Financial Accounting: Tools for Business Decision Making

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Financial AccountingTools for Business Decision
Making
Kimmel, Weygandt, Kieso
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Chapter 4Accrual 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.

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Chapter 4Accrual 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.

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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.

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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.
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Matching Principle...

• requires that expenses be recorded in the same
  period in which the revenues they helped produce
  are recorded.

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Page 152 in book
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Cash Basis

Revenue recorded only when cash is
received. Expense recorded only when cash is paid.
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Cash Basis in not GAAP

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Accrual Basis Accounting

• Adheres to the
• Revenue Recognition Principle
• Matching Principle

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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

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Accrual Basis adheres to...

• Generally
• Accepted
• Accounting
• Principles

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Page 153 in book
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Adjusting Entries

• Adjusting entries make the
• revenue recognition
• matching principles
  

HAPPEN!
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Types of Adjusting Entries
Page 155 in book

• 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.

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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

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You can start with the trial balance to find
information to adjust prepayments.
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Sierra Corporation Trial Balance October 31, 1998
Page 155 in book

Debit Credit
Cash
15,200 Advertising
Supplies
2,500 Prepaid Insurance

600 Office Equipment
5,000 Notes Payable

5,000 Accounts
Payable
2,500 Unearned
Service Revenue
1,200 Common Stock

10,000 Dividends

500 Service Revenue

10,000 Salaries Expense
4,000 Rent
Expense
900

28,700 28,700

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Prepaid Expenses
On October 4 the company paid 600 for a 1-year
insurance policy. Coverage began October 1.
GENERAL JOURNAL
Debit Credit Oct 4
Prepaid Insurance
600
Cash
600
Purchased one-year policy effective October 1
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Page 158 in book
Oct 50
Nov 50
Dec 50
Jan 50
Mar 50
Apr 50
May 50
Feb 50
June 50
July 50
Aug 50
Sept 50
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Prepaid Expenses
On October 31st, 50 (600/12months) of the
insurance was used-up or expired.
Prepaid Insurance
Insurance Expense
Cash
600
Oct 4
600
Oct 4
GENERAL JOURNAL
Debit Credit Oct 31
Insurance Expense 50
Prepaid Insurance
50
Record Insurance expense for the
month
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Supplies
On October 5 the company paid 2,500 for
advertising supplies.
Supplies Expense
Supplies
Cash

2,500
Oct 5
2,500
Oct 5
GENERAL JOURNAL
Debit Credit Oct 5
Supplies
2,500
Cash
2,500
Purchased Advertising Supplies
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Supplies
An inventory on October 31 reveals that 1,000 of
supplies remain on handtherefore 1,500 of
supplies had been used. (2,500- 1,000) 1,500
Supplies Expense
Supplies
Cash

2,500
Oct 5
2,500
Oct 5
GENERAL JOURNAL
Debit Credit Oct 5
Supplies Expense 1,500
Supplies

1,500 To record advertising
supplies consumed
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Supplies Expense
Oct 1500
Nov 1800
Dec 1410
Jan 1425
Mar 1435
Apr 1510
May 1592
Feb 1601
June 1652
July 1621
Aug 1427
Sept 1555
Supplies expense is based on usage... so
different amounts appear each month
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Depreciation
How do you apply the Matching Principle to the
cost of a long lived asset ?
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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.
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Page 159 in book
Oct 40
Nov 40
Dec 40
Jan 40
Mar 40
Apr 40
May 40
Feb 40
June 40
July 40
Aug 40
Sept 40
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Accumulated Depreciation-Office Equipment
Depreciation Expense
Office Equipment

GENERAL JOURNAL
Debit Credit

Oct 31
Depreciation Expense
40 Accumulated
Depreciation-Office Equip
40 To record monthly
depreciation

Accumulated depreciation is a contra asset
account - an offset against the fixed asset
account.
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Balance Sheet Presentation
Office equipment 5,000 Less accumulated
depreciation 40 4,960

Book Value
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Unearned Revenues
Received on Oct. 2 1,200 for advertising
services expected to be completed by 12/31.
GENERAL JOURNAL
Debit Credit

Oct 2 Cash

1,200
Unearned Service Revenue
1,200 Collected
money for work to be
performed by 12/31.
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Unearned Revenues
During October 400 of the revenue was earned.
Service Revenue
Unearned Service Insurance
Cash
GENERAL JOURNAL
Debit Credit

Oct 31
Unearned Service Revenue
400 Service
Revenue
400 To record
revenue earned
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Accrual

• Revenue has been earned, but not collected
• Expenses were incurred, but not yet paid

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Accrued Revenues
Revenues earned but not yet received in cash or
recorded at the statement date
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Accrued Revenues
Earned 200 for advertising services to clients
in October, but they were not billed until after
October 31st.
GENERAL JOURNAL
Debit Credit

Oct 31
Accounts Receivable
200 Service Revenue
200

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

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Accrued Interest
GENERAL JOURNAL
Debit Credit

Oct 31
Interest Expense
50
Interest Payable
50
Accrue interest expense for the month
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Accrued Salaries - Salaries Paid for after the
Service Has Been Performed.
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Accrued Salaries
GENERAL JOURNAL
Debit Credit

Oct 31
Salaries Expense 1,200 Salaries
Payable
1,200 Accrue
salary expense for the month
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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.
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Page 170 in book
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Page 171 in book
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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.
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Page 171 in book
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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.

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