Transcript Financial Accounting: CHAPTER 4 Tools for Business Decision Making, 4th Ed.

Financial Accounting:
Tools for Business Decision Making, 4th Ed.
Kimmel, Weygandt, Kieso
CHAPTER 4
Prepared by
Dr. Joseph Otto
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Chapter 4
ACCRUAL
ACCOUNTING
CONCEPTS
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Chapter 4
Accrual Accounting Concepts




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



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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11
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 a 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.
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Review
Which principle dictates that efforts (expenses)
be recorded with accomplishments (revenues)?
a. Cost Principle.
b.Matching Principle
c. Periodicity Principle
d.Revenue Recognition Principle
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Review
Which principle dictates that efforts (expenses)
be recorded with accomplishments (revenues)?
a. Cost Principle.
b.Matching Principle
c. Periodicity Principle
d.Revenue Recognition Principle
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Review
When would revenue be recorded for the
following scenario . . .
Ad agency is hired for a project in May,
does the work in June and is paid in
July?
June
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Review
When would expenses be recorded for this
companion scenario ?
The Ad agency on this project incurs
$1,500 of expenses in May, $3,000 in June,
and none in July?
The answer is June! Matching
says the expenses should follow
the revenue.
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Review
When would revenue be recorded for the
following scenario . . .
Sell plane ticket on September 1 for a
flight on October 15?
The answer is October – when the
service is provided!
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Review
When would expenses be recorded for the
following scenario . . .
The airline pays pilot salaries on October 7th
for the week ended September 30th?
The answer is September – the pilots
provided labor services for September
flights during that month.
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Cash Basis
Revenue recorded only when cash is received.
Expense recorded only when cash is paid.
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Accrual Basis Accounting
Adheres to the:
• Revenue Recognition Principle
Revenue recorded only when
earned, not when cash is
received
• Matching Principle
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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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
•PREPAID EXPENSES - Costs that
expire either with the passage of time
or through use.
•UNEARNED REVENUES- money has
been received before the goods or
services are provided.
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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, 2007
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
Prepaid Expenses
Amount equals cost of goods or services
used up or expired
If not adjusted, expenses would be
understated and assets overstated
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Supplies
On October 5 the company paid $2,500
for advertising supplies.
Advertising
Cash
Oct 5 2,500
Advertising
Supplies
Oct 5
Supplies
Expense
2,500
GENERAL JOURNAL
Oct 5 Supplies
Cash
Purchased advertising supplies
Debit Credit
2,500
2,500
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
Advertising
Advertising
Supplies
Cash
Expense
Supplies
Oct 5 2,500 Oct 5 2,500 Oct 31 1,500
Oct 31 1,500
Bal. 1,000
GENERAL JOURNAL
Oct 5 Supplies Expense
Supplies
To record advertising supplies consumed
Debit Credit
1,500
1,500
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
Purchased one-year policy effective October 1
600
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
Insurance
Expense
Oct 31
50
550
GENERAL JOURNAL
Oct 31
Insurance Expense
Prepaid Insurance
Record insurance expense for the month
Debit Credit
50
50
Depreciation
How do you apply the Matching
Principle to the cost of a long lived
asset ?
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Depreciation
Allocates the cost of an asset to expense
over its useful life – MATCHING
PRINCIPLE
Is an estimate
Depreciation is ALLOCATION of costnot VALUATION(Current Replacement
Cost)
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
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Accumulated Depreciation-Office Equip
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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
40
$4,960
Book Value or
Carrying Value
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5
Unearned Revenues
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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
Unearned Revenues
During October $400 of the revenue was earned.
Unearned Service
Revenue
Cash
Oct 2 1,200
Oct. 31 400 Oct 2
1,200
Bal
800
GENERAL JOURNAL
Oct 31 Unearned Service Revenue
Service Revenue
To record revenue earned
Service
Revenue
Oct. 31 400
Debit
Credit
400
400
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Accruals
•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
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
Accrued Interest
Interest Expense
Oct 31 50
Interest Payable
Oct 31
GENERAL JOURNAL
Oct 31 Interest Expense
Interest Payable
Accrue interest expense for the month
Debit
50
Credit
50
50
Accrued Salaries - Salaries Paid for
after the Service Has Been Performed.
Accrued Salaries
Salaries Expense
Oct 31 1,200
Salaries Payable
Oct 31 1,200
GENERAL JOURNAL
Oct 31 Salaries Expense
Salaries Payable
Accrue salary expense for the month
Debit
Credit
1,200
1,200
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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 (except Cash Flow
Statement) can be easily prepared from
the adjusted trial balance.
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11
Closing the Books
Closing entries transfer the temporary
account balances to the stockholders’
equity account...
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
Close Temporary Accounts
Only
Zero balance
after closing
entries!
Do not close!
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The Closing Process
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The Accounting Cycle
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Required
Steps in
the
Accounting
Cycle
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Review
Which is not a temporary account?
a.Salaries expense
b.Service revenue
c.Accounts Receivable
d.Dividends
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Review
Which is not a temporary account?
a.Salaries expense
b.Service revenue
c.Accounts Receivable
d.Dividends
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Review
Which account will have a zero
balance after closing entries?
a.Service Revenue
b.Advertising Supplies
c.Prepaid Insurance
d.Accumulated Depreciation
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Review
Which account will have a zero
balance after closing entries?
a.Service Revenue
b.Advertising Supplies
c.Prepaid Insurance
d.Accumulated Depreciation
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Review
Which types of accounts will appear
in the post-closing trial balance?
a.Temporary accounts
b.Accounts shown in the income statement
c.Permanent accounts
d.All of the above
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Review
Which types of accounts will appear
in the post-closing trial balance?
a.Temporary accounts
b.Accounts shown in the income statement
c.Permanent accounts
d.All of the above
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Assign #5: E4-1, E4-5, E4-9
Assign #6: E4-12, P4-3A