4-‹#›Accrual Accounting ConceptsKimmel ● Weygandt .docx

4-‹#›
Accrual Accounting Concepts
Kimmel ● Weygandt ● Kieso
Financial Accounting, Eighth Edition
4
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Prepare adjusting entries for deferrals.
CHAPTER OUTLINE
Explain the accrual basis of accounting and the reasons for
adjusting entries.
1
2
LEARNING OBJECTIVES
Prepare adjusting entries for accruals.
3
Prepare an adjusted trial balance and closing entries.
4
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LEARNING OBJECTIVE
adjusting entries.
1
LO 1
Generally a month, a quarter, or a year.
Fiscal year vs. calendar year.
Accountants divide the economic life of a business into
artificial time periods (Periodicity Assumption).
Jan.
Feb.
Mar.
Apr.
Dec.
. . . . .
▼ HELPFUL HINT
An accounting time period that is one year long is called a
fiscal year.
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Periodicity Assumption

Review Question
What is the periodicity assumption?
Companies should recognize revenue in the accounting period in
which it is earned.
Companies should match expenses with revenues.
The economic life of a business can be divided into artificial
time periods.
The fiscal year should correspond with the calendar year.
LO 1
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Companies recognize revenue in the accounting period in which
the performance obligation is satisfied.
REVENUE RECOGNITION PRINCIPLE
LO 1
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TEACHING TIP
Service businesses recognize revenue when the services are
performed, although many customers may have been billed for
the services (on account). The cash has not been received;
however, the services have been performed. Therefore, revenue
should be recognized.
Illustration: Assume Conrad Dry Cleaners cleans clothing on
June 30, but customers do not claim and pay for their clothes
until the first week of July. The journal entries for June and
July would be:

REVENUE RECOGNITION PRINCIPLE
LO 1
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“Let the expenses follow the revenues.”
ILLUSTRATION 4-1
EXPENSE RECOGNITION PRINCIPLE
LO 1
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ILLUSTRATION 4-1
GAAP relationships in revenue and expense recognition
EXPENSE RECOGNITION PRINCIPLE
LO 1
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INVESTOR INSIGHT
Reporting Revenue Accurately
The Until recently, electronics manufacturer Apple was required
to spread the revenues from iPhone sales over the two-year
period following the sale of the phone. Accounting standards

required this because Apple was obligated to provide software
updates after the phone was sold. Since Apple had service
obligations after the initial date of sale, it was forced to spread
the revenue over a two-year period. As a result, the rapid
growth of iPhone sales was not fully reflected in the revenue
amounts reported in Apple’s income statement. A new
accounting standard now enables Apple to report much more of
its iPhone revenue at the point of sale. It was estimated that
under the new rule revenues would have been about 17% higher
and earnings per share almost 50% higher.
Apple Inc.
LO 1
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Accrual-Basis Accounting
Transactions recorded in the periods in which the events occur.
Revenues are recognized when services performed, even if cash
was not received.
Expenses are recognized when incurred, even if cash was not
paid.
ACCRUAL VERSUS CASH BASIS
LO 1
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Cash-Basis Accounting
Revenues are recognized only when cash is received.
Expenses are recognized only when cash is paid.
Not in accordance with generally accepted accounting
principles (GAAP).

LO 1
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TEACHING TIP
Explain to students that many businesses use the cash basis of
accounting. These businesses outgrow the method when
accounts receivable and accounts payable become substantial.
Also, if the businesses need audited financial statements, they
must comply with GAAP and use the accrual basis. Remind
them that companies can use the cash method and that its use
does not mean that income is being manipulated. Without this
discussion, some students may unfairly criticize an employer,
relative or friend who is using the cash basis of accounting.
2016
2017
Illustration: Suppose that Fresh Colors paints a large building
in 2016. In 2016, it incurs and pays total expenses (salaries and
paint costs) of $50,000. It bills the customer $80,000, but does
not receive payment until 2017.
ILLUSTRATION 4-2
Accrual-versus cash-basis accounting
LO 1
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Periodicity Assumption
Review Question
Which one of these statements about the accrual basis of
accounting is false?
Companies record events that change their financial statements
in the period in which events occur, even if cash was not
exchanged.
Companies recognize revenue in the period in which the
performance obligation is satisfied.
This basis is in accord with generally accepted accounting
principles.
Companies record revenue only when they receive cash, and
record expense only when they pay out cash.
LO 1
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Adjusting entries
ensure that the revenue recognition and expense recognition
principles are followed.
are required every time a company prepares financial
statements.
includes one income statement account and one balance sheet
account.
THE NEED FOR ADJUSTING ENTRIES
LO 1
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Adjusting entries are made to ensure that:
a. expenses are recognized in the period in which they are
incurred.
b. revenues are recognized in the period in which the
performance obligation is satisfied.
c. balance sheet and income statement accounts have correct
balances at the end of an accounting period.
d. All of the above.
Review Question
LO 1
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Deferrals:
1.Prepaid expenses: Expenses paid in cash and recorded as
assets before they are used or consumed.
2.Unearned revenues: Cash received before service are
performed.
Accruals:
1.Accrued revenues: Revenues for services performed but not
yet received in cash or recorded.
2.Accrued expenses: Expenses incurred but not yet paid in cash
or recorded.
TYPES OF ADJUSTING ENTRIES
ILLUSTRATION 4-3
Categories of adjusting entries
LO 1

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LO 1
Trial Balance – Each account is analyzed to determine whether
it is complete and up-to-date.
ILLUSTRATION 4-4
Trial balance
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Timing Concepts
Below is a list of concepts in the left column, with descriptions
of the concepts in the right column. There are more descriptions
provided than concepts. Match the description of the concept to
the concept.
DO IT!
1
LO 1
1. ____ Accrual-basis accounting.
2. ____ Calendar year.
3. ____ Periodicity assumption.
4. ____ Expense recognition principle.
(a) Monthly and quarterly time periods.
(b) Efforts (expenses) should be matched with results
(revenues).
(c) Accountants divide the economic life of a business into time

periods.
(d) Companies record revenues when they receive cash and
record expenses when they pay out cash.
(e) An accounting time period that starts on January 1 and ends
on December 31.
(f) Companies record transactions in the period in which the
events occur.
f
e
c
b
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Analyze business transactions
Journalize
Post
Trial Balance
Journalize and Post Adjusting Entries
Adjusted Trial Balance
Financial Statements
Closing Entries
Post-Closing Trial Balance
To defer means to postpone or delay.
LO 2
LEARNING OBJECTIVE
2
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Deferrals are either:
Prepaid expenses
OR
Unearned revenues.
Deferrals
LO 2
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Expenses paid in cash before they are used or consumed.
insurance
supplies
advertising
Cash Payment
Expense Recorded
BEFORE
rent
equipment
buildings
Prepayments often occur in regard to:
PREPAID EXPENSES
LO 2
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Prepaid Expenses
Costs that expire either with the passage of time or through use.
Adjusting entry results in an increase (a debit) to an expense
account and a decrease (a credit) to an asset account.

PREPAID EXPENSES
LO 2
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Adjusting entries for prepaid expenses
Increases (debits) an expense account and
Decreases (credits) an asset account.
ILLUSTRATION 4-5
Adjusting entries for prepaid expenses
PREPAID EXPENSES
LO 2
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Illustration: Sierra Corporation purchased supplies costing
$2,500 on October 5. Sierra recorded the purchase by increasing
(debiting) the asset Supplies. This account shows a balance of
$2,500 in the October 31 trial balance. An inventory count at
the close of business on October 31 reveals that $1,000 of
supplies are still on hand.
Supplies
1,500
Supplies Expense
1,500
Oct. 31
ILLUSTRATION 4-6
($2,500 – 1,000 = $1,500)
Supplies

LO 2
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Illustration: On October 4, Sierra Corporation paid $600 for a
one-year fire insurance policy. Coverage began on October 1.
Sierra recorded the payment by increasing (debiting) Prepaid
Insurance. This account shows a balance of $600 in the October
31 trial balance. Insurance of $50 ($600 ÷ 12) expires each
month.
Prepaid Insurance
50
Insurance Expense
50
Oct. 31
ILLUSTRATION 4-7
Insurance
LO 2
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Buildings, equipment, and motor vehicles (long-lived assets) are
recorded as assets, rather than an expense, in the year acquired.
Depreciation is the process of allocating the cost of an asset to
expense (depreciation) over its useful life.
Depreciation does not attempt to report the actual change in the
value of the asset.
Depreciation

LO 2
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Illustration: For Sierra Corporation, assume that depreciation
on the office equipment is $480 a year, or $40 per month.
Accumulated Depreciation-Equipment
40
Depreciation Expense
40
Oct. 31
ILLUSTRATION 4-8
Depreciation
LO 2
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Statement Presentation
Accumulated Depreciation-Equipment is a contra asset account.
Appears just after the account it offsets (Equipment) on the
balance sheet.
ILLUSTRATION 4-9
Balance sheet presentation of
accumulated depreciation
Depreciation
▼ HELPFUL HINT
All contra accounts have increases, decreases, and normal
balances opposite to the account to which they relate.

LO 2
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ILLUSTRATION 4-10
Accounting for prepaid expenses
PREPAID EXPENSES
LO 2
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Receipt of cash recorded as a liability before services are
performed.
rent
airline tickets
Cash Receipt
Revenue Recorded
BEFORE
magazine subscriptions
customer deposits
Unearned revenues often occur in regard to:
UNEARNED REVENUES
LO 2
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Adjusting entry is made to record the revenue for services

performed during the period and to show the liability that
remains.
Adjusting entry results in a decrease (a debit) to a liability
account and an increase (a credit) to a revenue account.
UNEARNED REVENUES
LO 2
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Adjusting entries for unearned revenues
Decrease (a debit) to a liability account.
Increase (a credit) to a revenue account.
ILLUSTRATION 4-11
UNEARNED REVENUES
LO 2
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Illustration: Sierra Corporation received $1,200 on October 2
from R. Knox for guide services for multi-day trips expected to
be completed by December 31. Unearned Service Revenue
shows a balance of $1,200 in the October 31 trial balance.
From an evaluation of the service Sierra performed for Knox
during October, the company determines that it has earned $400
in October.
Service Revenue
400
Unearned Service Revenue
400

Oct. 31
ILLUSTRATION 4-12
UNEARNED REVENUES
LO 2
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ILLUSTRATION 4-13
Accounting for unearned revenues
Unearned Revenues recorded in liability accounts are now
recognized as revenue for services performed.
ACCOUNTING FOR UNEARNED REVENUES
Examples
Reason for
Adjustment
Accounts Before
Adjustment
Adjusting
Entry
Rent, magazine subscriptions, customer deposits for future
service.
Liabilities overstated.
Revenues understated.
Dr. Liabilities
Cr. Revenues
UNEARNED REVENUES
LO 2
4-‹#›

ACCOUNTING ACROSS THE ORGANIZATION
Turning Gift Cards into Revenue
Those of you who are marketing majors (and even most of you
who are not) know that gift cards are among the hottest
marketing tools in merchandising today. Customers purchase
gift cards and give them to someone for later use. In a recent
year, gift-card sales were expected to exceed $124 billion.
Although these programs are popular with marketing executives,
they create accounting questions. Should revenue be recorded at
the time the gift card is sold, or when it is exercised? How
should expired gift cards be accounted for? In a recent balance
sheet, Best Buy reported unearned revenue related to gift cards
of $406 million.
Source: “2014 Gift Card Sales to Top $124 Billion, But Growth
Slowing,” PRNewswire (December 10, 2014).
LO 2
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Adjusting Entries for Deferrals
The ledger of Hammond, Inc. on March 31, 2017, includes these
selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
An analysis of the accounts shows the following.
1. Insurance expires at the rate of $100 per month.
2. Supplies on hand total $800.

3. The equipment depreciates $200 a month.
4.During March, services were performed for $4,000 of the
unearned service revenue reported.
Prepare the adjusting entries for the month of March.
DO IT!
2
LO 2
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Debit Credit
Supplies 2,800
Equipment 25,000
Insurance expires at the rate of $100 per month.
SOLUTION
DO IT!
2
Insurance Expense100
Prepaid Insurance100
LO 2
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Debit Credit
Supplies 2,800
Equipment 25,000
Supplies on hand total $800.
SOLUTION
DO IT!
2
Supplies Expense2,000
Supplies2,000
LO 2
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Debit Credit
Supplies 2,800
Equipment 25,000

The equipment depreciates $200 a month.
SOLUTION
DO IT!
2
Depreciation Expense200
Accumulated Depreciation200
LO 2
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Debit Credit
Supplies 2,800
Equipment 25,000
During March, services were performed for $4,000 of the
unearned service revenue reported.
SOLUTION
DO IT!
2
Unearned Service Revenue4,000
Service Revenue4,000
LO 2
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Journalize
Post
Trial Balance
Journalize and Post Adjusting Entries
Closing Entries
Increase both a balance sheet and an income statement account.
LO 3
LEARNING OBJECTIVE
Prepare adjusting entries for accruals.
3
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Made to record:
Revenues for services performed and
OR
Expenses incurred
in the current accounting period that have not been recognized
through daily entries.
Adjusting Entries for Accruals
LO 3
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Revenues for services performed but not yet received in cash or
recorded.
rent
interest
services performed
BEFORE
Accrued revenues often occur in regard to:
Cash Receipt
Revenue Recorded
Adjusting entry results in:
ACCRUED REVENUES
LO 3
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Accrued Revenues
An adjusting entry serves two purposes:
Shows the receivable that exists, and
Records the revenues for services performed.
ACCRUED REVENUES
LO 3
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Adjusting entries for accrued revenues
Increases (debits) an asset account.
Increases (credits) a revenue account.
ILLUSTRATION 4-14

ACCRUED REVENUES
LO 3
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Illustration: In October, Sierra Corporation performed guide
services for $200 that were not billed to clients before October
31.
Service Revenue
200
Accounts Receivable
200
Oct. 31
ILLUSTRATION 4-15
ACCRUED REVENUES
LO 3
4-‹#›
ILLUSTRATION 4-16
Accounting for accrued revenues
Services performed but not yet received in cash or recorded.
ACCOUNTING FOR ACCRUED REVENUES
Examples
Reason for
Adjustment
Accounts Before

Adjustment
Adjusting
Entry
Interest, rent, services performed but not collected.
Assets understated.
Revenues understated.
Dr. Assets
Cr. Revenues
ACCRUED REVENUES
LO 3
4-‹#›
Expenses incurred but not yet paid in cash or recorded.
BEFORE
Accrued expenses often occur in regard to:
Cash Payment
Expense Recorded
utilities
salaries
Adjusting entry results in:
Interest
taxes
ACCRUED EXPENSES
LO 3
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An adjusting entry serves two purposes:
Records the obligations, and

Recognizes the expenses.
ACCRUED EXPENSES
LO 3
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Adjusting entries for accrued expenses
Increases (debits) an expense account.
Increases (credits) a liability account.
ILLUSTRATION 4-17
ACCRUED EXPENSES
LO 3
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Illustration: Sierra Corporation signed a three-month note
payable in the amount of $5,000 on October 1. The note
requires Sierra to pay interest at an annual rate of 12%.
Interest Payable
50
Interest Expense
50
Oct. 31
ILLUSTRATION 4-19
ILLUSTRATION 4-18
Formula for computing interest
Accrued Interest
$5,000 x 12% x 1/12 = $50

LO 3
4-‹#›
ILLUSTRATION 4-20
Illustration: Sierra Corporation last paid salaries on October
26; the next payment of salaries will not occur until November
9. The employees receive total salaries of $2,000 for a five-day
work week, or $400 per day. Thus, accrued salaries at October
31 are $1,200 ($400 × 3 days).
Accrued Salaries
LO 3
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Salaries and Wages Payable
1,200
Salaries and Wages Expense
1,200
Oct. 31
ILLUSTRATION 4-21
Illustration: Sierra Corporation last paid salaries on October
26; the next payment of salaries will not occur until November
9. The employees receive total salaries of $2,000 for a five-day
work week, or $400 per day. Thus, accrued salaries at October
31 are $1,200 ($400 × 3 days).
Accrued Salaries

LO 3
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ILLUSTRATION 4-22
Accounting for accrued expenses
ACCRUED EXPENSES
LO 3
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PEOPLE, PLANET, AND PROFIT INSIGHT
Got Junk?
Do you have an old computer or two in your garage? How about
an old TV that needs replacing? Many people do.
Approximately 163,000 computers and televisions become
obsolete each day. Yet, in a recent year, only 11% of computers
were recycled. It is estimated that 75% of all computers ever
sold are sitting in storage somewhere, waiting to be disposed of.
Each of these old TVs and computers is loaded with lead,
cadmium, mercury, and other toxic chemicals. If you have one
of these electronic gadgets, you have a responsibility, and a
probable cost, for disposing of it. Companies have the same
problem, but their discarded materials may include lead paint,
asbestos, and other toxic chemicals.
LO 3
4-‹#›

ILLUSTRATION 4-23
Summary of adjusting entries
SUMMARY OF BASIC RELATIONSHIPS
LO 3
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Micro Computer Services Inc. began operations on August 1,
2017. At the end of August 2017, management attempted to
prepare monthly financial statements. The following
information relates to August.
At August 31, the company owed its employees $800 in salaries
that will be paid on September 1.
On August 1, the company borrowed $30,000 from a bank on a
15-year mortgage. The annual interest rate is 10%.
Revenue for services performed but unrecorded for August
totaled $1,100.
Prepare the adjusting entries needed at August 31, 2017.
DO IT!
3
LO 3
4-‹#›

prepare monthly financial statements. Prepare the adjusting
entries needed at August 31, 2017.
At August 31, the company owed its employees $800 in salaries
that will be paid on September 1.
SOLUTION
DO IT!
3
Salaries and Wages Expense 800
Salaries and Wages Payable 800
LO 3
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On August 1, the company borrowed $30,000 from a bank on a
15-year mortgage. The annual interest rate is 10%.
SOLUTION
DO IT!
3
Interest Expense 250
Interest Payable 250
LO 3

4-‹#›
Revenue for services performed but unrecorded for August
totaled $1,100.
SOLUTION
DO IT!
3
Accounts Receivable 1,100
Service Revenue 1,100
LO 3
4-‹#›
Journalize
Post
Trial Balance
Adjusting Entries
Adjusted trial balance
Prepare financial statements
Journalize and post closing entries
Prepare a post-closing trial balance
LO 4
LEARNING OBJECTIVE

Prepare an adjusted trial balance and closing entries.
4
4-‹#›
After all adjusting entries are journalized and posted the
company prepares another trial balance from the ledger accounts
(Adjusted Trial Balance).
The adjusted trial balance’s purpose is to prove the equality of
debit balances and credit balances in the ledger.
The adjusted trial balance is the primary basis for the
preparation of the financial statements.
PREPARE ADJUSTED TRIAL BALANCE
LO 4
4-‹#›
LO 4
ILLUSTRATION 4-26
Adjusted trial balance
4-‹#›
PREPARE ADJUSTED TRIAL BALANCE
Which of the following statements is incorrect concerning the
adjusted trial balance?
An adjusted trial balance proves the equality of the total debit

balances and the total credit balances in the ledger after all
adjustments are made.
The adjusted trial balance provides the primary basis for the
preparation of financial statements.
The adjusted trial balance lists the account balances segregated
by assets and liabilities.
The adjusted trial balance is prepared after the adjusting entries
have been journalized and posted.
Review Question
LO 4
4-‹#›
Financial statements are prepared directly from the Adjusted
Trial Balance.
Balance Sheet
Income Statement
Retained Earnings Statement
PREPARING FINANCIAL STATEMENTS
LO 4
4-‹#›
ILLUSTRATION 4-27
Preparation of the income statement and retained earnings
statement from the adjusted trial balance

4-68
4-‹#›
Tell students to look at the date on the income statement in
Illustration 4-27. The date is “For the Month Ending October
31, 2014.” How can one be sure the revenues and expenses
reported on the income statement are just for that period?
Closing entries transfer the temporary account balances to the
stockholders’ equity account and reduce the balances in the
temporary accounts to zero. Therefore, at the beginning of the
period the temporary accounts have a balance of zero and the
revenues and expenses accumulated are for that particular
period.
ILLUSTRATION 4-28
Preparation of the balance sheet from the adjusted trial balance
LO 4
4-‹#›
Quality of Earnings – company provides full and transparent
information.
Earnings Management - the planned timing of revenues,
expenses, gains, and losses to smooth out bumps in net income.
Companies may manage earnings by:
one-time items to prop up earnings numbers.
inflating revenue numbers in the short-run.
improper adjusting entries.
As a result of the Sarbanes-Oxley Act, many companies are
trying to improve the quality of their financial reporting.

QUALITY OF EARNINGS
LO 4
4-‹#›
Trial Balance
DO IT!
4a
LO 4
4-‹#›
Trial Balance
DO IT!
(a) Determine the net income for the quarter April 1 to June 30.

LO 4
4a
4-‹#›
Trial Balance
DO IT!
Determine the total assets and total liabilities at June 30, 2017.
LO 4
4a
4-‹#›
Trial Balance
DO IT!

Determine the balance in Retained Earnings at June 30, 2017.
Retained earnings, April 1 $ 0
Add: Net income 2,490
Less: Dividends 600
Retained earnings, June 30 $1,890
LO 4
4a
4-‹#›
At the end of the accounting period, companies transfer the
temporary account balances to the permanent stockholders’
equity account—Retained Earnings.
ILLUSTRATION 4-29
Temporary versus permanent accounts
CLOSING THE BOOKS
LO 4
4-‹#›
In addition to updating Retained Earnings to its correct ending
balance, closing entries produce a zero balance in each
temporary account.
ILLUSTRATION 4-30
The closing process
Preparing Closing Entries
LO 4

4-‹#›
LO 4
ILLUSTRATION 4-31
4-‹#›
Illustration 4-32
Posting of closing entries
Preparing Closing Entries
LO 4
4-‹#›
The purpose of the post-closing trial balance is to prove the
equality of the permanent account balances that the company
carries forward into the next accounting period.
All temporary accounts will have zero balances.
Preparing a Post-Closing Trail Balance
LO 4
4-‹#›

1. Analyze business transactions
2. Journalize the transactions
6. Prepare an adjusted trial balance
7. Prepare financial statements
8. Journalize and post closing entries
9. Prepare a post-closing trial balance
4. Prepare a trial balance
3. Post to ledger accounts
Journalize and post adjusting entries:
Deferrals/Accruals
ILLUSTRATION 4-33
Required steps in the accounting cycle
SUMMARY OF THE ACCOUNTING CYCLE
LO 4
4-‹#›

ILLUSTRATION 4-33
LO 4
4-‹#›
ILLUSTRATION 4-33
LO 4
4-‹#›
ILLUSTRATION 4-33
LO 4
4-‹#›
ILLUSTRATION 4-33

LO 4
4-‹#›
ILLUSTRATION 4-33
LO 4
4-‹#›
ILLUSTRATION 4-33
LO 4
4-‹#›
ILLUSTRATION 4-33
LO 4
4-‹#›

ILLUSTRATION 4-33
LO 4
4-‹#›
ILLUSTRATION 4-33
LO 4
4-‹#›
Sierra Corporation’s income statement shows net income of
$2,860. Net income and net cash provided by operating
activities often differ.
Net income on a cash basis is referred to as “Net cash provided
by operating activities.”
The statement of cash flows, reports net cash provided by
operating activities.
Illustration 4-27
KEEPING AN EYE ON CASH

LO 4
4-‹#›
The difference for Sierra is $2,840 ($5,700 - $2,860). The
following summary shows the causes of this difference.
LO 4
KEEPING AN EYE ON CASH
4-‹#›
Closing Entries
Hancock Company has the following balances in selected
accounts of its adjusted trial balance.
Accounts Payable $27,000 Dividends $15,000
Service Revenue 98,000 Retained Earnings 42,000
Rent Expense 22,000 Accounts Receivable 38,000
Salaries and Wages Expense51,000 Supplies Expense 7,000
Prepare the entries to close the revenue and expense accounts.
SOLUTION
DO IT!
4b
Service Revenue 98,000
Income Summary 98,000
Salaries and Wages Expense 51,000
Rent Expense 22,000
Supplies Expense 7,000

LO 4
4-‹#›
Closing Entries
Hancock Company has the following balances in selected
accounts of its adjusted trial balance.
Accounts Payable $27,000 Dividends $15,000
Service Revenue 98,000 Retained Earnings 42,000
Rent Expense 22,000 Accounts Receivable 38,000
Salaries and Wages Expense51,000 Supplies Expense 7,000
Prepare the entries to close income summary and dividends.
SOLUTION
DO IT!
4b
Retained Earnings 18,000
Retained Earnings 15,000
Dividends 15,000
LO 4
4-‹#›
LO 5
LEARNING OBJECTIVE
APPENDIX 4A: Describe the purpose and the basic form of a
worksheet.
*5
Worksheet

A multiple-column form that may be used in the adjustment
process and in preparing financial statements.
Manual or computer spreadsheet.
A working tool, not a permanent accounting record.
Neither a journal nor a part of the general ledger.
4-‹#›
ILLUSTRATION 4A-1
Form and procedure for a worksheet
SIERRA CORPORATION
Worksheet
For the Month Ended October 31, 2017
LO 5
4-‹#›

(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
ILLUSTRATION 4A-1
Form and procedure for a worksheet
SIERRA CORPORATION
Worksheet
For the Month Ended October 31, 2017
LO 5
4-‹#›
KEY POINTS
A Look at IFRS
LEARNING OBJECTIVE
Compare the procedures for adjusting entries under GAAP and

IFRS.
6
Similarities
Companies applying IFRS also use accrual-basis accounting to
ensure that they record transactions that change a company’s
financial statements in the period in which events occur.
Similar to GAAP, cash-basis accounting is not in accordance
with IFRS.
LO 6
4-‹#›
A Look at IFRS
KEY POINTS
Similarities
IFRS also divides the economic life of companies into artificial
time periods. Under both GAAP and IFRS, this is referred to as
the periodicity assumption.
The general revenue recognition principle required by GAAP
that is used in this textbook is similar to that used under IFRS.
Revenue recognition fraud is a major issue in U.S. financial
reporting. The same situation occurs in other countries, as
evidenced by revenue recognition breakdowns at Dutch software
company Baan NV, Japanese electronics giant NEC, and Dutch
grocer Ahold NV.
LO 6
4-‹#›

A Look at IFRS
KEY POINTS
Differences
Under IFRS, revaluation (using fair value) of items such as land
and buildings is permitted. IFRS allows depreciation based on
revaluation of assets, which is not permitted under GAAP.
The terminology used for revenues and gains, and expenses and
losses, differs somewhat between IFRS and GAAP. For
example, income under IFRS includes both revenues, which
arise during the normal course of operating activities, and gains,
which arise from activities outside of the normal sales of goods
and services.
LO 6
4-‹#›
A Look at IFRS
KEY POINTS
Differences
Under IFRS, expenses include both those costs incurred in the
normal course of operations as well as losses that are not part of
normal operations. This is in contrast to GAAP, which defines
each separately.
LO 6

4-‹#›
A Look at IFRS
LOOKING TO THE FUTURE
The IASB and FASB are completing a joint project on revenue
recognition. The purpose of this project is to develop
comprehensive guidance on when to recognize revenue. It is
hoped that this approach will lead to more consistent accounting
in this area. For more on this topic, see
www.fasb.org/project/revenue_recognition.shtml.
LO 6
4-‹#›
IFRS Practice
IFRS:
uses accrual accounting.
uses cash-basis accounting.
allows revenue to be recognized when a customer makes an
order.
requires that revenue not be recognized until cash is received.
A Look at IFRS
LO 6

4-‹#›
IFRS Practice
Which of the following statements is false?
IFRS employs the periodicity assumption.
IFRS employs accrual accounting.
IFRS requires that revenues and costs must be capable of being
measured reliably.
IFRS uses the cash basis of accounting.
A Look at IFRS
LO 6
4-‹#›
IFRS Practice
Accrual-basis accounting:
is optional under IFRS.
results in companies recording transactions that change a
company’s financial statements in the period in which events
occur.
has been eliminated as a result of the IASB/FASB joint project
on revenue recognition.
is not consistent with the IASB conceptual framework.

A Look at IFRS
LO 6
4-‹#›
“Copyright © 2016 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted
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and not for distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages, caused by the
use of these programs or from the use of the information
contained herein.”
COPYRIGHT
4-‹#›
Account TitlesDr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.
Cash15,200
Supplies2,500
Prepaid Insurance600
Equipment5,000
Notes Payable5,000
Accounts Payable2,500
Unearned Service Revenue1,200
Common Stock10,000
Dividends500

Salaries & Wages Exp.4,000
Rent Expense900
Totals28,700 28,700
Balance Sheet
AdjustedIncome
Trial BalanceAdjustmentsTrial BalanceStatement
Sheet1AdjustedIncomeTrial BalanceAdjustmentsTrial
BalanceStatementBalance SheetAccount
TitlesDr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.Cash15,200Supplies2,500P
repaid Insurance600Equipment5,000Notes
Payable5,000Accounts Payable2,500Unearned Service
Revenue1,200Common Stock10,000Dividends500Service
Revenue10,000Salaries & Wages Exp.4,000Rent
Expense900Totals28,70028,700Miscellaneous Expense
20055,970 55,970
Account TitlesDr.Cr.Dr.Cr.Dr.Cr. Dr. Cr. Dr. Cr.
Cash15,200 15,200 15,200
Supplies2,500 1,500 1,000 1,000
Prepaid Insurance600 50 550 550
Equipment5,000 5,000 5,000
Notes Payable5,000 5,000 5,000
Accounts Payable2,500 2,500 2,500
Unearned Service Revenue1,200 400 800 800
Common Stock10,000 10,000 10,000
Dividends500 500 500
Service Revenue10,000 400 10,600 10,600
200
Salaries & Wages Exp.4,000 1,200 5,200 5,200
Rent Expense900 900 900
Totals28,700 28,700
Supplies Expense1,500 1,500 1,500
Insurance Expense50 50 50
Accumulated Depreciation40 40 40
Depreciation Expense40 40 40
Accounts Receivable200 200 200

Interest Expense50 50 50
Interest Payable50 50 50
Salaries and Wages Payable1,200 1,200 1,200
Totals3,440 3,440 30,190 30,190 7,740 10,600
22,450 19,590
Net Income2,860 2,860
Totals10,600 10,600 22,450 22,450
Balance Sheet
Adjusted Income
Trial BalanceAdjustmentsTrial Balance Statement
Sheet1AdjustedIncomeTrial BalanceAdjustmentsTrial
BalanceStatementBalance SheetAccount
TitlesDr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.Cash15,20015,20015,200S
upplies2,5001,5001,0001,000Prepaid
Insurance60050550550Equipment5,0005,0005,000Notes
Payable5,0005,0005,000Accounts
Payable2,5002,5002,500Unearned Service
Revenue1,200400800800Common
Stock10,00010,00010,000Dividends500500500Service
Revenue10,00040010,60010,600200Salaries & Wages
Exp.4,0001,2005,2005,200Rent
Expense900900900Totals28,70028,700Supplies
Expense1,5001,5001,500Insurance Expense505050Accumulated
Depreciation404040Depreciation Expense404040Accounts
Receivable200200200Interest Expense505050Interest
Payable505050Salaries and Wages
Payable1,2001,2001,200Totals3,4403,44030,19030,1907,74010,
60022,45019,590Net
Income2,8602,860Totals10,60010,60022,45022,450Miscellaneo
us Expense 20055,970 55,970

3-‹#›
The Accounting Information System
Kimmel ● Weygandt ● Kieso
Financial Accounting, Eighth Edition
3
3-‹#›
Explain how accounts, debits, and credits are used to record
business transactions.
CHAPTER OUTLINE
Analyze the effect of business transactions on the basic
accounting equation.
1
2
LEARNING OBJECTIVES
Indicate how a journal is used in the recording process.
3
Explain how a ledger and posting help in the recording process.
4
Prepare a trial balance.
5
3-‹#›
Accounting Information System
System of
collecting and

processing transaction data and
communicating financial information to decision-makers.
LEARNING OBJECTIVE
Analyze the effect of business transactions on the basic
accounting equation.
1
LO 1
3-‹#›
Accounting information systems rely on a process referred to as
the accounting cycle.
Accounting Information System
Journalize
Post
Trial Balance
Adjusting Entries
Closing Entries
Most businesses use computerized accounting systems.
LO 1
3-‹#›
Transactions are economic events that require recording in the
financial statements.
Not all activities represent transactions.

Assets, liabilities, or stockholders’ equity items change as a
result of some economic event.
Dual effect on the accounting equation.
ACCOUNTING TRANSACTIONS
LO 1
3-‹#›
Question: Are the following events recorded in the accounting
records?
Event
Purchase computer
Criterion
Pay rent
Record/ Don’t Record
Discuss guided trip options with potential customer
Illustration 3-1
Transaction identification process
ACCOUNTING TRANSACTIONS
Is the financial position (assets, liabilities, or stockholders’
equity) of the company changed?
LO 1
3-‹#›

Assets
Liabilities
Stockholders’ Equity
=
+
Basic Accounting Equation
The process of identifying the specific effects of economic
events on the accounting equation.
ANALYZING TRANSACTIONS
LO 1
3-‹#›
Illustration 3-2
Expanded accounting equation
LO 1
3-‹#›
Event (1). On October 1, cash of $10,000 is invested in Sierra
Corporation by investors in exchange for $10,000 of common
stock.
1.+10,000+10,000

LO 1
3-‹#›
Event (2). On October 1, Sierra borrowed $5,000 from Castle
Bank by signing a 3-month, 12%, $5,000 note payable.
1.+10,000+10,000
2.+5,000+5,000
LO 1
3-‹#›
Event (3). On October 2, Sierra purchased equipment by paying
$5,000 cash to Superior Equipment Sales Co.
3.-5,000+5,000
1.+10,000+10,000
2.+5,000+5,000
LO 1
3-‹#›
Event (4). On October 2, Sierra received a $1,200 cash advance
from R. Knox, a client.

4.+1,200+1,200
3.-5,000+5,000
1.+10,000+10,000
2.+5,000+5,000
LO 1
3-‹#›
Event (5). On October 3, Sierra received $10,000 in cash from
Copa Company for guide services performed.
4.+1,200+1,200
5.+10,000+10,000
3.-5,000+5,000
1.+10,000+10,000
2.+5,000+5,000
LO 1
3-‹#›
Event (6). On October 3, Sierra Corporation paid its office rent
for the month of October in cash, $900.
4.+1,200+1,200
5.+10,000+10,000
6.-900-900
3.-5,000+5,000
1.+10,000+10,000

2.+5,000+5,000
LO 1
3-‹#›
Event (7). On October 4, Sierra paid $600 for a one-year
insurance policy that will expire next year on September 30.
4.+1,200+1,200
5.+10,000+10,000
6.-900-900
7.-600+600
3.-5,000+5,000
1.+10,000+10,000
2.+5,000+5,000
LO 1
3-‹#›
Event (8). On October 5, Sierra purchased an estimated three
months of supplies on account from Aero Supply for $2,500.
4.+1,200+1,200
5.+10,000+10,000
6.-900-900
7.-600+600
8.+2,500+2,500
3.-5,000+5,000

1.+10,000+10,000
2.+5,000+5,000
LO 1
3-‹#›
Event (9). On October 9, Sierra hired four new employees to
begin work on October 15.
4.+1,200+1,200
5.+10,000+10,000
6.-900-900
7.-600+600
8.+2,500+2,500
3.-5,000+5,000
1.+10,000+10,000
2.+5,000+5,000
An accounting transaction has not occurred.
LO 1
3-‹#›
Event (10). On October 20, Sierra paid a $500 dividend.
4.+1,200+1,200
5.+10,000+10,000
6.-900-900
7.-600+600

8.+2,500+2,500
10.-500-500
3.-5,000+5,000
1.+10,000+10,000
2.+5,000+5,000
LO 1
3-‹#›
Event (11). Employees have worked two weeks, earning $4,000
in salaries, which were paid on October 26.
4.+1,200+1,200
5.+10,000+10,000
6.-900-900
7.-600+600
8.+2,500+2,500
10.-500-500
11.-4,000-4,000
3.-5,000+5,000
1.+10,000+10,000
2.+5,000+5,000
LO 1
3-‹#›

INVESTOR INSIGHT
Why Accuracy Matters
While most companies record transactions very carefully, the
reality is that mistakes still happen. For example, bank
regulators fi ned Bank One Corporation (now JPMorgan Chase)
$1.8 million because they felt that the unreliability of the
bank’s accounting system caused it to violate regulatory
requirements. Also, in recent years Fannie Mae, the government
chartered mortgage association, announced a series of large
accounting errors. These announcements caused alarm among
investors, regulators, and politicians because they feared that
the errors might suggest larger, undetected problems. This was
important because the home-mortgage market depends on
Fannie Mae to buy hundreds of billions of dollars of mortgages
each year from banks, thus enabling the banks to issue new
mortgages. Finally, before a major overhaul of its accounting
system, the financial records of Waste Management Company
were in such disarray that of the company’s 57,000 employees,
10,000 were receiving pay slips that were in error. The
Sarbanes-Oxley Act was created to minimize the occurrence of
errors like these by increasing every employee’s responsibility
for accurate financial reporting.
LO 1
3-‹#›
Transaction Analysis
A tabular analysis of the transactions for the month of August is
shown below. Describe each transaction.
DO IT!
1
LO 1

1. Company issued shares of stock for $25,000 cash.
2. Company purchased $7,000 of equipment on account.
3. Company received $8,000 cash in exchange for services
performed.
4. Company paid $850 for this month’s rent.
3-‹#›
Double-entry system
Each transaction must affect two or more accounts to keep the
basic accounting equation in balance.
Recording done by debiting at least one account and crediting
another.
DEBITS must equal CREDITS.
Debit and Credit Procedures
LEARNING OBJECTIVE
Explain how accounts, debits, and credits are used to record
business transactions.
2
LO 2
3-‹#›
If Debits are greater than Credits, the account will have a debit
balance.
$10,000
Transaction #2
$3,000

$15,000
8,000
Transaction #3
Balance
Transaction #1
DEBIT AND CREDIT PROCEDURES
LO 2
3-‹#›
$10,000
Transaction #2
$3,000
Balance
Transaction #1
$1,000
8,000
Transaction #3
DEBIT AND CREDIT PROCEDURES
If Credits are greater than Debits, the account will have a credit
balance.
LO 2
3-‹#›
Assets - Debits should exceed credits.
Liabilities – Credits should exceed debits.

Procedures for Assets and Liabilities
▼ HELPFUL HINT
The normal balance is the side where increases in the account
are recorded.
LO 2
3-‹#›
Investments by stockholders and revenues increase
stockholders’ equity (credit).
Dividends and expenses decrease stockholder’s equity (debit).
Procedures for Stockholders’ Equity
LO 2
3-‹#›
Revenues increase stockholder’s equity.
Expenses have the opposite effect: expenses decrease

stockholders’ equity.
The effect of debits and credits on revenue and expense
accounts is the same as their effect on stockholders’ equity.
Procedures for Stockholders’ Equity
LO 2
3-‹#›
INVESTOR INSIGHT
Keeping Score
The Chicago Cubs baseball team has these major revenue and
expense accounts:
Revenues Expenses
Admissions (ticket sales) Players’ salaries
Concessions Administrative salaries
Television and radio Travel
Advertising Ballpark maintenance
Chicago Cubs
LO 2
3-‹#›
STOCKHOLDERS’ EQUITY RELATIONSHIPS
ILLUSTRATION 3-15
Stockholders’ equity
relationships

LO 2
3-‹#›
LO 2
Normal Balance Credit
Normal Balance Debit
DEBIT/CREDIT RULES
3-‹#›
Balance Sheet Income Statement
=
+
=
-
Asset
Liability
Equity

Revenue
Expense
Debit
Credit
SUMMARY OF DEBIT/CREDIT RULES
LO 2
3-‹#›
Relationship among the assets, liabilities and stockholders’
equity of a business:
The equation must be in balance after every transaction. For
every Debit there must be a Credit.
ILLUSTRATION 3-16
Assets
Liabilities
=
Basic Equation

Expanded Basic Equation
+
LO 2
3-‹#›
Review Question
Debits:
increase both assets and liabilities.
decrease both assets and liabilities.
increase assets and decrease liabilities.
decrease assets and increase liabilities.
LO 2
3-‹#›
Review Question
Accounts that normally have debit balances are:
assets, expenses, and revenues.
assets, expenses, and equity.
assets, liabilities, and dividends.
assets, dividends, and expenses.
LO 2

3-‹#›
The Recording Process
LEARNING OBJECTIVE
Indicate how a journal is used in the recording process.
3
LO 3
Journalize the transaction
Post to ledger accounts
Analyze each transaction in terms of its effect on the accounts.
Enter the transaction information in a journal.
Transfer the journal information to the appropriate accounts in
the ledger.
3-‹#›
THE RECORDING PROCESS
Analyze transaction
Enter
transaction
Transfer from journal to ledger
ILLUSTRATION 3-17
The recording process

LO 3
3-‹#›
Transactions recorded in chronological order in a journal before
they are transferred to the accounts.
Contributions to the recording process:
Discloses the complete effects of a transaction.
Provides a chronological record of transactions.
Helps to prevent or locate errors because the debit and credit
amounts can be easily compared.
THE JOURNAL
LO 3
3-‹#›
Journalizing - Entering transaction data in the journal.
Illustration: Presented below is information related to Sierra
Corporation.
Oct. 1Sierra issued common stock in exchange for $10,000 cash.
1Sierra borrowed $5,000 by signing a note.
2 Sierra purchased equipment for $5,000.
Instructions - Journalize these transactions.
THE JOURNAL
LO 3
3-‹#›

THE JOURNAL
Oct. 1Sierra issued common stock in exchange for $10,000 cash.
General Journal
Cash
Common Stock
10,000
10,000
Oct. 1
LO 3
3-‹#›
THE JOURNAL
Oct. 1Sierra borrowed $5,000 by signing a note.
General Journal
Cash
Notes Payable
5,000
5,000
Oct. 1
LO 3
3-‹#›

THE JOURNAL
Oct. 2Sierra purchased equipment for $5,000.
General Journal
Equipment
Cash
5,000
5,000
Oct. 2
LO 3
3-‹#›
THE JOURNAL
ILLUSTRATION 3-18
Recording transactions in
journal form
LO 3
3-‹#›
Boosting Profits
Microsoft originally designed the Xbox 360 to have 256
megabytes of memory. But the design department said that
amount of memory wouldn’t support the best special effects.
The purchasing department said that adding more memory

would cost $30—which was 10% of the estimated selling price
of $300. The marketing department, however, “determined that
adding the memory would let Microsoft reduce marketing costs
and attract more game developers, boosting royalty revenue. It
would also extend the life of the console, generating more
sales.” As a result of these changes, Xbox enjoyed great
success. But, it does have competitors. Its newest video game
console, Xbox One, is now in a battle with Sony’s Playstation4
for market share. How to compete? First, Microsoft bundled the
critically acclaimed Titan fall with its Xbox One. By including
the game most Xbox One buyers were going to purchase
anyway, Microsoft was making its console more attractive. In
addition, retailers are also discounting the Xbox, which should
get the momentum going for increased sales. What Microsoft is
doing is making sure that Xbox One is the center of the home
entertainment system in the long run.
LO 3
3-‹#›
Journal Entries
The following events occurred during the first month of
business of Hair It Is Inc., Kate Browne’s beauty salon:
Issued common stock to shareholders in exchange for $20,000
cash.
Purchased $4,800 of equipment on account (to be paid in 30
days).
Interviewed three people for the position of stylist.
The three activities are recorded as follows:
DO IT!
3
1. Cash 20,000

Common Stock 20,000
2. Equipment 4,800
Accounts Payable 4,800
3. No entry because no transaction occurred.
LO 3
3-‹#›
The Accounting Cycle
LEARNING OBJECTIVE
Explain how a ledger and posting help in the recording process.
4
LO 4
Trial Balance
Adjusting Entries
Closing Entries
3-‹#›
The Ledger is comprised of the entire group of accounts
maintained by a company.
THE LEDGER
ILLUSTRATION 3-19

The general ledger
LO 4
3-‹#›
Listing of accounts used by a company to record transactions.
CHART OF ACCOUNTS
ILLUSTRATION 3-20
Chart of accounts for Sierra
Corporation
LO 4
3-‹#›
General Ledger
J1
The process of transferring journal entry amounts to ledger
accounts.
POSTING
General Journal
Cash
Common Stock
10,000
10,000
Oct. 1

J1
Oct. 1
Stock issued
10,000
10,000
101
LO 4
3-‹#›
POSTING
Review Question
Posting:
normally occurs before journalizing.
transfers ledger transaction data to the journal.
is an optional step in the recording process.
transfers journal entries to ledger accounts.
LO 4
3-‹#›
ETHICS INSIGHT
A Convenient Overstatement
Sometimes a company’s investment securities suffer a
permanent decline in value below their original cost. When this
occurs, the company is supposed to reduce the recorded value of
the securities on its balance sheet (“write them down” in
common financial lingo) and record a loss. It appears, however,
that during the financial crisis of 2008, employees at some

financial institutions chose to look the other way as the value of
their investments skidded. A number of Wall Street traders that
worked for the investment bank Credit Suisse Group were
charged with intentionally overstating the value of securities
that had suffered declines of approximately $2.85 billion. One
reason that they may have been reluctant to record the losses is
out of fear that the company’s shareholders and clients would
panic if they saw the magnitude of the losses. However,
personal self-interest might have been equally to blame—the
bonuses of the traders were tied to the value of the investment
securities.
Source: S. Pulliam, J. Eaglesham, and M. Siconolfi , “U.S.
Plans Changes on Bond Fraud,” Wall Street Journal Online
(February 1, 2012).
Credit Suisse Group
LO 4
3-‹#›
Follow these steps:
1. Determine what type of account is involved.
2. Determine what items increased or decreased and by how
much.
3. Translate the increases and decreases into debits and credits.
RECORDING PROCESS ILLUSTRATED
ILLUSTRATION 3-21
Investment of cash by
stockholders
LO 4
3-‹#›

LO 4
ILLUSTRATION 3-22
3-‹#›
LO 4
ILLUSTRATION 3-23
3-‹#›
ILLUSTRATION 3-24
LO 4
3-‹#›
ILLUSTRATION 3-25
LO 4
3-‹#›
ILLUSTRATION 3-26

LO 4
3-‹#›
ILLUSTRATION 3-27
LO 4
3-‹#›
LO 4
ILLUSTRATION 3-28
3-‹#›
ILLUSTRATION 3-29
LO 4
3-‹#›
ILLUSTRATION 3-30
LO 4
3-‹#›

ILLUSTRATION 3-31
LO 4
3-‹#›
LO 4
JOURNALIZING SUMMARY
ILLUSTRATION 3-32
General journal for Sierra Corporation
3-‹#›
LO 4
Illustration 3-32
3-‹#›
ILLUSTRATION 3-33
General ledger for Sierra Corporation
POSTING SUMMARY

3-‹#›
Selected transactions from the journal of Faital Inc. during its
first month of operations are presented below. Post these
transactions to T-accounts.
Posting
DO IT!
4
LO 4
3-‹#›
The Accounting Cycle
LEARNING OBJECTIVE
Prepare a trial balance.
5
LO 5

Prepare a Trial Balance
Adjusting Entries
Closing Entries
3-‹#›
A list of accounts and their balances at a given time.
Accounts are listed in the order in which they appear in the
ledger.
Purpose is to prove that debits equal credits.
May also uncover errors in journalizing and posting.
Useful in the preparation of financial statements.
TRIAL BALANCE
▼ HELPFUL HINT
Note that the order of
presentation in the trial balance is:
Assets
Liabilities
Stockholders’ equity
Revenues
Expenses
LO 5
3-‹#›

TRIAL BALANCE
ILLUSTRATION 3-34
Sierra Corporation
trial balance
LO 5
3-‹#›
The trial balance may balance even when
a transaction is not journalized,
a correct journal entry is not posted,
a journal entry is posted twice,
incorrect accounts are used in journalizing or posting, or
offsetting errors are made in recording the amount of a
transaction.
ETHICS NOTE An error is the result of an unintentional
mistake. It is neither ethical nor unethical. An irregularity is an
intentional misstatement, which is viewed as unethical.
LIMITATIONS OF A TRIAL BALANCE
LO 5
3-‹#›
Review Question
A trial balance will not balance if:
a correct journal entry is posted twice.
the purchase of supplies on account is debited to Supplies and
credited to Cash.
a $100 cash dividends is debited to the Dividends account for

$1,000 and credited to Cash for $100.
a $450 payment on account is debited to Accounts Payable for
$45 and credited to Cash for $45.
TRIAL BALANCE
LO 5
3-‹#›
Trial Balance
DO IT!
5
The following accounts come from the ledger of SnowGo
Corporation at December 31, 2017.
Equipment $88,000
Dividends 8,000
Accounts Payable 22,000
Salaries and Wages
Expense42,000
Accounts Receivable4,000
Common Stock$20,000
Salaries and Wages
Payable 2,000
Notes Payable (due in
3 months) 19,000
Utilities Expense 3,000
Prepaid Insurance 6,000
Cash 7,000
Prepare a trial balance in good form.
LO 5

3-‹#›
LO 5
3-‹#›
KEY POINTS
A Look at IFRS
LEARNING OBJECTIVE
Compare the procedures for the recording process under GAAP
and IFRS.

6
Similarities
Transaction analysis is the same under IFRS and GAAP.
Both the IASB and the FASB go beyond the basic definitions
provided in the textbook for the key elements of financial
statements, that is assets, liabilities, equity, revenues, and
expenses. The implications of the expanded definitions are
discussed in more advanced accounting courses.
LO 6
3-‹#›
A Look at IFRS
KEY POINTS
Similarities
As shown in the textbook, dollar signs are typically used only in
the trial balance and the financial statements. The same practice
is followed under IFRS, using the currency of the country where
the reporting company is headquartered.
A trial balance under IFRS follows the same format as shown in
the textbook.
LO 6
3-‹#›

A Look at IFRS
KEY POINTS
Differences
IFRS relies less on historical cost and more on fair value than
do FASB standards.
Internal controls are a system of checks and balances designed
to prevent and detect fraud and errors. While most public U.S.
companies have these systems in place, many non-U.S.
companies have never completely documented the controls nor
had an independent auditor attest to their effectiveness.
LO 6
3-‹#›
A Look at IFRS
LOOKING TO THE FUTURE
The basic recording process shown in this textbook is followed
by companies around the globe. It is unlikely to change in the
future. The definitional structure of assets, liabilities, equity,
revenues, and expenses may change over time as the IASB and
FASB evaluate their overall conceptual framework for
establishing accounting standards.
LO 6
3-‹#›

IFRS Practice
Which statement is correct regarding IFRS?
IFRS reverses the rules of debits and credits, that is, debits are
on the right and credits are on the left.
IFRS uses the same process for recording transactions as GAAP.
The chart of accounts under IFRS is different because revenues
follow assets.
None of the above statements are correct.
A Look at IFRS
LO 6
3-‹#›
IFRS Practice
A trial balance:
is the same under IFRS and GAAP.
proves that transactions are recorded correctly.
proves that all transactions have been recorded.
will not balance if a correct journal entry is posted twice.
A Look at IFRS
LO 6
3-‹#›

IFRS Practice
One difference between IFRS and GAAP is that:
GAAP uses accrual-accounting concepts and IFRS uses
primarily the cash basis of accounting.
IFRS uses a different posting process than GAAP.
IFRS uses more fair value measurements than GAAP.
the limitations of a trial balance are different between IFRS and
GAAP.
A Look at IFRS
LO 6
3-‹#›
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COPYRIGHT
3-‹#›

Account Name
Debit / Dr.
Credit / Cr.
Account Name
Debit / Dr.
Credit / Cr.
Account Name
Debit / Dr.
Credit / Cr.
Chapter
3-23
Assets
Assets
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Chapter
3-24
Liabilities
Liabilities
Debit / Dr.

Credit / Cr.
Normal Balance
Normal Balance
Chapter 3-*
Assets
Debit / Dr.
Credit / Cr.
Normal Balance
Chapter 3-*
Liabilities
Debit / Dr.
Credit / Cr.
Normal Balance
Chapter
3-25
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Common Stock
Common Stock
Chapter
3-23
Dividends

Dividends
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Chapter
3-25
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Stockholders
Stockholders
’
’
Equity
Equity
Chapter
3-25
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Retained Earnings
Retained Earnings
Chapter 3-*
Debit / Dr.
Credit / Cr.
Normal Balance
Retained Earnings

Chapter 3-*
Debit / Dr.
Credit / Cr.
Normal Balance
Common Stock
Chapter 3-*
Dividends
Debit / Dr.
Credit / Cr.
Normal Balance
Chapter 3-*
Debit / Dr.
Credit / Cr.
Normal Balance
Chapter
3-27
Debit / Dr.

Credit / Cr.
Normal Balance
Normal Balance
Expense
Expense
Chapter
3-26
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Revenue
Revenue
Chapter 3-*
Debit / Dr.
Credit / Cr.
Normal Balance
Expense
Chapter 3-*
Debit / Dr.
Credit / Cr.
Normal Balance
Revenue
Chapter

3-23
Assets
Assets
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Chapter
3-27
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Expense
Expense
Chapter
3-24
Liabilities
Liabilities
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Chapter
3-25
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Stockholders
Stockholders
’
’
Equity
Equity
Chapter

3-26
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Revenue
Revenue
Chapter 3-*
Debit / Dr.
Credit / Cr.
Normal Balance
Chapter 3-*
Debit / Dr.
Credit / Cr.
Normal Balance
Revenue
Chapter 3-*
Assets

Debit / Dr.
Credit / Cr.
Normal Balance
Chapter 3-*
Debit / Dr.
Credit / Cr.
Normal Balance
Expense
Chapter 3-*
Liabilities
Debit / Dr.
Credit / Cr.
Normal Balance
Account TitleRef.DebitCreditDate
Sheet1DateAccount TitleRef.DebitCredit
Cash
Acct. No. 101
ExplanationRef.DebitCreditBalanceDate
Account TitleRef.DebitCreditDate
Chart of AccountsChart of AccountsAcct.
No.Account100Cash105Accounts

receivable110Inventory130Building200Accounts
payable220Note payable300Common stock330Retained
earnings400Sales500Cost of goods sold
General LedgerGeneral JournalDateAccount
TitleRef.DebitCreditJan.3Cash100100,000Common
stock300100,00010Building130150,000Note
payable220150,00015Inventory11060,000Accounts
payable20060,00020Accounts
receivable10575,000Sales40075,00020Cost of goods
sold50030,000Inventory11030,00029Cash10040,000Accounts
receivable10540,000General LedgerCashAcct. No.
100DateExplanationRef.DebitCreditBalanceJan.3Sale of
common stockGJ100,000100,00020GJ40,000140,000Accounts
ReceivableAcct. No.
105DateExplanationRef.DebitCreditBalanceJan.20GJ75,00075,0
00GJ40,00035,000InventoryAcct. No.
0020GJ30,00030,000BuildingAcct. No.
130DateExplanationRef.DebitCreditBalanceJan.10GJ150,00015
0,000Accounts payableAcct. No.
200DateExplanationRef.DebitCreditBalanceJan.15GJ60,000(60,
000)Notes payableAcct. No.
220DateExplanationRef.DebitCreditBalanceJan.10GJ150,000(15
0,000)Common stockAcct. No.
300DateExplanationRef.DebitCreditBalanceJan.3Sale for
cashGJ100,000(100,000)Retained EarningsAcct. No.
330DateExplanationRef.DebitCreditBalance- 0SalesAcct. No.
400DateExplanationRef.DebitCreditBalanceJan.20GJ75,000(75,
000)Cost of Goods SoldAcct. No.
00
Trial BalanceTrial BalanceAcct.
No.AccountDebitCredit100Cash140,000105Accounts
receivable35,000110Inventory30,000130Building150,000200Ac
counts payable60,000220Note payable150,000300Common
stock100,000330Retained earnings400Sales75,000500Cost of

goods sold30,000385,000385,000
Journal EntryNo.AccountDebitCredit110,000
Sheet1 (2)DateAccount
TitleRef.DebitCreditJan.3Cash100100,000Common
stock300100,000CashAcct. No.
101DateExplanationRef.DebitCreditBalance
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01lo1,ch04,ch04lo1,ch04lo2,ch04lo3,ch04lo4,ch04lo5,ch04ifrs
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LEARNINGOBJECTIVE1
Identify the forms of business organization and the uses of
accounting information.
Suppose you graduate with a business degree and decide you
want to start your own business. But what
kind of business? You enjoy working with people, especially
teaching them new skills. You also spend most
of your free time outdoors, kayaking, backpacking, skiing, rock
climbing, and mountain biking. You think
you might be successful in opening an outdoor guide service
where you grew up, in the Sierra Nevada
mountains.
FORMS OF BUSINESS ORGANIZATION
Your next decision is to determine the organizational form of
your business. You have three choices—sole
proprietorship, partnership, or corporation.

SOLEPROPRIETORSHIP
You might choose the sole proprietorship form for your outdoor
guide service. A business owned by one
person is a soleproprietorship. It is simpletosetup and
givesyoucontrol over the business. Small
owner-operated businesses such as barber shops, law of�ices,
and auto repair shops are often sole
proprietorships, as are farms and small retail stores.
PARTNERSHIP
Another possibility is for you to join forces with other
individuals to form a partnership. A business owned
by two or more persons associated as partners is a partnership.
Partnerships often are formed because
one individual does not have enougheconomicresources to
initiate or expand the business. Sometimes
partnersbringuniqueskillsorresources to the partnership. You
and your partners should formalize
your duties and contributions in a written partnership
agreement. Retail and service-type businesses,
including professional practices (lawyers, doctors, architects,
and certi�ied public accountants), often
organize as partnerships.
4/2/2019 Print
AlternativeTerminologynotespresent synonymous terms that

youmay
comeacrossinpractice.
CORPORATION
As a third alternative, you might organize as a corporation. A
business organized as a separate legal entity
owned by stockholders is a corporation. Investors in a
corporation receive shares of stock to indicate
their ownership claim. Buying stock in a corporation is often
more attractive than investing in a
partnership because shares of stock are easy to sell (transfer
ownership). Selling a proprietorship or
partnership interest is much more involved. Also, individuals
can become stockholders by investing
relatively small amounts of money. Therefore, it is easier for
corporations to raise funds. Successful
corporations often have thousands of stockholders, and their
stock is traded on organized stock exchanges
like the New York Stock Exchange. Many businesses start as
sole proprietorships or partnerships and
eventually incorporate.
Other factors to consider in deciding which organizational form
to choose are taxesandlegalliability. If
you choose a sole proprietorship or partnership, you generally
receive more favorable tax treatment than
a corporation. However, proprietors and partners are personally
liable for all debts and legal obligations of
the business; corporate stockholders are not. In other words,
corporate stockholders generally pay higher
taxes but have no personal legal liability. We will discuss these
issues in more depth in a later chapter.
Finally, while sole proprietorships, partnerships, and
corporations represent the main types of business

organizations, hybrid forms are now allowed in all states. These
hybrid business forms combine the tax
advantages of partnerships with the limited liability of
corporations. Probably the most common among
4/2/2019 Print
these hybrids types are limited liability companies (LLCs) and
subchapter S corporations. These forms are
discussed extensively in business law classes.
The combined number of proprietorships and partnerships in the
United States is more than �ive times
the number of corporations. However, the revenue produced by
corporations is eight times greater. Most
of the largest businesses in the United States—for example,
Coca-Cola, ExxonMobil, General Motors,
Citigroup, and Microsoft—are corporations. Because the
majority of U.S. business is done by corporations,
the emphasis in this textbook is on the corporate form of
organization.
ALTERNATIVE TERMINOLOGY
Stockholders are sometimes called shareholders.
USERS AND USES OF FINANCIAL INFORMATION
The purpose of �inancial information is to provide inputs for
decision-making. Accounting is the
information system that identi�ies, records, and communicates

the economic events of an organization to
interested users. Users of accounting information can be divided
broadly into two groups: internal users
and external users.
InternalUsers
Internalusers of accounting information are managers who plan,
organize, and run a business. These
include marketingmanagers, productionsupervisors,
�inancedirectors, andcompany of�icers. In
running a business, managers must answer many important
questions, as shown in Illustration 1-1
(http://content.thuzelearning.com/books/Kimmel.2745.17.1/secti
ons/ch01lo1#c01-�ig-0001).
ILLUSTRATION1-1
Questionsthatinternalusersask
Accounting Across the Organization boxes show applications of
accountinginformationinvariousbusinessfunctions.
https://content.ashford.edu/books/Kimmel.2745.17.1/sections/ch
01lo1#c01-fig-0001
4/2/2019 Print
To answer these and other questions, you need detailed
information on a timely basis. For internal users,
accounting provides internal reports, such as �inancial
comparisons of operating alternatives, projections

of income from new sales campaigns, and forecasts of cash
needs for the next year. In addition, companies
present summarized �inancial information in the form of
�inancial statements.
ClifBar&Company
OwningaPieceoftheBar
The original Clif Bar® energy bar was created in 1990 after six
months of experimentation by Gary Erickson and his mother in
her
kitchen. Today, the company has almost 300 employees and is
considered one of the leading Landor's Breakaway Brands®.
One of
Clif Bar & Company's proudest moments was the creation of an
employee stock ownership plan (ESOP) in 2010. This plan gives
its
employees 20% ownership of the company. The ESOP also
resulted in
Clif Bar enacting an open-book management program, including
the
commitment to educate all employee-owners about its �inances.
Armed with basic
accounting knowledge, employees are more aware of the
�inancial impact of their actions,
which leads to better decisions.
Whatarethebene�itstothecompanyandtotheemployeesofmakingth
e�inancial
statementsavailabletoallemployees?(GotoWileyPLUSforthisans
werand
additionalquestions.)

ExternalUsers
There are several types of externalusers of accounting
information. Investors (owners) use accounting
information to make decisions to buy, hold, or sell stock.
Creditors such as suppliers and bankers use
accounting information to evaluate the risks of selling on credit
or lending money. Some questions that
investors and creditors may ask about a company are shown in
Illustration 1-2
ons/ch01lo1#c01-�ig-0002).
ILLUSTRATION1-2
Questionsthatexternalusersask
01lo1#c01-fig-0002
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The information needs and questions of other external users
vary considerably. Taxingauthorities, such
as the Internal Revenue Service, want to know whether the
company complies with the tax laws.
Customers are interested in whether a company like General
Motors will continue to honor product
warranties and otherwise support its product lines. Laborunions,
such as the Major League Baseball
Players Association, want to know whether the owners have the
ability to pay increased wages and

bene�its. Regulatoryagencies, such as the Securities and
Exchange Commission or the Federal Trade
Commission, want to know whether the company is operating
within prescribed rules. For example,
Enron, Dynegy, Duke Energy, and other big energy-trading
companies reported record pro�its at the same
time as California was paying extremely high prices for energy
and suffering from blackouts. This disparity
caused regulators to investigate the energy traders to make sure
that the pro�its were earned by legitimate
and fair practices.
Spinning the Career Wheel
How will the study of accounting help you? A working
knowledge of
accounting is desirable for virtually every �ield of business.
Some
examples of how accounting is used in business careers include
the
following.
Generalmanagement: Managers of Ford Motors,
Massachusetts General Hospital, California State University–
Fullerton, a McDonald's franchise, and a Trek bike shop all
need to understand accounting data in order to make wise
business decisions.
Marketing: Marketing specialists at Procter & Gamble must
be sensitive to costs and bene�its, which accounting helps
them quantify and understand. Making a sale is meaningless
unless it is a pro�itable sale.
Finance: Do you want to be a banker for Citicorp, an

investment analyst for Goldman Sachs, or a stock broker for
Merrill Lynch? These �ields rely heavily on accounting
knowledge to analyze �inancial statements. In fact, it is
dif�icult to get a good job in a �inance function without two or
three courses in accounting.
Realestate: Are you interested in being a real estate broker
for Prudential Real Estate? Because a third party—the bank
—is almost always involved in �inancing a real estate
transaction, brokers must understand the numbers involved:
Can the buyer afford to make the payments to the bank? Does
the cash �low from an industrial property justify the purchase
price? What are the tax bene�its of the purchase?
4/2/2019 Print
Howmightaccountinghelpyou?(GotoWileyPLUSforthisansweran
dadditional
questions.)
ETHICS IN FINANCIAL REPORTING
People won't gamble in a casino if they think it is “rigged.”
Similarly, people won't “play” the stock market
if they think stock prices are rigged. At one time, the �inancial
press was full of articles about �inancial
scandals at Enron, WorldCom, HealthSouth, and AIG. As more
scandals came to light, a mistrust of
�inancial reporting in general seemed to be developing. One
article in the Wall Street Journal noted that
“repeated disclosures about questionable accounting practices

have bruised investors' faith in the
reliability of earnings reports, which in turn has sent stock
prices tumbling.” Imagine trying to carry on a
business or invest money if you could not depend on the
�inancial statements to be honestly prepared.
Information would have no credibility. There is no doubt that a
sound, well-functioning economy depends
on accurate and dependable �inancial reporting.
United States regulators and lawmakers were very concerned
that the economy would suffer if investors
lost con�idence in corporate accounting because of unethical
�inancial reporting. Congress passed the
Sarbanes-OxleyAct(SOX) to reduce unethical corporate
behavior and decrease the likelihood of future
corporate scandals. As a result of SOX, top management must
now certify the accuracy of �inancial
information. In addition, penalties for fraudulent �inancial
activity are much more severe. Also, SOX
increased both the independence of the outside auditors who
review the accuracy of corporate �inancial
statements and the oversight role of boards of directors.
ETHICSNOTE
Circus-founder P.T. Barnum is alleged to have said, “Trust
everyone, but cut
the deck.” What Sarbanes-Oxley does is to provide measures
that (like cutting
the deck of playing cards) help ensure that fraud will not occur.
EthicsNoteshelpsensitizeyoutosomeoftheethicalissuesinaccounti
ng.
Effective �inancial reporting depends on sound ethical
behavior. To sensitize you to ethical situations and

to give you practice at solving ethical dilemmas, we address
ethics in a number of ways in this textbook.
(1) A number of the FeatureStories and other parts of the text
discuss the central importance of ethical
behavior to �inancial reporting. (2) Ethics Insight boxes and
marginal Ethics Notes highlight ethics
situations and issues in actual business settings. (3) Many of the
People, Planet, andPro�it Insightboxes
focus on ethical issues that companies face in measuring and
reporting social and environmental issues.
(4) At the end of each chapter, an EthicsCase simulates a
business situation and asks you to put yourself in
the position of a decision-maker in that case.
4/2/2019 Print
When analyzing these various ethics cases and your own ethical
experiences, you should apply the three
steps outlined in Illustration 1-3
ons/ch01lo1#c01-�ig-0003).
ILLUSTRATION1-3
Stepsinanalyzingethicscases
ETHICS INSIGHT
Dewey & LeBoeuf LLP
IFeltthePressure—WouldYou?

“I felt the pressure.” That's what some of the employees of the
now-
defunct law �irm of Dewey & LeBoeuf LLP indicated when
they helped
to overstate revenue and use accounting tricks to hide losses
and
cover up cash shortages. These employees worked for the
former
�inance director and former chief �inancial of�icer (CFO) of
the �irm.
Here are some of their comments:
“I was instructed by the CFO to create invoices, knowing they
would not be sent to clients. When I created these invoices, I
knew that it was inappropriate.”
“I intentionally gave the auditors incorrect information in the
course of the audit.”
What happened here is that a small group of lower-level
employees over a period of years
carried out the instructions of their bosses. Their bosses,
however, seemed to have no
concern as evidenced by various e-mails with one another in
which they referred to their
�inancial manipulations as accounting tricks, cooking the
books, and fake income.
Source: Ashby Jones, “Guilty Pleas of Dewey Staff Detail the
Alleged Fraud,” Wall Street Journal
(March 28, 2014).
Why did these employees lie, and what do you believe should be
their penalty for these
lies? (Go to WileyPLUS for this answer and additional

questions.)
01lo1#c01-fig-0003
4/2/2019 Print
Insightboxesprovideexamples of business situations from
various perspectives—ethics, investor,
international, and corporate social responsibility. Guideline
answers to the critical thinking
questions are available in WileyPLUS and at
www.wiley.com/college/weygandt
(http://www.wiley.com/college/weygandt).Additionalquestionsa
reofferedinWileyPLUS.
DOIT!1
Business Organization Forms
DOIT!exercisespromptyoutostopandreviewthekeypoints
youhave just studied. The ActionPlan offers you tips about
howtoapproachtheproblem.
In choosing the organizational form for your outdoor guide
service, you should consider
the pros and cons of each. Identify each of the following
organizational characteristics
with the organizational form or forms with which it is
associated.

1. Easier to raise funds.
2. Simple to establish.
3. No personal legal liability.
4. Tax advantages.
5. Easier to transfer ownership.
ActionPlan
✓ Know which organizational form best matches the business
type, size, and preferences of the owner(s).
http://www.wiley.com/college/weygandt
4/2/2019 Print
SOLUTION
1. Easier to raise funds: Corporation.
2. Simple to establish: Sole proprietorship and partnership.
3. No personal legal liability: Corporation.
4. Tax advantages: Sole proprietorship and partnership.
5. Easier to transfer ownership: Corporation.

Related exercise material: BE1-1andDOIT!1-1.
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4
Accrual Accounting Concepts
CHAPTER PREVIEW
As indicated in the Feature Story, making adjustments is
necessary to avoid
misstatement of revenues and expenses such as those at
Groupon. In this chapter, we
introduce you to the accrual accounting concepts that make such
adjustments possible.
4/2/2019 Print
KeepingTrackofGroupons
Who doesn't like buying things at a discount? That's why it's not
surprising that three years after it started
as a company, Groupon, Inc. was estimated to be worth $16

billion. This translates into an average
increase in value of almost $15 million per day.
Now consider that Groupon had previously been estimated to be
worth even more than that. What
happened? Well, accounting regulators and investors began to
question the way that Groupon had
accounted for some of its transactions. Groupon sells coupons
(“Groupons”), so how hard can it be to
account for that? It turns out that accounting for coupons is not
as easy as you might think.
First, consider what happens when Groupon makes a sale.
Suppose it sells a Groupon for $30 for Highrise
Hamburgers. When it receives the $30 from the customer, it
must turn over half of that amount ($15) to
Highrise Hamburgers. So should Groupon record revenue for
the full $30 or just $15? Until recently,
Groupon recorded the full $30. But, in response to an SEC
ruling on the issue, Groupon now records
revenue of $15 instead. This caused Groupon to restate its
previous �inancial statements. This restatement
reduced annual revenue by $312.9 million.
A second issue is a matter of timing. When should Groupon
record this $15 revenue? Should it record the
revenue when it sells the Groupon, or must it wait until the
customer uses the Groupon at Highrise
Hamburgers? The accounting becomes even more complicated
when you consider the company's loyalty
programs. Groupon offers free or discounted Groupons to its
subscribers for doing things such as referring
new customers or participating in promotions. These Groupons
are to be used for future purchases, yet
the company must record the expense at the time the customer
receives the Groupon.

Finally, Groupon, like all other companies, relies on many
estimates in its �inancial reporting. For example,
Groupon reports that “estimates are utilized for, but not limited
to, stock-based compensation, income
taxes, valuation of acquired goodwill and intangible assets,
customer refunds, contingent liabilities and
the depreciable lives of �ixed assets.” It notes that “actual
results could differ materially from those
estimates.” So, next time you use a coupon, think about what
that means for the company's accountants!
4/2/2019 Print
LEARNINGOBJECTIVE1
adjusting
entries.
Businesses need feedback about how well they are performing
during a period of time. For example,
management usually wants monthly reports on �inancial
results, most large corporations are required to
present quarterly and annual �inancial statements to
stockholders, and the Internal Revenue Service
requires all businesses to �ile annual tax returns.
Accountingdivides theeconomic lifeofabusiness
into arti�icial time periods. As indicated in Chapter 2

ons/ch02#ch02) , this is the periodicity
assumption.
Accountingtimeperiodsaregenerallyamonth,aquarter,orayear.
Companies often
report using the calendar year (i.e., January 1 to December 31)
but sometimes choose a different 12-
month period (e.g., August 1 to July 31).
Many business transactions affect more than one of these
arbitrary time periods. For example, a new
building purchased by Citigroup or a new airplane purchased by
Delta Air Lines will be used for many
years. It would not make sense to expense the full cost of the
building or the airplane at the time of
purchase because each will be used for many subsequent
periods. Instead, companies allocate the cost to
the periods of use.
Determining the amount of revenues and expenses to report in a
given accounting period can be dif�icult.
Proper reporting requires an understanding of the nature of the
company's business. Two principles are
used as guidelines: the revenue recognition principle and the
expense recognition principle.
▼ HELPFUL HINT
An accounting time period that is one year long is called a
�iscalyear.
THE REVENUE RECOGNITION PRINCIPLE
When a company agrees to perform a service or sell a product to
a customer, it has a performance
obligation. The revenue recognition principle requires that
companies recognize revenue in the
accountingperiodinwhichtheperformanceobligationissatis�ied.

To illustrate, assume Conrad Dry
Cleaners cleans clothing on June 30, but customers do not claim
and pay for their clothes until the �irst
week of July. Under the revenue recognition principle, Conrad
records revenue in June when it satis�ies its
performance obligation, which is when it performs the service,
not in July when it receives the cash. At
June 30, Conrad would report a receivable on its balance sheet
and revenue in its income statement for the
service performed. The journal entries for June and July would
be as follows.
02#ch02
4/2/2019 Print
THE EXPENSE RECOGNITION PRINCIPLE
In recognizing expenses, a simple rule is followed: “Let the
expenses follow the revenues.” Thus, expense
recognition is tied to revenue recognition. Applied to the
preceding example, this means that the salary
expense Conrad incurred in performing the cleaning service on
June 30 should be reported in the same
period in which it recognizes the service revenue. The critical
issue in expense recognition is determining
when the expense makes its contribution to revenue. This may
or may not be the same period in which the
expense is paid. If Conrad does not pay the salary incurred on
June 30 until July, it would report salaries
and wages payable on its June 30 balance sheet.

4/2/2019 Print
The practice of expense recognition is referred to as the
expenserecognitionprinciple (often referred to
as the matching principle). It dictates that efforts (expenses) be
matched with results (revenues).
Illustration 4-1
ons/ch04lo1#c04-�ig-0001)
shows these relationships.
ILLUSTRATION4-1
GAAPrelationshipsinrevenueandexpenserecognition
INVESTOR INSIGHT
Apple Inc.
ReportingRevenueAccurately
Until recently, electronics manufacturer Apple was required to
spread
the revenues from iPhone sales over the two-year period
following
the sale of the phone. Accounting standards required this
because
Apple was obligated to provide software updates after the phone
was
sold. Since Apple had service obligations after the initial date

of sale,
it was forced to spread the revenue over a two-year period. As a
result, the rapid growth of iPhone sales was not fully re�lected
in the
revenue amounts reported in Apple's income statement. A new
accounting standard now enables Apple to report much more of
its
iPhone revenue at the point of sale. It was estimated that under
the
new rule revenues would have been about 17% higher and
earnings per share almost
50% higher.
04lo1#c04-fig-0001
4/2/2019 Print
In the past, why was it argued that Apple should spread the
recognition of iPhone revenue
over a two-year period, rather than recording it upfront? (Go to
WileyPLUS for this
answer and additional questions.)
DECISION TOOLS
The revenue recognition principle and the expense recognition
principle help
to ensure that companies report the correct amount of revenues
and
expenses in a given period.

ACCRUAL VERSUS CASH BASIS OF ACCOUNTING
Accrual-basis accounting means that transactions that change a
company's �inancial statements are
recorded intheperiodsinwhichtheeventsoccur, even if cash was
not exchanged. For example, using
the accrual basis means that companies recognize revenues
when they perform the services (the revenue
recognition principle), even if cash was not received. Likewise,
under the accrual basis, companies
recognize expenses when incurred (the expense recognition
principle), even if cash was not paid.
An alternative to the accrual basis is the cash basis. Under cash-
basis accounting, companies record
revenue at the time they receive cash. They record an expense at
the time they pay out cash. The cash
basis seems appealing due to its simplicity, but it often
produces misleading �inancial statements. For
example, it fails to record revenue for a company that has
performed services but has not yet received
payment. As a result, the cash basis may not re�lect revenue in
the period that a performance obligation is
satis�ied. Cash-
basisaccountingisnotinaccordancewithgenerallyacceptedaccounti
ngprinciples
(GAAP).
Illustration 4-2
ons/ch04lo1#c04-�ig-0002)
compares accrual-based numbers and cash-based numbers.
Suppose that Fresh Colors paints a large
building in 2016. In 2016, it incurs and pays total expenses
(salaries and paint costs) of $50,000. It bills
the customer $80,000 but does not receive payment until 2017.

On an accrual basis, Fresh Colors reports
$80,000 of revenue during 2016 because that is when it
performed the service. The company matches
expenses of $50,000 to the $80,000 of revenue. Thus, 2016 net
income is $30,000 ($80,000−$50,000). The
$30,000 of net income reported for 2016 indicates the
pro�itability of Fresh Colors' efforts during that
period.
04lo1#c04-fig-0002
4/2/2019 Print
ILLUSTRATION4-2
Accrual-versuscash-basisaccounting
If Fresh Colors instead used cash-basis accounting, it would
report $50,000 of expenses in 2016 and
$80,000 of revenues during 2017. As shown in Illustration 4-2
ons/ch04lo1#c04-�ig-0002) , it would report a
loss of $50,000 in 2016 and net income of $80,000 in 2017.
Clearly, the cash-basis measures are
misleading because the �inancial performance of the company
would be misstated for both 2016 and
2017.
INTERNATIONAL NOTE
Although different accounting standards are often used by
companies in

other countries, the accrual basis of accounting is central to all
of these
standards.
In order for revenues to be recorded in the period in which the
performance obligations are satis�ied and
for expenses to be recognized in the period in which they are
incurred, companies make adjusting entries.
Adjusting entries ensure that the revenue recognition and
expense recognition principles are
followed.
Adjusting entries are necessary because the trialbalance—the
�irst pulling together of the transaction
data—may not contain up-to-date and complete data. This is
true for several reasons:
1. Some events are not recorded daily because it is not
ef�icient to do so. Examples are the use of
supplies and the earning of wages by employees.
2. Some costs are not recorded during the accounting period
because these costs expire with the
passage of time rather than as a result of recurring daily
transactions. Examples are charges
related to the use of buildings and equipment, rent, and
insurance.
04lo1#c04-fig-0002
4/2/2019 Print

3. Some items may be unrecorded. An example is a utility
service bill that will not be received until
the next accounting period.
Adjustingentriesarerequiredeverytimeacompanyprepares
�inancial statements. The company
analyzes each account in the trial balance to determine whether
it is complete and up-to-date for �inancial
statement purposes. Every adjusting entry will include one
income statement account and one
balancesheetaccount.
Adjusting entries are classi�ied as either deferrals or accruals.
As Illustration 4-3
ons/ch04lo1#c04-�ig-0003) shows, each of
these classes has two subcategories.
ILLUSTRATION4-3
Categoriesofadjustingentries
Subsequent sections give examples of each type of adjustment.
Each example is based on the October 31
trial balance of Sierra Corporation from Chapter 3
ons/ch03#ch03) . It is reproduced in
Illustration 4-4
ons/ch04lo1#c04-�ig-0004) .
Note that Retained Earnings has been added to this trial balance
with a zero balance. We will explain its
use later.

04lo1#c04-fig-0003
03#ch03
04lo1#c04-fig-0004
4/2/2019 Print
ILLUSTRATION4-4
Trialbalance
We assume that Sierra uses an accounting period of one month.
Thus, monthly adjusting entries are made.
The entries are dated October 31.
DOIT!1
Timing Concepts
Below is a list of concepts in the left column, with descriptions
of the concepts in the right
column. There are more descriptions provided than concepts.
Match the description of the
concept to the concept.
1. ________ Accrual-basis accounting.
2. ________ Calendar year.

3. ________ Periodicity assumption.
4. ________ Expense recognition principle.
(a) Monthly and quarterly time periods.
(b) Efforts (expenses) should be matched with results
(revenues).
(c) Accountants divide the economic life of a business into
arti�icial time periods.
(d) Companies record revenues when they receive cash and
record expenses when they
pay out cash.
(e) An accounting time period that starts on January 1 and ends
on December 31.
(f) Companies record transactions in the period in which the
events occur.
ActionPlan
✓ Review the terms identi�ied on pages 152–153.
✓ Study carefully the revenue recognition principle, the
expense
recognition principle, and the periodicity assumption.
4/2/2019 Print

SOLUTION
1. f 2. e 3. c 4. b
Related exercise material: BE4-1,BE4-2,DOIT!4-1,E4-1,E4-
2,E4-3,andE4-5.
4/2/2019 Print
LEARNINGOBJECTIVE2
To defer means to postpone or delay. Deferrals are costs or
revenues that are recognized at a date later
than the point when cash was originally exchanged. Companies
make adjusting entries for deferred
expenses to record the portion that was incurred during the
period. Companies also make adjusting
entries for deferred revenues to record services performed
during the period. The two types of deferrals
are prepaid expenses and unearned revenues.
PREPAID EXPENSES
Companies record payments of expenses that will bene�it more
than one accounting period as assets.
These prepaidexpenses or prepayments are expenses paid in
cash before they are used or consumed.
When expenses are prepaid, an asset account is increased

(debited) to show the service or bene�it that the
company will receive in the future. Examples of common
prepayments are insurance, supplies,
advertising, and rent. In addition, companies make prepayments
when they purchase buildings and
equipment.
Prepaidexpensesarecoststhatexpireeitherwiththepassageoftime
(e.g., rent and insurance) or
throughuse (e.g., supplies). The expiration of these costs does
not require daily entries, which would be
impractical and unnecessary. Accordingly, companies postpone
the recognition of such cost expirations
until they prepare �inancial statements. At each statement date,
they make adjusting entries to record the
expenses applicable to the current accounting period and to
show the remaining amounts in the asset
accounts.
Prior to adjustment, assets are overstated and expenses are
understated. Therefore, as shown in
Illustration 4-5
ons/ch04lo2#c04-�ig-0005) ,
anadjustingentryforprepaidexpensesresultsinanincrease(adebit)t
oanexpenseaccountand
adecrease(acredit)toanassetaccount.
04lo2#c04-fig-0005
4/2/2019 Print

ILLUSTRATION4-5
Adjustingentriesforprepaidexpenses
Let's look in more detail at some speci�ic types of prepaid
expenses, beginning with supplies.
Supplies
The purchase of supplies, such as paper and envelopes, results
in an increase (a debit) to an asset account.
During the accounting period, the company uses supplies.
Rather than record supplies expense as the
supplies are used, companies recognize supplies expense at the
end of the accounting period. At the end
of the accounting period, the company counts the remaining
supplies. The difference between the
unadjusted balance in the Supplies (asset) account and the
actual cost of supplies on hand represents the
supplies used (an expense) for that period.
Recall from Chapter 3
ons/ch03#ch03) that
Sierra Corporation purchased supplies costing $2,500 on
October 5. Sierra recorded the purchase by
increasing (debiting) the asset Supplies. This account shows a
balance of $2,500 in the October 31 trial
balance. A physical count of the inventory at the close of
business on October 31 reveals that $1,000 of
supplies are still on hand. Thus, the cost of supplies used is
$1,500 ($2,500−$1,000). This use of supplies
decreases an asset, Supplies. It also decreases stockholders'
equity by increasing an expense account,
Supplies Expense. This is shown in Illustration 4-6

4-‹#›Accrual Accounting ConceptsKimmel ● Weygandt .docx

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