Financial Accounting:

Tools for Business Decision Making, 4th Ed.

Kimmel, Weygandt, Kieso

CHAPTER 4

Prepared by
Ellen L. Sweatt
Georgia Perimeter College

1
 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
1
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.
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 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.

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 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.

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9
 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 7th
for the week ended September 30th?

The answer is September – the pilots

provided labor services for September
flights during that month.

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211

Cash Basis

GA
AP
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
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Accrual Basis adheres to..

•Generally
•Accepted
•Accounting
•Principles

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19
 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.

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 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.

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 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
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 Supplies
On October 5 the company paid
$2,500 for advertising supplies.
Advertising
Advertising Supplies
Cash Supplies Expense
Oct 5 2,500 Oct 5 2,500

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
Cash Supplies Expense
Oct 5 2,500 Oct 5 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 Nov Dec Jan
$1,500 $1,800 $1,410 $1,425
Feb Mar Apr May
$1,601 $1,435 $1,510 $1,592

June July Aug Sept

$1,652 $1,621 $1,427 $1,555
Supplies expense is based on usage... so
different amounts appear each month
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 Prepaid Expenses
On October 1 the company paid $600 for a 1-year
insurance policy. Coverage began October 1.

Prepaid Insurance
Cash Insurance Expense
Oct 1 600 Oct 1 600

GENERAL JOURNAL Debit Credit

Oct 1 Prepaid Insurance 600
Cash 600
Purchased one-year policy effective October 1
 Insurance Policy
Oct Nov Dec Jan
$50 $50 $50 $50
Feb Mar Apr May
$50 $50 $50 $50

June July Aug Sept

$50 $50 $50 $50

1 Year $ 600
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 Prepaid Expenses
On October 31st, $50 ($600/12
months) of the insurance was used-up
or expired.
Prepaid Insurance
Cash Insurance Expense
Oct 1 600 Oct 1 600 Oct 31 50 Oct 31 50

550

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
 Depreciation
Allocates the cost of an asset to expense
over its useful life – MATCHING
PRINCIPLE
Is an estimate
Depreciation is ALLOCATION of cost-
not VALUATION(Current Replacement
Cost)
We’re not attempting to reflect the actual
change in value of an asset! 32
 Office Equipment
Oct Nov Dec Jan
$40 $40 $40 $40
Feb Mar Apr May
$40 $40 $40 $40

June July Aug Sept

$40 $40 $40 $40

Depreciation= $480/year
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 Accumulated
Depreciation- Depreciation
Office Equipment Office Equipment Expense
Oct 2 5,000 Oct 31 40 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.
Unearned Service Service
Cash Revenue Revenue
Oct 2 1,200 Oct 2 1,200

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.
Unearned Service Service
Cash Revenue Revenue
Oct 2 1,200 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
5
11

Accruals

•Revenue has been earned, but not

collected.
•Expenses have been incurred, but
not yet paid.

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 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 Service
Receivable Revenue
Oct 31 200 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.

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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 Annual Time

of Note Interest in term of Interest
Rate One Year

$ 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
 6
11

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.
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11

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.

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 Temporary Permanent

All revenues accounts All asset accounts

All expense accounts All liability accounts

Stockholders’ equity
Dividends
accounts
Close Temporary Accounts
Only

Zero balance
after closing
entries!

Do not close!
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The Closing Process
8
11

The Accounting Cycle

57
Required
Steps in
the
Accountin
g Cycle

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

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 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

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