Chapter

4

McGraw-Hill/Irwin

THE ACCOUNTING
CYCLE:
Accruals and Deferrals

© The McGraw-Hill Companies, Inc., 2002
At the end of the
period, we need to
make adjusting entries
to get the accounts up
to date for the financial
statements.

...
Adjusting Entries
Adjusting
entries are
needed whenever
revenue or expenses
affect more than one
accounting
period.

McGra...
Types of Adjusting Entries
 Converting
assets to
expenses

 Converting
liabilities to
revenue

 Accruing
unpaid
expense...
Converting Assets to Expenses
End of Current Period
Prior Periods

Transaction
Paid future
expenses in
advance
(creates an...
Converting Assets to Expenses

Examples Include:

Depreciation
Supplies
Expiring Insurance Policies

McGraw-Hill/Irwin

© ...
Converting Assets to Expenses
$2,400 Insurance Policy
Coverage for 12 Months

$200 Monthly Insurance Expense

Jan. 1

Dec....
Converting Assets to Expenses
Initially, costs that benefit more than one
accounting period are recorded as assets.

GENER...
Converting Assets to Expenses
The costs are expensed as they are used to
generate revenue.

GENERAL JOURNAL
Date

Account ...
Converting Assets to Expenses
Balance Sheet

Income Statement

Cost of assets
that benefit
future periods.

Cost of assets...
The Concept of Depreciation
Depreciable assets are physical objects
that retain their size and shape but lose
their econom...
The Concept of Depreciation
The portion of an asset’s utility that is used
up must be expensed in the period used.
Fixed
A...
Depreciation Is Only an Estimate
On May 2, 2003, JJ’s Lawn Care Service
purchased a lawn mower with a useful
life of 50 mo...
Depreciation Is Only an Estimate
JJ’s Lawn Care Service would make the
following adjusting entry.
GENERAL JOURNAL
Date

Ac...
Depreciation Is Only an Estimate
JJ’s $15,000 truck is depreciated over 60
months as follows:
GENERAL JOURNAL
Date

Accoun...
JJ's Lawn Care Service
Partial Balance Sheet
Accumulated depreciation would
May 31, 2001
appear on the balance sheet as
As...
Converting Liabilities to Revenue
End of Current Period
Prior Periods

Transaction
Collected
from
customers in
advance
(cr...
Converting Liabilities to Revenue

Examples Include:

Airline Ticket Sales
Sports Teams’ Sales of
Season Tickets

McGraw-H...
Converting Liabilities to Revenue
$6,000 Rental Contract
Coverage for 12 Months

$500 Monthly Rental Revenue

Jan. 1

Dec....
Converting Liabilities to Revenue
Initially, revenues that benefit more than one
accounting period are recorded as liabili...
Converting Liabilities to Revenue
Over time, the revenue is recognized as it is
earned.

GENERAL JOURNAL
Date

Account Tit...
Converting Liabilities to Revenue
Balance Sheet

Income Statement

Liability for
future periods.

Revenue earned
this peri...
Accruing Unpaid Expenses
End of Current Period
Prior Periods

Current Period

Adjusting Entry
 Recognize expense
incurred...
Accruing Unpaid Expenses
Hey, when do
we get paid?
Examples Include:

Interest
Wages and Salaries
Property Taxes

McGraw-H...
Accruing Unpaid Expenses
$3,000 Wages
Expense

Monday,
May 29

Wednesday,
May 31

Friday,
June 2

On May 31, Webb Co. owes...
Accruing Unpaid Expenses
Initially, an expense and a liability are
recorded.

GENERAL JOURNAL
Date

Account Titles and Exp...
Accruing Unpaid Expenses
Balance Sheet

Income Statement

Liability to be
paid in a future
period.

Cost incurred this
per...
Accruing Unpaid Expenses
$5,000 Weekly Wages
$3,000 Wages
Expense

Monday,
May 29

$2,000 Wages
Expense

Wednesday,
May 31...
Accruing Unpaid Expenses
The liability is extinguished when the debt is
paid.

GENERAL JOURNAL
Date

Account Titles and Ex...
Accruing Uncollected Revenue
End of Current Period
Prior Periods

Current Period

Adjusting Entry
Recognize revenue
earne...
Accruing Uncollected Revenue

Examples Include:

Interest Earned
Work Completed But Not
Yet Billed to Customer

McGraw-Hil...
Accruing Uncollected Revenue
$170 Interest
Revenue

Saturday,
Jan. 15

Monday,
Jan. 31

Tuesday,
Feb. 15

On Jan. 31, the ...
Accruing Uncollected Revenue
Initially, the revenue is recognized and a
receivable is created.

GENERAL JOURNAL
Date

Acco...
Accruing Uncollected Revenue
Balance Sheet
Receivable to
be collected in a
future period.

Interest Receivable
1/31
170

M...
Accruing Uncollected Revenue
$320 Monthly Interest
$170 Interest
Revenue

Saturday,
Jan. 15

$150 Interest
Revenue

Monday...
Accruing Uncollected Revenue
The receivable is collected in a future period.

GENERAL JOURNAL
Date

Account Titles and Exp...
Accruing Income Taxes Expense: The
Final Adjusting Entry
As a corporation earns taxable income, it
incurs income taxes exp...
Adjusting Entries and Accounting
Principles
Costs are matched with revenue
in two ways:

 Direct association of costs
wit...
The Concept of Materiality
An item is “material” if knowledge of the
item might reasonably influence the
decisions of user...
Effects of the Adjusting Entries

Journalize
transactions.

Post entries to
the ledger
accounts.

Prepare trial
balance.

...
End of Chapter 4

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2002
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Principles of Accounting/ Financial and Managerial Accounting Chapter 04

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Transcript of " Principles of Accounting/ Financial and Managerial Accounting Chapter 04"

  1. 1. Chapter 4 McGraw-Hill/Irwin THE ACCOUNTING CYCLE: Accruals and Deferrals © The McGraw-Hill Companies, Inc., 2002
  2. 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. 3. Adjusting Entries Adjusting entries are needed whenever revenue or expenses affect more than one accounting period. McGraw-Hill/Irwin Every adjusting entry involves a change in either a revenue or expense and an asset or liability. © The McGraw-Hill Companies, Inc., 2002
  4. 4. Types of Adjusting Entries  Converting assets to expenses  Converting liabilities to revenue  Accruing unpaid expenses  Accruing uncollected revenues McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  5. 5. Converting Assets to Expenses End of Current Period Prior Periods Transaction Paid future expenses in advance (creates an asset). McGraw-Hill/Irwin Current Period Future Periods Adjusting Entry  Recognize portion of asset consumed as expense, and  Reduce balance of asset account. © The McGraw-Hill Companies, Inc., 2002
  6. 6. Converting Assets to Expenses Examples Include: Depreciation Supplies Expiring Insurance Policies McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  7. 7. 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 oneyear insurance policy for $2,400. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  8. 8. Converting Assets to Expenses Initially, costs that benefit more than one accounting period are recorded as assets. GENERAL JOURNAL Date Jan. Account Titles and Explanation 1 Unexpired Insurance Cash Debit Credit 2,400 2,400 Purchase a one-year insurance policy. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  9. 9. Converting Assets to Expenses The costs are expensed as they are used to generate revenue. GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Monthly Adjusting Entry for Insurance Jan. 31 Insurance Expense Unexpired Insurance 200 200 Insurance expense for January. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  10. 10. Converting Assets to Expenses Balance Sheet Income Statement Cost of assets that benefit future periods. Cost of assets used this period to generate revenue. Unexpired Insurance 1/1 2,400 1/31 200 Bal. 2,200 McGraw-Hill/Irwin Insurance Expense 1/31 200 © The McGraw-Hill Companies, Inc., 2002
  11. 11. The Concept of Depreciation Depreciable assets are physical objects that retain their size and shape but lose their economic usefulness over time. Depreciation is the systematic allocation of the cost of a depreciable asset to expense. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  12. 12. The Concept of Depreciation The portion of an asset’s utility that is used up must be expensed in the period used. Fixed Asset (debit) On date when initial payment is made . . . Cash (credit) McGraw-Hill/Irwin The asset’s usefulness is partially consumed during the period. Accumulated Depreciation (credit) At end of period . . . Depreciation Expense (debit) © The McGraw-Hill Companies, Inc., 2002
  13. 13. 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 McGraw-Hill/Irwin 50 © The McGraw-Hill Companies, Inc., 2002
  14. 14. Depreciation Is Only an Estimate JJ’s Lawn Care Service would make the following adjusting entry. GENERAL JOURNAL Date Account Titles and Explanation Debit May 31 Depreciation Expense: Tools & Eq. Credit 50 Accumulated Depreciation: Tools & Eq. 50 To record one month's depreciation. Contra-asset McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  15. 15. Depreciation Is Only an Estimate JJ’s $15,000 truck is depreciated over 60 months as follows: GENERAL JOURNAL Date Account Titles and Explanation May 31 Depreciation Expense: Truck Accumulated Depreciation: Truck Debit Credit 250 250 To record one month's depreciation. $15,00060 months = $250 per McGraw-Hill Companies, Inc., 2002 month © The McGraw-Hill/Irwin
  16. 16. JJ's Lawn Care Service Partial Balance Sheet Accumulated depreciation would May 31, 2001 appear on the balance sheet as Assets Cash $ 3,925 follows: Accounts receivable 75 Tools & equipment $ 2,650 Less: Accum. depr. 50 2,600 Truck $ 15,000 O Less: Accum. depr. 250 14,750 T McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  17. 17. Converting Liabilities to Revenue End of Current Period Prior Periods Transaction Collected from customers in advance (creates a liability). McGraw-Hill/Irwin Current Period Future Periods Adjusting Entry  Recognize portion earned as revenue, and  Reduce balance of liability account. © The McGraw-Hill Companies, Inc., 2002
  18. 18. Converting Liabilities to Revenue Examples Include: Airline Ticket Sales Sports Teams’ Sales of Season Tickets McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  19. 19. 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 advance for a one-year rental contract. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  20. 20. Converting Liabilities to Revenue Initially, revenues that benefit more than one accounting period are recorded as liabilities. GENERAL JOURNAL Date Jan. Account Titles and Explanation 1 Cash Unearned Rental Revenue Debit Credit 6,000 6,000 Collected $6,000 in advance for rent. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  21. 21. Converting Liabilities to Revenue Over time, the revenue is recognized as it is earned. GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Monthly Adjusting Entry for Rent Revenue Jan. 31 Unearned Rental Revenue Rental Revenue 500 500 Rental revenue for January. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  22. 22. Converting Liabilities to Revenue Balance Sheet Income Statement Liability for future periods. Revenue earned this period. Unearned Rental Revenue 1/31 500 McGraw-Hill/Irwin 1/1 6,000 Bal. 5,500 Rental Revenue 1/31 500 © The McGraw-Hill Companies, Inc., 2002
  23. 23. Accruing Unpaid Expenses End of Current Period Prior Periods Current Period Adjusting Entry  Recognize expense incurred, and  Record liability for future payment. McGraw-Hill/Irwin Future Periods Transaction Liability will be paid. © The McGraw-Hill Companies, Inc., 2002
  24. 24. Accruing Unpaid Expenses Hey, when do we get paid? Examples Include: Interest Wages and Salaries Property Taxes McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  25. 25. Accruing Unpaid Expenses $3,000 Wages Expense Monday, May 29 Wednesday, May 31 Friday, June 2 On May 31, Webb Co. owes wages of $3,000. Pay day is Friday, June 2. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  26. 26. Accruing Unpaid Expenses Initially, an expense and a liability are recorded. GENERAL JOURNAL Date Account Titles and Explanation May 31 Wages Expense Wages Payable Debit Credit 3,000 3,000 To accrue wages owed to employees. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  27. 27. Accruing Unpaid Expenses Balance Sheet Income Statement Liability to be paid in a future period. Cost incurred this period to generate revenue. Wages Payable 5/31 3,000 McGraw-Hill/Irwin Wages Expense 5/31 3,000 © The McGraw-Hill Companies, Inc., 2002
  28. 28. Accruing Unpaid Expenses $5,000 Weekly Wages $3,000 Wages Expense Monday, May 29 $2,000 Wages Expense Wednesday, May 31 Friday, June 2 Let’s look at the entry for June 2. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  29. 29. Accruing Unpaid Expenses The liability is extinguished when the debt is paid. GENERAL JOURNAL Date Account Titles and Explanation June 2 Wages Expense (for June) Wages Payable (accrued in May) Cash Debit Credit 2,000 3,000 5,000 Weekly payroll for May 29-June 2. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  30. 30. Accruing Uncollected Revenue End of Current Period Prior Periods Current Period Adjusting Entry Recognize revenue earned but not yet recorded, and Record receivable. McGraw-Hill/Irwin Future Periods Transaction Receivable will be collected. © The McGraw-Hill Companies, Inc., 2002
  31. 31. Accruing Uncollected Revenue Examples Include: Interest Earned Work Completed But Not Yet Billed to Customer McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  32. 32. Accruing Uncollected Revenue $170 Interest Revenue Saturday, Jan. 15 Monday, Jan. 31 Tuesday, Feb. 15 On Jan. 31, the bank owes Webb Co. interest of $170. Interest is paid on the 15th day of each month. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  33. 33. Accruing Uncollected Revenue Initially, the revenue is recognized and a receivable is created. GENERAL JOURNAL Date Account Titles and Explanation Jan. 31 Interest Receivable Interest Revenue Debit Credit 170 170 To recognize interest revenue. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  34. 34. Accruing Uncollected Revenue Balance Sheet Receivable to be collected in a future period. Interest Receivable 1/31 170 McGraw-Hill/Irwin Income Statement Revenue earned this period. Interest Revenue 1/31 170 © The McGraw-Hill Companies, Inc., 2002
  35. 35. Accruing Uncollected Revenue $320 Monthly Interest $170 Interest Revenue Saturday, Jan. 15 $150 Interest Revenue Monday, Jan. 31 Tuesday, Feb. 15 Let’s look at the entry for February 15. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  36. 36. Accruing Uncollected Revenue The receivable is collected in a future period. GENERAL JOURNAL Date Account Titles and Explanation Debit Feb. 15 Cash Credit 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. 37. Accruing Income Taxes Expense: The Final Adjusting Entry As a corporation earns taxable income, it incurs income taxes expense, and also a liability to governmental tax authorities. GENERAL JOURNAL Date Account Titles and Explanation Dec. 31 Income Taxes Expense Income Taxes Payable Debit Credit 780 780 Estimated income taxes applicable to taxable income earned in December. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  38. 38. Adjusting Entries and Accounting Principles Costs are matched with revenue in two ways:  Direct association of costs with specific revenue transactions.  Systematic allocation of costs over the “useful life” of the expenditure. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  39. 39. The Concept of Materiality An item is “material” if knowledge of the item might reasonably influence the decisions of users of financial statements. Many companies immediately charge the cost of immaterial items to expense. Lightbulbs Supplies McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  40. 40. Effects of the Adjusting Entries Journalize transactions. Post entries to the ledger accounts. Prepare trial balance. Recall from the accounting cycle discussed in Chapter 3, that after the adjusting entries are made, an adjusted trial balance is prepared. McGraw-Hill/Irwin Make end-ofyear adjustments. Prepare adjusted trial balance. © The McGraw-Hill Companies, Inc., 2002
  41. 41. End of Chapter 4 McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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