Download Revenues earned but not yet received in cash or recorded. Accrued

Chapter 4
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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.
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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.
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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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Time Period
Assumption...
Generally a month, a quarter, or
a year.
An accounting time period that is one
year long is called fiscal year.
An accounting time period that starts on
January 1 and ends December 31 is
called a calendar year.
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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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Matching Principle...
requires that expenses be recorded
in the same period in which the
revenues they helped produce are
recorded. (or in the period to
which they relate)
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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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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
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Adjusting Entries
Adjusting entries make the:
 revenue recognition &
 matching principles
HAPPEN!
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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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You can start with the trial
balance to find information to
adjust prepayments.
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Sierra Corporation
Trial Balance
October 31, 2004
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
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Illustration 4-6
Supplies
On October 5 the company paid $2,500
for advertising supplies.
Cash
Oct 5 2,500
Supplies
Oct 5
Supplies
Expense
2,500
GENERAL JOURNAL
Oct 5 Supplies
Cash
Debit Credit
2,500
2,500
Purchased advertising supplies
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Supplies
Illustration 4-6
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
Cash
Supplies
Oct 5 2,500 Oct 5 2,500 Oct 31 1,500
GENERAL JOURNAL
Oct 5 Supplies Expense
Supplies
Supplies
Expense
Oct 31 1,500
Debit Credit
1,500
1,500
To record advertising supplies consumed
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Supplies Expense
Oct
$1,500
Nov
$1,800
Dec
$1,410
Jan
$1,425
Feb
$1,601
Mar
$1,435
Apr
$1,510
May
$1,592
June
$1,652
July
$1,621
Aug
$1,427
Sept
$1,555
Supplies expense is based on usage... so
different amounts appear each month
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Prepaid Expenses
On October 1 the company paid $600 for a 1-year
insurance policy. Coverage began October 1.
Cash
Oct 1
Insurance
Expense
Prepaid
Insurance
600 Oct 1
600
GENERAL JOURNAL
Debit Credit
Oct 1 Prepaid Insurance
Cash
600
600
Purchased one-year policy effective October 1
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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
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Prepaid Expenses
On October 31st, $50 ($600/12 months)
of the insurance was used-up or expired.
Prepaid
Insurance
Cash
Oct 1
600 Oct 1
600 Oct 31 50
GENERAL JOURNAL
Oct 31
Insurance Expense
Prepaid Insurance
Insurance
Expense
Oct 31
50
Debit Credit
50
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 ?
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Depreciation
Allocate the cost of an asset to expense
over its useful life
Depreciation is an ALLOCATION
CONCEPT- not a VALUATION
CONCEPT.
We’re not attempting to reflect the
actual change in value of an asset!
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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
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Office Equipment
Accumulated
DepreciationOffice Equipment
Oct 2 5,000
Oct 31
40
GENERAL JOURNAL
Oct 31 Depreciation Expense
Depreciation
Expense
Oct 31
40
Debit
Credit
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
Less : accumulated depreciation
$ 5,000
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$4,960
Book Value or
Carrying Value
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Unearned Revenues
Received on Oct. 2 $1,200 for advertising
services expected to be completed by Dec 31.
Unearned Service
Service
Revenue
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 Dec 31.
Credit
1,200
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Unearned Revenues
During October $400 of the revenue was earned.
Unearned Service
Revenue
Cash
Oct 2 1,200
Oct. 31 400 Oct 2
GENERAL JOURNAL
Oct 31 Unearned Service Revenue
Service Revenue
Service
Revenue
Oct. 31 400
1,200
Debit
Credit
400
400
To record revenue earned
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Accrual
•Revenue has been earned, but
not collected.
•Expenses have been 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.
Accounts
Receivable
Oct 31
200
GENERAL JOURNAL
Oct 31 Accounts Receivable
Service Revenue
Service
Revenue
Oct 31
Debit
200
Credit
200
200
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Accrued Expenses
Expenses incurred but not
yet paid or recorded at the
statement date.
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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
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
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Accrued Interest
Interest Expense
Oct 31 50
Interest Payable
Oct 31
GENERAL JOURNAL
Oct 31 Interest Expense
Interest Payable
Debit
50
Credit
50
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
Salaries Expense
Oct 31 1,200
Salaries Payable
Oct 31 1,200
GENERAL JOURNAL
Oct 31 Salaries Expense
Salaries Payable
Debit
Credit
1,200
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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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
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SIERRA CORPORATION
Adjusted Trial Balance
For the Month Ended October 31, 2004
SIERRA CORPORATION
Balance Sheet
October 31, 2004
Balance as Oct. 31 from
Retained Earnings Statement
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Closing the Books
Closing entries transfer the
temporary account balances to
the retained earnings account
in stockholders’ equity ...
and reduce the balances in the
temporary accounts to zero.
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Temporary
Permanent
All revenues accounts
All asset accounts
All expense accounts
All liability accounts
Dividends
Stockholders’ equity
accounts
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Individual Revenues
Individual Expenses
2
Income Summary
3
Retained Earnings
1
Retained Earnings
is a permanent
account; the others
shown here
are temporary
4
Dividends
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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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