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  • 1. Chapter THE ACCOUNTING 4 CYCLE: Accruals and DeferralsMcGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 2. At the end of the period, we need to make adjusting entries to get the accounts up to date for the financial statements.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 3. Adjusting Entries Adjusting Entries Adjusting Every entries are adjusting needed whenever entry involves a revenue or expenses change in either a affect more than one revenue or expense accounting and an asset period. or liability.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 4. Types of Adjusting Entries Types of Adjusting Entries Converting Converting Converting Converting assets to assets to liabilities to liabilities to expenses expenses revenue revenue Accruing Accruing Accruing Accruing unpaid unpaid uncollected uncollected expenses expenses revenues revenuesMcGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 5. Converting Assets to Expenses Converting Assets to Expenses End of Current Period Prior Periods Current Period Future Periods Transaction Transaction Adjusting Entry Adjusting Entry Paid future Paid future Recognize portion Recognize portion expenses in expenses in of asset consumed of asset consumed advance advance (creates an (creates an as expense, and as expense, and asset). asset). Reduce balance of Reduce balance ofMcGraw-Hill/Irwin asset account. Companies, Inc., 2002 asset account. © The McGraw-Hill
  • 6. Converting Assets to Expenses Converting Assets to Expenses Examples Include: Depreciation Supplies Expiring Insurance PoliciesMcGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 7. Converting Assets to Expenses Converting Assets to Expenses $2,400 Insurance Policy Coverage for 12 Months $200 Monthly Insurance Expense Jan. 1 Dec. 31 On January 1, Webb Co. purchased a one- On January 1, Webb Co. purchased a one- year insurance policy for $2,400. year insurance policy for $2,400.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 8. Converting Assets to Expenses Converting Assets to Expenses Initially, costs that benefit more than one Initially, costs that benefit more than one accounting period are recorded as assets. accounting period are recorded as assets. GENERAL JOURNAL P Date Account Titles and Explanation R Debit CreditJan. 1 Unexpired Insurance 2,400 Cash 2,400 Purchase a one-year insurance policy.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 9. Converting Assets to Expenses Converting Assets to Expenses The costs are expensed as they are used to The costs are expensed as they are used to generate revenue. generate revenue. GENERAL JOURNAL P Date Account Titles and Explanation R Debit Credit Monthly Adjusting Entry for InsuranceJan. 31 Insurance Expense 200 Unexpired Insurance 200 Insurance expense for January.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 10. Converting Assets to Expenses Converting Assets to Expenses Balance Sheet Balance Sheet Income Statement Income Statement Cost of assets Cost of assets Cost of assets Cost of assets that benefit that benefit used this period to used this period to future periods. future periods. generate revenue. generate revenue. Unexpired Insurance Insurance Expense 1/1 2,400 1/31 200 1/31 200 Bal. 2,200McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 11. The Concept of Depreciation The Concept of Depreciation Depreciable assets are physical objects Depreciable assets are physical objects that retain their size and shape but lose that retain their size and shape but lose their economic usefulness over time. their economic usefulness over time. Depreciation is the systematic allocation Depreciation is the systematic allocation of the cost of a depreciable asset to of the cost of a depreciable asset to expense. expense.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 12. The Concept of Depreciation The Concept of Depreciation The portion of an asset’s utility that is used The portion of an asset’s utility that is used up must be expensed in the period used. up must be expensed in the period used. Fixed Fixed The asset’s Accumulated usefulness is Accumulated Asset Asset Depreciation partially Depreciation (debit) (debit) (credit) consumed (credit) On date during the period. At end of when initial payment is period . . . made . . . Depreciation Depreciation Cash Cash Expense Expense (credit) (credit) (debit) (debit)McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 13. Depreciation Is Only an Estimate Depreciation Is Only an Estimate On May 2, 2003, JJ’s Lawn Care Service purchased a lawn mower with a useful life of 50 months for $2,500 cash. Using the straight-line method, calculate the monthly depreciation expense. Depreciation Cost of the asset expense (per = Estimated useful life period) $50 = $2,500 50McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 14. Depreciation Is Only an Estimate Depreciation Is Only an Estimate JJ’s Lawn Care Service would make the JJ’s Lawn Care Service would make the following adjusting entry. following adjusting entry. GENERAL JOURNAL P Date Account Titles and Explanation RDebit Credit May 31 Depreciation Expense: Tools & Eq. 50 Accumulated Depreciation: Tools & Eq. 50 To record one months depreciation. Contra-asset Contra-assetMcGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 15. Depreciation Is Only an Estimate Depreciation Is Only an Estimate JJ’s $15,000 truck is depreciated over 60 JJ’s $15,000 truck is depreciated over 60 months as follows: months as follows: GENERAL JOURNAL P Date Account Titles and Explanation R Debit CreditMay 31 Depreciation Expense: Truck 250 Accumulated Depreciation: Truck 250 To record one months depreciation. $15,000 ÷ 60 months = $250 perMcGraw-Hill Companies, Inc., 2002 $15,000 ÷ 60 months = $250 per month © The monthMcGraw-Hill/Irwin
  • 16. Accumulated depreciation would Accumulated depreciation would appear on the balance sheet as appear on the balance sheet as follows: follows:McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 17. Converting Liabilities to Revenue Converting Liabilities to Revenue End of Current Period Prior Periods Current Period Future Periods Transaction Transaction Adjusting Entry Adjusting Entry Collected Collected  Recognize portion  Recognize portion from from earned as revenue, earned as revenue, customers in customers in and and advance advance  Reduce balance of  Reduce balance of (creates a (creates a liability account. liability account. liability). liability).McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 18. Converting Liabilities to Revenue Converting Liabilities to Revenue Examples Include: Airline Ticket Sales Sports Teams’ Sales of Season TicketsMcGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 19. Converting Liabilities to Revenue Converting Liabilities to Revenue $6,000 Rental Contract Coverage for 12 Months $500 Monthly Rental Revenue Jan. 1 Dec. 31 On January 1, Webb Co. received $6,000 in On January 1, Webb Co. received $6,000 in advance for a one-year rental contract. advance for a one-year rental contract.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 20. Converting Liabilities to Revenue Converting Liabilities to RevenueInitially, revenues that benefit more than one Initially, revenues that benefit more than oneaccounting period are recorded as liabilities.accounting period are recorded as liabilities. GENERAL JOURNAL P Date Account Titles and Explanation R Debit CreditJan. 1 Cash 6,000 Unearned Rental Revenue 6,000 Collected $6,000 in advance for rent.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 21. Converting Liabilities to Revenue Converting Liabilities to Revenue Over time, the revenue is recognized as it is Over time, the revenue is recognized as it is earned. earned. GENERAL JOURNAL P Date Account Titles and Explanation R Debit Credit Monthly Adjusting Entry for Rent RevenueJan. 31 Unearned Rental Revenue 500 Rental Revenue 500 Rental revenue for January.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 22. Converting Liabilities to Revenue Converting Liabilities to Revenue Balance Sheet Balance Sheet Income Statement Income Statement Liability for Liability for Revenue earned Revenue earned future periods. future periods. this period. this period. Unearned Rental Revenue Rental Revenue 1/31 500 1/1 6,000 1/31 500 Bal. 5,500McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 23. Accruing Unpaid Expenses Accruing Unpaid Expenses End of Current Period Prior Periods Current Period Future Periods Adjusting Entry Adjusting Entry Transaction Transaction  Recognize expense  Recognize expense Liability will Liability will incurred, and incurred, and be paid. be paid.  Record liability for  Record liability for future payment. future payment.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 24. Accruing Unpaid Expenses Accruing Unpaid Expenses Hey, when do we get paid? Examples Include: Interest Wages and Salaries Property TaxesMcGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 25. Accruing Unpaid Expenses Accruing Unpaid Expenses $3,000 Wages Expense Monday, Wednesday, Friday, May 29 May 31 June 2 On May 31, Webb Co. owes wages of On May 31, Webb Co. owes wages of $3,000. Pay day is Friday, June 2. $3,000. Pay day is Friday, June 2.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 26. Accruing Unpaid Expenses Accruing Unpaid Expenses Initially, an expense and a liability are Initially, an expense and a liability are recorded. recorded. GENERAL JOURNAL P Date Account Titles and Explanation R Debit Credit May 31 Wages Expense 3,000 Wages Payable 3,000 To accrue wages owed to employees.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 27. Accruing Unpaid Expenses Accruing Unpaid Expenses Balance Sheet Balance Sheet Income Statement Income Statement Liability to be Liability to be Cost incurred this Cost incurred this paid in a future paid in a future period to generate period to generate period. period. revenue. revenue. Wages Payable Wages Expense 5/31 3,000 5/31 3,000McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 28. Accruing Unpaid Expenses Accruing Unpaid Expenses $5,000 Weekly Wages $3,000 Wages $2,000 Wages Expense Expense Monday, Wednesday, Friday, May 29 May 31 June 2 Let’s look at the entry for June 2. Let’s look at the entry for June 2.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 29. Accruing Unpaid Expenses Accruing Unpaid Expenses The liability is extinguished when the debt is The liability is extinguished when the debt is paid. paid. GENERAL JOURNAL P Date Account Titles and Explanation R Debit CreditJune 2 Wages Expense (for June) 2,000 Wages Payable (accrued in May) 3,000 Cash 5,000 Weekly payroll for May 29-June 2.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 30. Accruing Uncollected Revenue Accruing Uncollected Revenue End of Current Period Prior Periods Current Period Future Periods Adjusting Entry Adjusting Entry Transaction Transaction Recognize revenue Recognize revenue Receivable Receivable earned but not yet earned but not yet will be will be recorded, and recorded, and collected. collected. Record receivable. Record receivable.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 31. Accruing Uncollected Revenue Accruing Uncollected Revenue Examples Include: Interest Earned Work Completed But Not Yet Billed to CustomerMcGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 32. Accruing Uncollected Revenue Accruing Uncollected Revenue $170 Interest Revenue Saturday, Monday, Tuesday, Jan. 15 Jan. 31 Feb. 15 On Jan. 31, the bank owes Webb Co. On Jan. 31, the bank owes Webb Co. interest of $170. Interest is paid on the 15 th interest of $170. Interest is paid on the 15 th day of each month. day of each month.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 33. Accruing Uncollected Revenue Accruing Uncollected Revenue Initially, the revenue is recognized and a Initially, the revenue is recognized and a receivable is created. receivable is created. GENERAL JOURNAL P Date Account Titles and Explanation R Debit CreditJan. 31 Interest Receivable 170 Interest Revenue 170 To recognize interest revenue.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 34. Accruing Uncollected Revenue Accruing Uncollected Revenue Balance Sheet Balance Sheet Income Statement Income Statement Receivable to Receivable to be collected in a be collected in a Revenue earned Revenue earned future period. future period. this period. this period. Interest Receivable Interest Revenue 1/31 170 1/31 170McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 35. Accruing Uncollected Revenue Accruing Uncollected Revenue $320 Monthly Interest $170 Interest $150 Interest Revenue Revenue Saturday, Monday, Tuesday, Jan. 15 Jan. 31 Feb. 15 Let’s look at the entry for February 15. Let’s look at the entry for February 15.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 36. Accruing Uncollected Revenue Accruing Uncollected Revenue The receivable is collected in a future period. The receivable is collected in a future period. GENERAL JOURNAL P Date Account Titles and Explanation R Debit CreditFeb. 15 Cash 320 Interest Revenue (for February) 150 Interest Receivable (accrued Jan. 31) 170 To record interest received.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 37. Accruing Income Taxes Expense: The Accruing Income Taxes Expense: The Final Adjusting Entry Final Adjusting Entry As a corporation earns taxable income, it As a corporation earns taxable income, it incurs income taxes expense, and also a incurs income taxes expense, and also a liability to governmental tax authorities. liability to governmental tax authorities. GENERAL JOURNAL P Date Account Titles and Explanation R Debit CreditDec. 31 Income Taxes Expense 780 Income Taxes Payable 780 Estimated income taxes applicable to taxable income earned in December.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 38. Adjusting Entries and Accounting Adjusting Entries and Accounting Principles Principles Costs are matched with revenue Costs are matched with revenue in two ways: in two ways:  Direct association of costs  Direct association of costs with specific revenue with specific revenue transactions. transactions.  Systematic allocation of costs  Systematic allocation of costs over the “useful life” of the over the “useful life” of the expenditure. expenditure.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 39. The Concept of Materiality The Concept of Materiality An item is “material” if knowledge of the An item is “material” if knowledge of the item might reasonably influence the item might reasonably influence the decisions of users of financial statements. decisions of users of financial statements. Many companies immediately charge the cost of Lightbulbs immaterial items to expense. SuppliesMcGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 40. Effects of the Adjusting Entries Make end-of- Journalize year Post entries to Prepare trial transactions. adjustments. the ledger balance. accounts. Recall from the accounting cycle Recall from the accounting cycle discussed in Chapter 3, that after discussed in Chapter 3, that after the adjusting entries are made, an the adjusting entries are made, an Prepare adjusted adjusted trial balance is prepared. adjusted trial balance is prepared. trial balance.McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • 41. End of Chapter 4 End of Chapter 4McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002