1. Accrual
Accounting
Concepts

2. Time Period Assumption...
Divides the economic life of a business into reporting (time) periods.
Generally a month, a quarter, semi-annual or a year.
An accounting time period that is one year long is called fiscal year.
A fiscal year ending December 31 is called a calendar year.

3. Accounting Method...
Determines which time period revenues and expenses are recorded.
For example, when I sell something in December but get paid the cash in January, which income statement should show the revenue, December’s or January’s?
Two general methods exist: Cash Basis Accrual Basis

4. Cash Basis Method
Defined Record revenue when cash is received. Record expense when cash is paid out.
Not GAAP -> We won’t use in class
Possible manipulation. (Receipt or payment of cash can be controlled.)
Allowed for Income Taxes (sometimes).

5. Accrual Basis Method Defined: Record revenues when earned.
- (when goods are sold or services performed)
- Called Revenue Recognition Principle
Record expenses when incurred.
- (When they were used up to produce revenue) - Called Matching Principle.
GAAP -> We will concentrate on in class.
Requires adjustments and additional accounts.

6. EXAMPLE: Magazine Inc sells only 3 year subscriptions for Rs.60 each.
On 1/1/08 sold 10,000 subscriptions and received full payment of Rs.600,000.
Wages, rent, and miscellaneous operating expenses incurred and paid are Rs.50,000 per year.
On 1/1/08, a special deal came along and the company bought Rs.200,000 of paper which should be enough to complete the 10,000 subscriptions for 2 years. Compute net income for 2008 and 2009 using cash method and then using accrual method.

7. Cash Method:
Revenues 600,000 0
Oper Exp - 50, ,000
Paper Exp ,
Net Income , ,000
Accrual:
Revenues 200, ,000
Oper Exp - 50, ,000
Paper Exp , ,000
Net Income , ,000

8. Adjusting Journal Entries (AJEs)
PowerPoint Slides
Adjusting Journal Entries (AJEs)
Are needed only for the accrual method
Are used to handle inter-period timing issues
Split up a revenue or expense (when needed) and record part of it in one accounting period and the rest of it in a later period.
For example, in the previous example 1/3 of the revenue and 1/2 of the paper.
Getting revenues and expenses in the correct accounting periods is referred to as achieving a proper “Cut-Off” of the accounting period. 10

9. Types of Adjusting Entries
PowerPoint Slides
Types of Adjusting Entries
Advance receipts or payments
Unearned Revenues: We receive cash in advance (before revenue is earned) and we don’t complete the job before year end.
Prepaid expenses: We pay cash for an item in the current period, but the item acquired has not been used up by year end. 10

10. Types of Adjusting Entries
PowerPoint Slides
Types of Adjusting Entries
Delayed receipts or payments
Accrued revenues: We earn revenue in the current period, but we have not received the cash or recorded the revenue by period end.
Accrued expenses: We have used up an item in the current period but we have not paid for it in cash or recorded the expense by period end. 10

11. Unadjusted Trial Balance
PowerPoint Slides
Example: Sierra Corporation
Unadjusted Trial Balance
October 31, 2008
Debit Credit
Cash Rs.15,200
Advertising Supplies ,500
Prepaid Insurance
Office Equipment ,000
Notes Payable Rs. 5,000
Accounts Payable ,500
Unearned Service Revenue ,200
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Rent Expense
Rs.28,700 Rs.28,700 9

12. Information for Sierra October AJEs (monthly statements)
PowerPoint Slides
Information for Sierra October AJEs (monthly statements)
Supplies: Per count, only Rs.1,000 are left at 10/31.
Insurance: Paid Rs.600 for a 1 year policy.
Equipment (Depreciation): Assume depreciation expense = Rs.480/month
Notes Payable (Interest): Interest is due when note is paid next year. Rate is 12% per year.
Unearned Revenue: 1/3 of the Rs.1,200 received was earned during October.
Service Revenue: 50% of a Rs.400 project was completed during the last day of October. Nothing was recorded.
Salaries Expense: 10/31 is a Wednesday. Employees are paid Fridays for the M->F week. Salaries total Rs.400/day. 10

13. Supplies: Per count, only Rs.1,000 are left at 10/31.
PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2008
Supplies: Per count, only Rs.1,000 are left at 10/31.
Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Advertising Supplies ,500
Prepaid Insurance
Office Equipment ,000
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Rent Expense
28, ,700
1,500
1,000
1,500
Advert Supply Expense
1,500 9

14. Insurance: Paid Rs.600 for a 1 year policy.
Sierra Corporation
Trial Balance
October 31, 2008
PowerPoint Slides
Insurance: Paid Rs.600 for a 1 year policy.
Rs.600/12 months = Rs.50/month
Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Advertising Supplies ,500
Prepaid Insurance
Office Equipment ,000
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Rent Expense
28, ,700
1,500
1,000 50
550
Advert Supply Expense
1,500
1,500 50
Insurance Expense 50 9

15. Equipment (Depreciation): Assume depreciation expense = Rs.480/month
PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2008
Equipment (Depreciation): Assume depreciation expense = Rs.480/month
Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Advertising Supplies ,500
Prepaid Insurance
Office Equipment ,000
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Rent Expense
28, ,700
1,500
1,000 50
550
Advert Supply Expense
1,500
1,500 50
Insurance Expense 50
480
Depreciation Expense
480
480
Accumulated Deprec.
480 9

16. PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2008
Notes Payable (Interest): Interest is due on note paid next year. Rate is 12% per year.
Rs.5,000 x .12 x 1/12 = Rs.50/month
Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Advertising Supplies ,500
Prepaid Insurance
Office Equipment ,000
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Rent Expense
28, ,700
1,500
1,000 50
550
Advert Supply Expense
1,500
1,500 50
Insurance Expense 50
Depreciation Expense
480
480
Accumulated Deprec.
480
480 50
Interest Expense 50 50
Interest Payable 50 9

17. PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2008
Unearned Revenue: 1/3 of the Rs.1,200 received was earned during October.
Rs.1,200 x 1/3 = Rs.400 earned
Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Advertising Supplies ,500
Prepaid Insurance
Office Equipment ,000
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Rent Expense
28, ,700
1,500
1,000 50
550
400
800
400
10,400
Advert Supply Expense
1,500
1,500 50
Insurance Expense 50
Depreciation Expense
480
480
Accumulated Deprec.
480
480 50
Interest Expense 50
Interest Payable 50 50 9

18. PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2008
Service Revenue: 50% of a Rs.400 project was completed during the last day of October. Nothing was recorded.
Rs.400 x .5 = Rs.200 to be recorded.
Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Advertising Supplies ,500
Prepaid Insurance
Office Equipment ,000
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Rent Expense
28, ,700
1,500
1,000 50
550
400
800
+200
400
10,400
10,600
Advert Supply Expense
1,500
1,500 50
Insurance Expense 50
Depreciation Expense
480
480
Accumulated Deprec.
480
480
Interest Expense 50 50
Interest Payable 50
200
Accounts Receivable
200 9

19. PowerPoint Slides
Sierra Corporation
Trial Balance
October 31, 2008
Salaries Expense: 10/31 is a Wednesday. Employees are paid Fridays for the M->F week. Salaries total Rs.400/day.
Rs.400 x 3 = Rs.1,200 to be recorded.
Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Advertising Supplies ,500
Prepaid Insurance
Office Equipment ,000
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Rent Expense
28, ,700
1,500
1,000 50
550
400
800
10,400
10,600
1,200
5,200
Advert Supply Expense
1,500
1,500 50
Insurance Expense 50
Depreciation Expense
480
480
Accumulated Deprec.
480
480
Interest Expense 50 50
Interest Payable 50
1,200
Salaries Payable
1,200 9

20. Rs.600/12 months = Rs.50/month x 3 months (Oct, Nov, Dec)
Sierra Corporation
Trial Balance
October 31, 2008
PowerPoint Slides
Modification: Prepare insurance entry as of 12/31/08 assuming Sierra prepares statements only annually? Insurance: On 10/1 paid Rs.600 for a 1 year policy.
Rs.600/12 months = Rs.50/month x 3 months (Oct, Nov, Dec)
Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash ,200
Advertising Supplies ,500
Prepaid Insurance
Office Equipment ,000
Notes Payable ,000
Accounts Payable ,500
Unearned Service Rev ,200
Common Stock ,000
Dividends
Service Revenue ,000
Salaries Expense ,000
Rent Expense
28, ,700
1,500
1,000
150
450
Advert Supply Expense
1,500
1,500
150
Insurance Expense
150 9

21. CLOSING ENTRIES
All accounts are classified as either permanent or temporary.

22. Permanent Accounts Also called Real accounts
Consist of all balance sheet accounts
Beginning balances are needed to arrive at ending balances
DO NOT get closed

23. Temporary Accounts Also called nominal accounts
Consist of all income statement accounts and a few more
Have a temporary life = 1 accounting period
Are closed (zeroed out) at the end of each accounting period

24. The CLOSING PROCESS PURPOSE: TIMING:
Set the stage for the next accounting cycle. (Revenue & Expense accounts will contain info for the next period only).
Summarize income and expenses for the period just past and record this result in the RETAINED EARNINGS account.
TIMING:
Performed just after the period end. (after adjusting entries)

25. CLOSING PROCEDURE STEP 1
Debit all revenue accounts. Credit a new account called INCOME SUMMARY.
LEDGER
INCOME SUMMARY
SERVICE REVENUE
9000

26. CLOSING PROCEDURE STEP 1
Debit all revenue accounts. Credit a new account called INCOME SUMMARY.
LEDGER
INCOME SUMMARY
9000
SERVICE REVENUE
9000
9000
JOURNAL
SERVICE REVENUE
INCOME SUMMARY

27. CLOSING PROCEDURE STEP 1
Debit all revenue accounts. Credit a new account called INCOME SUMMARY.
STEP 2
Credit all expense accounts. DEBIT goes to INCOME SUMMARY.
LEDGER
OPERATING EXPENSE
INCOME SUMMARY
9000
SERVICE REVENUE
5000
9000
9000
JOURNAL
SERVICE REVENUE
INCOME SUMMARY

28. CLOSING PROCEDURE STEP 1
Debit all revenue accounts. Credit a new account called INCOME SUMMARY.
STEP 2
Credit all expense accounts. DEBIT goes to INCOME SUMMARY.
LEDGER
OPERATING EXPENSE
INCOME SUMMARY
5000
9000
SERVICE REVENUE
5000
5000
9000
9000
JOURNAL
SERVICE REVENUE
INCOME SUMMARY
INCOME SUMMARY
OPERATING EXPENSE

29. STEP 3
Determine the balance in the INCOME SUMMARY account. Then close it out. Use RETAINED EARNINGS for the other debit or credit.
LEDGER
INCOME SUMMARY
RETAINED EARNINGS
5000
9000
Beginning balance
4000

30. STEP 3
Determine the balance in the INCOME SUMMARY account. Then close it out. Use RETAINED EARNINGS (or CAPITAL) for the other debit or credit.
LEDGER
INCOME SUMMARY
RETAINED EARNINGS
5000
9000
Beginning balance
4000
4000
4000
JOURNAL
INCOME SUMMARY
RETAINED EARNINGS

31. STEP 4
Close the DIVIDENDS PAID (or Drawing) out directly to the RETAINED EARNINGS account. Not to Income Summary!
LEDGER
DIVIDENDS PAID
RETAINED EARNINGS
1000
Beginning balance
4000 Income Summary

32. STEP 4
Close the DIVIDENDS PAID out directly to the RETAINED EARNINGS account. Not to Income Summary!
LEDGER
DIVIDENDS PAID
RETAINED EARNINGS
1000
Beginning balance
4000 Income Summary
1000
1000
Ending balance
JOURNAL
RETAINED EARNINGS
DIVIDENDS PAID

33. Required Steps in the Accounting Cycle
PowerPoint Slides
Required Steps in the Accounting Cycle
1. Analyze business transactions.
2. Journalize the transactions.
3. Post to ledger accounts.
4. Prepare a trial balance.
5. Journalize and post adjusting entries.
Prepare an adjusting trial balance.
Prepare financial statements
Journalize and post closing entries
Prepare a post closing trial balance 20

34. Example:
On the next slide is the adjusted trial balance for Konk Co.
Required: Prepare closing journal entries.

35. Accumulated Depreciation Rs.35,000 Accounts Payable 5,000
PowerPoint Slides
Cash Rs.11,000
Accounts Receivable ,500
Art Supplies ,000
Prepaid Insurance ,500
Printing Equipment ,000
Accumulated Depreciation Rs.35,000
Accounts Payable ,000
Interest Payable
Notes Payable ,000
Unearned Advertising Revenue ,600
Salaries Payable ,300
Common Stock ,000
Retained Earnings ,500
Dividends ,000
Advertising Revenue ,500
Salaries Expense ,300
Insurance Expense
Depreciation Expense ,000
Art Supplies Expense ,400
Rent Expense ,350
Rs.139, Rs.139,050 D O N’ T C L S E 9

36. To close revenue accounts 12/31 Income Summary 26050
General Journal
12/31 Advertising Revenue 61500
Income Summary
To close revenue accounts
12/31 Income Summary 26050
Salaries Expense
Insurance Expense 850
Interest Expense 150
Depreciation Expense 7000
Art Supplies Expense 2400
Rent Expense 4350
To close expense accounts
( =26050)

37. To close income summary and update retained earnings
General Journal
12/31 Income summary 35450
Retained Earnings
To close income summary and update retained earnings
(61500cr net with 26050dr = 35450cr). Close with 35450dr.
12/31 Retained Earnings 12000
Dividends
To close dividends paid against retained earnings

38. Post Closing Trial Balance
PowerPoint Slides
Konk Co. Agency
Post Closing Trial Balance
December 31, 2008
Debit Credit
Cash Rs.11,000
Accounts Receivable ,500
Art Supplies ,000
Prepaid Insurance ,500
Printing Equipment ,000
Accumulated Depreciation Rs.35,000
Accounts Payable ,000
Interest Payable
Notes Payable ,000
Unearned Advertising Revenue ,600
Salaries Payable ,300
Common Stock ,000
Retained Earnings (Begin 5, , ,000) ,950
Rs.101, Rs.101,000 9