The Accounting Cycle
Accruals and Deferrals
Chapter 4
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
Copyright © 2012 The McGraw-Hill Companies, Inc.4-1
ADJUSTING ENTRIES
Adjusting
entries are
needed whenever
revenue or expenses
affect more than one
accounting
period.
Every
adjusting
entry involves a
change in either a
revenue or expense
and an asset
or liability.
4-2
Adjusting Entries
Adjusting Entries are
journal entries recorded at
the end of an accounting
period to adjust income
and expense accounts so
that they comply with the
Accrual Concept of
accounting.
4-3
ACCRUAL CONCEPT
Business
transactions are
recorded when they
occur.
NOT when the
related payments are
received or made.
4-4
Accrual Concept
Accrual Concept, requires that;
Revenues of the business are recognised in the
accounts when earned.
Expenses are recognised when incurred.
NOT when the money is received or paid.
4-5
Accrual Concept – Example-1
An airline company sells its tickets
weeks before the flight is due.
BUT
It does not record the payments as
revenue because the event on which
the revenue is based has not
occurred yet.
Once the service has being provided,
we can make the adjusting entry.
(i.e. We can record it as received)
4-6
Accrual Concept – Example- 2
A business records its
utility bills as soon
as it receives them.
Not when the bills
are paid, because
the service has
already been used.
4-7
Adjusting Entries
 Adjusting
Entries are necessary when
accrual basis accounting is used.
 Adjusting
entries allow businesses to
adhere to the Matching Principle.
4-8
The MATCHING PRINCIPLE
This principle, requires a
company to match
expenses with the related
revenues in order to report
the company`s
profitability during the
accounting period.
4-9
The Matching Principle
Revenues
earned this
month
Are offset
against...
Expenses
incurred in
earning the
revenue
4-10
The Matching Principle

A hospital pays £20,000 per month to 5 of its
doctors.

Monthly sales are £ 500,000.

£100,000 (£20,000 x 5) worth of monthly salaries
should be matched with £500,000 of revenue
generated.

Net profit for this month would be:
500,000
-100,000
------------------£ 400,000
4-11
The Matching Principle

The objective is to match the income
receivable and the expenditure payable to
the appropriate accounting period.
4-12
TYPES of ADJUSTING ENTRIES
Prepayments
Accruals
1- Prepaid
Expenses
3-Accrued
Revenues
2-Unearned
Revenues
4-Accrued
Expenses
4-13
Type 1: Prepaid Expenses
 Prepaid
expenses are the type of
expenses which are paid in cash and
recorded as assets prior to being used.
 Prepaid
expenses are also known as
deferred expenses
4-14
Adjusting Entries for
“Prepaid Expenses”
•
Let`s say you prepaid £15,000 for your
property insurance on 1st September of
the current year.
•
Make the appropriate adjustment as of
the end of the accounting period. (i.e.
31/12/2012)
4-15
Adjusting Entries for
“Prepaid Expenses”
Original Entry: On September 1 the following entry
would be recorded when the insurance was prepaid:
Dec. 31 DR Prepaid Insurance
CR
15,000
Cash
15,000
Prepaid Insurance
Debit
15,000
Credit
Cash
Debit
Credit
15,000
15,000
4-16
Adjusting Entries for
“Prepaid Expenses”
Prepaid Insurance is an asset account – it is an
amount owned by the company that has
economic value.
We will recognise Prepaid
Insurance under current assets.
4-17
Analyzing an Adjusting Entry:
• Each month, a portion of the prepaid
insurance expires.
• At the end of the accounting period, the
Prepaid Insurance and Insurance
Expense accounts must be updated for
the insurance that has expired (been
used).
4-18
Analyzing an Adjusting Entry:
(Example 1)
What accounts are involved?
• When something is “used up” it indicates
an expense account.
• In this case, we need to debit Insurance
Expense for the expired insurance.
• Furthermore, the asset, Prepaid Insurance,
has decreased so we will credit this asset.
4-19
Analyzing an Adjusting Entry:
£15,000 for 12 months = £1,250/month
Policy purchased on Sept 1.
(£15,000/12 )
Months that have expired between purchase and
fiscal year-end
4 months (Sept, Oct, Nov,
Dec)
Amount of adjustment =(£1,250/month X 4
months)
£ 5,000
4-20
Let’s record the adjusting entry;
Dec. 31 DR Insurance Expense
CR
15,000
£10,000
£5,000
Prepaid Insurance
Prepaid Insurance
Debit
£5,000
Credit
5,000
Insurance Expense
Debit
Credit
5,000
£5,000
4-21
The Concept of Depreciation
(Example 2)
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 is
partially
consumed
during the
period.
Depreciation
Expense
(debit)
At end of
period . . .
Accumulated
Depreciation
(credit)
4-22
Depreciation Is Only an Estimate
On May 2, 2011, 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.
Depreciation
Cost of the asset
expense (per =
Estimated useful life
period)
$50 = $2,500
50
4-23
Depreciation Is Only an Estimate
JJ’s Lawn Care Service would make the
following adjusting entry.
GENERAL JOURNAL
Date
Account Titles and Explanation
May 31 Depreciation Expense: Equipment
Accumulated Depreciation: Equipment
Debit
Credit
50
50
To record one month's depreciation.
Contra-asset
4-24
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
May 31 Depreciation Expense: Truck
Debit
Credit
250
Accumulated Depreciation: Truck
250
To record one month's depreciation.
$15,00060 months = $250 per month
4-25
Depreciation
Is Only
an Estimate
JJ's Lawn
Care Service
Partial Balance Sheet
Accumulated
depreciation
would
May
31, 2001
appear on theAssets
balance sheet as L
Cash
$ 3,925 N
follows:
Accounts receivable
75 A
Equipment
$ 2,500
Less: Accum. depr.
50
2,450
Truck
$ 15,000
Ow
Less: Accum. depr.
250 14,750 J
To
Cost - Accumulated Depreciation = Book Value
4-26
Adjusted Trial Balance
JJ's Lawn Care Service
Adjusted Trial Balance
May 31, 2011
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
Capital stock
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
May 31 after
preparing the
two
depreciation
adjusting
entries.
4-27
TYPES of ADJUSTING ENTRIES
Prepayments
Accruals
1- Prepaid
Expenses
3-Accrued
Revenues
2-Unearned
Revenues
4-Accrued
Expenses
4-28
Type 2: Unearned Revenues

Unearned Revenues are payments for future
services to be performed or goods to be
delivered.

At the end of each accounting period,
adjusting entries must be made to recognize
the portion of unearned revenues that have
been earned during the period.
4-29
Adjusting Entries for
“Unearned Revenues”

Suppose that you are the owner of an
Insurance company and on November 30th a
customer pays £1,800 for an insurance
policy to protect her delivery vehicles for six
months.

Make the appropriate adjustment as of the
end of the accounting period. (i.e.
31/12/2012)
4-30
Adjusting Entries for
“Unearned Revenues”
 Initially,
the insurance company
records this transaction by;
 increasing
an asset account (cash)
with a debit
 increasing
a liability account
(unearned revenue) with a credit.
4-31
Adjusting Entries for
“Unearned Revenues”
Adjusting Entry:
Nov. 30 DR
Cash
£1,800
Unearned Insurance
CR
Cash
Debit
£ 1,800
Unearned Insurance
Credit
Debit
Credit
1,800
1,800
£ 1,800
£ 1,800
4-32
Adjusting Entries for
“Unearned Revenues”
 After
one month on 31 December
2012, the insurance company makes
an adjusting entry;
 To
decrease (debit) unearned revenue
 To
increase (credit) revenue by an
amount equal to one sixth of the
initial payment.
4-33
Adjusting Entries for
“Unearned Revenues”
(£1,800 /
6months)= 300 per
Adjusting Entry:
month
Dec. 31 DR
CR
Vehicle Insurance Revenue
Vehicle Insurance Revenue
Debit
£ 300
Unearned Insurance
Credit
Unearned Insurance
Debit
300
300
$300
£ 300
Credit
1,800
$1,500
4-34
Adjusting Entries for
“Unearned Revenues”
 If
we do not include adjusting entries
to show the earning of previously
unearned revenues ;
 We
overstate total liabilities and
understate total revenues and net
income.
4-35
TYPES of ADJUSTING ENTRIES
Prepayments
Accruals
1- Prepaid
Expenses
3-Accrued
Revenues
2-Unearned
Revenues
4-Accrued
Expenses
4-36
Type 3: Accrued Revenues

An asset class for goods or services that
have been sold or completed but that have
not yet been billed and/or paid for.

Accrued revenue is income that has been
incurred but not received

Accrued revenue is also called accrued
assets.
4-37
Adjusting Entries for
“Accrued Revenues”
ABC
Ltd. sold £1,000 of products to a
customer who is not required to pay for
60 days.
The
sale is recorded by ABC Ltd. on the
income statement as revenue and on the
balance sheet as a current asset
Even
though no money will be received
until later. (The sale process is occurred)
4-38
Adjustıng Entries for “accrued revenues”
Initial Entry:
Dec. 31 DR Receivables (Current Asset)
CR
Revenue
£ 1,000
Receivables
Debit
1,000
£ 1,000
Credit
Revenue
Debit
Credit
1,000
1,000
4-39
Adjusting Entries for “accrued revenues”
 The
concept of accrued revenue is
needed in order to properly match
revenues with expenses.
 The
absence of accrued revenue
would tend to show excessively low
initial revenue levels. Thus, low
profits for a business
4-40
Adjusting Entries for
“Accrued Revenues”
For example;
 Muffin Ltd. rented its office to Cookie
Ltd. for £500 a month.
Muffin
Ltd. has not received December
rent of £500 from Cookie Ltd.
What
figure of rent receivable should be
shown as income for Muffin Ltd. for the
year ended 31/12/2012
4-41
Adjusting Entries for
“Accrued Revenues”
Adjusting Entry: The adjusting entry at the end of
December is to debit rent receivable and credit rental
revenue by £500.
Dec. 31 DR Rent Receivable (Current Asset)
CR
Rental Revenue
Rent Receivable
Debit
500
£500
Credit
£500
Rental Revenue
Debit
Credit
500
500
4-42
Adjusting Entries for
“Accrued Revenues”
After
one month, on January 2013 Muffin
Ltd. received the rental income of £500 form
Cookie Ltd.
What
To
would be the double entry?
increase (debit) as cash is received.
To
decrease (credit) as rent is paid by Cookie
Ltd.
4-43
Adjusting Entries for
“Accrued Revenues”
Adjusting Entry: The adjusting entry on January 2013 is
to debit Cash / Bank and credit Receivable`s account for
£500.
Jan. 31 DR Cash or Bank
CR
£500
Rent Receivable
Rent Receivable
Debit
500
-
£500
Credit
Cash / Bank
Debit
Credit
500
500
-
500
4-44
TYPES of ADJUSTING ENTRIES
Prepayments
Accruals
1- Prepaid
Expenses
3-Accrued
Revenues
2-Unearned
Revenues
4-Accrued
Expenses
4-45
Type 4: Accrued Expenses
Accrued
Expense is an expense incurred but
not yet paid.
A
journal entry is created to record the
expense, as well as an offsetting liability
(which is usually classified as a current
liability in the balance sheet).
The
absence of a journal entry result in
reported profits being too high in that period.
(as expense will not be reported in the FS)
4-46
Adjusting Entries for
“Accrued Expenses”
Examples of expenses that are commonly accrued
include:
 Interest on loans, for which no lender invoice has
yet been received
 Goods received and consumed or sold, for which
no supplier invoice has yet been received
 Services received, for which no supplier invoice has
yet been received
 Wages incurred, for which payment to
employees has not yet been made
4-47
Adjusting Entries for
“Accrued Expenses”
For example;
 Green Ltd. enters into a rental agreement to
use the trucks of Car & Cars Ltd.
 The term states that Green Ltd. will pay
monthly rentals of £2,000 at the end of each
month.
 The lease started on July 1st, 2012. On July
31, the rent for the month has not yet been
paid and no record for rent expense was
made.
4-48
Adjusting Entries for
“Accrued Expenses”

What would be the necessary adjusting entry
for rent expense?

In this case, Green Ltd. has already incurred
(consumed/used) the expense. Even if it has
not yet been paid, it should be recorded as an
expense.
4-49
Adjusting Entries for
“Accrued Expenses”
Adjusting Entry: The adjusting entry at the end of July is
to debit rent expense and credit rent payable for £2,000.
July. 31 DR Rent Expense
CR
2,000
£ 2,000
Rent Payable
Rent Expense
Debit
£ 2,000
Credit
Rent Payable
Debit
Credit
2,000
2,000
4-50
Adjusting Entries for
“Accrued Expenses”
Expense recognition
principle, requires expenses
to be recognized when
incurred regardless of when
paid.
4-51
SUMMARY
Prepaid expenses
Debit Expense
Credit Asset (Prepaid)
Depreciation
Debit Depreciation Expense
Credit Accumulated Depreciation
Accrued revenues
Debit Receivable
Credit Revenue
4-52
SUMMARY
Accrued expenses
Debit Expense
Credit Liability
Unearned revenues
Debit Liability (Unearned)
Credit Revenue
4-53
End of Chapter 4
4-54