Directory UMM :wiley:Public:college:accounting:kimmel:
Financial Accounting:
Tools for Business Decision Making
Kimmel, Weygandt, Kieso
S
EL
1
Chapter
4
Chapter 4
Accrual Accounting Concepts
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.
3
Chapter 4
Accrual Accounting Concepts
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.
4
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.
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
Matching Principle...
requires that expenses be recorded
in the same period in which the
revenues they helped produce are
recorded.
7
Page 152 in book
8
Cash Basis
Revenue recorded only when cash is received.
Expense recorded only when cash is paid.
9
Cash Basis in not GAAP
AP
GA
10
Accrual Basis Accounting
Adheres to the:
• Revenue Recognition Principle
• Matching Principle
11
Accrual Basis Accounting
•Revenue recorded only when earned
not when cash is received
•Expense recorded only when
incurred not when cash paid
12
Accrual Basis adheres to...
•Generally
•Accepted
•Accounting
•Principles
13
Page 153 in book
Year 1
Year 2
Activity
Purchased paint, painted building ,
paid employees
Accrual
basis
Cash
basis
Received payment for work
done in year one
Revenue
$80,000
Revenue
Expense
50,000
Expense
$
0
0
Net Income
$30,000
Net Income
$
Revenue
$
0
Revenue
$80,000
Expense
50,000
Expense
0
Net Loss
( $50,000)
Net Income
0
$80,000
Adjusting Entries
Adjusting entries make the:
revenue recognition &
matching principles
HAPPEN!
15
Page 155 in book
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
16
yet paid in cash or recorded.
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
17
You can start with the trial
balance to find information to
adjust prepayments.
Sierra Corporation
Page 155 in book
Trial Balance
October 31, 1998
Cash
Advertising Supplies
Prepaid Insurance
Office Equipment
Notes Payable
Accounts Payable
Unearned Service Revenue
Common Stock
Dividends
Service Revenue
Salaries Expense
Rent Expense
Debit Credit
$15,200
2,500
600
5,000
$ 5,000
2,500
1,200
10,000
500
10,000
4,000
900
$28,700 $28,700
Prepaid Expenses
On October 4 the company paid $600 for a
1-year insurance policy. Coverage began
October 1.
Insurance
Prepaid
Cash
Expense
Insurance
Oct 4
600 Oct 4
600
GENERAL JOURNAL
Debit
Oct 4
600
Prepaid Insurance
Cash
Purchased one-year policy effective October 1
Credit
600
Page 158 in book
Insurance Policy
Oct
$50
Nov
$50
Dec
$50
Jan
$50
Feb
$50
Mar
$50
Apr
$50
May
$50
June
$50
July
$50
Aug
$50
Sept
$50
1 Year $ 600
Prepaid Expenses
On October 31st, $50
($600/12months) of the insurance was
used-up or expired.
Insurance
Prepaid
Cash
Expense
Insurance
Oct 4
600 Oct 4
600 Oct 31 50
GENERAL JOURNAL
Oct 31
Insurance Expense
Prepaid Insurance
50
Record Insurance expense for the month
Oct 31
Debit
50
50
Credit
Supplies
On October 5 the company paid
$2,500 for advertising supplies.
Supplies
Cash
Oct 5 2,500
Oct 5
2,500
GENERAL JOURNAL
Oct 5
Supplies
Expense
Supplies
Cash
Purchased Advertising Supplies
Debit
Credit
2,500
2,500
Supplies
An inventory on October 31 reveals that $1,000
of supplies remain on hand;therefore $1,500 of
supplies had been used. ($2,500- $1,000) =$
1,500
Cash
Supplies
Oct 5 2,500 Oct 5 2,500 Oct 31 1,500
GENERAL JOURNAL
Oct 5
Supplies Expense
Supplies
1,500
To record advertising supplies consumed
Supplies
Expense
Oct 31 1,500
Debit
1,500
Credit
Supplies Expense
Oct
$1500
Nov
$1800
Dec
$1410
Jan
$1425
Feb
$1601
Mar
$1435
Apr
$1510
May
$1592
June
$1652
July
$1621
Aug
$1427
Sept
$1555
Supplies expense is based on usage... so
different amounts appear each month
Depreciation
How do you apply the Matching
Principle to the cost of a long lived
asset ?
26
Depreciation
Allocate the cost of an asset to expense
over its useful life
Depreciation is an Estimated Value not an actual change in the Value of
the asset.
27
Page 159 in book
Office Equipment
Oct
$40
Nov
$40
Dec
$40
Jan
$40
Feb
$40
Mar
$40
Apr
$40
May
$40
June
$40
July
$40
Aug
$40
Sept
$40
Depreciation= $480/year
Office Equipment
Accumulated
DepreciationOffice Equipment
Oct 2 5000
Oct 31
40
GENERAL JOURNAL
Oct 31 Depreciation Expense
Accumulated Depreciation-Office Equip
Depreciation
Expense
Oct 31
40
Debit
Credit
40
40
To record monthly depreciation
Accumulated depreciation is a
contra asset account - an offset
against the fixed asset account.
Balance Sheet Presentation
Office equipment
Less : accumulated depreciation
$ 5,000
40
$4,960
Book Value
30
Unearned Revenues
Received on Oct. 2 $1,200 for advertising
services expected to be completed by
12/31.
Unearned Service
Service
Insurance
Revenue
Cash
Oct 2 1,200
Oct 2
1,200
GENERAL JOURNAL
Debit
Oct 2
1,200
Cash
Unearned Service Revenue
Collected money for work to be
performed by 12/31.
Credit
1,200
Unearned Revenues
During October $400 of the revenue was
earned.
Unearned Service
Insurance
Cash
Oct 2 1,200
Oct. 31 400 Oct 2
GENERAL JOURNAL
Oct 31 Unearned Service Revenue
Service Revenue
To record revenue earned
Service
Revenue
Oct. 31 400
1,200
Debit
Credit
400
400
Accrual
•Revenue has been earned, but not collected
•Expenses were incurred, but not yet paid
33
Accrued Revenues
Revenues earned but not yet received in
cash or recorded at the statement date
34
Accrued Revenues
Earned $200 for advertising services to
clients in October, but they were not
billed until after October 31st.
Accounts
Receivable
Oct 31
200
GENERAL JOURNAL
Oct 31 Accounts Receivable
Service Revenue
Service
Revenue
Oct 31
Debit
200
Credit
200
200
Accrued Expenses
Expenses incurred but not yet paid
or recorded at the statement date.
36
Page 164 in book
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
of Note
$ 5,000 X
Annual
Interest
Rate
12%
Time
in term of
One Year
1/12
Interest
=
$50
Accrued Interest
Interest Expense
Oct 31 50
Interest Payable
Oct 31
GENERAL JOURNAL
Oct 31 Interest Expense
Interest Payable
Accrue interest expense for the month
Debit
50
Credit
50
50
Accrued Salaries - Salaries Paid for
after the Service Has Been Performed.
Accrued Salaries
Salaries Expense
Oct 31 1,200
Salaries Payable
Oct 31 1,200
GENERAL JOURNAL
Debit
Oct 31 Salaries Expense
1,200
Salaries Payable
Accrue salary expense for the month
Credit
1,200
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.
41
Page 170 in book
Page 171 in book
Balance as Oct. 31 from
Retained Earnings Statement
43
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.
44
Page 171 in book
Temporary
Permanent
All revenues accounts
All asset accounts
All expense accounts
All liability accounts
Dividends
Stockholders’ equity
accounts
Individual Revenues
Individual Expenses
2
Income Summary
3
Retained Earnings
4
Dividends
1
Retained Earnings
is a permanent
account; the others
shown here
are temporary
The Accounting Cycle
47
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.
48
COP Y R I GHT
Copyright © 1999, John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility
for errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.
Tools for Business Decision Making
Kimmel, Weygandt, Kieso
S
EL
1
Chapter
4
Chapter 4
Accrual Accounting Concepts
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.
3
Chapter 4
Accrual Accounting Concepts
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.
4
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.
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
Matching Principle...
requires that expenses be recorded
in the same period in which the
revenues they helped produce are
recorded.
7
Page 152 in book
8
Cash Basis
Revenue recorded only when cash is received.
Expense recorded only when cash is paid.
9
Cash Basis in not GAAP
AP
GA
10
Accrual Basis Accounting
Adheres to the:
• Revenue Recognition Principle
• Matching Principle
11
Accrual Basis Accounting
•Revenue recorded only when earned
not when cash is received
•Expense recorded only when
incurred not when cash paid
12
Accrual Basis adheres to...
•Generally
•Accepted
•Accounting
•Principles
13
Page 153 in book
Year 1
Year 2
Activity
Purchased paint, painted building ,
paid employees
Accrual
basis
Cash
basis
Received payment for work
done in year one
Revenue
$80,000
Revenue
Expense
50,000
Expense
$
0
0
Net Income
$30,000
Net Income
$
Revenue
$
0
Revenue
$80,000
Expense
50,000
Expense
0
Net Loss
( $50,000)
Net Income
0
$80,000
Adjusting Entries
Adjusting entries make the:
revenue recognition &
matching principles
HAPPEN!
15
Page 155 in book
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
16
yet paid in cash or recorded.
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
17
You can start with the trial
balance to find information to
adjust prepayments.
Sierra Corporation
Page 155 in book
Trial Balance
October 31, 1998
Cash
Advertising Supplies
Prepaid Insurance
Office Equipment
Notes Payable
Accounts Payable
Unearned Service Revenue
Common Stock
Dividends
Service Revenue
Salaries Expense
Rent Expense
Debit Credit
$15,200
2,500
600
5,000
$ 5,000
2,500
1,200
10,000
500
10,000
4,000
900
$28,700 $28,700
Prepaid Expenses
On October 4 the company paid $600 for a
1-year insurance policy. Coverage began
October 1.
Insurance
Prepaid
Cash
Expense
Insurance
Oct 4
600 Oct 4
600
GENERAL JOURNAL
Debit
Oct 4
600
Prepaid Insurance
Cash
Purchased one-year policy effective October 1
Credit
600
Page 158 in book
Insurance Policy
Oct
$50
Nov
$50
Dec
$50
Jan
$50
Feb
$50
Mar
$50
Apr
$50
May
$50
June
$50
July
$50
Aug
$50
Sept
$50
1 Year $ 600
Prepaid Expenses
On October 31st, $50
($600/12months) of the insurance was
used-up or expired.
Insurance
Prepaid
Cash
Expense
Insurance
Oct 4
600 Oct 4
600 Oct 31 50
GENERAL JOURNAL
Oct 31
Insurance Expense
Prepaid Insurance
50
Record Insurance expense for the month
Oct 31
Debit
50
50
Credit
Supplies
On October 5 the company paid
$2,500 for advertising supplies.
Supplies
Cash
Oct 5 2,500
Oct 5
2,500
GENERAL JOURNAL
Oct 5
Supplies
Expense
Supplies
Cash
Purchased Advertising Supplies
Debit
Credit
2,500
2,500
Supplies
An inventory on October 31 reveals that $1,000
of supplies remain on hand;therefore $1,500 of
supplies had been used. ($2,500- $1,000) =$
1,500
Cash
Supplies
Oct 5 2,500 Oct 5 2,500 Oct 31 1,500
GENERAL JOURNAL
Oct 5
Supplies Expense
Supplies
1,500
To record advertising supplies consumed
Supplies
Expense
Oct 31 1,500
Debit
1,500
Credit
Supplies Expense
Oct
$1500
Nov
$1800
Dec
$1410
Jan
$1425
Feb
$1601
Mar
$1435
Apr
$1510
May
$1592
June
$1652
July
$1621
Aug
$1427
Sept
$1555
Supplies expense is based on usage... so
different amounts appear each month
Depreciation
How do you apply the Matching
Principle to the cost of a long lived
asset ?
26
Depreciation
Allocate the cost of an asset to expense
over its useful life
Depreciation is an Estimated Value not an actual change in the Value of
the asset.
27
Page 159 in book
Office Equipment
Oct
$40
Nov
$40
Dec
$40
Jan
$40
Feb
$40
Mar
$40
Apr
$40
May
$40
June
$40
July
$40
Aug
$40
Sept
$40
Depreciation= $480/year
Office Equipment
Accumulated
DepreciationOffice Equipment
Oct 2 5000
Oct 31
40
GENERAL JOURNAL
Oct 31 Depreciation Expense
Accumulated Depreciation-Office Equip
Depreciation
Expense
Oct 31
40
Debit
Credit
40
40
To record monthly depreciation
Accumulated depreciation is a
contra asset account - an offset
against the fixed asset account.
Balance Sheet Presentation
Office equipment
Less : accumulated depreciation
$ 5,000
40
$4,960
Book Value
30
Unearned Revenues
Received on Oct. 2 $1,200 for advertising
services expected to be completed by
12/31.
Unearned Service
Service
Insurance
Revenue
Cash
Oct 2 1,200
Oct 2
1,200
GENERAL JOURNAL
Debit
Oct 2
1,200
Cash
Unearned Service Revenue
Collected money for work to be
performed by 12/31.
Credit
1,200
Unearned Revenues
During October $400 of the revenue was
earned.
Unearned Service
Insurance
Cash
Oct 2 1,200
Oct. 31 400 Oct 2
GENERAL JOURNAL
Oct 31 Unearned Service Revenue
Service Revenue
To record revenue earned
Service
Revenue
Oct. 31 400
1,200
Debit
Credit
400
400
Accrual
•Revenue has been earned, but not collected
•Expenses were incurred, but not yet paid
33
Accrued Revenues
Revenues earned but not yet received in
cash or recorded at the statement date
34
Accrued Revenues
Earned $200 for advertising services to
clients in October, but they were not
billed until after October 31st.
Accounts
Receivable
Oct 31
200
GENERAL JOURNAL
Oct 31 Accounts Receivable
Service Revenue
Service
Revenue
Oct 31
Debit
200
Credit
200
200
Accrued Expenses
Expenses incurred but not yet paid
or recorded at the statement date.
36
Page 164 in book
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
of Note
$ 5,000 X
Annual
Interest
Rate
12%
Time
in term of
One Year
1/12
Interest
=
$50
Accrued Interest
Interest Expense
Oct 31 50
Interest Payable
Oct 31
GENERAL JOURNAL
Oct 31 Interest Expense
Interest Payable
Accrue interest expense for the month
Debit
50
Credit
50
50
Accrued Salaries - Salaries Paid for
after the Service Has Been Performed.
Accrued Salaries
Salaries Expense
Oct 31 1,200
Salaries Payable
Oct 31 1,200
GENERAL JOURNAL
Debit
Oct 31 Salaries Expense
1,200
Salaries Payable
Accrue salary expense for the month
Credit
1,200
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.
41
Page 170 in book
Page 171 in book
Balance as Oct. 31 from
Retained Earnings Statement
43
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.
44
Page 171 in book
Temporary
Permanent
All revenues accounts
All asset accounts
All expense accounts
All liability accounts
Dividends
Stockholders’ equity
accounts
Individual Revenues
Individual Expenses
2
Income Summary
3
Retained Earnings
4
Dividends
1
Retained Earnings
is a permanent
account; the others
shown here
are temporary
The Accounting Cycle
47
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.
48
COP Y R I GHT
Copyright © 1999, John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility
for errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.