Financial Accounting Second Canadian Edition by xeniawinifredzoe



Accrual Accounting
       Time Period Assumption

• Divides the economic life of a business into
  artificial time periods
  – Interim period (month, quarter)
  – Year (fiscal, calendar)
• WHY?
  – To provide immediate feedback on how the
    business is doing
  Revenue Recognition Principle

• Dictates that revenue 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
          Matching Principle

• Requires that expenses be recorded in the
  same period in which the revenues they
  helped produce are recorded
               Cash Basis

• Revenue is recorded only when cash is
• Expense is recorded only when cash is paid
     Accrual Basis Accounting

• Adheres to the time period assumption and
  revenue recognition and matching principles
• Revenue is recorded when earned,
  rather than when cash is received
• Expense recorded when incurred,
  rather than when cash is paid
• Accrual accounting records events when the
  economic event occurs
           Adjusting Entries

• Adjusting entries are made to adjust or
  update accounts at the end of the accounting
• Adjusting entries can be categorized as
  – Prepayments
  – Accruals
    Types of Adjusting Entries

– Prepayments
  • Prepaid expenses
  • Unearned revenues
– Accruals
  • Accrued revenues
  • Accrued expenses

• Cash has been spent but the item acquired has
  not been used or consumed (prepaid expenses)
• Cash has been collected but the revenue has
  not been earned (unearned revenues)

   On January 5 the company paid $2,500 for
   advertising supplies.
                            Advertising      Advertising Supplies
    Cash                     Supplies             Expense
         Jan. 5 2,500 Jan. 5 2,500

GENERAL JOURNAL                            Debit   Credit
Jan. 5   Advertising Supplies              2,500
           Cash                                    2,500
          Purchased advertising supplies

An inventory on January 31 reveals that $1,000 of supplies
remain on hand; therefore, $1,500 of supplies had been used.
($2,500 - $1,000) =$ 1,500
                             Advertising              Advertising
     Cash                     Supplies             Supplies Expense
         Jan. 5 2,500 Jan. 5 2,500 Jan. 31 1,500 Jan. 31 1,500
                       Bal. 1,000

GENERAL JOURNAL                                 Debit   Credit
Jan. 5    Advertising Supplies Expense       1,500
            Advertising Supplies                        1,500
         To record advertising supplies consumed
                Prepaid Expenses

On February 4 the company paid $600 for a 1-year insurance
policy; coverage began February 1.
                             Prepaid                  Insurance
    Cash                    Insurance                  Expense
          Feb. 4 600    Feb. 4 600

GENERAL JOURNAL                               Debit   Credit
Feb. 4    Prepaid Insurance                     600
            Cash                                        600
         Purchased one-year policy effective February 1
                Prepaid Expenses

On February 28, $50 ($600/12 months) of the insurance
had been used or had expired.
                            Prepaid                   Insurance
    Cash                   Insurance                   Expense
          Feb. 4 600   Feb. 4 600 Feb. 28 50     Feb. 28 50

GENERAL JOURNAL                          Debit    Credit
Feb. 28    Insurance Expense                50
              Prepaid Insurance                   50
           Record insurance expense for the month

• How do you apply
  the matching
  principle to the cost
  of a long-lived

• Allocate the cost of an asset to expense over
  its useful life
• Amortization is an allocation concept, not a
  valuation concept

 Note: This is not an attempt to reflect the actual
 change in value of an asset.
        Amortization Example

• Assume a piece of equipment was purchased
  on March 2 for $5,000. Its salvage value is
  $200 and its useful life is 10 years
• Straight-line amortization calculation is:
     Cost - Salvage value = $5,000 - $200 = $480/yr
       Useful Life              10            OR
                 Amortization Example
                          Amortization-Office            Amortization
  Office Equipment           Equipment                    Expense
Mar. 2 5,000                          Mar. 31 40      Mar. 31 40

   GENERAL JOURNAL                                      Debit    Credit
   Mar. 31 Amortization Expense                           40
              Accumulated Amortization –                             40
                Office Equipment
           To record monthly amortization
    Accumulated Amortization is a contra asset account – an offset
    (deduction) against the asset account.
  Balance Sheet Presentation

Office equipment                 $5,000

Less: Accumulated amortization      40

Net book value                    4,960

             Net book value
                    Unearned Revenues

     Received on August 2 $1,200 for advertising services
     expected to be completed by December 31.
                           Unearned Service               Service
        Cash                  Revenue                     Revenue
Aug. 2 1,200                          Aug. 2 1,200

   GENERAL JOURNAL                                Debit    Credit
   Aug. 2      Cash                                1,200
                  Unearned Service Revenue                 1,200
               Collected money for work to be performed by
               December 31
                   Unearned Revenues

        During August, $400 of the revenue was earned.

                         Unearned Service                Service
        Cash                Revenue                      Revenue
Aug. 2 1,200            Aug. 31 400 Aug. 2 1,200                Aug. 31 400
                                     Bal. 800

   GENERAL JOURNAL                              Debit    Credit
   Aug. 31     Unearned Service Revenue            400
                 Service Revenue                          400
               To record revenue earned

• Revenue has been earned, but not
  collected (accrued revenues)
• Expenses were incurred, but not yet paid
  (accrued expenses)

 Note: Entry has not yet been recorded!
          Accrued Revenues

• Revenues earned but not yet received in
  cash or recorded at the end of period
                  Accrued Revenues

 Earned $200 for advertising services to clients in
 October, but they were not billed until after October 31.

                 Accounts            Service
                Receivable           Revenue
           Oct. 31 200                     Oct. 31 200

GENERAL JOURNAL                          Debit   Credit
Oct . 31     Accounts Receivable          200
               Service Revenue                     200
          Accrued Expenses

• Expenses incurred but not yet paid or
  recorded at the end of period
      Accrued Interest Expense

Interest expense is the cost a company
incurs to use money. Information needed to
calculate interest expense:
• Face value of note
• Interest rate (always expressed in annual rate)
• The length of time note is outstanding
             Accrued Interest Expense

        Formula for Calculating Interest

Face Value       Annual            Time
 of Note         Interest       in Terms of       Interest
                  Rate           One Year

$ 5,000 X         12%       X     1/2         =    $50
        Accrued Interest Expense

         Interest Expense            Interest Payable
     Oct. 31 50                               Oct. 31 200

GENERAL JOURNAL                           Debit    Credit
Oct. 31 Interest Expense                      50
           Interest Payable                           50
        Accrue interest expense for the month
     Accrued Salaries Expense

• Assume that the employees receive total
  salaries of $2,000 for a five-day (Monday to
  Friday) work week, or $400 a day.
• Salaries were last paid on October 26 and the
  next payment of salaries will be November 9.
  As shown on the calendar on the following
  slide there are three unpaid work days remain
  as of October 31.
Accrued Salaries Expense
(Salaries paid after the service has been performed)
        Accrued Salaries Expense

         Salaries Expense            Salaries Payable
   Oct. 31 1,200                              Oct. 31 1,200

GENERAL JOURNAL                            Debit   Credit
Oct. 31 Salaries Expense                   1,200
          Salaries Payable                          1,200
        Accrue salary expense for the month
        Adjusted Trial Balance

• Adjusted trial balance proves 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
           Closing the Books

• Closing entries
  – Transfer the temporary account balances to
    update the retained earnings account
  – Reduce the balances in the temporary
    accounts to zero to prepare for the next
    period’s postings
                                Illustration 4-17

  Temporary                 Permanent

All revenue accounts    All asset accounts

All expense accounts   All liability accounts

                       Shareholders’ equity
 Dividends account
Individual Expenses                                 Individual Revenues

                      2   Income Summary      1

                                3                 Retained Earnings
                                                  is a permanent
                          Retained Earnings       account; the others
                                                  shown here
                                                  are temporary

Required Steps in the Accounting Cycle

 •   Analyse business transactions
 •   Journalize the transactions
 •   Post to general ledger accounts
 •   Prepare a trial balance
 •   Journalize and post adjusting entries
     (prepayments and accruals)
Required Steps in the Accounting Cycle

 •   Prepare an adjusted trial balance
 •   Prepare financial statements
 •   Journalize and post closing entries
 •   Prepare a post-closing trial balance

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