4
Accrual Accounting Concepts
Kimmel ● Weygandt ● Kieso
Accounting, Sixth Edition
4-1
CHAPTER OUTLINE
LEARNING OBJECTIVES
4-2
1
Explain the accrual basis of accounting and the reasons
for adjusting entries.
2
Prepare adjusting entries for deferrals.
3
Prepare adjusting entries for accruals.
4
Prepare an adjusted trial balance and closing entries.
4-3
LEARNING
OBJECTIVE
1
Explain the accrual basis of accounting and the
reasons for adjusting entries.
Accountants divide the economic life of a business into
artificial time periods Periodicity/Time Period Assumption.
Jan.

4-4
Feb.
Mar.
Apr.
.....
Dec.
Generally a month, a quarter, or a year.
LO 1
ACCRUAL VERSUS CASH BASIS
Accrual-Basis Accounting
► Transactions recorded in the periods in which the
events occur.

Companies recognize revenues when they perform
services (rather than when they receive cash).

Expenses are recognized when incurred (rather than
when paid).
4-5
LO 1
ACCRUAL VERSUS CASH BASIS
Cash-Basis Accounting

Revenues are recorded when cash is received.

Expenses are recorded when cash is paid.

Cash-basis accounting is not in accordance with
generally accepted accounting principles (GAAP).
Only micro-businesses might use it as well as
government entities (MoF accrual accounting
project)
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LO 1
MoF accrual accounting project

Saudi Arabia’s adoption of the accrual basis accounting program aims to play an effective
role in providing financial data that help measure performance, analyze gaps and seize
available opportunities in light of financial performance.

The Kingdom’s transition from cash to accrual accounting was not just a technical
requirement. It will help developing effective financial policies.

In addition, the successful shift will allow the government entities to have an integrated
financial system, based on international accounting standards for public sector called:

4-7
International Public Sector Accounting Standards (IPSAS)
ACCRUAL VERSUS CASH BASIS
Illustration: Suppose that Fresh Colors paints a large building
in 2016. In 2016, it incurs and pays total expenses (salaries
and paint costs) of $50,000. It bills the customer $80,000, but
does not receive payment until 2017.
2016
ILLUSTRATION 4-2
Accrual-versus cash-basis accounting
4-8
2017
LO 1
Recognizing Revenues and Expenses
Illustration 3-1
GAAP relationships in revenue
and expense recognition
4-9
LO 1
THE NEED FOR ADJUSTING ENTRIES
Adjusting entries
4-10

Ensure that the revenue recognition and expense
recognition principles are followed.

Necessary because the trial balance may not
contain up-to-date and complete data.

Required every time a company prepares
financial statements.
LO 1
Types of Adjusting Entries
Deferrals
Accruals
Prepaid Expenses + Supplies
1. Accrued Revenues.
+ Depreciation
Expenses paid in
Revenues for services
cash and recorded as assets before they
performed but not yet
are used or consumed.
received in cash.
1.
(Expenses paid in advance)
2. Unearned Revenues.
Cash received before services
are performed.
(Revenues received in advance)
(Owned Revenues, no cash yet)
2. Accrued Expenses.
Expenses incurred but not yet
paid in cash.
(Owned Expenses, no cash yet)
Illustration 3-2
Categories of adjusting entries
4-11
LO 1
Adjusting Entries for Deferrals
Made to record expenses or revenues that are
recognized at a date later than the point when cash was
originally exchanged. There are two types:

Prepaid expenses (including supplies and
depreciation)
OR

4-12
Unearned revenues
LO 3
Prepaid Expenses
Expenses paid in cash before they are used or consumed.
Cash Payment
BEFORE
Expense Recorded
Prepayments often occur in regard to:
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
insurance

rent

supplies

equipment

advertising

buildings
LO 2
Prepaid Expenses
Prepaid Expenses

Costs that expire either with the passage of time or
through use.

Adjusting entry:
► Increase (debit) to an expense account and
► Decrease (credit) to a prepaid expense account.
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LO 2
Prepaid Expenses_1
Illustration: On October 1, Pioneer
Advertising Inc. paid $600 for a one-year fire
insurance policy. Pioneer recorded the
payment by increasing (debiting) Prepaid
Insurance. This account shows a balance of
$600 in the October 31 trial balance.
Insurance of $50 ($600 ÷ 12) expires each
month.
Oct. 1
Prepaid Insurance
600
Cash
Oct. 31
Insurance Expense
Prepaid Insurance
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600
50
50
LO 2
Prepaid Expenses_1
Illustration 3-6
4-16
LO 2
Prepaid Expenses_2 (Supplies)
Illustration: Pioneer Advertising Inc. Inc.
purchased supplies costing $2,500 on
October 5. Pioneer recorded the
purchase by increasing (debiting) the
asset Supplies. This account shows a
balance of $2,500 in the October 31 trial
balance. An inventory count at the close
of business on October 31 reveals that
$1,000 of supplies are still on hand.
Oct. 31
Supplies Expense
Supplies
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1,500
1,500
LO 2
Prepaid Expenses_2
Illustration 3-5
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LO 2
Prepaid Expenses_3 (Depreciation)

Buildings, equipment, and motor vehicles (long-lived
assets) are recorded as assets, rather than an
expense, in the year acquired.

Depreciation is the process of allocating the cost of an
asset to expense (depreciation) over its useful life.

Depreciation does not attempt to report the actual
change in the value of the asset.
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LO 2
Prepaid Expenses_3 (Depreciation)
Illustration: For Pioneer Advertising, assume
that depreciation on the equipment is $480 a
year, or $40 per month.
Oct. 31
Depreciation Expense
40
Accumulated Depreciation
40
Accumulated Depreciation is called a
contra asset account.
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Helpful Hint
All contra accounts have increases,
decreases, and normal balances opposite
to the account to which they relate.
LO 2
Prepaid Expenses_3 (Depreciation)
Illustration 3-7
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LO 2
Prepaid Expenses_3 (Depreciation)
Statement Presentation


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Accumulated DepreciationEquipment is a contra asset
account.
Appears just after the account it
offsets (Equipment) on the
balance sheet.
▼ HELPFUL HINT
All contra accounts have
increases, decreases,
and normal balances
opposite to the account
to which they relate.
ILLUSTRATION 4-9
Balance sheet presentation of
accumulated depreciation
LO 2
Unearned Revenues
Receipt of cash recorded as a liability before services are
performed.
Cash Receipt
BEFORE
Revenue Recorded
Unearned revenues often occur in regard to:
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
rent

magazine subscriptions

airline tickets

customer deposits
LO 2
Unearned Revenues


Adjusting entry is made to record the revenue for services
performed during the period and to show the liability that
remains at the end of the accounting period.
Results in a decrease to unearned revenues account
(so debited because it is a liability account) and an
increase to revenue account (so credited because it is a
revenue account).
4-24
LO 2
Unearned Revenues
Illustration: Pioneer Advertising Inc. received $1,200 on October 2
from R. Knox for advertising services expected to be completed by
December 31. Unearned Service Revenue shows a balance of
$1,200 in the October 31 trial balance. Analysis reveals that the
company performed $400 of services in October.
Oct. 2
Cash
1,200
Unearned Service Revenue
Oct. 31
Unearned Service Revenue
Service Revenue
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1,200
400
400
LO 2
Unearned Revenues
Illustration 3-11
4-26
LO 2
Debit
Assets
Expenses
Credit
Liabilities
Equity *
Revenues
Prepaid Expenses
Unearned Revenues
Supplies
Depreciation Expense
4-27
Accumulated Depreciation
DO IT!
2
Adjusting Entries for Deferrals
The ledger of Hammond, Inc. on March 31, 2017, includes these selected
accounts before adjusting entries are prepared.
Debit
Credit
Prepaid Insurance
Supplies
Equipment
Accumulated Depreciation—Equipment
Unearned Service Revenue
$ 3,600
2,800
25,000
$5,000
9,200
An analysis of the accounts shows the following.
1. Insurance expires at the rate of $100 per month.
2. Supplies on hand total $800.
3. The equipment depreciates $200 a month.
4. During March, services were performed for $4,000 of the unearned
service revenue reported.
Prepare the adjusting entries for the month of March.
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LO 2
DO IT!
2
Adjusting Entries for Deferrals
The ledger of Hammond, Inc. on March 31, 2017, includes these selected
accounts before adjusting entries are prepared.
Debit
Credit
Prepaid Insurance
Supplies
Equipment
Accumulated Depreciation—Equipment
Unearned Service Revenue
$ 3,600
2,800
25,000
$5,000
9,200
Prepare the adjusting entries for the month of March.
1.
Insurance expires at the rate of $100 per month.
SOLUTION
Insurance Expense
Prepaid Insurance
4-29
100
100
LO 2
DO IT!
2
Adjusting Entries for Deferrals
The ledger of Hammond, Inc. on March 31, 2017, includes these selected
accounts before adjusting entries are prepared.
Debit
Credit
Prepaid Insurance
Supplies
Equipment
Accumulated Depreciation—Equipment
Unearned Service Revenue
$ 3,600
2,800
25,000
$5,000
9,200
Prepare the adjusting entries for the month of March.
2.
Supplies on hand total $800.
SOLUTION
Supplies Expense
Supplies
4-30
2,000
2,000
LO 2
DO IT!
2
Adjusting Entries for Deferrals
The ledger of Hammond, Inc. on March 31, 2017, includes these selected
accounts before adjusting entries are prepared.
Debit
Credit
Prepaid Insurance
Supplies
Equipment
Accumulated Depreciation—Equipment
Unearned Service Revenue
$ 3,600
2,800
25,000
$5,000
9,200
Prepare the adjusting entries for the month of March.
3.
The equipment depreciates $200 a month.
SOLUTION
Depreciation Expense
Accumulated Depreciation
4-31
200
200
LO 2
DO IT!
2
Adjusting Entries for Deferrals
The ledger of Hammond, Inc. on March 31, 2017, includes these selected
accounts before adjusting entries are prepared.
Debit
Credit
Prepaid Insurance
Supplies
Equipment
Accumulated Depreciation—Equipment
Unearned Service Revenue
$ 3,600
2,800
25,000
$5,000
9,200
Prepare the adjusting entries for the month of March.
4.
During March, services were performed for $4,000 of the unearned
service revenue reported.
SOLUTION
Unearned Service Revenue
Service Revenue
4-32
4,000
4,000
LO 2
Adjusting Entries for Accruals
Accruals are made to record:

Revenues for services performed but not yet recorded at
the statement date (accrued revenues).
(Owned Revenues, no cash received yet)
OR

Expenses incurred but not yet paid or recorded at the
statement date (accrued expenses).
(Owned Expenses, no cash paid yet)
4-33
LO 3
ACCRUED REVENUES
Revenues for services performed but not yet received in
cash or recorded.
Adjusting entry results in:
Revenue Recorded
BEFORE
Cash Receipt
Accrued revenues often occur in regard to:
4-34

rent

interest

services performed
LO 3
ACCRUED REVENUES
Illustration: In October, Pioneer Advertising
Inc. performed services worth $200 that were
not received from clients in October.
Oct. 31
Accounts Receivable
200
Service Revenue
200
On November 10, Pioneer receives cash of $200 for the services
performed.
Nov. 10
Cash
Accounts Receivable
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200
200
LO 3
ACCRUED REVENUES
Illustration 3-14
4-36
LO 3
ACCRUED EXPENSES
Expenses incurred but not yet paid in cash or recorded.
Adjusting entry results in:
Expense Recorded
BEFORE
Cash Payment
Accrued expenses often occur in regard to:
4-37

Interest

utilities

taxes

salaries
LO 3
ACCRUED EXPENSES
Illustration: Pioneer Advertising Inc. signed a three-month note
payable in the amount of $5,000 on October 1. The note requires
Pioneer to pay interest at an annual rate of 12%. Thus, the
accrued interest expense (interest payable) is:
Illustration 3-17
Oct. 31
Interest Expense
Interest Payable
4-38
50
50
LO 3
ACCRUED EXPENSES
Illustration 3-18
4-39
LO 3
ACCRUED EXPENSES (Accrued Salaries)
Illustration: Sierra Corporation last paid employees' salaries on
October 26 but the accrued salaries at October 31 are $1,200.
Thus, the accrued salaries & wages expense is:
Oct. 31
Salaries and Wages Expense
Salaries and Wages Payable
1,200
1,200
ILLUSTRATION 4-21
4-40
LO 3
ACCRUED EXPENSES (Accrued Salaries)
Illustration 3-20
4-41
LO 3
Debit
Assets
Expenses
Credit
Liabilities
Equity *
Revenues
Accrued Revenues
(receivable)
4-42
Accrued Expenses
(payable)
DO IT!
3
Adjusting Entries for Accruals
Micro Computer Services Inc. began operations on August 1, 2017.
At the end of August 2017, management attempted to prepare
monthly financial statements. The following information relates to
August.
1. At August 31, the company owed its employees $800 in
salaries that will be paid on September 1.
2. On August 1, the company borrowed $30,000 from a bank on a
15-year mortgage. The annual interest rate is 10%.
3. Revenue for services performed but unrecorded for August
totaled $1,100.
Prepare the adjusting entries needed at August 31, 2017.
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LO 3
DO IT!
3
Adjusting Entries for Accruals
Micro Computer Services Inc. began operations on August 1, 2017.
At the end of August 2017, management attempted to prepare
monthly financial statements. Prepare the adjusting entries needed
at August 31, 2017.
1. At August 31, the company owed its employees $800 in
salaries that will be paid on September 1.
SOLUTION
Salaries and Wages Expense
Salaries and Wages Payable
4-44
800
800
LO 3
DO IT!
3
Adjusting Entries for Accruals
Micro Computer Services Inc. began operations on August 1, 2017.
At the end of August 2017, management attempted to prepare
monthly financial statements. Prepare the adjusting entries needed
at August 31, 2017.
2. On August 1, the company borrowed $30,000 from a bank on
a 15-year mortgage. The annual interest rate is 10%.
SOLUTION
Interest Expense
Interest Payable
4-45
250
250
LO 3
DO IT!
3
Adjusting Entries for Accruals
Micro Computer Services Inc. began operations on August 1, 2017.
At the end of August 2017, management attempted to prepare
monthly financial statements. Prepare the adjusting entries needed
at August 31, 2017.
3. Revenue for services performed but unrecorded for August
totaled $1,100.
SOLUTION
Accounts Receivable
Service Revenue
4-46
1,100
1,100
LO 3
Using T-Account
Debit
Credit
Assets
Liabilities
Expenses
Equity *
Revenues
4-47
Accrued Revenues
Accrued Expenses
Prepaid Expenses
Supplies
Unearned Revenues
Depreciation Expense
Accumulated Depreciation
*: Dividends are debit account because they decrease equity
LEARNING
OBJECTIVE
Analyze
business
transactions
Adjusted
trial
balance
4-48
4
Prepare an adjusted trial balance and
closing entries.
Journalize
Prepare
financial
statements
Post
Trial
Balance
Journalize
and post
closing
entries
Adjusting
Entries
Prepare a postclosing trial
balance
LO 4
PREPARE ADJUSTED TRIAL BALANCE
After all adjusting entries are journalized and posted the
company prepares another trial balance from the ledger
accounts (Adjusted Trial Balance).
The adjusted trial balance’s purpose is to prove the equality of
debit balances and credit balances in the ledger.
The adjusted trial balance is the primary basis for the
preparation of the financial statements.
4-49
LO 4
ILLUSTRATION 4-26
Adjusted trial balance
4-50
LO 4
PREPARING FINANCIAL STATEMENTS
Financial statements are prepared directly from the
Adjusted Trial Balance.
Income
Statement
4-51
Retained
Earnings
Statement
Balance
Sheet
LO 4
4-68
4-52
ILLUSTRATION 4-27
Preparation of the income statement and retained
earnings statement from the adjusted trial balance
4-53
ILLUSTRATION 4-28
Preparation of the balance sheet
from the adjusted trial balance
LO 4
Group activity
4-54
Prepare the following statements:
1- Income Statement
2- Retained Earning Statement
3- Balance Sheet
Income Statement
4-55
Retained Earning Statement
4-56
Balance Sheet
& Equity
4-57
CLOSING THE BOOKS
At the end of the accounting period, companies transfer the
temporary account balances to the permanent stockholders’
equity account—Retained Earnings.
ILLUSTRATION 4-29
Temporary versus permanent accounts
4-58
LO 4
Preparing Closing Entries
In addition to updating Retained Earnings to its correct
ending balance, closing entries produce a zero balance in
each temporary account.
ILLUSTRATION 4-30
The closing process
4-59
LO 4
4-60
ILLUSTRATION 4-31
LO 4
Preparing Closing Entries
Illustration 4-32
Posting of closing entries
4-61
LO 4
Preparing a Post-Closing Trail Balance
The purpose of the post-closing trial balance is to prove the
equality of the permanent account balances that the
company carries forward into the next accounting period.
All temporary accounts will have zero balances.
4-62
LO 4
DO IT!
4b
Closing Entries
Hancock Company has the following balances in selected accounts of its
adjusted trial balance.
Accounts Payable
Service Revenue
Rent Expense
Salaries and Wages Expense
$27,000
98,000
22,000
51,000
Dividends
$15,000
Retained Earnings
42,000
Accounts Receivable 38,000
Supplies Expense
7,000
Prepare the entries to close the revenue and expense accounts.
SOLUTION
4-63
Service Revenue
Income Summary
98,000
Income Summary
Salaries and Wages Expense
Rent Expense
Supplies Expense
80,000
98,000
51,000
22,000
7,000
LO 4
DO IT!
4b
Closing Entries
Hancock Company has the following balances in selected accounts of its
adjusted trial balance.
Accounts Payable
Service Revenue
Rent Expense
Salaries and Wages Expense
$27,000
98,000
22,000
51,000
Dividends
$15,000
Retained Earnings
42,000
Accounts Receivable 38,000
Supplies Expense
7,000
Prepare the entries to close income summary and dividends.
SOLUTION
4-64
Income Summary
Retained Earnings
18,000
Retained Earnings
Dividends
15,000
18,000
15,000
LO 4
SUMMARY OF THE ACCOUNTING CYCLE
1. Analyze business transactions
4-65
9. Prepare a post-closing trial
balance
2. Journalize the transactions
8. Journalize and post closing
entries
3. Post to ledger accounts
7. Prepare financial statements
4. Prepare a trial balance
6. Prepare an adjusted trial
balance
5. Journalize and post
adjusting entries:
Deferrals/Accruals
ILLUSTRATION 4-33
Required steps in the accounting cycle
LO 4
SUMMARY OF THE ACCOUNTING CYCLE
ILLUSTRATION 4-33
Required steps in the accounting cycle
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LO 4
SUMMARY OF THE ACCOUNTING CYCLE
ILLUSTRATION 4-33
Required steps in the accounting cycle
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LO 4
SUMMARY OF THE ACCOUNTING CYCLE
ILLUSTRATION 4-33
Required steps in the accounting cycle
4-68
LO 4
SUMMARY OF THE ACCOUNTING CYCLE
ILLUSTRATION 4-33
Required steps in the accounting cycle
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LO 4
SUMMARY OF THE ACCOUNTING CYCLE
ILLUSTRATION 4-33
Required steps in the accounting cycle
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LO 4
SUMMARY OF THE ACCOUNTING CYCLE
ILLUSTRATION 4-33
Required steps in the accounting cycle
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LO 4
SUMMARY OF THE ACCOUNTING CYCLE
ILLUSTRATION 4-33
Required steps in the accounting cycle
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LO 4
SUMMARY OF THE ACCOUNTING CYCLE
ILLUSTRATION 4-33
Required steps in the accounting cycle
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LO 4
SUMMARY OF THE ACCOUNTING CYCLE
ILLUSTRATION 4-33
Required steps in the accounting cycle
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LO 4
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