 Accrual
accounting
 Revenue
 Earned
when company delivers a product or performs
a service
 Expenses
 Incurred
when company uses resources or services to
help generate revenue
 Receipt
or payment of cash does not affect
revenue or expense recognition
 Time
period assumption
 Business
periods
 E.g.,
activities evaluated using specific time
months, quarters, years
 Difference
between when item is recognized
and actual cash flow
 Cash
received/paid before revenue/expense
recognized
 Recognition
deferred (postponed)
 Cash
received/paid after revenue/expense
recognized
 Recognition
accrued
 No
timing difference when cash received/paid at
same time revenue/expense is recognized
 The
accounting cycle
 Adjusting entries
 Financial statements
Adjusting Entries
 Accrued
revenues – revenue earned but not
yet received in cash or previously recorded
 Accrued expenses – expense incurred but not
yet paid in cash or previously recorded
 Deferred revenues – a liability resulting from
the receipt of cash before the recognition of
revenue; unearned revenue – liability that
company owes customers
 Deferred expenses – an asset resulting from
the payment of cash before the actual
incurrence of the expense, ‘an asset is just an
expense waiting to happen’
Accrued Revenues
 Types
of accrued revenue adjustments
 Interest
Revenue - Income earned from letting
someone else use your money
 Time passing is the action related to interest
income
 Interest = Principal x Rate x Time
 Principal
- amount loaned
 Rate - annual interest rate
 Time - portion of year loan outstanding
 Receivables
with interest
 Other accrued revenue
Accrued Expenses
 Expenses
incurred but not yet
 Paid
in cash
 Previously recorded
 Types
of accrued expense adjustments
 Interest
Other
Expense
accrued expenses
 Some expenses are recorded at the end of the
year because the accounting period ends
after the expense was incurred and before it
has been paid
 Salary expense is one of the most common
year-end accrued expenses
Deferred Revenues
 Deferred
revenues
 Dollars
have been received in a prior transaction
 Adjustment made for revenue earned related to
cash previously received
 Often called unearned revenue
 Deferred
 Dollars
expenses
were paid in a prior transaction
 Adjustment made for expense incurred in current
accounting period related to cash previously
received
 Often called prepaid expenses
 Purchase
of supplies is an asset exchange
 Supplies Expense should reflect only supplies
used up during the period
 Supplies on hand at the end of the period
should be recorded as an asset
 Are
supplies a current or non-current asset?
 Supplies Expense computation
Beginning Balance
+ Purchases
- Ending Balance
_
Supplies Used (expense)
Depreciation
 Equipment
that lasts longer than one year
should be treated like any other prepaid
expense
 We
should allocate the cost of the asset to the
periods that benefit from the use of the asset
 This
is called depreciation
 Depreciation
A
has NOTHING to do with the FAIR
MARKET VALUE of an asset
separate account is used to accumulate all
depreciation related to an asset
Depreciation is a contra-asset because
it reduces the value of the asset on the books
 Accumulated
 Book
value is the cost of an asset less Accumulated
Depreciation
Depreciation
Straight-line depreciation



Allocates an equal amount of the cost of the asset to
each accounting period.
Annual depreciation formula
Asset cost
_
useful life (in years)
 Accumulate depreciation – the total amount of
depreciation that has been recorded during an
asset’s life – contra-asset
 Residual value – the estimated value of an asset
at the end of its useful life, deducted in the
calculation of depreciation expense
 Book value – the cost of an asset minus the
total accumulated depreciation recorded for
the asset

Preparing Financial Statements
Prior to preparing financial statements, the
steps below in the accounting cycle are
performed
1.
2.
3.
4.
5.

Record transactions
Posting transactions to the general ledger
Prepare an unadjusted trial balance
Prepare and post adjusting entries
Prepare an adjusted trial balance
Adjusting entries – 5 basic types





Prepaid expense
Depreciation expense
Accrued expense
Accrued receivable
Unearned revenue
Closing Revenue and Expense Accounts
Revenue and expense, and dividend accounts –
temporary accounts
Permanent or real accounts – balances carry over
After preparing the financial statements, revenues
and expenses as well as dividends have to be
transferred from those temporary accounts to
retained earnings.
After this process, the income stmt. and dividend.
accounts are reset to zero.
Revenue accounts are reset to zero.







Since they have credit balances, we use a DEBIT to
decrease the accounts to zero (a zero balance).
The retained earnings account is CREDITED because
revenues increase retained earnings.
Closing Revenue and Expense Accounts
Expense accounts are reset to zero.



Dividends account is reset to zero.




Since they have DEBIT balances, we use a CREDIT to
decrease the accounts to zero (a zero balance).
The retained earnings account is DEBITED because
expenses decrease retained earnings.
Since it has a DEBIT balance, we use a CREDIT to
decrease the account to zero (a zero balance).
The retained earnings account is DEBITED because
dividends decrease retained earnings.
A post-closing trial balance is prepared, showing
only permanent accounts
Closing Revenue and Expense
Accounts
 Prepare
closing entries for the following
accounts.
Service Revenue
Dr.
Cr.
100
Wage Expense
Dr.
40
Cr.
Retained Earnings
Dr.
Rent Expense
Dr.
20
Cr.
Dividends
Dr.
10
Cr.
Cr.
500 beg bal
Financial Statement Analysis
 Debt-to-assets
 Measure
 What
 Also
ratio
of long-term liquidity
are two measures of short-term liquidity?
called a solvency ratio
Total Liabilities
Total Assets
Business Risk, Control, and Ethics
 Controls
that help a firm make sure all of
its transactions are recorded
Pre-numbered
documents
Segregation of duties
The
person who does the record-keeping for an
asset does not have control of the asset
How can the segregation of duties control be
circumvented?
 Assign
#7, pg. 200, E4-3A, E4-6A, E47A (due 2/12)
 Assign #8, pg. 210, P4-10A (due 2/12)