Chapter 3
Differentiate between accrual and cash-basis
accounting
Copyright (c) 2009 Prentice Hall. All rights reserved.
2
Accrual Basis
Cash Basis
Revenues are
recognized when
earned and expenses
are recognized when
incurred.
Revenues are
recognized when
cash is received and
expenses recorded
when cash is paid.
Not GAAP
Copyright (c) 2009 Prentice Hall. All rights reserved.
3
Accrual – Revenue recognized
when services provided
Cash – Revenue recognized
when cash is received
Copyright (c) 2009 Prentice Hall. All rights reserved.
4
Accrual – Expense recognized
when incurred
Cash – Expense recognized
when cash is paid
Copyright (c) 2009 Prentice Hall. All rights reserved.
5
Define and apply the accounting period concept,
revenue, and matching principles
Copyright (c) 2009 Prentice Hall. All rights reserved.
6


Businesses prepare financial statements for
specific periods to evaluate performance
Basic accounting period = one year
◦ Calendar year
◦ Fiscal year

Interim periods
◦ Financial statements of less than one year
 Monthly
 Quarterly
 Semiannually
Copyright (c) 2009 Prentice Hall. All rights reserved.
7

When to record revenue?
◦ When it is earned
 When service is provided or product delivered
 This is not necessarily the time when cash is received

What amount of revenue should be recorded?
◦ Value of item or service transferred to customer
Copyright (c) 2009 Prentice Hall. All rights reserved.
8


Measure all expenses incurred during the
accounting period
Match the expenses against the revenues earned
during the same period
Copyright (c) 2009 Prentice Hall. All rights reserved.
9


Requires that accounting information be reported
at regular intervals
Accounts are updated at the end of each
accounting period
Copyright (c) 2009 Prentice Hall. All rights reserved.
10






Which principle is a guide to accounting for
expenses. Identify all expenses incurred during
the period, measure the expenses, and match
them against the revenue earned during that same
time period.
A. Time-Period Principle
B. Matching Principle
C. Revenue Principle
D. Objectivity Principle
E. Reliability Principle
Copyright (c) 2009 Prentice Hall. All rights reserved.
11






Which principle is a guide to accounting for
expenses. Identify all expenses incurred during
the period, measure the expenses, and match
them against the revenue earned during that same
time period.
A. Time-Period Principle
B.
C.
D.
E.
Matching Principle
Revenue Principle
Objectivity Principle
Reliability Principle
Copyright (c) 2009 Prentice Hall. All rights reserved.
12







Which principle says:
Record revenue only after you have earned it.
A.
B.
C.
D.
E.
Time-Period Principle
Matching Principle
Revenue Principle
Objectivity Principle
Reliability Principle
Copyright (c) 2009 Prentice Hall. All rights reserved.
13

Record revenue only after you have earned it.

A. Time-Period Principle
B. Matching Principle




C. Revenue Principle
D. Objectivity Principle
E. Reliability Principle
Copyright (c) 2009 Prentice Hall. All rights reserved.
14
Explain why adjusting entries are needed
Copyright (c) 2009 Prentice Hall. All rights reserved.
15


Prepared at end of an accounting period
Assign:
◦ Revenues to the period when earned
◦ Expenses to the period when incurred


Update asset and liability accounts
Need to properly measure:
◦ Net Income
◦ Assets & Liabilities
Copyright (c) 2009 Prentice Hall. All rights reserved.
16
Never involve
cash
Either increase
revenue or
increase an
expense
“Accrued”
means amount
must be
recorded
Copyright (c) 2009 Prentice Hall. All rights reserved.
17
Journalize and post adjusting entries
Copyright (c) 2009 Prentice Hall. All rights reserved.
18
Prepaid
expenses
Depreciation
Accrued
expenses
Accrued
revenues
Unearned
revenues
Copyright (c) 2009 Prentice Hall. All rights reserved.
19


Advance payments of expenses
Examples:
◦ Rent
◦ Insurance
◦ Supplies


Recorded as an asset
Adjusting entry records amount used as an
expense
Copyright (c) 2009 Prentice Hall. All rights reserved.
20
GENERAL JOURNAL
DATE
Apr
REF
DESCRIPTION
1 Prepaid Rent
Cash
DEBIT
CREDIT
4,800
4,800
Prepaid rent for 6 months
Prepaid rent
4/1
4,800
Copyright (c) 2009 Prentice Hall. All rights reserved.
21
GENERAL JOURNAL
DATE
REF
DESCRIPTION
DEBIT
Apr 30 Rent expense
Prepaid rent
To record rent expired in April
Prepaid rent
4/1
4,800 4/30
Bal
4,000
CREDIT
800
800
Rent expense
800
4/30
800
Copyright (c) 2009 Prentice Hall. All rights reserved.
22

Plant assets
◦ Long-lived tangible assets used in business operations

Examples:
◦ Land, buildings, equipment, and furniture

Depreciation
◦ Allocation of a plant asset’s cost to expense over its
useful life
◦ Land is not depreciated
Copyright (c) 2009 Prentice Hall. All rights reserved.
23
GENERAL JOURNAL
DATE
12
REF
DESCRIPTION
31 Depreciation expense
DEBIT
$$$$
Accumulated depreciation
Contra-asset
account
CREDIT
$$$$
Amount
calculated based
on depreciation
method
Copyright (c) 2009 Prentice Hall. All rights reserved.
24

Contra asset
◦ Normal credit balance
◦ Always paired with related account


Holds sum of all depreciation recorded on a plant
asset
Book value:
◦ Cost minus accumulated depreciation
Copyright (c) 2009 Prentice Hall. All rights reserved.
25

Expenses incurred before payment is made
◦ Results in a liability


Opposite of a prepaid expense
Examples:
◦ Salaries
◦ Interest
Copyright (c) 2009 Prentice Hall. All rights reserved.
26
GENERAL JOURNAL
DATE
REF
DESCRIPTION
Dec 31 Interest expense
Interest payable
To record accrued interest
DEBIT
CREDIT
$$$$
$$$$$
GENERAL JOURNAL
DATE
REF
DESCRIPTION
Dec 31 Salaries expense
DEBIT
CREDIT
$$$$
Salaries payable
$$$$
To record accrued salaries
Copyright (c) 2009 Prentice Hall. All rights reserved.
27


Revenue earned before cash is received
Results in a receivable
GENERAL JOURNAL
DATE
REF
DESCRIPTION
Dec 31 Accounts receivable
DEBIT
CREDIT
$$$$
Service revenue
$$$$
To record accrued revenues
Copyright (c) 2009 Prentice Hall. All rights reserved.
28

Cash is collected before revenue is earned
◦ Results in a liability as the company owes a product or
service or they will have to give the money back

Also called deferred revenue
BEFORE
Copyright (c) 2009 Prentice Hall. All rights reserved.
29
GENERAL JOURNAL
DATE
Dec
REF
DESCRIPTION
1 Cash
DEBIT
CREDIT
$$$$
Unearned revenue
$$$$
To record cash received before service is provided
GENERAL JOURNAL
DATE
REF
DESCRIPTION
Dec 31 Unearned revenue
Service revenue
DEBIT
CREDIT
$$$$
$$$$
To record earned portion of
unearned revenue
Copyright (c) 2009 Prentice Hall. All rights reserved.
30

To properly measure net income on the income
statement
◦ Each adjusting entry affects a revenue or an expense

To update the balance sheet
◦ Each adjusting entry affects an asset or a liability
Copyright (c) 2009 Prentice Hall. All rights reserved.
31
Category of Adjusting Entry
Debit
Credit
Prepaid expense
Expense
Asset
Depreciation
Expense
Contra asset
Accrued expense
Expense
Liability
Accrued revenue
Asset
Revenue
Unearned revenue
Liability
Revenue
Copyright (c) 2009 Prentice Hall. All rights reserved.
32





A. PRE-PAID & DEPRECIATION
B. PRE-PAID & ACCRUALS
C. UNEARNED & DEPRECIATION
D. ACCUMULATED DEPRECIATION
& ACCRUALS
E. DEPRECIATION & ACCRUALS
Copyright (c) 2009 Prentice Hall. All rights reserved.
33

A. PRE-PAID & DEPRECIATION

B. PRE-PAID & ACCRUALS
C. UNEARNED & DEPRECIATION
D. ACCUMULATED DEPRECIATION
& ACCRUALS
E. DEPRECIATION & ACCRUALS



Copyright (c) 2009 Prentice Hall. All rights reserved.
34
Explain the purpose of and prepare an adjusted
trial balance



Prepared after adjusting entries are posted
Useful step in preparing financial statements
Often appears on a work sheet
◦ Tool accountants use at end of period
Copyright (c) 2009 Prentice Hall. All rights reserved.
36
Any Company
Worksheet
December 31, 2010
Trial Balance
Account Title
Cash
Supplies
Equipment
Accum. depr. - Equip.
Accounts payable
Interest payable
Note payable
Josie Smith, Capital
Josie Smith, W/D
Service revenue
Rent expense
Supplies expense
Depreciation expense
Interest expense
Totals
Dr.
5,400
700
17,000
Cr.
Adjustments
Adjusted
Trial Balance
Dr.
Dr.
Cr.
a. 500
1,000
200
200
b. 1,000
2,000
c. 100
100
9,000
6,000
9,000
6,000
1,000
1,000
12,000
12,000
4,000
100
27,200
Cr.
a. 500
b. 1,000
c. 100
27,200
1,600
1,600
4,000
500
1,000
200
28,300
28,300
Prepare the financial statements from the adjusted
trial balance
Income
statement
• Reports revenue and expenses
• Determines net income
Statement of
owner’s equity
• Shows why Capital changed during
the period
• Computes ending Capital
Balance sheet
• Reports assets, liabilities, and
owner’s equity
• Needs ending Capital to balance
Copyright (c) 2009 Prentice Hall. All rights reserved.
39
Any Company
Worksheet
December 31, 2010
Adjusted
Trial Balance
Account Title
Cash
Supplies
Equipment
Accum. depr. - Equip.
Accounts payable
Interest payable
Note payable
Josie Smith, Capital
Josie Smith, W/D
Service revenue
Rent expense
Supplies expense
Depreciation expense
Interest expense
Totals
Dr.
5,400
200
17,000
Cr.
2,000
200
100
9,000
6,000
Balance sheet
1,000
12,000
4,000
500
1,000
200
28,300
Income statement
28,300
Any Company
Income Statement
Year ended December 31, 2010
Revenue:
Service revenue
Expenses:
Rent expense
Depreciation expense
Supplies expense
Interest expense
Total expenses
Net income
$ 12,000
$ 4,000
1,000
500
200
5,700
$ 6,300
Copyright (c) 2009 Prentice Hall. All rights reserved.
41
Any Company
Statement of Owner’s Equity
Year ended December 31, 2010
Josie Smith, Capital, January 1, 2010
Add: Net income
Josie Smith, Capital, December 31, 2010
$ 5,000
6,300
$11,300
Copyright (c) 2009 Prentice Hall. All rights reserved.
42
Copyright (c) 2009 Prentice Hall. All rights reserved.
43






A. Balance Sheet to Income Statement
B. Income Statement to Balance Sheet
C. Income Statement to Statement of Cash Flow
D. Income Statement to Statement of Equity
E. Statement of Equity to Income Statement
F. Statement of Cash Flow to Statement of Equity
Copyright (c) 2009 Prentice Hall. All rights reserved.
44






A. Balance Sheet to Income Statement
B. Income Statement to Balance Sheet
C. Income Statement to Statement of Cash Flow
D. Income Statement to Statement of Equity
E. Statement of Equity to Income Statement
F. Statement of Cash Flow to Statement of Equity
Copyright (c) 2009 Prentice Hall. All rights reserved.
45






A. Balance Sheet
B. Income Statement
C. Statement of Cash Flow
D. Statement of Equity
E. Balance Sheet & Income Statement
F. Statement of Cash Flow & Statement of Equity
Copyright (c) 2009 Prentice Hall. All rights reserved.
46

A. Balance Sheet
B. Income Statement
C. Statement of Cash Flow
D. Statement of Equity

E. Balance Sheet & Income Statement

F. Statement of Cash Flow & Statement of Equity



Copyright (c) 2009 Prentice Hall. All rights reserved.
47