ACCT 100

I. Introduce the accrual accounting concept.
II. Introduce the adjusting entries.
Accrual Accounting and the Financial Statements 2

1. The time-period concept, the revenue recognition and the matching principles.
2. Accrual versus cash basis accounting.
Accrual Accounting and the Financial Statements 3

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Income and financial position of a business are reported periodically, not until the end of life of a business.
Accrual Accounting and the Financial Statements 4

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Revenue is recognized when it is earned and realized.

Earned : the entity has substantially accomplished what it must do to be entitled to compensation.

Realized : goods are exchanged for cash or claims
.
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In general, these conditions are met at time of sale (delivery) or when services are rendered regardless whether cash is collected or not .
Income Measurement And Profit Analysis 5

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If revenues are recognized in a period, all related expenses should be recognized in the same period regardless whether expenses are paid or not.

The related expenses include traceable costs (i.e., product costs), period costs, (i.e., interest and rent expenses) and estimated/allocation expenses
(i.e., depreciation expense and bad debt expense).
Accrual Accounting and the Financial Statements 6


Accrual-basis accounting :
Revenues are recognized based on revenue recognition principle (i.e., recognized when realized and earned regardless whether cash is collected or not).
Expenses are recognized based on matching principle.
Note: revenue and expense recognize before cash settlement
.
Accrual Accounting and the Financial Statements 7


Cash-basis accounting :
The accountant does not record a transaction until cash is received or paid.
Cash-basis accounting is NOT acceptable for financial reporting.
Accrual Accounting and the Financial Statements 8

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Due to the periodicity concept, financial reports are prepared periodically.

Based on revenue recognition principle, adjusting entries are prepared at the end of a period to recognize revenues earned during the period but not yet recorded (i.e., accrued revenues).
Accrual Accounting and the Financial Statements 9


Based on the matching principle , the accrued expenses (i.e., expenses incurred but not yet paid/recorded) and estimated expenses (i.e., depreciation expense and bad debt expense) are recorded at the end of a period.
Accrual Accounting and the Financial Statements 10

s
A. Accruals
B. Deferrals
C. Estimated Expenses
Accrual Accounting and the Financial Statements 11

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Unrecorded revenues or expenses (i.e., revenues earned or expenses occurred but not yet recorded).
a. Accrued expenses.
b. Accrued revenues.
Accrual Accounting and the Financial Statements 12

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A one-year note payable was issued on
11/1/x1 to purchase an equipment. The full amount of the note is $2,400. The annual interest rate is 10% and interests are paid on
4/30/x2 and 11/1/x2.
11/1/x1 Equipment
Note Payable
Adjusting Entry:
2,400
2,400
12/31/x1 Interest Expense 40
Interest payable 40
Accrual Accounting and the Financial Statements 13

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A one year note was received from a credit sale with a face amount of $3,000 and an annual interest rate of 12% on 9/1/x1.
Interests are received on 3/1/x2 and 9/1/x2.
9 /1/x1 Note Receivable 3,000
Sales Revenue
Adjusting Entry:
12/31/x1 Interest Receivable 120
3,000
Interest Revenue 120
Accrual Accounting and the Financial Statements 14

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Postponing the recognition of Revenues or expenses a. Unearned revenues b. Prepaid expenses
Accrual Accounting and the Financial Statements 15

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Receiving $2,400 for a one-year advanced rent payment from a tenant on 12/1/x1
(B/S Approach)
12/1/x1
Cash 2,400
Unearned Rent 2,400
12/30/x1
Unearned Rent 200
Rent Revenue 200
(I/S Approach)
12/1/x1
Cash 2,400
Rent Revenue 2,400
12/30/x1
Rent Revenue 2,200
Rent Unearned 2,200
Accrual Accounting and the Financial Statements 16


Prepaid a 12 month insurance premium of
$1,200 on 11/1/x1
(B/S Approach)
Prepaid Insur. 1,200
Cash 1,200
12/31/x1
Insurance Exp. 200
Prepaid Insurance 200
(I/S Approach)
Insurance Exp. 1,200
Cash 1,200
12/31/x1
Prepaid Insur. 1,000
Insurance Exp.
1,000
Accrual Accounting and the Financial Statements 17

(based on the matching principle)
Depreciation Expense
12/31 Depreciation Expense
Accumulated Depreciation
XXX
XXX
Bad Debt Expense
12/31 Bad Debt Expense
Allowance for B/D
Income Tax Expense
12/31 Income Tax Expense
Income Tax Payable
XXX
XXX
XXX
XXX
Accrual Accounting and the Financial Statements 18

Example
(from Financial Accounting by Harrison and Horngren)
:
Information for Adjustments at 4/30/ 19x1
(a) Prepaid rent expired, $1,000.
(b) Supplies on hand, $400 (balance of supplies equals $700 before adjustment).
(c) Depreciation on furniture, $275.
(d) Accrued salary expense, $950.
(e) Accrued service revenue, $250.
(f) Amount of unearned service revenue that has been earned, $150.
(g) Accrued income tax expense, $540.
Accrual Accounting and the Financial Statements

(a) Rent Expense
Prepaid Rent
To record rent expense.
(b) Supplies Expense
Supplies
To record supplies used.
1,000
300
(c) Depreciation Exp. - Furniture
Accumulated Depr. - Furniture
275
To record depreciation on furniture.
(d) Salary Expense
Salary Payable
To accrue salary expense.
950
Accrual Accounting and the Financial Statements
1,000
300
275
950

(e) Accounts Receivable
Service Revenue
To accrue service revenue.
250
250
(f) Unearned Service Revenue
Service Revenue
150
150
To record unearned revenue that has been earned.
(g) Income Tax Expense
Income Tax Payable
To accrue income tax expense.
540
540
Accrual Accounting and the Financial Statements