1. Introduction to Financial Accounting
BUS ADM 201
Lecture 4.1

2. Chapter 4: Accrual Accounting Concepts
Explain the accrual basis of accounting and the reasons for adjusting entries
Prepare adjusting entries for deferrals
Prepare adjusting entries for accruals
Prepare an adjusted trial balance and closing entries

3. Revisiting the Accounting Cycle
We ended the last chapter with a prepared Trial Balance
The next step involves adjusting entries, but what does that mean?
Prepare a Trial Balance
Analyze business transactions
Journalize the transaction
Post to ledger accounts
Adjusting Entries
Adjusted Trial Balance
Financial Statements
Closing Entries
Post-Closing Trial Balance

4. Recap of Accounting Transactions
Transactions are economic events that require recording in the financial statements
Not all activities represent transactions
Assets, liabilities, or stockholders’ equity items change as a result of some economic event
Typically it is an exchange
Dual effect on the accounting equation

5. Periodicity Assumption
Periodicity Assumption: Accountants divide the economic life of a business entity into artificial time periods (reporting periods)
Transactions are aggregated into financial statements for a given period of time
Generally, these are months, quarters, and/or years
A reporting period year is called a fiscal year
Fiscal years and calendar years are NOT always the same

6. Periodicity Assumption

7. Periodicity Assumption
Why do we care about periodicity?
Accountants need to know what period they are summarizing with financial statements so they can determine which transactions belong in which period
Some transactions are complex and belong to different periods based on the basis of accounting used!
There are two general methods of accounting
Cash Basis
Accrual Basis

8. Cash Basis Accounting
Revenues are recognized only when cash is received
Expenses are recognized only when cash is paid
Not in accordance with generally accepted accounting principles (GAAP)

9. Accrual Basis Accounting
Revenues are recognized only when goods are delivered or services are performed
Expenses are recognized only when incurred (even if no cash is paid)
This is the basis of accounting for the rest of the course

10. Accrual Basis Accounting
Revenue Recognition Principle
Companies recognize revenue in the accounting period in which the performance obligation is satisfied
Recognition for Accrual Accounting
Recognition for Cash Accounting

11. Accrual Basis Accounting
Expense Recognition
Match expenses to the corresponding revenues in the period when the company makes efforts to generate those revenues
This is called the Matching Principle

12. Accrual Basis Accounting
Example
Suppose that Dennis Painting Co. paints 2 large buildings for Bernie Buildings, Inc. One in late 2016 and one in early Dennis bills the customer $80,000 for each job, but does not receive payment from Bernie for both until 2017.
Suppose that in 2016 Dennis pays $50,000 cash for paint and supplies. Half of these were used on each job above.
Built Building 1
Built Building 2
Bills for Both
Paid for Both
1/1/2017
Bought Paint & Supplies

13. Accrual Basis Accounting
Dennis’ Accounting
2016
2017
Cash Basis
Revenue
Expense
Net Income
Accrual basis $
$ ,000
50,000
$ ( ,000)
$ ,000
$ ,000
$ ,000
25,000
25,000
$ ,000
$ ,000
Built Building 1
Built Building 2
Bills for Both
Paid for Both
1/1/2017
Bought Paint & Supplies

14. Adjusting Journal Entries
The way we account for the transactions during the year may require adjusting entries
Journalize and Post Adjusting Entries
Analyze business transactions
Journalize
Post
Trial Balance
Adjusted Trial Balance
Financial Statements
Closing Entries
Post-Closing Trial Balance

15. Accrual Basis Accounting
Adjusting Journal Entries
Used to adjust for timing issues across periods
Ensure that the revenue recognition and expense recognition principles are followed
This allows for proper “cut-off”
Required every time a company prepares financial statements

16. Adjusting Journal Entries
We look at facts related to the original transactions to determine if adjustments need to be made to our trial balance

17. Accrual Basis Accounting
Example
Dennis paid $50,000 cash for paint and supplies, half of these were used in 2016 and half in 2017
2016
Paint & Supplies Inventory
50,000
Cash
50,000
2016
Paint & Supplies Expense
25,000
Paint & Supplies Inventory
25,000

18. Adjusting Journal Entries
Deferrals
Prepaid expenses: Expenses paid in cash and recorded as assets before they are used or consumed
Unearned revenues: Cash received before service are performed
Accruals
Accrued revenues: Revenues for services performed but not yet received in cash or recorded
Accrued expenses: Expenses incurred but not yet paid in cash or recorded

19. Deferrals – Prepaid Expenses
Expenses paid in cash before they are used or consumed
Examples
Costs that expire either with the passage of time or through use
Adjusting entry results in an increase (a debit) to an expense account and a decrease (a credit) to an asset account
Insurance
Advertising
Equipment
Supplies
Rent
Buildings

20. Deferrals – Prepaid Expenses
Adjusting Journal Entry for Prepaid Expenses
Increases (debits) an expense account and
Decreases (credits) an asset account
Illustration 4-5

21. Deferrals – Prepaid Expenses
Depreciation
Depreciation is essentially an adjustment to a prepaid expense
Buildings, equipment, and motor vehicles (long-lived assets) are recorded as assets, rather than an expense, in the year acquired
Depreciation is the process of allocating the cost of an asset to expense (depreciation) over its useful life
Accumulated Depreciation is a contra asset account
All contra accounts have increases, decreases, and normal balances opposite to the account to which they relate

22. Deferrals – Unearned Revenues
Receipt of cash recorded as a liability before services are performed
Adjusting entry is made to record the revenue for services performed during the period and to show the liability that remains
Adjusting entry results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account
Rental Income
Magazine Subscriptions
Airline Tickets
Customer Deposits

23. Deferrals – Unearned Revenues
Adjusting Journal Entry for Unearned Revenues
Decreases (debits) a liability account and
Increases (credits) a revenue account
Illustration 4-11

24. Deferrals – Accrued Revenues
Revenues for services performed but not yet received in cash or recorded
Examples
An adjusting entry serves two purposes:
Shows the receivable that exists
Records the revenues for services performed
Interest
Services Performed

25. Deferrals – Accrued Revenues
Adjusting Journal Entry for Accrued Revenues
Increases (debits) an asset account and
Increases (credits) a revenue account
Illustration 4-14

26. Deferrals – Accrued Expenses
Expenses incurred but not yet paid in cash or recorded
Examples
An adjusting entry serves two purposes:
Records the obligations
Recognizes the expenses
Interest
Utilities
Taxes
Salaries

27. Deferrals – Accrued Expenses
Adjusting Journal Entry for Accrued Expenses
Increases (debits) an expense account and
Increases (credits) a liability account
Illustration 4-17

28. Summary of Basic Relationships
Illustration 4-23

29. Accumulated Depreciation 0 Notes Payable 5,000 Accounts Payable 2,500
EXAMPLE: Assume Sierra Corporation starts Sierra Corporation
business in early October Trial Balance
Statements are prepared every month. October 31, 2016
PowerPoint Slides
Unadjusted Trial Balance
Debit Credit
Cash ,200
Accounts Receivable 0
Advertising Supplies ,500
Prepaid Insurance
Equipment ,000
Accumulated Depreciation 0
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Salaries Payable 0
Interest Payable 0
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Supply Expense 0
Rent Expense 900
Insurance Expense 0
Interest Expense 0
Depreciation Expense
28, ,700 9

30. Information for Sierra Corporation’s October AJEs (monthly statements)
Supplies: Per count, only $1,000 are left at Oct 31
Insurance: Paid $600 for a 1 year policy on Oct 1
Equipment (Depreciation): Assume depreciation expense = $40/month
Notes Payable (Interest): Interest is due when note is paid next year. Rate is 12% per year.
Unearned Revenue: 1/3 of the $1,200 received was earned during October
Service Revenue: 50% of a $400 project was completed during the last day of October. Nothing was recorded
Salaries Expense: Oct 31 is a Wednesday. Employees are paid Fridays for the M->F week. Salaries total $400/day

31. Accumulated Depreciation 0 Notes Payable 5,000 Accounts Payable 2,500
PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2016
Unadjusted Trial Balance Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Accounts Receivable 0
Advertising Supplies ,500
Prepaid Insurance
Equipment ,000
Accumulated Depreciation 0
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Salaries Payable 0
Interest Payable 0
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Supply Expense 0
Rent Expense 900
Insurance Expense 0
Interest Expense 0
Depreciation Expense
28, ,700 9

32. This is called a worksheet
PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2016
Unadjusted Trial Balance Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Accounts Receivable 0
Advertising Supplies ,500
Prepaid Insurance
Equipment ,000
Accumulated Depreciation 0
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Salaries Payable 0
Interest Payable 0
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Supply Expense 0
Rent Expense 900
Insurance Expense 0
Interest Expense 0
Depreciation Expense
28, ,700
We use it to track the accounts from unadjusted trial balance through the adjustments and into the financial statements
This is called a worksheet 9

33. Supplies: Per count, only $1,000 are left at 10/31.
PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2016
Supplies: Per count, only $1,000 are left at 10/31.
Unadjusted Trial Balance Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Accounts Receivable 0
Advertising Supplies ,500
Prepaid Insurance
Equipment ,000
Accumulated Depreciation 0
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Salaries Payable 0
Interest Payable 0
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Supply Expense 0
Rent Expense 900
Insurance Expense 0
Interest Expense 0
Depreciation Expense
28, ,700
1,500
1,000
1,500
1,500 9

34. Insurance: Paid $600 for a 1 year policy. $600/12 months = $50/month
PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2016
Insurance: Paid $600 for a 1 year policy.
$600/12 months = $50/month
Unadjusted Trial Balance Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Accounts Receivable 0
Advertising Supplies , ,500 1,000
Prepaid Insurance
Equipment ,000
Accumulated Depreciation 0
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Salaries Payable 0
Interest Payable 0
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Supply Expense 0 1,500 1,500
Rent Expense 900
Insurance Expense 0
Interest Expense 0
Depreciation Expense
28, ,700 50
550 50 50 9

35. Equipment (Depreciation): Assume depreciation expense = $40/month
Sierra Corporation
Trial Balance
October 31, 2016
PowerPoint Slides
Equipment (Depreciation): Assume depreciation expense = $40/month
Unadjusted Trial Balance Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Accounts Receivable 0
Advertising Supplies , ,500 1,000
Prepaid Insurance
Equipment ,000
Accumulated Depreciation 0
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Salaries Payable 0
Interest Payable 0
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Supply Expense 0 1,500 1,500
Rent Expense 900
Insurance Expense
Interest Expense 0
Depreciation Expense
28, ,700 40 40 40 40 9

36. Sierra Corporation
Trial Balance
October 31, 2016
PowerPoint Slides
Notes Payable (Interest): Interest is due on note paid next year. Rate is 12% per year.
$5,000 x .12 x 1/12 = $50/month
Unadjusted Trial Balance Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Accounts Receivable 0
Advertising Supplies , ,500 1,000
Prepaid Insurance
Equipment ,000
Accumulated Depreciation
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Salaries Payable 0
Interest Payable 0
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Supply Expense 0 1,500 1,500
Rent Expense 900
Insurance Expense
Interest Expense 0
Depreciation Expense
28, ,700 50 50 50 50 9

37. PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2016
Unearned Revenue: 1/3 of the $1,200 received was earned during October.
$1,200 x 1/3 = $400 earned
Unadjusted Trial Balance Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Accounts Receivable 0
Advertising Supplies , ,500 1,000
Prepaid Insurance
Equipment ,000
Accumulated Depreciation
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Salaries Payable 0
Interest Payable
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Supply Expense 0 1,500 1,500
Rent Expense 900
Insurance Expense
Interest Expense
Depreciation Expense
28, ,700
400
800
400
10,400 9

38. PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2016
Service Revenue: 50% of a $400 project was completed during the last day of October. Nothing was recorded.
$400 x .5 = $200 to be recorded.
Unadjusted Trial Balance Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Accounts Receivable 0
Advertising Supplies , ,500 1,000
Prepaid Insurance
Equipment ,000
Accumulated Depreciation
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,
Salaries Payable 0
Interest Payable
Common Stock ,000
Dividends
Service Revenue , ,400
Salaries Expense ,000
Supply Expense 0 1,500 1,500
Rent Expense 900
Insurance Expense
Interest Expense
Depreciation Expense
28, ,700
200
200
200+
10,600 9

39. PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2016
Salaries Expense: 10/31 is a Wednesday. Employees are paid Fridays for the M->F week. Salaries total $400/day.
$400 x 3 = $1,200 to be recorded.
Unadjusted Trial Balance Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Accounts Receivable
Advertising Supplies , ,500 1,000
Prepaid Insurance
Equipment ,000
Accumulated Depreciation
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,
Salaries Payable 0
Interest Payable
Common Stock ,000
Dividends
Service Revenue , ,600
Salaries Expense ,000
Supply Expense 0 1,500 1,500
Rent Expense 900
Insurance Expense
Interest Expense
Depreciation Expense
28, ,700
1,200
1,200
1,200
5,200 9

40. Use to prepare Financial Statements
PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2016
Use to prepare Financial Statements
Unadjusted Trial Balance Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash , ,200
Accounts Receivable
Advertising Supplies , ,500 1,000
Prepaid Insurance
Equipment , ,000
Accumulated Depreciation
Notes Payable , ,000
Accounts Payable , ,500
Unearned Service Rev ,
Salaries Payable 0 1,200 1,200
Interest Payable
Common Stock , ,000
Dividends
Service Revenue , ,600
Salaries Expense ,000 1,200 5,200
Supply Expense 0 1,500 1,500
Rent Expense
Insurance Expense
Interest Expense
Depreciation Expense
28, , ,190 30,190
ILLUSTRATION 4-26
Adjusted trial balance 9

41. Revisiting the Accounting Cycle
Once we have an Adjusted Trial Balance, we can prepare our financial statements
Analyze business transactions
Journalize
Post
Trial Balance
Adjusting Entries
Adjusted trial balance
Prepare financial statements
Journalize and post closing entries
Prepare a post-closing trial balance

42. Preparing Financial Statements
Financial statements are prepared directly from the Adjusted Trial Balance.
Income Statement
Retained Earnings Statement
Balance Sheet

43. Preparing Financial Statements
ILLUSTRATION 4-26
Preparation of the income statement and retained earnings statement from the adjusted trial balance

44. Preparing Financial Statements
ILLUSTRATION 4-27
Preparation of the balance sheet from the adjusted trial balance

45. Revisiting the Accounting Cycle
Once we have an Adjusted Trial Balance, we can prepare our financial statements
Analyze business transactions
Journalize
Post
Trial Balance
Adjusting Entries
Adjusted trial balance
Prepare financial statements
Journalize and post closing entries
Prepare a post-closing trial balance

46. Journalize and Post Closing Entries
At the end of the accounting period, we transfer temporary account balances to the permanent stockholders’ equity account—Retained Earnings
This process follows the same path as the flow of information across the financial statements we just prepared
In addition to updating Retained Earnings to its correct ending balance, closing entries produce a zero balance in each temporary account

47. Journalize and Post Closing Entries
Temporary
Permanent
All revenue accounts
All expense accounts
Dividends
All asset accounts
All liability accounts
All stockholders’ equity accounts
Illustration 4-30

48. Journalize and Post Closing Entries
Illustration 4-31

49. Journalize and Post Closing Entries
Illustration 4-31

50. Journalize and Post Closing Entries
Posting the entries results in a zero balance in all temporary accounts
Note that the third entry matches our net income number from the Income Statement

51. Journalize and Post Closing Entries
Posting the entries results in a zero balance in all temporary accounts
Note that the third entry matches our net income number from the Income Statement
Note that the T Account for Retained Earnings matches the Statement of Retained Earnings

52. Revisiting the Accounting Cycle
With closing entries posted, we are ready to start the next fiscal period
Analyze business transactions
Analyze business transactions
Journalize
Post
Trial Balance
Adjusting Entries
Adjusted trial balance
Prepare financial statements
Journalize and post closing entries
Prepare a post-closing trial balance

53. Next Steps
Starting next week we will get into detail on exactly how to do accounting for the various business transactions
We will roughly follow the order of the balance sheet

55. Thank You!