Chapter 4 Accrual Accounting Concepts

1
(No Transcript)
2
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.

3
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.

4
Time Period Assumption...
Divides the economic life of a business into
artificial time periods WHY?
5
Time Period Assumption...

• Generally a month, a quarter, or a year.

An accounting time period that is one year long
is called ___________.
An accounting time period that starts on January
1 and ends December 31 is called a _____________.
6
Revenue Recognition Principle...

• dictates that revenue be recognized in the
  accounting period in which it is __________.

7
Matching Principle...

• requires that ____________ be recorded in the
  same period in which the __________ they helped
  produce are recorded.

8
Cash Basis

9
Cash Basis in not GAAP

10
Accrual Basis Accounting

• Adheres to the
• Revenue Recognition Principle
• Matching Principle

11
Accrual Basis Accounting

• _________ recorded only when earned, not when
  cash is received
• _________ recorded only when incurred, not when
  cash paid

12

13
Adjusting Entries

• Adjusting entries make the
• revenue recognition
• matching principles
  

HAPPEN!
14
Types of Adjusting Entries

• ______________
• 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.
• ______________
• Accrued revenues Revenues earned but not yet
  received in cash or recorded.
• Accrued expenses Expenses incurred but not yet
  paid in cash or recorded.

15
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

16
You can start with the trial balance to find
information to adjust prepayments.
17
Sierra Corporation Trial Balance October 31, 2004

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

18
Illustration 4-6
Supplies
On October 5 the company paid 2,500 for
advertising supplies.
Supplies Expense
Supplies
Cash

19
Illustration 4-6
Supplies
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
Supplies
Cash

20
Prepaid Expenses
On October 1 the company paid 600 for a 1-year
insurance policy. Coverage began October 1.
21
Prepaid Expenses
On October 31st, 50 (600/12 months) of the
insurance was used-up or expired.
Prepaid Insurance
Insurance Expense
Cash
22
Depreciation
How do you apply the Matching Principle to the
cost of a long lived asset ?
23
Depreciation
Allocate the cost of an asset to expense over its
useful life Depreciation is an ALLOCATION
CONCEPT- not a VALUATION CONCEPT. Were not
attempting to reflect the actual change in value
of an asset!
24
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.
25
Balance Sheet Presentation
Office equipment 5,000 Less accumulated
depreciation 40 4,960

26
Unearned Revenues
Received on Oct. 2 1,200 for advertising
services expected to be completed by Dec 31.
27
Unearned Revenues
During October 400 of the revenue was earned.
Service Revenue
Unearned Service Revenue
Cash
28
Accrual

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

29
Accrued Revenues
Revenues earned but not yet received in cash or
recorded at the statement date
30
Accrued Revenues
Earned 200 for advertising services to clients
in October, but they were not billed until after
October 31st.
31
Accrued Expenses
Expenses incurred but not yet paid or recorded at
the statement date.
32

• 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

33
Accrued Interest
34
Accrued Salaries - Salaries Paid for after the
Service Has Been Performed.
35
Accrued Salaries
36
Adjusted Trial Balance
The _________________ 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 _________________________ .
37
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
38
(No Transcript)
39
Closing the Books
_____________ entries transfer the temporary
account balances to the stockholders equity
account... and reduce the balances in the
temporary accounts to zero.
40
(No Transcript)
41
(No Transcript)
42
The Accounting Cycle
43
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.