Chp6 accrual basis of acctg

INTRODUCTORY ACCOUNTING
CHAPTER 6
Accrual Basis of
Accounting

ACCT 100
Adjusting Journal
Entries
Fundamentals of
Accounting
Chapter 5

Objectives of the Chapter
I. Introduce the accrual
accounting concept.
II.Introduce the adjusting
entries.
Accrual Accounting and the
Financial Statements
3

Adjusting the Accounts
4
After studying this chapter, you should be able
to:
CHAPTER 6
Accrual Basis of Accounting
1 Explain the time period assumption.
2 Explain the accrual basis of accounting.
3 Explain why adjusting entries are needed.
4 Identify the major types of adjusting entries.
5 Prepare adjusting entries for prepayments.
6 Prepare adjusting entries for accruals.

I. Accrual Accounting
1. The time-period concept, the
revenue recognition and the
matching principles.
2. Accrual versus cash basis
accounting.
5

The Time-Period Concept
(Periodicity)
Income and financial position of
a business are reported
periodically, not until the end of
life of a business.
6

Revenue Recognition Principle
(Accrual Basis)
 Revenue is recognized when it is earned
and realized.
 Earned : the entity has substantially
accomplished what it must do to be
entitled to compensation.
 Realized: goods are exchanged for cash
or claims.
 In general, these conditions are met at
time of sale (delivery) or when services
are rendered regardless whether cash is
collected or not.
Income Measurement
And Profit Analysis
7

8
OPERATING CYCLES FOR A SERVICE
COMPANY
Accounts
Receivable
Cash
Service
Company
Receive
Cash
Perform
Service
s
Revenue Recognition Principle
(Accrual Basis)

The Matching
Principle
If revenues are recognized in a period,
all related expenses should be
recognized in the same period
regardless whether expenses are paid
or not.
The related expenses include traceable
costs (i.e., product costs), period costs,
(i.e., interest and rent expenses) and
estimated/allocation expenses (i.e.,
depreciation expense and bad debt expense).
Accrual Accounting and
the Financial Statements
9

II. Adjusting
Entries
Due to the periodicity concept, financial
reports are prepared periodically.
Based on revenue recognition principle,
adjusting entries are prepared at the
end of a period to recognize revenues
earned during the period but not yet
recorded (i.e., accrued revenues).
10

Adjusting Entries (contd.)
Based on the matching principle, the
accrued expenses (i.e., expenses
incurred but not yet paid/recorded) and
estimated expenses (i.e., depreciation
expense and bad debt expense) are
recorded at the end of a period.
11

Types of Adjusting Entries
A. Accruals
B. Deferrals
C. Estimated Expenses
12

A. Accruals
Unrecorded revenues or
expenses (i.e., revenues earned
or expenses inccurred but not yet
recorded).
a. Accrued expenses.
b. Accrued revenues.
13

14
 Accrued expenses are expenses incurred
but not paid yet.
 A liability-expense account relationship
exists
 Prior to adjustment, liabilities and expenses
are understated
 The Adjusting Entry results in a debit to an
expense account and a credit to a liability
account
ACCRUED EXPENSES

15
ADJUSTING ENTRIES FOR ACCRUALS
ACCRUED INTEREST
Interest Payable
Oct. 31 50
Interest Expense
Oct. 31 50
Date Account Titles and Explanation Debit Credit
Oct. 31 Interest Expense 50
Interest Payable 50
(To accrue interest on notes payable)
JOURNAL ENTRY
POSTING
ADJUSTMENT October 31, the portion of the interest to be accrued
on a 3-month note payable is calculated to be $50.

16
ACCRUED SALARIES
Salaries Payable
Oct. 31 1,200
Oct. 31 Salaries Expense 1,200
Salaries Payable 1,200
(To record accrued salaries)
JOURNAL ENTRY
POSTING
ADJUSTMENT October 31, accrued salaries
are calculated to be $1,200.
Salaries Expense
Oct. 26 4,000
31 1,200
31 5,200

a. Accrued Expenses- An
Example
 A one-year note payable was issued on
11/1/11 to purchase an equipment. The full
amount of the note is $2,400. The annual
interest rate is 10% and interests are paid
on 4/30/12 and 11/1/12.
11/1/11 Equipment 2,400
Note Payable 2,400
Adjusting Entry:
12/31/11 Interest Expense 40
Interest payable 40
17

18
ACCRUED REVENUES
Service Revenue
Oct. 31 10,000
31 400
31 200
31 10,600
Accounts Receivable
Oct. 31 200
Oct. 31 Accounts Receivable 200
Service Revenue 200
(To accrue revenue for services provided)
October 31, the agency earned $200
for advertising services that were not
billed to clients before October 31.
JOURNAL ENTRY
POSTING
ADJUSTMENT

b. Accrued Revenues – An
Example
 A one year note was received from a credit
sale with a face amount of $3,000 and an
annual interest rate of 12% on 9/1/12.
Interests are received on 3/1/13 and 9/1/13.
9/1/x1 Note Receivable 3,000
Sales Revenue 3,000
Adjusting Entry:
12/31/x1 Interest Receivable 120
Interest Revenue 120
19

B. Deferrals
Postponing the recognition of
Revenues or expenses
a. Unearned revenues
b. Prepaid expenses
20

21
 Unearned revenues are revenues received
and recorded as liabilities before they are
earned.
 Unearned revenues are subsequently
earned by rendering a service to a
customer.
 A liability-revenue account relationship
exists with unearned revenues.
UNEARNED REVENUES

22
 Prior to adjustment, liabilities are
overstated and revenues are understated.
 The adjusting entry results in a debit to a
liability account and a credit to a revenue
account.
 Examples of unearned revenues include
rent, magazine subscriptions, and customer
deposits for future services.
UNEARNED REVENUES

23
ADJUSTING ENTRIES FOR PREPAYMENTS
UNEARNED REVENUES
Service Revenue
Oct. 31 10,000
31 400
Unearned Revenue
Oct. 31 400 Oct. 2 1,200
31 800
JOURNAL ENTRY
POSTING
ADJUSTMENT October 31, analysis reveals that, of $1,200
in fees, $400 has been earned in October.
Oct. 31 Unearned Revenue 400
Service Revenue 400
(To record revenue for services provided)

a. Unearned Revenues
Receiving $2,400 for a one-year advanced
rent payment from a tenant on 12/1/11
24
(B/S Approach)
12/1/11
Cash 2,400
Unearned Rent 2,400
12/30/11
Unearned Rent 200
Rent Revenue 200
(I/S Approach)
12/1/11
Cash 2,400
Rent Revenue 2,400
12/30/11
Rent Revenue 2,200
Rent Unearned 2,200

25
 Prepaid expenses are expenses paid in cash
and recorded as assets before they are used
or consumed.
 Prepaid expenses expire with the passage of
time or through use and consumption.
 An asset-expense account relationship exists
with prepaid expenses.
PREPAID EXPENSES

26
Advertising Supplies Expense
Oct. 31 1,500
Advertising Supplies
Oct. 5 2,500 Oct. 31 1,500
31 1,000
Oct. 31 Advertising Supplies Expense 1,500
Advertising Supplies 1,500
(To record supplies used)
JOURNAL ENTRY
POSTING
ADJUSTMENT October 31, an inventory count reveals that $1,000
of $2,500 of supplies are still on hand.
SUPPLIES

27
INSURANCE
Insurance Expense 63
Oct. 31 50
Prepaid Insurance 10
Oct. 4 600 Oct. 31 50
31 550
Oct. 31 Insurance Expense 50
(To record insurance
expired)
JOURNAL ENTRY
POSTING
ADJUSTMENT October 31, an analysis of the policy reveals
that $50 of insurance expires each month.

b. Prepaid Expense
Prepaid a 12 month insurance premium of
$1,200 on 11/1/11
28
(B/S Approach)
Prepaid Insur. 1,200
Cash 1,200
12/31/11
Insurance Exp. 200
(I/S Approach)
Insurance Exp.1,200
Cash 1,200
12/31/11
Prepaid Insur. 1,000
Insurance Exp. 1,000

29
ALTERNATIVE TREATMENT
OF PREPAID EXPENSES AND UNEARNED
REVENUES
 Some businesses use an alternative treatment for prepaids
and unearned revenues.
 Instead of debiting an asset at the time an expense is
prepaid, the amount is charged to an expense account.
 Instead of crediting a liability at the time cash is received
in advance of earning it, the amount is credited to a
revenue account.
 This treatment of prepaid expenses and unearned
revenues will ultimately result in the same effect on the
financial statements as initial entries to balance sheet
accounts and then adjusting entries.

30
ALTERNATIVE ADJUSTMENTS FOR PREPAYMENTS
SUPPLIES
Advertising Supplies Expense
Oct. 5 2,500 Oct. 31 1,000
31 1,500
Advertising Supplies
Oct. 31 1,000
Oct. 31 Advertising Supplies 1,000
Advertising Supplies Expense 1,000
(To record supplies
inventory)
JOURNAL ENTRY
POSTING
ADJUSTMENT October 31, an inventory count reveals that
$1,000 of $2,500 of supplies are still on hand.

31
ALTERNATIVE ADJUSTMENTS FOR PREPAYMENTS
UNEARNED REVENUES
Service Revenue
Oct. 31 800 Oct. 2 1,200
31 400
Oct. 31 Service Revenue 800
Unearned Revenue 800
(To record unearned revenue)
JOURNAL ENTRY
POSTING
ADJUSTMENT October 31, analysis reveals that, of $1,200
in fees, $400 has been earned in October.
Unearned Revenue
Oct. 31 800

Accounting Estimates
• Some assets are not fully used up in a
single fiscal period.
– A truck may last five years, but its value as a
resource declines with time and usage.

• Some assets are not fully used up in a
single fiscal period.
– A truck may last five years, but its value as a
resource declines with time and usage.
• Assets that benefit more than one year
are called long-term or “fixed” assets.

34
 Depreciation is the allocation of the cost of
an asset to expense over its useful life in a
rational and systematic manner.
 The purchase of equipment or a building is
viewed as a long-term prepayment of
services and, therefore, is allocated in the
same manner as other prepaid expenses.
DEPRECIATION

35
DEPRECIATION
 Depreciation is an estimate rather than
a factual measurement of the cost that
has expired.
 In recording depreciation, Depreciation
Expense is debited and a contra asset
account, Accumulated Depreciation, is
credited
Depreciation Expense
XXX
Accumulated Depreciation
XXX

36
 In the balance sheet, Accumulated
Depreciation is offset against the asset
account.
 The difference between the cost of any
depreciable asset and its related
accumulated depreciation is referred to as
the book value of the asset.
DEPRECIATION

The portion of an asset’s utility that is used
up must be expensed in the period used.
Cash
(credit)
Fixed Asset
(debit)
Journal entry
when
payment is
made.

Cash
(credit)
Fixed Asset
(debit)
Journal entry
when
payment is
made.
The asset’s
usefulness is
partially
consumed
during the
period.
The portion of an asset’s utility that is used up
must be expensed in the period used.

Accumulated
Depreciation
(credit)
Depreciation
Expense (debit)Cash
(credit)
Fixed Asset
(debit)
Journal entry
when
payment is
made.
The asset’s
usefulness is
partially
consumed
during the
period.
AJE at end
of period

Accumulated
Depreciation
(credit)
Depreciation
Expense (debit)
This is called a contra-asset
account and has a credit balance.
AJE at end
of period

Accumulated
Depreciation
(credit)
Depreciation
Expense (debit)
The portion of an asset’s utility that is used up
must be expensed in the period used.
AJE at end
of period
Balance Sheet Presentation
Asset (at cost) $40,000
Less: Accumulated Depr. 5,000
Book Value $35,000

Accumulated
Depreciation
(credit)
Depreciation
Expense (debit)
AJE at end
of period
Balance Sheet Presentation
Asset (at cost) $40,000
Less: Accumulated Depr. 5,000
Book Value $35,000

Definition of Book Value
Asset cost - Accumulated
Depreciation

Book Value = $35,000
Truck
Bal. 40,000
Accumulated Dep’n - Truck
5,000 Bal.

GENERAL JOURNAL
Page: 1
Date Description PR Debit Credit
Example
On 12/31/97, Putnam Plumbing, recorded
$2,000 of Depreciation Expense on a
$10,000 truck.
Prepare the proper adjusting
journal entry.

On 12/31/97, Putnam Plumbing, recorded
$2,000 of Depreciation Expense on a
$10,000 truck.
GENERAL JOURNAL
Page: 1
Date Description PR Debit Credit
31-Dec Depreciation Expense 2,000
Accumulated Depreciation 2,000
to record depreciation
expense on truck for the year
Example

Chp6 accrual basis of acctg

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