Chapter 3
Differentiate between accrual and cash-basis
accounting
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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
Often TAX
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3
Accrual – Revenue recognized
when services provided
Cash – Revenue recognized
when cash is received
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4
Accrual – Expense recognized
when incurred
Cash – Expense recognized
when cash is paid
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5

You pay 6 months of rent in advance?
◦ Accrual entry?
◦ Cash entry?
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6
Define and apply the accounting period concept,
revenue, and matching principles
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

Businesses prepare financial statements for
specific periods to evaluate performance
Basic accounting period = one year
◦ Calendar year
◦ Fiscal year
(often follows seasonal nature of business)

Interim periods
◦ Financial statements of less than one year
 Monthly
 Quarterly
 Semiannually
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
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
 Follows legal rules of transaction (Can you sue for it?)

What amount of revenue should be recorded?
◦ Value of item or service transferred to customer
◦ This is based on what they will pay for it
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9



Measure all expenses incurred during the
accounting period
Match the expenses against the revenues earned
during the same period
This is a MAJOR difference between cash and
accrual
◦ Accrual matches
◦ Cash may not
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10


Requires that accounting information be reported
at regular intervals
Accounts are updated at the end of each
accounting period
◦ MUST be updated at end of period
◦ May be updated at interval reporting
◦ It is driven by the need to prepare statements
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11
Explain why adjusting entries are needed
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12
Smart Touch Learning
Unadjusted Trial Balance
May 31, 2010
Cash
Accounts Receivable
Supplies
Prepaid Rent
Furniture
Building
Accounts Payable
Kay Torres, Capital
Unearned Service Revenue
Kay Torres, Withdrawals
Notes Payable
Service Revenue
Sheena Bright, Capital
Salary Expense
Sheena Bright, Withdrawals
Utilities Expense
Service Revenue
Salary Expense
Utilities Expense
4,800
2,200
700
3,000
18,000
48,000
3,200
550
1,000
400
50,050
900
400
79,000
18,200
29,500
600
20,000
7,000
33,200
7,000
50,050
79,000
13


Prepared at end of an accounting period
Assign:
◦ Revenues to the period when earned
 These were previously recorded as unearned revenue when
the cash was received
◦ Expenses to the period when incurred
 These were previously recorded as pre-paid expense when
the cash was paid out.

Need to properly measure:
◦ Net Income
◦ Assets & Liabilities
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
Update asset and liability accounts
◦ Assets
 Types of entries
 Prepaid expenses (record how much expense has been
incurred on expenses that were prepaid)
 Depreciation of Plant And Equipment (and amortization)
 Accrued revenue (record how much revenue has been earned
from customers who owe for goods and services received)
 You will be doing one of the following
 Decreasing the asset (credit)
 recording an expense (debit)
 Increasing an asset (debit)
 recording revenue
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15

Update asset and liability accounts
◦ Liabilities
 Types of entries
 Unearned revenue (When customers prepay, you set up a
liability. You now must show how much of this prepayment has
been earned)
 Accrued expense (Business owes for goods and services
received but that haven’t been paid)
 You will be doing one of the following
 Decreasing the liability (debit)
 Recording a revenue (credit)
 Increasing a liability (credit)
 Recording an expense (debit)
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16
Never involve
cash
Either increase
revenue or
increase an
expense
“Accrued”
means amount
must be
recorded
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17
Journalize and post adjusting entries
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18
Prepaid
expenses
Depreciation
Accrued
expenses
Accrued
revenues
Unearned
revenues
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

Advance payments of expenses
Examples:
◦ Rent
◦ Insurance
◦ Supplies


Recorded as an asset
Adjusting entry records amount used as an
expense
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20
Adjustments – Prepaid/Unearned an Accrued
Expenses
Expenses
Prepaid
Current Period
Cash Paid
End of the current
Period/future Period
Expense Recorded
21
GENERAL JOURNAL
DATE
REF
DESCRIPTION
May 1 Prepaid Rent
Cash
DEBIT
CREDIT
3,000
3,000
Prepaid rent for 3 months
Prepaid rent
5/1
3,000
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GENERAL JOURNAL
DATE
REF
DESCRIPTION
May 31 Rent expense
Prepaid rent
To record rent expired in May
Prepaid rent
5/1
3,000 5/31 1,000
Bal
2,000
DEBIT
CREDIT
1,000
1,000
Rent expense
5/31 1,000
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23
GENERAL JOURNAL
DATE
DESCRIPTION
May 2 Suplies
Cash
REF
DEBIT
CREDIT
500
500
Supplies
5/2
500
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GENERAL JOURNAL
DATE
DESCRIPTION
May 15 Suplies
Cash
REF
DEBIT
CREDIT
200
200
Supplies
5/2
15
500
200
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25
GENERAL JOURNAL
DATE
DESCRIPTION
REF
May 31 Supplies expense
Supplies
To record supplies used in May
5/31
Bal
DEBIT
CREDIT
100
100
Supplies
Supplies expense
700
5/31 100
5/31 100
600
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26

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
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27

Depreciation spreads the COST of an
asset, (its book value) over the life of the
asset (the time it will be used to generate
revenue).

It is NOT adjusting the asset to market
value
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GENERAL JOURNAL
DATE
DESCRIPTION
May 3 Furniture
Cash
Purchased furniture
REF
DEBIT
CREDIT
18,000
18,000
Furniture
5/3 18,000
29
Depreciation - process of allocating the cost
of a plant asset to expense over its expected
useful life
Straight-Line
Depreciation Expense
Asset Cost
=
Useful Life
30
Accumulated depreciation accounts are called
contra asset accounts because they are deducted
from the related asset accounts on the balance
sheet.
Hint! Consider it like a tick on the back of a dog!
31
Income Statement
Account
GENERAL JOURNAL
DATE
May 31
DESCRIPTION
REF
Depreciation Expense,
Furniture
DEBIT
CREDIT
300
Accumulated Depreciation,
Furniture
300
To record depreciation for Sep.
Balance Sheet Account
Accumulated depreciation is
a contra asset account
32
Furniture
Bal. 18,000
Accumulated Depreciation,
Furniture
5/31 300
Bal
300
Depreciation Expense,
Furniture
5/31 300
Bal
300
33


Reported on balance sheet
Cost minus accumulated depreciation
34
Smart Touch Learning
Balance Sheet
May 31, 20XX
Assets
Cash
.
.
.
Furniture
Less: Accumulated Depreciation
Total Assets
$XXXX
$ 18,000
(300) 17,700
$XXXX
Book Value
35
Income Statement
Account
GENERAL JOURNAL
DATE
May 31
DESCRIPTION
REF
Depreciation Expense,
Building
DEBIT
CREDIT
200
Accumulated Depreciation,
Building
200
To record depreciation for Sep.
Balance Sheet Account
Accumulated depreciation is
a contra asset account
36
Building
Bal. 48,000
Accumulated Depreciation,
Building
5/31 200
Bal
200
Depreciation Expense,
Building
5/31 200
Bal
200
37

Expenses incurred before payment is made
◦ Results in a liability


Opposite of a prepaid expense
Examples:
◦ Salaries
◦ Interest
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38
Adjustments – Deferrals and Accruals
Revenues
Current Period
Unearned
Cash Received
Accruals
Revenue Recorded
Expenses
Prepaid
Accruals
Current Period
Cash Paid
Expense Recorded
Future Period
Revenue Recorded
Cash Received
Future Period
Expense Recorded
Cash Paid
39
Adjustments – Accrued Expense
Smart Touch received employee services for the second half of
the month of May amounting to $900, to be paid on June 1.
Record accrued wages of $900
Salary Payable
Liabilities
Salary Expense
5/15
900
Expenses
40
GENERAL JOURNAL
DATE
DESCRIPTION
REF
May 31 Salary expense
Salary Payable
To record salaries accrued in May
DEBIT
CREDIT
900
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900
41
Adjustments – Accrued Expense
Smart Touch received employee services for the second half of the
month of May amounting to $900, to be paid on June 1.
Record accrued wages of $900
Salary Payable
Liabilities
900
A5
Salary Expense
5/15 900
5/31 900
1,800
A5
Expenses
42
Adjustments – Accrued Expenses
On May 1, Smart Touch borrowed $20,000 from a bank signing
a one year note payable.
Cash
20,000
Notes Payable
20,000
43
GENERAL JOURNAL
DATE
DESCRIPTION
REF
May 31 Interest expense
Interest Payable
To record interest accrued in May
DEBIT
CREDIT
100
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100
44
Adjustments – Accrued Expense
Smart Touch recorded interest accrued of $100
Interest Payable
Liabilities
100
A5
Interest Expense
5/31 100
Bal. 100
A5
Expenses
45


Revenue earned before cash is received
Results in a receivable
GENERAL JOURNAL
DATE
REF
DESCRIPTION
Dec 31 Accounts receivable
Service revenue
DEBIT
CREDIT
$$$$
$$$$
To record accrued revenues
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46
Adjustments – Deferrals and Accruals
Revenues
Accruals
Expenses
Prepaid
Accruals
Current Period
Revenue Recorded
Current Period
Cash Paid
Expense Recorded
Future Period
Cash Received
Future Period
Expense Recorded
Cash Paid
47
Adjustments – Accrued Revenue
As of May 31, Smart Touch provided a ½ month of services.
Cash to be received on 6/15.
Record services earned of $400.
Accounts Receivable
Assets
Bal.....2,200
Services Revenue
7,000 Bal.
Revenues
48


Revenue earned before cash is received
Results in a receivable
GENERAL JOURNAL
DATE
REF
DESCRIPTION
May 31 Accounts receivable
Service revenue
DEBIT
CREDIT
400
400
To record accrued revenues
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49
Adjustments – Accrued Revenue
As May 31 Smart Touch provided a ½ month of services. Cash to be
received on 6/15.
Record services earned of $400.
Accounts Receivable
Assets
Bal.....2,200
5/31 400
2,600
A6
Services Revenue
7,000 bal.
400 5/31
7,400 bal.
A6
Revenues
50

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
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51
Adjustments – Deferrals and Accruals
Revenues
Current Period
Unearned
Cash Received
Accruals
Revenue Recorded
Expenses
Prepaid
Accruals
Current Period
Cash Paid
Expense Recorded
Future Period
Revenue Recorded
Cash Received
Future Period
Expense Recorded
Cash Paid
52
Adjustments – Deferred Revenue
On May 21, Smart Touch received cash of $600 in advance for
e-learning services to be performed over the next 30 days.
Example S1 – Sale initially recorded as a liability.
Adjustment A3 – Record
services earned for Sept.
Cash
600
Unearned Service
Revenue
Liabilities
600
Service Revenue
7,000
400
Revenues
53
GENERAL JOURNAL
DATE
DESCRIPTION
REF
May 31 Unearned Service Revenue
Services Revenue
To record revenue earned in May
DEBIT
CREDIT
200
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200
54
Adjustments – Deferred Revenue
On May 21, Smart Touch received cash of $600 in advance for
e-learning services to be performed over the next 30 days.
Example S1 – Sale initially recorded as a liability.
Adjustment A3 – Record
services earned for May
10/30 X600= $200
Cash
600
Unearned Service
Revenue
5/31 200
600
Liabilities
Service Revenue
7,000
400
200
7,600
Revenues
55

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
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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
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57
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

It is now often done by computers and run with
closing entries (which we will get to later)
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59
Smart Touch Learning
Adjusted Trial Balance
May 31, 2020
Debit
Credit
Cash
4,800
Accounts Receivable
2,600
Supplies
600
Prepaid Rent
2,000
Furniture
18,000
Building
48,000
Accum. Deprec. Furniture
300
Accum. Depreciation:Building
200
Accounts Payable
18,200
Salary Payable
900
Interest Payable
100
Unearned Service Revenue
400
Notes Payable
20,000
Sheena Bright, Capital
33,200
Sheena Bright, Withdrawals
1,000
Service Revenue
7,600
Rent expense
1,000
Salary expense
1,800
Supplies expense
100
Deprec. Expense: Furniture
300
Depreciation Expense: Build.
200
Interest Expense
100
Utilities Expense
400
_ ____
80,900
80,900
60
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
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62
Smart Touch Learning
Adjusted Trial Balance
May 31, 2020
Debit
Credit
Cash
4,800
Accounts Receivable
2,600
Supplies
600
Prepaid Rent
2,000
Furniture
18,000
Building
48,000
Accum. Deprec. Furniture
300
Accum. Depreciation:Building
200
Accounts Payable
18,200
Salary Payable
900
Interest Payable
100
Unearned Service Revenue
400
Notes Payable
20,000
Sheena Bright, Capital
33,200
Sheena Bright, Withdrawals
1,000
Service Revenue
7,600
Rent expense
1,000
Salary expense
1,800
Supplies expense
100
Deprec. Expense: Furniture
300
Depreciation Expense: Build.
200
Interest Expense
100
Utilities Expense
400
_ ____
80,900
80,900
63
Smart Touch Learning
Income Statement
Month Ended May 31, 2010
Service Revenue
Expenses:
Salary expense
Rent Expense
Utilities Expense
Deprec. Expense-Furniture
Deprec. Expense-Building
Interest Expense
Supplies Expense
Total expenses
Net income
$7,600
$1,800
1,000
400
300
200
100
100
3,900
$3,700
Financial Statements
Smart Touch Learning
Statement of Owners Equity
Month Ended May 31, 2010
Sheena Bright, capital, May 1, 2010 $ 33,200
Net income
3,700
$36,900
Less withdrawals
(1,000)
Sheena Bright, Capital May 31, 2010 $35,900
Smart Touch Learning
Balance Sheet
May 31, 2020
Assets
Cash
Accounts Receivable
Supplies
Prepaid rent
Liabilities
$4,800
2,600
600
2,000
Furniture
$18,000
Less: Accum Dep. -300
17,700
Building
48,000
Accumulated
depreciation
-200 47,800
Total Assets
Accounts Payable
$18,200
Salary Payable
900
Interest Payable
100
Unearned Serv. Revenue
400
Notes Payable
20,000
Total Liabilities
$39,600
Owner’s Equity
Sheens Bright, Capital
35,900
Total Liabilities &
Owner’s Equity
$75,500
$75,500
66
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
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68
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69
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