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Financial Accounting:Tools for Business Decision Making, 4th Ed.
Kimmel, Weygandt, Kieso
CHAPTER 4
Prepared by
Ellen L. Sweatt
Georgia Perimeter College
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Chapter 4
ACCRUALACCRUAL
ACCOUNTINGACCOUNTINGCONCEPTSCONCEPTS
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Chapter 4Accrual Accounting Concepts
Explain the revenue recognition principleand the matching principle.
Differentiate between the cash basis andthe accrual basis of accounting.
Explain why adjusting entries are needed
and identify the major types of adjustingentries.
Prepare adjusting entries for prepayments.
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Chapter 4Accrual Accounting Concepts
Prepare adjusting entries for accruals.
Describe the nature and purpose of the
adjusted trial balance. Explain the purpose of closing entries.
Describe the required steps in the accountingcycle.
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Time Period Assumption...Divides the economic life of a
business into artificial time
periods
WHY?to provide immediate
feedback on how the
business is doing.
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Time Period Assumption...Generally a month, a quarter, or ayear.
An accounting time period that starts on January 1and ends December 31 is called a calendar year.
An accounting time period that is oneyear long is called a fiscal year.
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Revenue Recognition
Principle... Dictates that revenue be recognized
in the accounting period in which itis earned.
Is considered earned
when the service has been provided or
when the goods are delivered.
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Matching Principle...Requires that expensesbe
recorded in the same periodin which the revenues they
helped produce are recorded.
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ReviewReview
a.a. Cost Principle.Cost Principle.
b.b. Matching PrincipleMatching Principle
c.c. Periodicity PrinciplePeriodicity Principle
d.d. Revenue Recognition PrincipleRevenue Recognition Principle
Which principle dictates that efforts (expenses)Which principle dictates that efforts (expenses)
be recorded with accomplishments (revenues)?be recorded with accomplishments (revenues)?
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ReviewReview
a.a. Cost Principle.Cost Principle.
b.b. Matching PrincipleMatching Principle
c.c. Periodicity PrinciplePeriodicity Principle
d.d. Revenue Recognition PrincipleRevenue Recognition Principle
Which principle dictates that efforts (expenses)Which principle dictates that efforts (expenses)
be recorded with accomplishments (revenues)?be recorded with accomplishments (revenues)?
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When wouldWhen would revenuerevenue be recorded for thebe recorded for the
following scenario . . .following scenario . . .
Ad agency is hired for a project in May,Ad agency is hired for a project in May,does the work in June and is paid indoes the work in June and is paid in
July?July?
JuneJune
ReviewReview
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ReviewReviewWhen wouldWhen would expensesexpenses be recorded for thisbe recorded for thiscompanion scenario ?companion scenario ?
The Ad agency on this project incursThe Ad agency on this project incurs$1,500 of expenses in May, $3,000 in June,$1,500 of expenses in May, $3,000 in June,
and none in July?and none in July?
The answer is June! MatchingThe answer is June! Matching
says the expenses should followsays the expenses should follow
the revenue.the revenue.
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ReviewReviewWhen wouldWhen would revenuerevenuebe recorded for thebe recorded for thefollowing scenario . . .following scenario . . .
Sell plane ticket on September 1 for aSell plane ticket on September 1 for a
flight on October 15?flight on October 15?
The answer is October when theThe answer is October when theservice is provided!service is provided!
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ReviewReviewWhen wouldWhen would expensesexpenses be recorded for thebe recorded for thefollowing scenario . . .following scenario . . .
The airline pays pilot salaries on October 7The airline pays pilot salaries on October 7thth
for the week ended September 30th?for the week ended September 30th?
The answer is September the pilotsThe answer is September the pilots
provided labor services for Septemberprovided labor services for September
flights during that month.flights during that month.
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Cash Basis
Revenue recorded only when cash is received.Expense recorded only when cash is paid.
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GAA
P
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Accrual Basis AccountingAdheres to the:
Revenue RecognitionPrinciple Revenuerecorded only when earned,not when cash is received Matching Principle
Expense recorded onlywhen incurred, not when cash
paid
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Accrual Basis adheres to..
GenerallyAcceptedAccounting
Principles
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Types of Adjusting Entries
Prepayments: Prepaid expenses: Expenses paid in cash and
recorded as assets before they are used orconsumed.
Unearned Revenues: Cash received andrecorded as liabilities before revenue is earned.
Accruals: Accrued revenues: Revenues earned but not yet
received in cash or recorded. Accrued expenses: Expenses incurred but not
yet paid in cash or recorded.
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Prepayments
PREPAID EXPENSES - Costs thatexpire either with the passage of
time or through use.
UNEARNED REVENUES- money has
been received before the goods orservices are provided.
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You can start with the trialbalance to find information to
adjust prepayments.
Si C i
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Sierra CorporationTrial Balance
October 31, 2007
Debit CreditCash $15,200
Advertising Supplies 2,500
Prepaid Insurance 600
Office Equipment 5,000Notes Payable $ 5,000
Accounts Payable 2,500
Unearned Service Revenue 1,200
Common Stock 10,000
Dividends 500
Service Revenue 10,000
Salaries Expense 4,000
Rent Expense 900
$28,700 $28,700
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Prepaid ExpensesPrepaid Expenses
Amount equals cost of goods or
services used up or expired
If not adjusted, expenses would be
understated and assets overstated
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On October 5 the company paid$2,500 for advertising supplies.
GENERAL JOURNAL Debit Credit
Oct 5 Supplies 2,500
Cash 2,500
Purchased advertising supplies
Advertising
Supplies2,500Oct 5Cash 2,500Oct 5
Advertising
Supplies
Expense
Supplies
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An inventory on October 31 reveals that $1,000 osupplies remain on hand; therefore $1,500 ofsupplies have been used. ($2,500 - $1,000) =$1,500
GENERAL JOURNAL Debit Credit
Oct 5 Supplies Expense 1,500
Supplies
1,500
To record advertising supplies consumed
2,500Oct 5Cash
2,500Oct 5
Advertising
Supplies
Expense
Supplies
1,500Oct 311,500Oct 31
Advertising
Supplies
Bal. 1,000
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Oct
$1,500
Mar$1,435
Apr$1,510
May$1,592
Feb$1,601
Nov
$1,800
Dec
$1,410
Jan
$1,425
June
$1,652
July
$1,621
Aug
$1,427
Sept
$1,555
Supplies expense is based on usage... so
different amounts appear each month
Supplies Expense
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Prepaid Expenses
On October 1 the company paid $600 for a 1-yeainsurance policy. Coverage began October 1.
GENERAL JOURNAL Debit Credit
Oct 1 Prepaid Insurance 600
Cash 600
Purchased one-year policy effective October 1
Prepaid
Insurance600Oct 1
Cash600Oct 1
Insurance
Expense
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Insurance Policy
1 Year $ 600
Oct
$50
Mar$50
Apr$50
May$50
Feb$50
Nov
$50
Dec
$50
Jan
$50
June
$50
July
$50
Aug
$50
Sept
$50
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Prepaid Expenses
On October 31st, $50 ($600/12months) of the insurance was used-up
or expired.
GENERAL JOURNAL Debit Credit
Oct 31 Insurance Expense 50
Prepaid Insurance
50
Record insurance expense for the month
Prepaid
Insurance600Oct 1
Cash600Oct 1
Insurance
Expense50Oct 3150Oct 31
550
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How do you apply the Matching
Principle to the cost of a long lived
asset ?
Depreciation
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Office Equipment
Depreciation= $480/year
Oct
$40
Mar$40
Apr$40
May$40
Feb$40
Nov
$40
Dec
$40
Jan
$40
June
$40
July
$40
Aug
$40
Sept
$40
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GENERAL JOURNAL Debit Credit
Oct 31 Depreciation Expense 40
Accumulated Depreciation-Office Equip 40
To record monthly depreciation
Accumulated depreciation is acontra asset account - an offset
against the fixed asset account.
Accumulated
Depreciation-
Office Equipment40Oct 31
Office Equipment5,000Oct 2
Depreciation
Expense 40Oct 31
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Office equipment $ 5,000
Less : accumulated depreciation 40
$4,960
Balance Sheet Presentation
Book Value orCarrying Value
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Unearned RevenuesReceived on Oct. 2 $1,200 for advertising
services expected to be completed byDec 31.
Unearned Service
RevenueCash
1,200Oct 21,200Oct 2
Service
Revenue
GENERAL JOURNAL Debit Credit
Oct 2 Cash 1,200
Unearned Service Revenue 1,200
Collected money for work to beperformed by Dec 31.
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Unearned RevenuesDuring October $400 of the revenue was
earned.
Unearned Service
RevenueCash
1,200Oct 2
Service
Revenue
1,200Oct 2
GENERAL JOURNAL Debit Credit
Oct 31 Unearned Service Revenue 400
Service Revenue 400
To record revenue earned
Oct. 31 400 Oct. 31 400
800Bal
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Accruals
Revenue has been earned, but not
collected.
Expenses have been incurred, but
not yet paid.
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Accrued Revenues
Revenues earned but not yet
received in cash or recorded at thestatement date.
Accrued Revenues
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Accrued Revenues
Earned $200 for advertising services to
clients in October, but they were notbilled until after October 31st.
GENERAL JOURNAL Debit Credit
Oct 31 Accounts Receivable 200
Service Revenue 200
Accounts
Receivable200Oct 31
Service
Revenue 200Oct 31
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Accrued Expenses
Expenses incurred but not yet paid
or recorded at the statement date.
Interest expense is the cost a
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Formula for Computing Interest
*
Face Value
of Note Interest
Time
in term of
One Year
Annual
Interest
Rate
$ 5,000 X 12% 1/12 = $50
Interest expense is the cost acompany incurs to use money:Information needed to compute interest expense:
7 face value of note7 interest rate (always expressed in annual rate)
7 the length of time note is outstanding
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Interest Expense Interest Payable
Oct 31 50 Oct 31 50
GENERAL JOURNAL Debit Credit
Oct 31 Interest Expense 50
Interest Payable 50
Accrue interest expense for the month
Accrued Interest
A d S l i S l i P id f
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Accrued Salaries - Salaries Paid for
after the Service Has Been Performed.
d l i
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Salaries Expense Salaries PayableOct 31 1,200 Oct 31 1,200
GENERAL JOURNAL Debit Credit
Oct 31 Salaries Expense 1,200Salaries Payable 1,200
Accrue salary expense for the month
Accrued Salaries
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The adjusted trial balance is used to
prove the equity of total debit balances
and total credit balances after theadjusting entries have been made.
Financial statements (except Cash Flow
Statement) can be easily prepared from
the adjusted trial balance.
Adjusted Trial Balance
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Closing the Books
Closing entries transfer the temporary
account balances to the stockholdersequity account...
and reduce the balances in the
temporary accounts to zero.
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Temporary Permanent
All revenues accounts All asset accounts
All expense accounts All liability accounts
DividendsStockholders equity
accounts
Cl T A t
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Close Temporary AccountsOnly
Zero balanceZero balance
after closingafter closingentries!entries!
Do not close!Do not close!
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The Closing Process
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The Accounting Cycle
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R i d
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RequiredSteps in
theAccounting Cycle
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ReviewReview
Which isWhich is notnota temporary account?a temporary account?a.a.Salaries expenseSalaries expense
b.b.Service revenueService revenue
c.c.Accounts ReceivableAccounts Receivabled.d.DividendsDividends
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ReviewReview
Which isWhich is notnota temporary account?a temporary account?a.a.Salaries expenseSalaries expense
b.b.Service revenueService revenue
c.c.Accounts ReceivableAccounts Receivabled.d.DividendsDividends
ReviewReview
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ReviewReview
Which account will have a zeroWhich account will have a zerobalance after closing entries?balance after closing entries?
a.a.Service RevenueService Revenueb.b.Advertising SuppliesAdvertising Supplies
c.c.Prepaid InsurancePrepaid Insurance
d.d.Accumulated DepreciationAccumulated Depreciation
ReviewReview
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ReviewReview
Which account will have a zeroWhich account will have a zerobalance after closing entries?balance after closing entries?
a.a.Service RevenueService Revenueb.b.Advertising SuppliesAdvertising Supplies
c.c.Prepaid InsurancePrepaid Insurance
d.d.Accumulated DepreciationAccumulated Depreciation
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ReviewReview
Which types of accounts will appearWhich types of accounts will appear
in the post-closing trial balance?in the post-closing trial balance?
a.Temporary accounts
b.Accounts shown in the income statement
c.Permanent accountsd.All of the above
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ReviewReview
Which types of accounts will appearWhich types of accounts will appear
in the post-closing trial balance?in the post-closing trial balance?
a.Temporary accounts
b.Accounts shown in the income statement
c.Permanent accountsd.All of the above
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