Accrual Accounting &
Adjusting Entries
Chapter 4
Chapter 4 Highlights
Examine Revenue Recognition and
Matching Principles
 What is an accrual?
 What type of accrual entries do we need?
 Prepare adjusting entries, closing entries
and an adjusted Trial Balance

Revenue Recognition



Accounting rule: revenue
must be recorded in the
books in the period it is
“earned”
For example: If purchase
a CD on May 1st but don’t
pay for it until June
Record sale in May
Matching Principle



Expenses must be
matched to revenue
i.e.. must record all
expenses associated
with the revenue you
are recording
Not following either of
this principles will
distort results!
Cash Basis of Accounting
Revenue
recorded only
when cash
received
 Expense
recorded only
when cash paid

Accrual Basis of Accounting

Adheres to the
Revenue recognition
principle
 Matching principle
Revenue recorded when
earned, not only when cash
received
Expense recorded when
incurred, not only when cash
paid



Adjusting Entries


Required to ensure
matching and rev
recognition followed
Normally req’d each
time statements are
prepared
Common Adjusting Entries



Prepaid Expense =
item paid for that
have not been used
or consumed (ie
shown as assets)
Example: autopac
insurance


Unearned Revenue
= cash rec’d and
recorded before
revenue has been
earned
Should appear as a
liability
Example:
maintenance fees,
deposits
Common Adjusting Entries


Accrued Revenue =
revenue earned but
not yet recorded
and/or cash not rec’d
yet
Example: Home
builder


Accrued Expenses
= expenses incurred
but not yet billed or
paid for
Example: place ad
in the newspaper on
April 27 not billed
until May
Supplies
On October 5 the company paid $2,500
for advertising supplies.
Advertising
Advertising
Supplies Expense
Cash
Supplies
Oct 5 2,500
Oct 5
2,500
GENERAL JOURNAL
Debit
Oct 5
2,500
Advertising Supplies
Cash
Purchased advertising supplies
Credit
2,500
Supplies
An inventory on October 31 reveals that $1,000 of
supplies remain on hand; therefore, $1,500 of
supplies had been used. ($2,500- $1,000) =$ 1,500
Cash
Advertising
Supplies
Oct 5 2,500 Oct 5 2,500 Oct 31 1,500
Advertising
Supplies Expense
Oct 31 1,500
Bal. 1,000
GENERAL JOURNAL
Oct 5
Advertising Supplies Expense
Advertising Supplies
To record advertising supplies consumed
Debit
Credit
1,500
1,500
Advertising Supplies Expense
Oct
$1,500
Nov
$1,800
Dec
$1,410
Jan
$1,425
Feb
$1,601
Mar
$1,435
Apr
$1,510
May
$1,592
June
$1,652
July
$1,621
Aug
$1,427
Sept
$1,555
Advertising supplies expense is based on usage...
so different amounts appear each month
Prepaid Expenses
On October 4 the company paid $600 for a 1-year
insurance policy. Coverage began October 1.
Prepaid
Insurance
Cash
Oct 4
600 Oct 4
Insurance
Expense
600
GENERAL JOURNAL
Debit
Oct 4
600
Prepaid Insurance
Cash
Purchased one-year policy effective October 1
Credit
600
Prepaid Expenses
On October 31st, $50 ($600/12 months)
of the insurance was used-up or expired.
Prepaid
Insurance
Cash
Oct 4
600 Oct 4
600 Oct 31 50
GENERAL JOURNAL
Oct 31
Insurance Expense
Prepaid Insurance
Record insurance expense for the month
Insurance
Expense
Oct 31
Debit
50
Credit
50
50
Insurance Policy
Oct
$50
Nov
$50
Dec
$50
Jan
$50
Feb
$50
Mar
$50
Apr
$50
May
$50
June
$50
July
$50
Aug
$50
Sept
$50
1 Year $ 600
Office Equipment
Oct
$40
Nov
$40
Dec
$40
Jan
$40
Feb
$40
Mar
$40
Apr
$40
May
$40
June
$40
July
$40
Aug
$40
Sept
$40
Amortization= $480/year
Office Equipment
Accumulated
AmortizationOffice Equipment
Oct 2 5000
Oct 31
40
GENERAL JOURNAL
Oct 31 Amortization Expense
Amortization
Expense
Oct 31
40
Debit
Credit
40
Accumulated Amortization-Office Equip
To record monthly amortization
Accumulated Amortization is a
contra asset account - an offset
against the capital asset account
40
Unearned Revenues
Received on Oct. 2 $1,200 for advertising
services expected to be completed by 12/31.
Unearned Service
Service
Revenue
Revenue
Cash
Oct 2 1,200
Oct 2
1,200
GENERAL JOURNAL
Debit
Oct 2
1,200
Cash
Unearned Service Revenue
Collected money for work to be
performed by 12/31.
Credit
1,200
Unearned Revenues
During October $400 of the revenue was earned.
Unearned Service
Revenue
Cash
Oct 2 1,200
Oct. 31 400 Oct 2
Bal.
GENERAL JOURNAL
Oct 31 Unearned Service Revenue
Service Revenue
To record revenue earned
Service
Revenue
Oct. 31 400
1,200
800
Debit
Credit
400
400
Accrued Revenues
Earned $200 for advertising services to clients
in October, but they were not billed until after
October 31st.
Accounts
Receivable
Oct 31
200
Service
Revenue
Oct 31
GENERAL JOURNAL
Debit
Oct 31
200
Accounts Receivable
Service Revenue
200
Credit
200
Interest expense is the cost a
company incurs to use money:
Information needed to compute interest expense:
 face value of note
 interest rate (always expressed in annual rate)
 the length of time note is outstanding
Formula for Calculating Interest
Face Value
of Note
$ 5,000 X
Annual
Interest
Rate
12%
Time
in Terms of
One Year
1/12
Interest
=
$50
Accrued Interest Expense
Interest Expense
Oct 31 50
Interest Payable
Oct 31
GENERAL JOURNAL
Oct 31 Interest Expense
Interest Payable
Accrue interest expense for the month
Debit
50
Credit
50
50
Accrued Salaries Expense
(Salaries Paid for after the Service Has Been Performed)
Accrued Salaries Expense
Salaries Expense
Oct 31 1,200
Salaries Payable
Oct 31 1,200
GENERAL JOURNAL
Debit
Oct 31 Salaries Expense
1,200
Salaries Payable
Accrue salary expense for the month
Credit
1,200
Summary of Adjustments
Type of Adjustment
Adjusting Entries
Prepd Exp.
Dr. Exp
Unearned Rev.
Dr. Liab
Accrued Rev.
Dr. Assets
Accrued Exp.
Dr. Exp.
Cr. Assets
Cr. Rev.
Cr. Rev.
Cr. Liab.
Adjusted Trial Balance




1st need to journalize the
adjusting entries
Next post adjusting entries
Prepare the “new” adjusted
Trial balance reflecting
these changes
Note: all should still balance
between Dr & Cr balances
Adjusted Trial Balance





Once adjusted TB has
been prepared and
reviewed create financial
stmts
Note: Top of financial
statement(s) should have 3
lines
1st – Organization name
2nd – Type of report
3rd – reporting period and
date
Closing the Books



Involves preparing the
books for a new year of
activity
I/S related accounts must
be closed as they represent
the activity for a period only
I.e. not cumulative
Closing the Books


Temporary accounts are
closed (i.e. record entry to
create a zero balance in
that account) at the end of
the period
All Rev & Exp are closed
out to a summary acct.
called “Income Summary”
which is then closed out to
Retained Earnings
Temporary
Accounts
All revenue accounts
All expense accounts
Dividends
Individual Revenues
Individual Expenses
2
Income Summary
3
Retained Earnings
4
Dividends
1
Retained Earnings
is a permanent
account; the others
shown here
are temporary
The Accounting Cycle Review
1. Analyze business transactions
2. Journalize the transactions
3. Post to ledger accounts
4. Prepare a trial balance
5. Journalize and post adjusting
entries-prepayments and accruals
The Accounting Cycle Review
6.
Prepare an adjusting trial balance
7.
Prepare financial statements
8.
Journalize and post closing
entries
9.
Prepare a post-closing trial
balance
Chapter 4 – The End