Chapter THE ACCOUNTING

4 CYCLE:
Accruals and Deferrals

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 At the end of the
period, we need to
make adjusting entries
to get the accounts up
to date for the financial
statements.

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 Adjusting Entries

Adjusting Every
entries are adjusting
needed whenever entry involves a
revenue or expenses change in either a
affect more than one revenue or expense
accounting and an asset
period. or liability.

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 Types of Adjusting Entries

 Converting  Converting
assets to liabilities to
expenses revenue

 Accruing  Accruing
unpaid uncollected
expenses revenues

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 Converting Assets to Expenses
End of Current Period
Prior Periods Current Period Future Periods

Transaction Adjusting Entry

Paid future  Recognize portion
expenses in of asset consumed
advance as expense, and
(creates an  Reduce balance of
asset). asset account.
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 Converting Assets to Expenses

Examples Include:
Depreciation
Supplies
Expiring Insurance Policies

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 Converting Assets to Expenses

$2,400 Insurance Policy

Coverage for 12 Months

$200 Monthly Insurance Expense

Jan. 1 Dec. 31

On January 1, Webb Co. purchased a one-

year insurance policy for $2,400.
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 Converting Assets to Expenses
Initially, costs that benefit more than one
accounting period are recorded as assets.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Jan. 1 Unexpired Insurance 2,400
Cash 2,400
Purchase a one-year insurance policy.

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

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Monthly Adjusting Entry for Insurance
Jan. 31 Insurance Expense 200
Unexpired Insurance 200
Insurance expense for January.
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 Converting Assets to Expenses
Balance Sheet Income Statement
Cost of assets Cost of assets
that benefit used this period to
future periods. generate revenue.

Unexpired Insurance Insurance Expense

1/1 2,400 1/31 200 1/31 200
Bal. 2,200

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 The Concept of Depreciation
Depreciable assets are physical objects
that retain their size and shape but lose
their economic usefulness over time.

Depreciation is the systematic allocation of

the cost of a depreciable asset to expense.

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 The Concept of Depreciation
The portion of an asset’s utility that is used
up must be expensed in the period used.

Fixed The asset’s Accumulated

Asset usefulness is Depreciation
(debit) partially (credit)
consumed
On date during the
period. At end of
when initial
payment is period . . .
made . . . Depreciation
Cash Expense
(credit) (debit)
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 Depreciation Is Only an Estimate
On May 2, 2003, JJ’s Lawn Care Service
purchased a lawn mower with a useful
life of 50 months for $2,500 cash.
Using the straight-line method, calculate
the monthly depreciation expense.
Depreciation
Cost of the asset
expense (per =
Estimated useful life
period)

$50 = $2,500
50 © The McGraw-Hill Companies, Inc., 2002
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 Depreciation Is Only an Estimate
JJ’s Lawn Care Service would make the
following adjusting entry.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

May 31 Depreciation Expense: Tools & Eq. 50
Accumulated Depreciation: Tools & Eq. 50
To record one month's depreciation.

Contra-asset
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 Depreciation Is Only an Estimate
JJ’s $15,000 truck is depreciated over 60
months as follows:

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

May 31 Depreciation Expense: Truck 250
Accumulated Depreciation: Truck 250
To record one month's depreciation.

$15,00060 months = $250 per month

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McGraw-Hill/Irwin
 JJ's Lawn Care Service
Partial Balance Sheet
Accumulated depreciation
May 31, 2001 would
appear on the balance
Assets sheet as
Cash follows: $ 3,925
Accounts receivable 75
Tools & equipment $ 2,650
Less: Accum. depr. 50 2,600
Truck $ 15,000 O
Less: Accum. depr. 250 14,750
T

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 Converting Liabilities to Revenue
End of Current Period
Prior Periods Current Period Future Periods

Transaction Adjusting Entry

Collected  Recognize portion
from earned as revenue,
customers in and
advance  Reduce balance of
(creates a liability account.
liability).
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 Converting Liabilities to Revenue

Examples Include:
Airline Ticket Sales
Sports Teams’ Sales of
Season Tickets

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 Converting Liabilities to Revenue

$6,000 Rental Contract

Coverage for 12 Months

$500 Monthly Rental Revenue

Jan. 1 Dec. 31

On January 1, Webb Co. received $6,000 in

advance for a one-year rental contract.
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 Converting Liabilities to Revenue
Initially, revenues that benefit more than one
accounting period are recorded as liabilities.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Jan. 1 Cash 6,000
Unearned Rental Revenue 6,000
Collected $6,000 in advance for rent.

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 Converting Liabilities to Revenue
Over time, the revenue is recognized as it is
earned.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Monthly Adjusting Entry for Rent Revenue
Jan. 31 Unearned Rental Revenue 500
Rental Revenue 500
Rental revenue for January.
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 Converting Liabilities to Revenue

Balance Sheet Income Statement

Liability for Revenue earned
future periods. this period.

Unearned Rental Revenue Rental Revenue

1/31 500 1/1 6,000 1/31 500
Bal. 5,500

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 Accruing Unpaid Expenses
End of Current Period
Prior Periods Current Period Future Periods

Adjusting Entry Transaction

 Recognize expense Liability will
incurred, and be paid.
 Record liability for
future payment.

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 Accruing Unpaid Expenses

Hey, when do
we get paid?
Examples Include:
Interest
Wages and Salaries
Property Taxes

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 Accruing Unpaid Expenses

$3,000 Wages
Expense

Monday, Wednesday, Friday,

May 29 May 31 June 2

On May 31, Webb Co. owes wages of $3,000.

Pay day is Friday, June 2.
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 Accruing Unpaid Expenses
Initially, an expense and a liability are
recorded.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

May 31 Wages Expense 3,000
Wages Payable 3,000
To accrue wages owed to employees.

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 Accruing Unpaid Expenses
Balance Sheet Income Statement
Liability to be Cost incurred this
paid in a future period to generate
period. revenue.

Wages Payable Wages Expense

5/31 3,000 5/31 3,000

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 Accruing Unpaid Expenses
$5,000 Weekly Wages

$3,000 Wages $2,000 Wages

Expense Expense

Monday, Wednesday, Friday,

May 29 May 31 June 2

Let’s look at the entry for June 2.

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 Accruing Unpaid Expenses
The liability is extinguished when the debt is
paid.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

June 2 Wages Expense (for June) 2,000
Wages Payable (accrued in May) 3,000
Cash 5,000
Weekly payroll for May 29-June 2.
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 Accruing Uncollected Revenue
End of Current Period
Prior Periods Current Period Future Periods

Adjusting Entry Transaction

Recognize revenue Receivable
earned but not yet will be
recorded, and collected.
Record receivable.

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 Accruing Uncollected Revenue

Examples Include:
Interest Earned
Work Completed But Not
Yet Billed to Customer

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 Accruing Uncollected Revenue

$170 Interest
Revenue

Saturday, Monday, Tuesday,

Jan. 15 Jan. 31 Feb. 15
On Jan. 31, the bank owes Webb Co.
interest of $170. Interest is paid on the 15th
day of each month.
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 Accruing Uncollected Revenue
Initially, the revenue is recognized and a
receivable is created.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Jan. 31 Interest Receivable 170
Interest Revenue 170
To recognize interest revenue.

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 Accruing Uncollected Revenue
Balance Sheet
Income Statement
Receivable to
be collected in a Revenue earned
future period. this period.

Interest Receivable Interest Revenue

1/31 170 1/31 170

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 Accruing Uncollected Revenue
$320 Monthly Interest

$170 Interest $150 Interest

Revenue Revenue

Saturday, Monday, Tuesday,

Jan. 15 Jan. 31 Feb. 15

Let’s look at the entry for February 15.

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

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Feb. 15 Cash 320
Interest Revenue (for February) 150
Interest Receivable (accrued Jan. 31) 170
To record interest received.
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 Accruing Income Taxes Expense: The
Final Adjusting Entry
As a corporation earns taxable income, it
incurs income taxes expense, and also a
liability to governmental tax authorities.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Dec. 31 Income Taxes Expense 780
Income Taxes Payable 780
Estimated income taxes applicable to
taxable income earned in December.

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 Adjusting Entries and Accounting
Principles
Costs are matched with revenue
in two ways:

 Direct association of costs

with specific revenue
transactions.

 Systematic allocation of costs

over the “useful life” of the
expenditure.
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 The Concept of Materiality
An item is “material” if knowledge of the
item might reasonably influence the
decisions of users of financial statements.

Many companies
immediately charge
the cost of Lightbulbs
immaterial items to
expense.
Supplies
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 Effects of the Adjusting Entries

Make end-of-
Journalize year
Post entries to Prepare trial
transactions. adjustments.
the ledger balance.
accounts.

Recall from the accounting cycle

discussed in Chapter 3, that after
the adjusting entries are made, an
Prepare adjusted
adjusted trial balance is prepared. trial balance.
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 End of Chapter 4

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