Chapter 3

Accrual Accounting

Accrual vs. Cash Basis Accounting

ACCRUAL ACCOUNTING

Records impact of transactions

when they occur
Required by IAS1
Presentation of Financial
Statements
Records:
Revenue when ________
Expenses when ________
Use by virtually all businesses

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CASH BASIS

Records transactions only if

cash is involved
Cash receipts
Cash payments
Ignores underlying economic
activities
Used by ________ or
________ operations
2

Learning Objective 1
Relate accrual accounting and cash flows

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Accrual accounting
Records _____ cash and non-cash transactions
Cash transactions

Non-cash transactions

Collecting payments from customers

Sales on account

Receiving cash from interest earned

Purchases of inventory on
account

Paying salaries, rent, and other

expenses

Accrual of expenses incurred but

not yet paid

Borrowing money

Depreciation expense

Paying off loans

Usage of prepaid rent, insurance,

and supplies

Issuing shares (for cash)

Earning of revenue when cash

was collected in advance

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Time Period Concept

Accounting information is reported at regular
intervals
Basic accounting period is ________

Calendar year
January 1 December 31

Fiscal year
12-month period ending on a date other than
December 31

Interim periods
Month or quarter
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Learning Objective Two

Apply the revenue and matching principles

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Time-period concept
Ensures that accounting information is
reported at regular intervals
IAS 1 requires an entity to present a
complete set of financial statements at
least annually.
Companies also prepare financial
statements for interim periods of less
than a year.
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Revenue Recognition Principle

What is Revenue?
Exchange of __________________

When should revenue be recorded?

Transfer of __________
The entity has transferred to the buyer the significant risks and rewards of
ownership of the goods

Transfer of __________
The entity retains neither continuing managerial involvement to the degree
usually associated with ownership nor effective control over the goods sold

Amounts _______________
The amount of revenue can be measured reliably

______________
It is probably that the economic benefits associated with the transaction will
flow to the entity

______________
The costs incurred or to be incurred in respect of the transaction can be
measured reliably

Matching Principle

Identify
expenses
incurred

Measure
the
expenses

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Match
against
revenues
earned

Learning Objective Three

Adjust the accounts

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Adjusting the Accounts

Transactions
In chapter 2, we discussed transactions and
accounting when they occur
Some events do not relate to specific transactions,
so we have to adjust for them

Adjusting Entries
Financial statements issued at end of period
Several accounts on trial balance need to be
brought up-to-date
Certain transactions that have not been recorded
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Categories of Adjustments

Think of
what is
being
deferred or
accrued:
_________
_________

Deferrals
Depreciation
Accruals
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Deferrals
Business has paid or received cash in advance
Prepaid expense

Unearned revenue

Recorded as an
_____ when
purchased
_______ when
used or expired

Recorded as a
________ when
payment is
received
Recorded as
________ when
earned

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Prepaid Expenses
Recorded as assets when purchased
Example: On June 1, you prepay 3 months of rent
for $3,000

Expensed when used (or when time passes)

JOURNAL
Date

Accounts and explanation

Jun 1

_______________

Debit

Credit

3,000

Cash

3,000

Paid three months rent in advance

Jun 30

Rent expense
_____________
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2014 Pearson Education
To record rent
expense

1,000
1,000
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Prepaid Rent
Prepaid rent
Jun 1

Rent expense
Jun 30

Jun 30

Amount
remaining

Amount
expired

Balance
Sheet

Income
Statement

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Prepaid Expenses
Recorded as assets when purchased
Some pass with time.
Other assets expensed when used
Example: Purchase $700 of supplies on Jun 2
JOURNAL
Date

Accounts and explanation

Jun 2

Supplies

Debit

Credit
700

Cash

700

Paid cash for supplies

Jun 30

Supplies expense
Supplies
To record rent expense

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300
300
How do we know this number?

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Supplies
Supplies
Jun 2

$700

Supplies expense

$___

Jun 30

Jun 30

$___

$400
Amount on
hand

Amount used

Balance
Sheet

Income
Statement
Supplies/Inventory _____

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Depreciation
Allocates cost of Property, Plant and Equipment
(PPE) to expense over __________
_______= estimated duration of how long longterm asset will last
Depreciation represents wear-and-tear and
obsolescence

Examples of PPE:
Buildings
Equipment
Furniture
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Accumulated Depreciation (__)

Depreciation expense (Exp)
amount allocated to __________

Accumulated Depreciation (XA)

Sum of ____________ expense and increases
over plant assets life

______-asset
Normal credit balance (opposite to the contra)
Always has a companion account

Book value (sometimes called Net Book Value)

Cost of plant asset less accumulated depreciation

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Depreciation
Example: Company buys Equipment with 5-year
useful life for $24,000 on June 2.
Assume the asset has no salvage value
Depreciation = $24,000/60 months =
$400/month
JOURNAL
Date

Accounts and explanation

Jun 2

Equipment

Debit
24,000

Cash

Jun 30

Depreciation expense
Accumulated depreciation
*Note:___________________

Credit
24,000

400
400
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Depreciation
Equipment
Jun 2

Depreciation Expense
Jun 30

$24,000

$400

Balance
Sheet

Accumulated Depreciation
$400

Income
Statement

Jun 30

$24,000/60 = $400
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Book Value
Balance Sheet
December 31, 2010
Equipment
Less: Accumulated Depreciation
Book value

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$24,000
(400)
$23,600

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Unearned Revenue
Sometimes called Advances from Customer
Receive cash before revenue is earned
Creates a liability
Business owes customer a good or service
JOURNAL
Date

Accounts and explanation

Jun 1

Cash (A)

Debit

Credit

400

Unearned service revenue (L)

400

Received cash for revenue in advance.

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Unearned Revenue
When revenue is earned
Liability is reduced
Revenue is increased
JOURNAL
Date

Accounts and explanation

Jun 30

Unearned revenue
Service revenue

Debit

Credit

200
200

To record unearned service revenue

that has been earned.

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Accruals
Accrued Expenses

Accrued Revenues

Record expense
before paying
cash
Salaries, interest,
and income taxes

Record revenue
before collecting
cash
Earned and will
collect next
period

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Accrued Salaries
2-days accrued

$15,000 weekly salaries

$6,000

$15,000
Jan 3 (Fri)

Dec 31 (Tues)

JOURNAL
Date

Accounts and explanation

Dec 31

Salaries expense
Salaries Payable

Debit

Credit

6,000
6,000

To accrue salaries expense

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Accrued Salaries

$15,000 weekly salaries

$6,000

Jun 1

$15,000
Jan 3

Dec 31

JOURNAL
Date

Accounts and explanation

Jan 3

Salaries Payable

6,000

Salaries Expense (Salaries Payable)

9,000

Cash

Debit

Credit

15,000

Pay Salaries
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Accrued Revenue
Revenue earned but not yet received
Assume that a company is hired on June 15 to
wash trucks each month for $600 (starting on
June 15). The company will be paid on July 15.
JOURNAL
Date

Accounts and explanation

Jun 30

Accounts receivable ($600 x )

Service revenue

Debit

Credit

300
300

To accrue service revenue.

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Prepaids and Accruals

PREPAIDS CASH FIRST
FIRST

LATER

Prepaid
expenses

Prepaid expense

Expense

Unearned
revenues

Cash

Cash

Prepaid expense
Unearned revenue

Unearned revenue

Revenue

ACCRUALS CASH LATER

FIRST

LATER

Accrued
expenses

Expense

Payable

Accrued
revenues

Receivable

Payable
Revenue

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Cash
Cash
Receivable
29

Summary of the Adjusting Process

Two purpose of adjusting process
Measure (_____) income
Update balance sheet

Every adjusting entry affects at least one (of

each):
Revenue or expense
Asset or liability

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Summary of Adjusting Entries

Type of Account
Category of Adjustment

Debit

Credit

Prepaid expense

Expense

Asset

Depreciation

Expense

Contra asset

Accrued expense

Expense

Liability

Accrued revenue

Asset

Revenue

Unearned revenue

Liability

Revenue

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Exercise 3-22A
Jenkins Motor Company faced the following situations.
Journalize the adjusting entry needed at December
31, 2010, for each situation. Consider each fact
separately.
a. The business has interest expense of $9,500 incurred
during 2010 that it must pay early in January 2011.
b. Interest revenue of $4,500 has been earned but not yet
received.
c. On July 1, when we collected $13,600 rent in advance, we
debited Cash and credited Unearned Rent Revenue. The
tenant was paying us for 2 years rent, starting on July 1,
2010.

Exercise 3-22A
JOURNAL
Date

Accounts and explanation

Debit

Credit

(a)

(b)

(c)

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1-34

Exercise 3-22A
d. Salary expense is $1,800 per dayMonday
through Fridayand the business pays employees
each Friday. This year, December 31 falls on a
Wednesday.
e. The unadjusted balance of the Supplies account
is $3,300. The total cost of supplies on hand is
$1,200.
f. Equipment was purchased at the beginning of
this year at a cost of $100,000. The equipments
useful life is 5 years with no salvage value.
2010 Pearson Prentice Hall. All rights reserved.

Exercise 3-22A
JOURNAL
Date

Accounts and explanation

Debit

Credit

(d)

(e)

(f)

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36

Exercise 3-22A
Record depreciation for this year and then
determine the equipments book value.
Balance Sheet
December 31, 20X6
Equipment
Less: Accumulated Depreciation
Book value
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$100,000
(
)

The Adjusted Trial Balance

Prepared after adjustments are journalized and
posted
Useful step in preparing financial statements

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Learning Objective Four

Prepare the financial statements

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The Financial Statements

Income Statement
Lists revenues & expenses

Statement of Changes in Equity

Shows changes in components of equity

Balance Sheet
Reports assets, liabilities and shareholders
equity
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Flow of Data in Financial Statements

Income Statement
Revenues

$$,$$$

Less: Expenses
Net Income

($$,$$$)
$$,$$$

Statement Changes in Equity

Beginning equity balance

$$,$$$

Plus: Net income

$$,$$$

Less: Dividends

($,$$$)

Ending equity balance

$$,$$$

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Flow of Data in Financial Statements

Statement of Changes in Equity
Beginning equity balance

$$,$$$

Plus: Net income

$$,$$$

Less: Dividends

($,$$$)

Ending equity balance

$$,$$$

Balance Sheet
Current assets

$$,$$$ Liabilities

$$,$$$

PPE

$$,$$$

Share Capital

$$,$$$

Other assets

$$,$$$

Retained earnings

$$,$$$

Total assets

Total liabilities &

$$$,$$$ shareholders equity
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$$$,$$$

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Learning Objective Five

Close the books

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Closing the books

Prepares the accounts for next period
Temporary accounts are set to zero and closed
into Retained earnings
Permanent accounts are not closed

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Temporary

Permanent

Closed
_______,
_______
and
_______

Not closed
Assets,
liabilities
and equity

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Closing Entries

Close Revenues

Debit each revenue account

Credit Retained earnings

Close Expenses

Debit Retained earnings

Credit each expense account

Close Dividends
Debit Retained earnings

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Credit Dividends

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1-46

P3-67A

This is your trial balance. Record all of the closing entries. What
is the ending balance in Retained Earnings?
Account

Amount

Account

Amount

Accounts payable

$14,400

Interest expense

$900

Accounts receivable

16,100

Note payable, long term

6,100

Accumulated depreciation 6,900

Equipment

Other assets

14,400

Advertising expense

10,900

Prepaid expense

6,000

Cash

7,900

Retained Earnings

22,000

Share capital

5,600

Salary expense

17,800

Current portion of note

payable

1,000

Salary payable

2,900

Depreciation expense

1,700

Service revenue

95,000

Dividends

31,200

Supplies

3,600

Equipment

41,700

Supplies expense

4,400

Problem 3-67A
JOURNAL
Date

Accounts and explanation

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Debit

Credit

47

Problem 3-67A
Retained Earnings
Expenses

Beginning
Balance

Dividends

Revenues

Ending
Balance

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Classifying Assets & Liabilities

Classified as current or long-term term based on
liquidity
How quickly an item can be converted to cash
Cash

Most liquid

Accounts receivable

Very liquid

Inventory

Somewhat liquid

PPE

Not liquid

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Current
assets

Converted to cash, sold or

consumed in the next year

Non-current
assets

Held for longer than one year

Includes plant assets

Current
liabilities

Must be paid within one year

Non-current
liabilities

Due date more than one year

from balance sheet date

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Classified Balance Sheet

Categorizes and subtotals assets and liabilities
Assets

Liabilities

Current assets

Current liabilities

Long-term investments

Long-term liabilities

Property, plant and equipment

Other assets

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