Chapter 4

The
Accounting
Cycle:
Accruals and
Deferrals

Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
4-1
Introduction
In Chapter 3, you learned that we
record revenue when it is earned.
For example, when a hairdresser cuts
a customer’s hair, revenue is earned
when the hair is cut and the fee is
collected.
Suppose the same passenger boards a
Carnival Corporation cruise ship to
the Bahamas using a ticket that was
purchased six months in advance. At
what point should the cruise line
recognize that ticket revenue has 4-2
Introduction: Carnival
Corporation
In its balance sheet, Carnival
Corporation reports a $3.3 billion
liability account called Customer
Deposits. As passengers purchase
tickets in advance, Carnival
Corporation credits the Customer
Deposits account for an amount equal
to the cash it receives. It is not until
passengers actually use their tickets
that the company reduces this liability
account and records Passenger Ticket
Revenue in its income statement.
4-3
Timing Differences
For most companies, revenue is not
always earned as cash is received, nor
is an expense necessarily incurred as
cash is disbursed.
Timing differences between cash flows
and the recognition of revenue and
expenses are referred to as accruals
and deferrals.
In this chapter, we examine how
accounting information must be
adjusted for accruals and deferrals
prior to the preparation of financial 4-4
Step 4 in the Accounting Cycle
We covered the first three steps of the
accounting cycle in Chapter 3:
◦ Recording transactions
◦ Posting transactions
◦ Preparing a trial balance
KEY POINT
In this chapter, we focus solely upon the fourth step of
the accounting cycle—performing the end-of-period
adjustments required to measure business income.

4-5
The Need for Adjusting Entries
Certain transactions affect the
revenue or expenses of two or more
accounting periods.
Adjusting entries are needed at the
end of each accounting period to
make certain that appropriate
amounts or revenue and expense are
reported in the company’s income
statement.

4-6
Categories of Adjusting Entries
Most adjusting entries fall into one of
four general categories:
1. Converting assets to expenses.
2. Converting liabilities to revenue.
3. Accruing unpaid expenses.
4. Accruing uncollected revenue.

4-7
Introduction: Converting Assets
to Expenses
A cash expenditure (or cost) that will benefit
more than one accounting period usually is
recorded by debiting an asset account (for
example, Supplies, Unexpired Insurance, and so
on) and by crediting Cash.
 The asset account created actually represents
the deferral (or the postponement) of an
expense.
 In each future period that benefits from the use
of this asset, an adjusting entry is made to
allocate a portion of the asset’s cost from the
balance sheet to the income statement as an
expense.
 This adjusting entry is recorded by debiting the
appropriate expense account (for example, 4-8
Introduction: Converting
Liabilities to Revenue
 A business may collect cash in advance for services
to be rendered in future accounting periods.
 Transactions of this nature are usually recorded by
debiting Cash and by crediting a liability account
(typically called Unearned Revenue or Customer
Deposits). Here, the liability account created
represents the deferral (or the postponement) of a
revenue.
 In the period that services are actually rendered (or
that goods are sold), an adjusting entry is made to
allocate a portion of the liability from the balance
sheet to the income statement to recognize the
revenue earned during the period.
 The adjusting entry is recorded by debiting the
liability (Unearned Revenue or Customer Deposits)
and by crediting Revenue Earned (or a similar
4-9
Introduction: Accruing Unpaid
Expenses
 An expense may be incurred in the current
accounting period even though no cash
payment will occur until a future period.
 These accrued expenses are recorded by an
adjusting entry made at the end of each
accounting period.
 The adjusting entry is recorded by debiting
the appropriate expense account (for
example, Interest Expense or Salary
Expense) and by crediting the related
liability (for example, Interest Payable or
Salaries Payable).

4-10
Introduction: Accruing
Uncollected Revenue
 Revenue may be earned (or accrued) during
the current period, even though the
collection of cash will not occur until a future
period.
 Unrecorded earned revenue, for which no
cash has been received, requires an
adjusting entry at the end of the accounting
period.
 The adjusting entry is recorded by debiting
the appropriate asset (for example, Accounts
Receivable or Interest Receivable) and by
crediting the appropriate revenue account
(for example, Service Revenue Earned or
Interest Earned). 4-11
Adjusting Entries and Timing
Differences
In an accrual accounting system, there
are often timing differences between
cash flows and the recognition of
expenses or revenue.
A company can pay cash in advance
of incurring certain expenses or
receive cash before revenue has been
earned.
Likewise, it can incur certain expenses
before paying any cash or it can earn
revenue before any cash is received.
4-12
Adjusting Entries and Timing
Differences (cont.)
 These timing differences, and the adjusting
entries that result from them, are summarized
as follows.
◦ Adjusting entries to convert assets to
expenses result from cash being paid prior
to an expense being incurred.
◦ Adjusting entries to convert liabilities to
revenue result from cash being received
prior to revenue being earned.
◦ Adjusting entries to accrue unpaid expenses
result from expenses being incurred before
cash is paid.
◦ Adjusting entries to accrue uncollected
revenue result from revenue being earned 4-13
Adjusting Entries

Adjusting Every
entries are adjusting
needed whenever entry involves a
revenue or expenses change in either a
affect more than one revenue or expense
accounting and an asset
period. or liability.

4-14
Converting Assets to Expenses
End of Current Period

Prior Periods Current Period Future Periods

Transaction
Transaction Adjusting
AdjustingEntry
Entry
Pay
Paycash
cashin in 
 Recognizes
Recognizesportion
portionofof
advance
advanceof of asset
assetconsumed
consumedas as
incurring
incurring expenses,
expenses,and
and
expense
expense 
 Reduces
Reducesbalance
balanceofof
(creates
(createsan an asset
assetaccount
account
asset)
asset)
4-15
Example: Insurance Policy

$18,000 Insurance Policy

Coverage for 12 Months

$1,500 Monthly Insurance Expense

Mar. 1 Feb.28

On
On March
March 1,
1, Overnight
Overnight Auto
Auto Service
Service
purchased
purchased aa one-year
one-year insurance
insurance policy
policy
for
for $18,000.
$18,000.
4-16
 Insurance Policy: Initial Entry

Initially,
Initially, costs
costs that
that benefit
benefit more
more than
than one
one
accounting
accounting period
period are
are recorded
recorded as
as assets.
assets.

GENERAL J OURNAL
P
Date Account Titles and Explanation R Debit Credit
Mar. 1 Unexpired Insurance 18,000
Cash 18,000
Purchased a one-year insurance policy.

4-17
Insurance: Adjusting Entry

The
The costs
costs are
are expensed
expensed asas they
they are
are
used
used to
to generate
generate revenue.
revenue.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Monthly Adjusting Entry for Insurance
Mar. 31 Insurance Expense 1,500
Unexpired Insurance 1,500
Adjusting entry to record insurance expense for March.
4-18
Insurance: Financial Statement
Impact

Balance
Balance Sheet
Sheet Income
Income Statement
Statement
Cost
Cost of
of assets
assets Cost
Cost of
of assets
assets
that
that benefit
benefit used
used this
this period
period to
to
future
future periods.
periods. generate
generate revenue.
revenue.

Unexpired Insurance Insurance Expense

3/1 18,000 3/31 1,500 3/31 1,500
Bal. 16,500

4-19
Your Turn: Insurance
You as a Car Owner
Car owners typically pay insurance
premiums six months in advance.
Assume that you recently paid your six-
month premium of $600 on February 1
(for coverage through July 31). On
March 31, you decide to switch
insurance companies. You call your
existing agent and ask that your policy
be canceled. Are you entitled to a
refund? If so, why, and how much will it
be?
4-20
 The Concept of Depreciation
Depreciation
Depreciation is is the
the systematic
systematic allocation
allocation of
of
the
the cost
cost of
of aa depreciable
depreciable asset
asset to
to expense.
expense.

The asset’s
Fixed
Fixed Depreciation
usefulness is Depreciation
Asset
Asset Expense
partially Expense
(debit)
(debit) (debit)
consumed (debit)
during the
On date At the end of
period.
when initial the period . . .
payment is
made . . . Accumulated
Accumulated
Cash
Cash Depreciation
Depreciation
(credit)
(credit) (credit)
(credit)
4-21
Depreciation Is Only an Estimate
On Jan. 22, 2018, Overnight Auto
Service purchased a building
with a useful life of 240 months
for $36,000.
Using the straight-line method,
calculate the monthly
Depreciation
depreciation
expense (per =
Cost ofexpense.
the asset
Estimated useful life
period)

$150/month = $36,000
240
4-22
Case in Point
How long does a building last? For
purposes of computing depreciation
expense, most companies estimate
about 30 or 40 years. Yet the Empire
State Building was built in 1931, and
it’s not likely to be torn down anytime
soon. As you might guess, it often is
difficult to estimate in advance just
how long depreciable assets may
remain in use.

4-23
 Example: Depreciation Expense

Overnight
Overnight Auto
Auto Service
Service would
would make
make the
the
following
following adjusting
adjusting entry.
entry.

GENERAL J OURNAL
P
Date Account Titles and Explanation R Debit Credit
Feb. 28 Depreciation Expense: Building 150
Accumulated Depreciation: Building 150
To record one month's depreciation.

Contra-asset
Contra-asset
4-24
 Example 2: Depreciation Expense

Overnight depreciates its $12,000 of tools

and equipment over 60 months. Calculate
monthly depreciation and make the journal
entry.

GENERAL J OURNAL
P
Date Account Titles and Explanation R Debit Credit
Feb. 28 Depreciation Expense: Tools and Equipment 200
Accumulated Depreciation: Tools and Equipment 200
To record one month's depreciation.

$12,00060
$12,00060 months
months == $200
$200 per
per month
month
4-25
Computing Book Value for Assets
We
Wewill
will assume
assumethatthat Overnight
Overnight did
did not
not record
record any
any
depreciation
depreciationexpense
expenseininJanuary
Januarybecause
becauseitit
operated
operated for
for only
only aasmall
small part
part of
of the
the month.
month.
December 31, 2018 Balance Sheet
Presentation

Building $ 36,000
Less: Accum. depr. 1,650 34,350
Tool and Equipment $ 18,000
Less: Accum. depr. 2,200 15,800

Cost
Cost −− Accumulated
Accumulated Depreciation
Depreciation == Book
Book Value
Value

4-26
Converting Liabilities to Revenue
End of Current Period

Prior Periods Current Period Future Periods

Transaction
Transaction Adjusting
AdjustingEntry
Entry
Collect
Collectcash
cashin in 
 Recognizes
Recognizesportion
portion
advance
advanceof of earned
earnedas asrevenue,
revenue,and
and
earning
earningrevenue
revenue 
 Reduces
Reducesbalance
balanceofof
(creates
(createsaa liability
liabilityaccount
account
liability)
liability)

4-27
 Example: Rental Revenue

$3,000 Rental Contract

Coverage for 3 Months

$1,000 Monthly Rental Revenue

Dec. 1 Feb. 28

On
On December
December 1, 1, Overnight
Overnight received
received $3,000
$3,000
in
in advance
advance for
for aa three-month
three-month rental
rental contract.
contract.
4-28
 Rental Revenue: Initial Entry

Initially,
Initially, revenues
revenues that
that benefit
benefit more
more than
than one
one
accounting
accounting period
period are
are recorded
recorded as
as liabilities.
liabilities.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Dec. 1 Cash 3,000
Unearned Rent Revenue 3,000
Collected $3,000 in advance for rent.

4-29
 Rental Revenue: Adjusting Entry

Over
Over time,
time, the
the revenue
revenue is is recognized
recognized
as
as itit is
is earned.
earned.

GENERAL J OURNAL
P
Date Account Titles and Explanation R Debit Credit
Monthly Adjusting Entry for Rent Revenue
Dec. 31 Unearned Rent Revenue 1,000
Rental Revenue 1,000
Adjusting entry to record rental revenue for December.

4-30
Rental Revenue: Financial
Statement Impact

Balance Income
Income Statement
Statement
Balance Sheet
Sheet
Liability Revenue
Revenue earned
earned
Liability for
for
future this
this period.
period.
future periods.
periods.

Unearned Rental Revenue Rental Revenue

12/31 1,000 12/1 3,000 12/31 1,000
Bal. 2,000

4-31
Accruing Unpaid Expenses
End of Current Period

Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry Transaction
Transaction

 Recognizes
Recognizesexpenses
expenses Pay
Paycash
cashin in
incurred,
incurred,and
and settlement
settlementof of

 Records
Recordsliability
liabilityfor
for liability.
liability.
future
futurepayment
payment

4-32
Example: Wages Owed
Friday,
$1,950 Wages Jan. 3
Expense

Monday, Tuesday,
Dec. 30 Dec. 31

On
On Dec.
Dec. 31,
31, Overnight
Overnight owes
owes wages
wages of
of
$1,950.
$1,950. Payday
Payday is
is Friday,
Friday, Jan.
Jan. 3.
3.

4-33
 Wages Owed: Initial Entry

Initially,
Initially, an
an expense
expense and
and aa liability
liability are
are
recorded.
recorded.

GENERAL J OURNAL
P
Date Account Titles and Explanation R Debit Credit
Dec. 31 Wages Expense 1,950
Wages Payable 1,950
Adjusting entry to accrue wages owed to employees.

4-34
Wages Owed: Financial
Statement Impact

Balance
Balance Sheet
Sheet Income
Income Statement
Statement
Liability
Liability toto be
be Cost
Cost incurred
incurred this
this
paid
paid in
in aa future
future period
period to
to generate
generate
period.
period. revenue.
revenue.

Wages Payable Wages Expense

12/31 3,000 12/31 1,950

4-35
Wage Expense Calculation

$2,397 Weekly Wages

$1,950 Wages $447 Wages

Expense Expense

Monday, Tuesday, Friday,

Dec. 30 Dec. 31 Jan. 3

Let’s
Let’s look
look at
at the
the entry
entry for
for Jan.
Jan. 3.
3.
4-36
 Wages Owed: Payment Entry

The
The liability
liability is
is extinguished
extinguished when
when the
the
debt
debt is
is paid.
paid.

GENERAL J OURNAL
P
Date Account Titles and Explanation R Debit Credit
J an. 3 Wages Expense (for J an.) 447
Wages Payable (accrued in Dec.) 1,950
Cash 2,397
Weekly payroll for Dec. 30–J an. 3.
4-37
Accruing Uncollected Revenue
End of Current Period

Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry Transaction
Transaction

 Recognizes
Recognizesrevenue
revenue Collect
Collectcash
cashinin
earned
earnedbut
butnot
notyet
yet settlement
settlementofof
recorded,
recorded,and
and receivable
receivable

 Records
Recordsreceivable
receivable

4-38
Example: Service Revenue
$750 Repair
Service
Revenue

Dec. 15 Dec. 31 Jan. 15

On
On Dec.
Dec. 31,
31,Airport
Airport Shuttle
Shuttle Service
Service owes
owes
Overnight
Overnight half
half of
of its
its maintenance
maintenance agreement.
agreement.
The
The one-month
one-month feefee of
of $1,500
$1,500 is
is to
to be
be paid
paid on
on
the
the 15th day
15 th
day of
of January.
January.
4-39
 Accrued Service Revenue Entry

Initially,
Initially, the
the revenue
revenue isis recognized
recognized and
and
aa receivable
receivable is
is created.
created.

GENERAL J OURNAL
P
Date Account Titles and Explanation R Debit Credit
Dec. 31 Accounts Receivable 750
Repair Service Revenue 750
Adjusting entry to record accrued service revenue.

4-40
Accrued Revenue: Financial
Statement Impact

Balance
Balance Sheet
Sheet Income
Income Statement
Statement
Receivable
Receivable toto Revenue
Revenue earned
earned
be
be collected
collected in
in aa this
this period.
period.
future
future period.
period.

Accounts Receivable Repair Service Revenue

12/31 750 12/31 750

4-41
Accrued Revenue Calculation

$1,500 Total Revenue

$750 Service $750 Service

Revenue Revenue

Dec. 15 Dec. 31 Jan. 15

Let’s
Let’s look
look at
at the
the entry
entry for
for January
January 15.
15.
4-42
 Accrued Revenue: Collection
Entry

The
The receivable
receivable is
is collected
collected in
in aa future
future
period.
period.

GENERAL J OURNAL
P
Date Account Titles and Explanation R Debit Credit
J an. 15 Cash 1,500
Repair Service Revenue (for J an.) 750
Accounts Receivable (accrued Dec. 31) 750
To record cash collected for monthly maintenance fee.

4-43
Accruing Income Taxes Expense:
The Final Adjusting Entry
As
As aa corporation
corporation earns
earns taxable
taxable income,
income, itit
incurs
incurs income
income taxes
taxes expense,
expense, and
and also
also aa
liability
liability to
to governmental
governmental tax
tax authorities.
authorities.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Dec. 31 Income Taxes Expense 4,020
Income Taxes Payable 4,020
Adjusting entry to record income taxes accrued in December.

4-44
International Case in Point
Corporate income tax rates vary around the
world. A recent survey shows that rates range
from 9 percent in Montenegro to 55 percent in
the United Arab Emirates. Worldwide, the
average tax rate is 24 percent. The average
rate in the United States is 40 percent, which
is the highest rate among OECD countries.* In
addition to corporate income taxes, some
countries also (1) withhold taxes on dividends,
interest, and royalties, (2) charge value-added
taxes at specified production and distribution
points, and (3) impose border taxes such as
customs and import duties. A few countries,
including the Bahamas, have no corporate
4-45
Supporting the Matching
Principle
The matching principle underlies such
accounting practices as:
◦ Depreciating plant assets.
◦ Measuring the cost of supplies used.
◦ Amortizing the cost of unexpired
insurance policies.
All end-of-the-period adjusting entries
involving expense recognition are
applications of the matching principle.

4-46
Matching Costs
Costs are matched with revenue in one of two
ways.
1. Direct association of costs with specific
revenue transactions. The ideal method of
matching revenue with expenses is to
determine the actual amount of expense
associated with specific revenue
transactions. However, this approach works
only for those costs and expenses that can
be directly associated with specific revenue
transactions. Commissions paid to
salespeople are an example of costs that
can be directly associated with the revenue
of a specific accounting period.
4-47
Matching Costs (cont.)
2. Systematic allocation of costs over the
useful life of the expenditure. Many
expenditures contribute to the earning of
revenue for a number of accounting periods
but cannot be directly associated with
specific revenue transactions. Examples
include the costs of insurance policies and
depreciable assets. In these cases,
accountants attempt to match revenue and
expenses by systematically allocating the
cost to expense over its useful life. Straight-
line depreciation is an example of a
systematic technique used to match the
cost of an asset with the related revenue
4-48
Materiality Concept
Materiality refers to the relative
importance of an item or an event.
An item is considered material if
knowledge of the item might
reasonably influence the decisions of
users of financial statements.
Accountants must be sure that all
material items are properly reported in
financial statements.

4-49
Materiality Concept (cont.)
Immaterial items are those of little or
no consequence to decision makers.
◦ The financial reporting process
should be cost-effective—that is, the
value of the information should
exceed the cost of its preparation.
◦ Immaterial items may be handled in
the easiest and most convenient
manner.

4-50
Materiality and Adjusting Entries
The concept of materiality enables
accountants to shorten and simplify the
process of making adjusting entries in several
ways. For example:
1. Businesses purchase many assets that
have a very low cost or that will be
consumed quickly in business operations.
Examples include wastebaskets, lightbulbs,
and janitorial supplies. The materiality
concept permits charging such purchases
directly to expense accounts, rather than to
asset accounts. This treatment
conveniently eliminates the need to
prepare adjusting entries to depreciate
4-51
Materiality and Adjusting Entries
(cont.)
2. Some expenses, such as telephone bills
and utility bills, may be charged to
expenses as the bills are paid, rather than
as the services are used. Technically this
treatment violates the matching principle.
However, accounting for utility bills on a
cash basis is very convenient, as the
monthly cost of utility service is not even
known until the utility bill is received.
Under this cash basis approach, the
amount of utility expense recorded each
month is actually based on the prior
month’s bill.
3. Adjusting entries to accrue unrecorded
expenses or unrecorded revenue may 4-52
Materiality and Professional
Judgment
Whether a specific item or event is
material is a matter of professional
judgment. In making these judgments,
accountants consider several factors:
1. The size of the organization.
2. The cumulative effect of numerous
immaterial events.
3. Nature of the item.
4. Dollar amount of the item.

4-53
Your Turn: Materiality
You as Overnight Auto’s Service
Department Manager
You just found out that Betty, one of the best
mechanics that you supervise for Overnight
Auto, has taken home small items from the
company’s supplies, such as a screwdriver
and a couple of cans of oil. When you talk to
Betty, she suggests that these items are
immaterial to Overnight Auto because they
are not recorded in the inventory and they are
expensed when they are purchased. How
should you respond to Betty?

4-54
 Effects of the Adjusting Entries

Income Statement Balance Sheet

Net Owners'
Adjustment Revenue Expenses Income Assets Liabilities Equity
Type I
Converting Assets to Expenses No effect Increase Decrease Decrease No effect Decrease
Type II
Converting Liabilities to Revenue Increase No effect Increase No effect Decrease Increase
Type III
Accruing Unpaid Expenses No effect Increase Decrease No effect Increase Decrease
Type IV
Accruing Uncollected Revenue Increase No effect Increase Increase No effect Increase

4-55
Overnight’s Adjusted Trial
Balance
 After these
adjustments
are posted to
the ledger,
Overnight’s
ledger
accounts will
be up-to-date
(except for the
balance in the
Retained
Earnings
account). 4-56
Ethics, Fraud, & Corporate
Governance
Improper accounting for operating costs has
often resulted in the SEC bringing action
against companies for fraudulent financial
reporting. Expenditures that are expected only
to benefit the year in which they are made
should be expensed (deducted from revenue
in the determination of net income for the
current period). Companies that engage in
fraud will often defer these expenditures by
capitalizing them (they debit an asset account
reported in the balance sheet instead of an
expense account reported in the income
statement).

4-57
Ethics, Fraud, & Corporate
Governance (cont. 1)
Prior to Enron and WorldCom, one of the
largest financial scandals in U.S. history
occurred at Waste Management. Waste
Management was the world’s largest waste
services company. The improper accounting at
Waste Management lasted for approximately
five years and resulted in an overstatement of
earnings during this time period of $1.7 billion.
Investors lost over $6 billion when Waste
Management’s improper accounting was
revealed.

4-58
Ethics, Fraud, & Corporate
Governance (cont. 2)
Waste Management’s scheme for overstating
earnings was simple. The company deferred
recognizing normal operating expenditures as
expenses until future periods. These improper
deferrals were accomplished in a number of
different ways, many of which involved
improper accounting for long-term assets. For
example, Waste Management incurred costs in
buying and developing land to be used as
landfills (i.e., garbage dumps).

4-59
Ethics, Fraud, & Corporate
Governance (cont. 3)
Capitalizing these costs—treating them as
long-term assets—was proper accounting.
However, in certain cases, the company was
not able to secure the necessary governmental
permits and approvals to use the purchased
land as intended. In these cases, the costs that
had been capitalized and reported as landfills
in the balance sheet should have been
expensed immediately, thereby reducing net
income for the year in which the company’s
failure to obtain government permits and
approvals occurred.

4-60
Learning Objective Summary
LO4-1
LO4-1: Explain the purpose of
adjusting entries. The purpose of
adjusting entries is to allocate revenue and
expenses among accounting periods in
accordance with the realization and
matching principles. These end-of-period
entries are necessary because revenue
may be earned and expenses may be
incurred in periods other than the period in
which related cash flows are recorded.

4-61
Learning Objective Summary
LO4-2
LO4-2: Describe and prepare the four
basic types of adjusting entries. The
four basic types of adjusting entries are
made to (1) convert assets to expenses, (2)
convert liabilities to revenue, (3) accrue
unpaid expenses, and (4) accrue uncollected
revenue. Often a transaction affects the
revenue or expenses of two or more
accounting periods. The related cash inflow
or outflow does not always coincide with the
period in which these revenue or expense
items are recorded. Thus, the need for
adjusting entries results from timing
differences between the receipt or
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Learning Objective Summary
LO4-3
LO4-3: Prepare adjusting entries to
convert assets to expenses. When an
expenditure is made that will benefit more
than one accounting period, an asset
account is debited and cash is credited. The
asset account is used to defer (or postpone)
expense recognition until a later date. At
the end of each period benefiting from this
expenditure, an adjusting entry is made to
transfer an appropriate amount from the
asset account to an expense account. This
adjustment reflects the fact that part of the
asset’s cost has been matched against
revenue in the measurement of income for
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Learning Objective Summary
LO4-4
LO4-4: Prepare adjusting entries to convert
liabilities to revenue. Customers sometimes pay
in advance for services to be rendered in later
accounting periods. For accounting purposes, the
cash received does not represent revenue until it
has been earned. Thus, the recognition of revenue
must be deferred until it is earned. Advance
collections from customers are recorded by debiting
Cash and by crediting a liability account for
unearned revenue. This liability is sometimes called
Customer Deposits, Advance Sales, or Deferred
Revenue. As unearned revenue becomes earned, an
adjusting entry is made at the end of each period to
transfer an appropriate amount from the liability
account to a revenue account. This adjustment
reflects the fact that all or part of the company’s
obligation to its customers has been fulfilled and 4-64
Learning Objective Summary
LO4-5
LO4-5: Prepare adjusting entries to
accrue unpaid expenses. Some
expenses accumulate (or accrue) in the
current period but are not paid until a
future period. These accrued expenses are
recorded as part of the adjusting process
at the end of each period by debiting the
appropriate expense (e.g., Salary Expense,
Interest Expense, or Income Taxes
Expense), and by crediting a liability
account (e.g., Salaries Payable, Interest
Payable, or Income Taxes Payable). In
future periods, as cash is disbursed in
settlement of these liabilities, the
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Learning Objective Summary
LO4-6
LO4-6: Prepare adjusting entries to
accrue uncollected revenue. Some
revenues are earned (or accrued) in the
current period but are not collected until a
future period. These revenues are normally
recorded as part of the adjusting process
at the end of each period by debiting an
asset account called Accounts Receivable,
and by crediting the appropriate revenue
account. In future periods, as cash is
collected in settlement of outstanding
receivables, Cash is debited and Accounts
Receivable is credited.

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Learning Objective Summary
LO4-7
LO4-7: Explain how the principles of
realization and matching relate to
adjusting entries. Adjusting entries are
the tools by which accountants apply the
realization and matching principles.
Through these entries, revenues are
recognized as they are earned, and
expenses are recognized as resources are
used or consumed in producing the
related revenue.

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Learning Objective Summary
LO4-8
LO4-8: Explain the concept of
materiality. The concept of materiality
allows accountants to use estimated
amounts and to ignore certain accounting
principles if these actions will not have a
material effect on the financial
statements. A material effect is one that
might reasonably be expected to
influence the decisions made by the users
of financial statements. Thus, accountants
may account for immaterial items and
events in the easiest and most convenient
manner.

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Learning Objective Summary
LO4-9
LO4-9: Prepare an adjusted trial
balance and describe its purpose. The
adjusted trial balance reports all of the
balances in the general ledger after the
end-of-period adjusting entries have been
made and posted. Generally, all of a
company’s balance sheet accounts are
listed, followed by the statement of
retained earnings accounts and, finally, the
income statement accounts. The amounts
shown in the adjusted trial balance are
carried forward directly to the financial
statements.

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End of Chapter 4

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