4-1
The Accounting Cycle:
Accruals (應計項目) and Deferrals (遞延項目)
Chapter 4
Accounting Cycle
Generally consists of eight specific steps
1. Journalize
2. Posting to Ledger
Chapter 3
3. Unadjusted Trial balance
4. Making (end of period) adjustments
Chapter 4
(journalize and posting adjusting entries)
5. Adjusted trial balance
We use adjusting
6. Financial statements
entries to record
7. Closing entries (and posting)
events that have
occurred but not
8. After-closing trial balance *

yet recorded and
bring those
account balances
up-to-date.
4-2
4-2
Preparing Financial Statements Covering Different
Periods of Time
Interim
Financial
Statements
(中期財務報
表)
Timing Issues
• Many companies prepare financial statements at various points throughout the
year.
• Most organizations use a year as their primary accounting period (It is the period
for which financial statements are prepared).
• Many organizations also prepare interim financial statements (中期財務報表),
covering one, three, or six months of activity (i.e. not on annual basis).
• Fiscal Year (會計年度 / 財政年度) = Accounting time period that is one year in
length.
• Calendar Year (日曆年) = January 1 to December 31.
4-3
Accounting Periods
Chapter 3
Time Period Principle
To provide users of
financial statements with
timely information, profit
is measured for relatively
short accounting periods
of equal length.
 This principle allows the life of a company to be divided
into artificial (人为的) time periods such as months and
years so that profit can be measured for a specific period
of time (e.g., monthly, quarterly, annually).
 Without this principle, a company’s income statement
could only be reported at the end of its life.
4-4
4-3
The Recognition Principle:
When to record Revenue (p102)
Chapter 3
Recognition Principle:
Revenue should be
recognized at the time
goods are sold and
services are rendered,
regardless of when cash
is received.
4-5
The Matching Principle:
When to record Expenses (p103)
Chapter 3
Matching Principle:
Expenses should be
recorded in the period in
which they are used up
to generate revenue,
regardless of when cash
is paid.
4-6
4-4
What is the difference between Cash Basis
Accounting and Accrual Basis Accounting?
For Students
Reference
There are two ways to record transactions:
Cash basis accounting
Accrual basis accounting
• Revenues are recorded when
cash is received
• Revenues are recorded when
earned (goods are sold and
services are rendered)
• Expenses are recorded when
incurred
• Used by most businesses
• Provides a better picture of a
business’s revenues and
expenses
• Expenses are recorded when
cash is paid
• Not allowed under GAAP
• Easier method to follow;
requires less knowledge of
accounting concepts and
principles
4-7
What is the difference between Cash Basis
Accounting and Accrual Basis Accounting?
For Students
Reference
Example: On May 1, Smart Touch Learning paid $1,200 for insurance for the next six
months ($200 per month). Assume financial statements are prepared on a monthly basis.
•
Under the cash basis
method, Smart T would
record Insurance Expense
of $1,200 on May 1. This is
because the cash basis
method records an expense
when cash is paid.
•
Accrual basis accounting
requires the company to
prorate ( 按比例分配 ) the
expense. Smart would record
a $200 expense which is
used every month from May
through October.
•
In short, the difference
between cash-basis and
accrual-basis accounting is a
matter of timing.
4-8
4-5
Adjusting Entries
… are used to apply accrual accounting to transactions that
span (involve) more than one accounting period to ensure
that a company’s financial statements include the proper
amount of revenues, expenses, assets, liabilities and
shareholders’ equity.



Each adjusting entry must include
◦ either an asset or liability and
◦ either a revenue or expense
◦ Never a Cash account
Entries are made only at the end of each accounting period to
get the accounts up to date for the financial statements.
The two basic categories are deferrals and accruals.
4-9
Four Types of Adjustments
Types of Adjusting Entries
Deferrals
Cash
Accruals
(遞延項目)
Adjustments
Deferrals
Adj
Adj
Cash
(應計項目)
Accruals
Paid (or received) cash before
expense (or revenue) recognized
Paid (or received) cash after
expense (or revenue) recognized
1
3
2
4
Prepaid
(Deferred)
expenses
Unearned
(Deferred)
revenues
Accrued
expense
预付費用
(assets)
未獲收益
(liabilities)
應計費用
(liabilities)
Accrued
revenues
應計收益
(assets)
4-10
4-6
Four Types of Adjustments
(1.Deferred/ Prepaid Expenses)
Asset
Expense
Examples of
recorded costs:
Prepaid Rent
Prepaid Insurance
Supplies
Equipment
Building
1. Recorded costs are
allocated between
two or more
accounting periods
(Deferred/ Prepaid Expenses)
Also called deferred
expenses or prepaid
expenses
They represent
expenses paid in
advance that
have not expired
yet
• Recorded costs are assets
• Once a recorded cost expires it becomes an expense
• The adjusting entry involves an asset account and an expense
account
4-11
Four Types of Adjustments
(3. Accrued Expenses)
Asset
Expense
1. Recorded costs are
allocated between
two or more
accounting periods
(Deferred/ Prepaid Expenses)
Liability
3. Expenses are
incurred but not yet
recorded
(Accrued Expenses)
Also called accrued
expenses
Example:
Wages earned by
employees in the
current accounting
period but only pay
in the next period
• These expenses have been incurred and must be recorded as
liabilities to the company
• The adjusting entry involves an expense account and a liability
account
4-12
4-7
Four Types of Adjustments
(2. Deferred Revenues)
Asset
Expense
Liability
1. Recorded costs are 3. Expenses are
allocated between
incurred but not yet
two or more
recorded
accounting periods
(Deferred/Prepaid Expenses)
(Accrued Expenses)
2. Recorded unearned
revenues are
allocated between
two or more
accounting periods
Revenue
An example of
recorded unearned
revenue is
Unearned Art Fees
(Deferred Revenues)
It represents fees
that have been
received and
recorded for
services not yet
provided
• Recorded unearned revenues are liabilities
• Once earned, recorded unearned revenue becomes revenue
• The adjusting entry involves a liability account and a revenue
account
4-13
Four Types of Adjustments
(4. Accrued Revenues)
Expense
Asset
Liability
1. Recorded costs are
allocated between
two or more
accounting periods
3. Expenses are
incurred but not yet
recorded
(Deferred/Prepaid Expenses)
Revenue
Also called accrued
revenues
4. Revenues are
earned but not yet
recorded
(Accrued Revenues)
(Accrued Expenses)
2. Recorded unearned
revenues are
allocated between
two or more
accounting periods
(Deferred Revenues)
Example:
Advertising
services that
have been
performed but
no fees have
been collected
and the
customer has not
yet been billed
• These revenues have been earned and must be recorded as
assets to the company
• The adjusting entry involves an asset account and a revenue
account
4-14
4-8
Types of Adjusting Entries
 Converting
assets to
expenses
 Converting
liabilities to
revenue
(prepaid expense)
(unearned revenue)
 Accruing
unpaid
expenses
(accrued expenses)
Payable
 Accruing
uncollected
revenue
(accrued revenue)
Receivable
4-15
External vs Internal Transaction

A transaction may be external or internal.
External
transactions involve economic
events between the company and some
outside enterprise. Example: Selling of
products and services.
Internal
transactions are economic
events that occur entirely within one
company. Example: Supplies are assets.
When business used its supplies, they
are reported as expenses.
4-16
4-9
(1) Converting Assets to Expenses - Deferrals
(Prepaid expense / Deferred expense) – represents expense paid in
advance that have not used (预付費用)  (Asset)
End of Current Period
Prior Periods
Current Period
External
transaction
Transaction
Paid cash in advance of
incurring expense
(creates an asset
because expense not yet
used).
Future Periods
Internal
transaction
Adjusting Entry
 Recognizes portion
of asset consumed / used
as expense, and
 Reduces balance of
asset account.
When an adjusting entry is used to convert an asset to expense, a transaction took
place in a prior period that involved the advance payment of an expense.
4-17
Converting Assets to Expenses
$2,400 Insurance Policy
Coverage for 12 Months
$200 Monthly Insurance Expense
1 Jan.
31 Dec.
On 1 January, Webb Co. purchased a
one-year insurance policy for $2,400.
(situation: cash paid before expense is incurred/used)
4-18
4-10
Converting Assets to Expenses
(Prior Periods)
Initially, costs that benefit more than one accounting
period are recorded as assets.
(external transaction)
GENERAL JOURNAL
Date
1
Account Titles and Explanation
Jan Unexpired Insurance (Asset)
Debit
Credit
2,400
Cash
2,400
Purchase a one-year insurance policy.
4-19
Converting Assets to Expenses
(Current Periods)
The costs are expensed
as they are used to
generate revenue.
(internal transaction)
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
Monthly Adjusting Entry for Insurance
31 Jan Insurance Expense
Unexpired Insurance
200
200
Insurance expense for January.
4-20
4-11
Converting Assets to Expenses
Statement of
Financial Positon
Cost of assets that
benefit future
periods.
Income Statement
Cost of assets
used this period to
generate revenue.
Unexpired Insurance
1/1 2,400 31/1
200
Bal. 2,200
Insurance Expense
31/1
200
Both the asset account and the expense account
are now carried at their proper balance.
4-21
(2)Converting Liabilities to Revenue – Deferrals (liability)
(Unearned revenue / Deferred Revenue) is cash that has been
received prior to the provision of goods or services. The subsequent provision of
the goods or services will be regarded as revenue earned. (未獲收益)
End of Current Period
External
transaction
Prior Periods
Current Period
Transaction
Collect cash in advance of
earning revenue
(creates a liability because
revenue not yet earned).
Future Periods
Adjusting Entry
 Recognizes portion
earned as revenue, and
 Reduces balance of
liability account.
When an adjusting entry is used to convert a liability to revenue, a transaction took
place in a prior period that involved the advance receipt of a revenue.
4-22
4-12
Converting Liabilities to Revenue
$6,000 Rental Contract
Coverage for 12 Months
$500 Monthly Rental Revenue
1 Jan.
31 Dec.
On January 1, Webb Co. received $6,000 in advance
for a one-year rental contract.
(situation: cash received before revenue is earned)
4-23
Converting Liabilities to Revenue
(Prior Periods)
Initially, revenues that benefit more than one
accounting period are recorded as liabilities.
(external transaction)
GENERAL JOURNAL
Date
Account Titles and Explanation
1 Jan Cash
Unearned Rent Revenue (Liab)
Debit
Credit
6,000
6,000
Collected $6,000 in advance for rent.
4-24
4-13
Converting Liabilities to Revenue
(Current Periods)
Over time, the revenue is recognized as it is earned.
(internal transaction)
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
Monthly Adjusting Entry for Rent Revenue
31 Jan Unearned Rent Revenue
500
Rental Revenue
500
Rental revenue for January.
4-25
Converting Liabilities to Revenue
Statement of
Financial Positon
Liability for future
periods.
Unearned Rental Revenue
31/1
500
1/1 6,000
Bal. 5,500
Income Statement
Revenue earned
this period.
Rental Revenue
31/1
500
Represents 11 months
of unearned rent at
$500 per month
4-26
4-14
(3) Accruing Unpaid Expenses (= accrued
expenses) – Accruals (liability)
is expense that is incurred but it has not yet been paid (應計費用)
An expense has been incurred in the
current accounting period but will not
be paid until the following accounting
period.
Prior Periods
1.
2.
End of Current Period
Current Period
Adjusting Entry
Recognizes expense
incurred but not yet paid, and
Records liability for
future payment.
Future Periods
Transaction
Pay cash in
settlement of
liability.
4-27
Accruing Unpaid Expenses
$3,000 Wages
Expense
Monday,
29 May
Wednesday,
31 May
Friday,
2 June
On 31 May, Webb Co. owes wages of $3,000. Payday is
Friday, 2 June.
(situation: expense incurred before cash is paid)
4-28
4-15
Accruing Unpaid Expenses
(Current Periods)
Initially, an expense and a liability are recorded.
(internal transaction)
Date
Account Titles and Explanation
Debit
31 May Wages Expense
Credit
3,000
Wages Payable
3,000
To accrue wages owed to employees.
**(To accrue means to accumulate over time)
4-29
Accruing Unpaid Expenses
Income Statement
Cost incurred this period
to generate revenue.
(matching principle)
Statement of Financial
Positon
Liability to be paid in
a future period.
Wages Payable
31/5 3,000
Wages Expense
31/5 3,000
Expenses should be
recorded in the period in
which they are used up to
generate revenue.
4-30
4-16
Accruing Unpaid Expenses
- Pay cash in settlement of liability.
$5,000 Weekly Wages
$3,000 Wages
Expense
Monday,
29 May
$2,000 Wages
Expense
Wednesday,
31 May
Friday,
2 June
Let’s look at the entry for 2 June.
4-31
Accruing Unpaid Expenses (Future Periods)
The liability is settled when the debt is paid.
(external transaction)
GENERAL JOURNAL
Date
Account Titles and Explanation
2 June Wages Expense (for June)
Wages Payable (accrued in May)
Cash
Debit
Credit
2,000
3,000
5,000
Weekly payroll for 29 May - 2 June
4-32
4-17
(4) Accruing Uncollected Revenue
(= accrued revenue) – Accruals (asset)
is revenue that is earned for goods or services provided but has not yet been
billed or invoiced. (應計收益)
End of Current Period
Prior Periods
Current Period
Adjusting Entry
1. Recognizes revenue
earned but not yet
received, and
2. Records receivable.
Future Periods
Transaction
Collect cash in
settlement of
receivable.
4-33
Accruing Uncollected Revenue
$170 Interest
Revenue
Saturday,
15 Jan.
Monday,
31 Jan.
Tuesday,
15 Feb.
On 31 Jan., the bank owes Webb Co.
interest of $170. Interest is paid on the
15th day of each month.
(situation: revenue earned before cash is received)
4-34
4-18
Accruing Uncollected Revenue
(Current Periods)
Initially, the revenue is recognized and a receivable
is created. (internal transaction)
GENERAL JOURNAL
Date
Account Titles and Explanation
31 Jan Interest Receivable
Debit
Credit
170
Interest Revenue
170
To recognize interest revenue
4-35
Accruing Uncollected Revenue
Statement of
Financial Positon
Receivable to be
collected in a
future period.
Interest Receivable
31/1
170
Income Statement
Revenue earned
this period.
Interest Revenue
31/1
170
4-36
4-19
Accruing Uncollected Revenue
- Collect cash
$320 Monthly Interest
$170 Interest
Revenue
Saturday,
15 Jan.
$150 Interest
Revenue
Monday,
31 Jan.
Tuesday,
15 Feb.
Let’s look at the entry for 15 February.
4-37
Accruing Uncollected Revenue
(Future Periods)
The receivable is collected in a future period.
(external transaction)
GENERAL JOURNAL
Date
Account Titles and Explanation
15 Feb Cash
Debit
Credit
320
Interest Revenue (for February)
150
Interest Receivable (accrued 31 Jan)
170
To record interest received.
4-38
4-20
Accruing Income Taxes Expense:
The Final Adjusting Entry:
- taxes incurred but not yet paid
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
31 Dec Income Taxes Expense
Debit
Credit
780
Income Taxes Payable
780
Estimated income taxes applicable to
taxable income earned in December.
4-39
Recap - Adjusting Entries and Accounting Principles
Matching Principle:
Expenses should be recorded in the period in which they are
used up to generate revenue, regardless of when cash is paid.
Adjusting entries help match costs with
revenue in two ways:

Direct association of actual amount of expense
(costs) with specific revenue transactions.
Example: Commissions paid to salespeople.

Systematic allocation of costs (expenses) over the
“useful life” (使用年限) of the expenditure.
Example: the cost of insurance policy and
depreciable assets.
4-40
4-21
The Concept of Depreciation (折舊)
Depreciable assets (應折舊資產) are physical objects that
retain their size and shape but lose their economic
usefulness (經濟效用) over time.
Example: Buildings, equipment, truck, etc.
Depreciation is the systematic allocation of
the cost of a depreciable asset to expense.
4-41
The Concept of Depreciation
Depreciation is the systematic allocation of
the cost of a depreciable asset to expense.
Fixed
Asset
(debit)
On date
when initial
payment is
made . . .
Cash
(credit)
The asset’s
usefulness (效
用) is partially
consumed
during the
period.
Depreciation
Expense
(debit)
At end of
period . . .
Accumulated
Depreciation
累計折舊
(credit)
4-42
4-22
Depreciation Is Only an Estimate
On 2 May 2009, 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 and allocate the cost over the useful
life (使用年限) of the lawn mower.
Depreciation
expense
=
(per period)
Cost of the asset
Estimated useful life
$50 = $2,500
50
4-43
Depreciation Is Only an Estimate
JJ’s Lawn Care Service would make the
following adjusting entry.
GENERAL JOURNAL
Date
31
Account Titles and Explanation
May Depreciation Expense: Equipment
Accumulated Depreciation: Equipment
Debit
Credit
50
50
To record one month's depreciation.
Contra-asset
(i)
(ii)
It has a credit balance.
It is offset against an asset account.
4-44
4-23
Depreciation Is Only an Estimate
JJ’s $15,000 truck is depreciated over 60
months. Calculate monthly depreciation and
make the journal entry.
GENERAL JOURNAL
Date
Account Titles and Explanation
31 May Depreciation Expense: Truck
Debit
Credit
250
Accumulated Depreciation: Truck
250
To record one month's depreciation.
$15,00060 months = $250 per month
4-45
Posting to T-Ledger
Depreciation Exp. - Truck
5/31 250
Depreciation Exp. - Equip.
5/31 50
Accum. Dep. - Truck
5/31 250
Accum. Dep. - Equip.
5/31 50
4-46
4-24
Adjusted Trial Balance
JJ's Lawn Care Service
Adjusted Trial Balance
31 May 2009
Cash
$
3,925
Accounts receivable
75
Tools & equipment
2,650
Accum. depreciation: tools & eq.
$
50
Truck
15,000
Accum. depreciation: truck
250
Notes payable
13,000
Accounts payable
150
Share capital
8,000
Dividends
200
Sales revenue
750
Gasoline expense
50
Depreciation exp.: tools & eq.
50
Depreciation exp.: truck
250
Total
$
22,200 $ 22,200
All balances
are taken from
the ledger
accounts on
31 May after
preparing the
two
depreciation
adjusting
entries.
4-47
Depreciation Is Only an Estimate
Accumulated depreciation累計折舊 (contra asset account) would
appear on the statement of financial position to reduce assets
as follows:
(Note: Accumulated depreciation means total amount of depreciation
that the company has expensed in the asset’s life.)
Equipment
$ 2,500
Less: Accum. depr.
50
Truck
$ 15,000
Less: Accum. depr.
250
2,450
14,750
Cost - Accumulated Depreciation = Book Value
4-48
4-25
Depreciation Is Only an Estimate
Depreciation would appear on the
income statement as follows:
JJ's Lawn Care Service
Income Statement After Adjustments
For the Month Ended May 31, 2009
Sales Revenue
Operating Expense:
Dep. Exp. - Equipment
Dep. Exp. - Truck
Gasoline Expense
Net Income
$ 750
50
250
50
350
$ 400
4-49
The Concept of Materiality (重要性)
An item is “material” if knowledge of the item
might reasonably influence the decisions of users
of financial statements.
Therefore only significant information should be
reflected in the business’s financial reports.
Many companies
immediately charge
the cost of immaterial
(not important) items to
expense.
Light bulbs
Supplies
4-50
4-26
Prepaid Expenses – Supplies Expense (page 148)
Supplies include food and paper products. At the end of the month,
Papa John’s counted $12,000 in supplies on hand, but the
Supplies account indicated a balance of $16,000. We need to
determine the supplies used during the current accounting period.
4-51
Prepaid Expenses
Supplies include food and paper products. At the end of the month,
Papa John’s counted $12,000 in supplies on hand, but the
Supplies account indicated a balance of $16,000. We need to
determine the supplies used during the current accounting period.
4-52
4-27
Summary: Deferral and Accrual Adjustments
4-53
Impact of Adjusting Journal Entry Errors or Omissions
Note: Balance Sheet = Statement of Financial Position
4-54
4-28
Readings and Home Exercises

Readings – Chapter 4 Williams


Exercises 4.1, 4.7 and 4.9
Problem 4.1B, 4.3B and 4.5B
(solutions are available on SOUL)

**Practice makes perfect

End of Chapter 4
4-55