAL Debit Credit
Oct 31 Interest Expense 50
Interest Payable 50
Accrue interest expense for the month

Accrued Salaries - Salaries Paid for
after the Service Has Been Performed.

Accrued Salaries
Salaries Expense
Salaries Payable
Oct 31 1,200 Oct 31 1,200
GENERAL JOURNAL Debit Credit
Oct 31 Salaries Expense 1,200
Salaries Payable 1,200
Accrue salary expense for the month

611
Adjusted Trial Balance
The adjusted trial balance is used to
prove the equity of total debit balances
and total credit balances after the
adjusting entries have been made.
Financial statements (except Cash Flow
Statement) can be easily prepared from
the adjusted trial balance.
46

711
Closing the Books
Closing entries transfer the temporary
account balances to the stockholders’
equity account...
and reduce the balances in the
temporary accounts to zero.
50

Temporary
Permanent
All revenues accounts
All asset accounts
All expense accounts
All liability accounts
Dividends
Stockholders’ equity
accounts

Close Temporary Accounts
Only
Zero balance
after closing
entries!
Do not close!
52

The Closing Process

811
The Accounting Cycle
57

Required
Steps in
the
Accounting
Cycle
58

Review
Which is not a temporary account
a.Salaries expense
b.Service revenue
c.Accounts Receivable
d.Dividends
59

Review
Which is not a temporary account
a.Salaries expense
b.Service revenue
c.Accounts Receivable
d.Dividends
60

Review
Which account will have a zero
balance after closing entries
a.Service Revenue
b.Advertising Supplies
c.Prepaid Insurance
d.Accumulated Depreciation
61

Review
Which account will have a zero
balance after closing entries
a.Service Revenue
b.Advertising Supplies
c.Prepaid Insurance
d.Accumulated Depreciation
62

Review
Which types of accounts will appear
in the post-closing trial balance
a.Temporary accounts
b.Accounts shown in the income statement
c.Permanent accounts
d.All of the above
63

Review
Which types of accounts will appear
in the post-closing trial balance
a.Temporary accounts
b.Accounts shown in the income statement
c.Permanent accounts
d.All of the above
64

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