Accrual Accounting Concepts

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Chapter 4

• Accrual Accounting Concepts

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Time Period Assumption
Divides the economic life of a business into
artificial time periods a month, a quarter, a
year Purpose is to provide immediate feedback on
how the business is doing. An accounting period
that is one year long is called a fiscal
year. Accounting period January 1 December 31
a calendar year
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Revenue Recognition Principle

• Revenue must be recognized in the accounting
  period in which it is earned.
• Revenue is considered earned when the service has
  been provided or when the goods are delivered.

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Matching Principle

• Expenses be recorded in the same period in which
  the revenues they helped produce are recorded.

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Illustration 4-1
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Cash Basis v. Accrual Basis
Cash basis Revenues recorded only when cash is
received. Expenses recorded only when cash is
paid. Cash basis is not GAAP - Example Accrual
basis Record revenues when earned (revenue
recognition principle) Record expenses when
incurred and match them with revenues (matching
principle) Accrual basis is GAAP - Example

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Adjusting Entries

• Adjusting entries are made to adhere to the
• revenue recognition matching principles.
• Four types of adjusting entries

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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 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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Illustration 4-6
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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Illustration 4-6
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 31
Supplies Expense 1,500
Supplies

1,500 To record advertising
supplies consumed
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Illustration 4-7
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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Illustration 4-7
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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Depreciation
How do you apply the Matching Principle to the
cost of a long lived asset ? Allocate the cost of
an asset to expense over its useful
life Depreciation is an allocation concept- not a
valuation concept no attempt to reflect the
change in the value of the asset
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Illustration 4-8
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
Illustration 4-9
Office equipment 5,000 Less accumulated
depreciation 40 4,960

Book Value
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Illustration 4-10
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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Illustration 4-10
Unearned Revenues
During October 400 of the revenue was earned.
Service Revenue
Unearned Service Revenue
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.
• Accrued revenues are revenues earned but not
  yet received in cash or recorded at the
  statement date.
• Expenses were incurred, but not yet paid.
• Accrued expenses are expenses incurred but not
  yet paid or recorded at the statement date.

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Accrued Revenues
Illustration 4-12
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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• 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

Illustration 4-13
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Illustration 4-14
Accrued Interest
GENERAL JOURNAL
Debit Credit

Oct 31
Interest Expense
50
Interest Payable
50
Accrue interest expense for the month
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Illustration 4-15
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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Closing the Books
Closing entries transfer the temporary account
balances to the stockholders equity
account Reduce the balances in the temporary
accounts to zero.
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Illustration 4-22
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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