Tools for Business Decision Making_ 2nd Ed.

1Financial Accounting:Tools for Business Decision Making, 2nd Ed.Kimmel, Weygandt, KiesoELSAccrual Accounting Concepts Chapter 43Chapter 4Accrual Accounting ConceptsAfter 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.4Chapter 4Accrual Accounting ConceptsAfter 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.5Time Period Assumption...Divides the economic life of a business into artificial time periodsWHY?to provide immediate feedback on how the business is doing.6Time Period Assumption...Generally a month, a quarter, or a year.An accounting time period that starts on January 1 and ends December 31 is called a calendar year.An accounting time period that is one year long is called fiscal year.7Revenue 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.8Matching Principle...requires that expensesbe recorded in the same period in which the revenuesthey helped produce are recorded.9Illustration 4-110Cash BasisRevenue recorded only when cash is received.Expense recorded only when cash is paid.11Cash Basis in not GAAPGAAP12Accrual Basis AccountingAdheres to the:•Revenue Recognition Principle•Matching Principle13Accrual Basis Accounting•Revenue recorded only when earned not when cash is received•Expense recorded only when incurred not when cash paid14Accrual Basis adheres to...•Generally•Accepted•Accounting•PrinciplesIllustration 4-216Adjusting EntriesAdjusting entries make the:revenue recognition &matching principlesHAPPEN!17Types 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.Illustration 4-3 18Prepayments•Cash or other asset has been spent but the item acquired has not been used or consumed•Cash has been collected before revenue is earnedYou can start with the trial balanceto find information to adjust prepayments.Sierra CorporationTrial BalanceOctober 31, 2001Debit Credit Cash $15,200Advertising Supplies 2,500Prepaid Insurance 600Office Equipment 5,000Notes Payable $ 5,000Accounts Payable 2,500Unearned Service Revenue 1,200Common Stock 10,000Dividends 500Service Revenue 10,000Salaries Expense 4,000Rent Expense 900$28,700 $28,700Illustration 4-4On October 5 the company paid $2,500 for advertising supplies.GENERAL JOURNALDebit CreditOct 5 Supplies 2,500 Cash 2,500Purchased Advertising Supplies Supplies2,500Oct 5Cash2,500Oct 5Supplies ExpenseSuppliesIllustration 4-6An inventory on October 31 reveals that $1,000 of supplies remain on hand;therefore $1,500 of supplies had been used. ($2,500-$1,000) =$ 1,500GENERAL JOURNALDebit CreditOct 31 Supplies Expense 1,500 Supplies 1,500To record advertising supplies consumedSupplies2,500Oct 5 Cash2,500Oct 5Supplies ExpenseSupplies1,500Oct 311,500Oct 31Illustration 4-6Oct $1500Mar $1435Apr $1510May $1592Feb $1601Nov $1800Dec $1410Jan $1425June $1652July $1621Aug $1427Sept $1555Supplies expense is based on usage... so different amounts appear each monthSupplies ExpensePrepaid ExpensesOn October 4 the company paid $600 for a 1-year insurance policy. Coverage began October 1.GENERAL JOURNALDebit CreditOct 4 Prepaid Insurance 600 Cash 600Purchased one-year policy effective October 1 Prepaid Insurance600Oct 4Cash600Oct 4Insurance ExpenseIllustration 4-7Insurance Policy1 Year $ 600Oct $50Mar $50Apr $50May $50Feb $50Nov $50Dec $50Jan $50June $50July $50Aug $50Sept $50Illustration 4-7Prepaid ExpensesOn October 31st, $50 ($600/12months) of the insurance was used-up or expired. GENERAL JOURNALDebit CreditOct 31 Insurance Expense 50Prepaid Insurance 50Record Insurance expense for the month Prepaid Insurance600Oct 4Cash600Oct 4Insurance Expense50Oct 3150Oct 31Illustration 4-727How do you apply the Matching Principle to the cost of a long lived asset ?DepreciationIllustration 4-828Allocate the cost of an asset to expense over its useful lifeDepreciation is an ALLOCATIONCONCEPT-not a VALUATION CONCEPT.We’re not attempting to reflect the actual change in value of an asset!DepreciationOffice EquipmentDepreciation= $480/year Oct $40Mar $40Apr $40May $40Feb $40Nov $40Dec $40Jan $40June $40July $40Aug $40Sept $40Illustration 4-8GENERAL JOURNALDebit Credit Oct 31 Depreciation Expense 40Accumulated Depreciation-Office Equip 40To record monthly depreciation Accumulated depreciation is a contra asset account -an offset against the fixed asset account.Accumulated Depreciation-Office Equipment40Oct 31Office Equipment5000Oct 2Depreciation Expense40Oct 31 Illustration 4-831Office equipment$ 5,000 Less : accumulated depreciation40$4,960Balance Sheet PresentationBook ValueIllustration 4-9Unearned RevenuesReceived on Oct. 2 $1,200 for advertising services expected to be completed by 12/31.Unearned Service RevenueCash1,200Oct 21,200Oct 2Service RevenueGENERAL JOURNALDebit Credit Oct 2 Cash 1,200 Unearned Service Revenue 1,200Collected money for work to be performed by 12/31.Illustration 4-10Unearned RevenuesDuring October $400 of the revenue was earned.Unearned Service RevenueCash1,200Oct 2Service Revenue1,200Oct 2GENERAL JOURNALDebit Credit Oct 31 Unearned Service Revenue 400Service Revenue 400To record revenue earnedOct. 31 400Oct. 31 400Illustration 4-1034Accrual•Revenue has been earned, but not collected•Expenses were incurred, but not yet paid35Accrued RevenuesRevenues earned but not yet received in cash or recorded at the statement dateAccrued RevenuesEarned $200 for advertising services to clients in October, but they were not billed until after October 31st.GENERAL JOURNALDebit Credit Oct 31 Accounts Receivable 200 Service Revenue 200Accounts Receivable200Oct 31Service Revenue200Oct 31Illustration 4-1237Accrued ExpensesExpenses incurred but not yet paid or recorded at the statement date.Formula for Computing InterestFace Value of NoteInterestTimein term of One YearAnnual Interest Rate$ 5,000 X12%1/12=$50Interest 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 outstandingIllustration 4-13Interest ExpenseInterest PayableOct 31 50Oct 31 50GENERAL JOURNALDebit Credit Oct 31 Interest Expense 50 Interest Payable 50Accrue interest expense for the monthAccrued InterestIllustration 4-14Accrued Salaries -Salaries Paid for after the Service Has Been Performed.Illustration 4-15Salaries ExpenseSalaries PayableOct 31 1,200Oct 31 1,200GENERAL JOURNALDebit Credit Oct 31 Salaries Expense 1,200Salaries Payable 1,200Accrue salary expense for the monthAccrued SalariesIllustration 4-1542The adjusted trial balanceis 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.Adjusted Trial BalanceIllustration 4-2044Illustration 4-2145Closing the BooksClosing entries transfer the temporary account balances to the stockholders’ equity account...and reduce the balances in the temporary accounts to zero. Illustration 4-22Retained Earnings is a permanent account; the others shown hereare temporaryIndividual ExpensesRetained EarningsIncome SummaryIndividual RevenuesDividends134248The Accounting Cycle49Required 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.COPYRIGHT Copyright ©2000, John Wiley & Sons, Inc. All rights reserved.Reproduction or translation of this work beyond that permitted inSection 117 of the 1976 United States Copyright Act without theexpress written permission of the copyright owner is unlawful.Request for further information should be addressed to thePermissions Department, John Wiley & Sons, Inc. The purchasermay make back-up copies for his/her own use only and not fordistribution or resale. 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