1. Financial Accounting: Tools for Business Decision Making, 3rd Ed.
Kimmel, Weygandt, Kieso
ELS

2. Chapter 4

3. Chapter 4 Accrual Accounting Concepts
PowerPoint Slides
After studying Chapter 4, you should be able to:
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. 1

4. Chapter 4 Accrual Accounting Concepts
PowerPoint Slides
After studying Chapter 4, you should be able to:
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. 2

5. 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.

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

7. Revenue Recognition Principle...
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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. 3

8. PowerPoint Slides
Matching Principle...
requires that expenses be recorded in the same period in which the revenues they helped produce are recorded. 4

10. Cash Basis Revenue recorded only when cash is received.
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Cash Basis
Revenue recorded only when cash is received.
Expense recorded only when cash is paid. 5

11. PowerPoint Slides
Cash Basis in not GAAP
GAAP 5

12. Accrual Basis Accounting
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Accrual Basis Accounting
Adheres to the:
Revenue Recognition Principle
Matching Principle 5

13. Accrual Basis Accounting
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Accrual Basis Accounting
Revenue recorded only when earned, not when cash is received
Expense recorded only when incurred, not when cash paid 5

14. Accrual Basis adheres to...
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Accrual Basis adheres to...
Generally
Accepted
Accounting
Principles 5

15. Purchased paint, painted building , Received payment for work
Year Year 2
Purchased paint, painted building ,
paid employees
Received payment for work
done in year one
Activity
Accrual
basis
Cash
Revenue $80,000
Expense ,000
Net Income $30,000
Revenue $
Expense ,000
Net Loss ( $50,000)
Expense
Net Income $80,000
Revenue $
Expense
Net Income $

16. HAPPEN! Adjusting Entries revenue recognition & matching principles
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Adjusting Entries
Adjusting entries make the:
revenue recognition &
matching principles
HAPPEN! 9

17. Types of Adjusting Entries
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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. 10

18. Prepayments
Cash or other asset has been spent but the item acquired has not been used or consumed
Cash has been collected before revenue is earned

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

20. Sierra Corporation Trial Balance October 31, 2004 Debit Credit
PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2004
Debit Credit
Cash $15,200
Advertising Supplies ,500
Prepaid Insurance
Office Equipment ,000
Notes Payable $ 5,000
Accounts Payable ,500
Unearned Service Revenue ,200
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Rent Expense
$28,700 $28,700 9

21. Illustration 4-6
Supplies
On October 5 the company paid $2,500 for advertising supplies.
Supplies Expense
Cash
Supplies
Oct 5
2,500
Oct 5
2,500
GENERAL JOURNAL Debit Credit
Oct 5 Supplies , Cash ,500
Purchased advertising supplies

22. Supplies Supplies Expense Cash Supplies
Illustration 4-6
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
Supplies Expense
Cash
Supplies
Oct 5
2,500
Oct 5
2,500
1,500
Oct 31
1,500
Oct 31
GENERAL JOURNAL Debit Credit
Oct 5 Supplies Expense , Supplies ,500
To record advertising supplies consumed

23. 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

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

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

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

27. Depreciation
How do you apply the Matching Principle to the cost of a long lived asset ?

28. Depreciation
Allocate the cost of an asset to expense over its useful life
Depreciation is an ALLOCATION CONCEPT- not a VALUATION CONCEPT.
We’re not attempting to reflect the actual change in value of an asset!

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

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

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

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

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

34. Accrual Revenue has been earned, but not collected.
Expenses have been incurred, but not yet paid.

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

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

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

38. Formula for Computing Interest
Face Value of Note
Interest
Time
in term of One Year
Annual Interest
Rate
$ 5,000 X
12%
1/12 =
$50
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

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

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

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

42. 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 can be easily prepared from the adjusted trial balance.

43. Adjusted Trial Balance For the Month Ended October 31, 2004
SIERRA CORPORATION
Adjusted Trial Balance
For the Month Ended October 31, 2004
SIERRA CORPORATION
Adjusted Trial Balance
For the Month Ended October 31, 2004
SIERRA CORPORATION
Retained Earnings Statement
For the Month Ended October 31, 2004

44. Balance as Oct. 31 from Retained Earnings Statement
SIERRA CORPORATION
Adjusted Trial Balance
For the Month Ended October 31, 2004
Balance Sheet
October 31, 2004

45. 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.

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

47. Retained Earnings is a permanent account; the others shown here
are temporary
Individual Expenses
Retained Earnings
Income Summary
Individual Revenues
Dividends 1 3 4 2

48. The Accounting Cycle

49. Required Steps in the Accounting Cycle
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Required Steps in the Accounting Cycle
Analyze business transactions.
Journalize the transactions.
Post to ledger accounts.
Prepare a trial balance.
Journalize and post adjusting entries--prepayments and accruals.
Prepare an adjusting trial balance. 20