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.

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Types of Adjusting Entries

Converting assets to expenses Converting liabilities to revenue

Accruing unpaid expenses

Accruing uncollected revenue

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Converting Assets to Expenses

End of Current Period Prior Periods Current Period Future Periods

Transaction Paid cash in advance of incurring expense (creates an asset).

Adjusting Entry Recognizes portion of asset consumed as expense, and Reduces balance of asset account.

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Converting Assets to Expenses

$2,400 Insurance Policy Coverage for 12 Months $200 Monthly Insurance Expense

Jan. 1

Dec. 31

On January 1, Webb Co. purchased a one-year insurance policy for $2,400.

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Converting Assets to Expenses

Initially, costs that benefit more than one accounting period are recorded as assets.

GENERAL JOURNAL
Date Account Titles and Explanation Cash Purchase a one-year insurance policy. Debit 2,400 2,400 Credit

Jan. 1 Unexpired Insurance

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Converting Assets to Expenses

The costs are expensed as they are used to generate revenue.

GENERAL JOURNAL
Date Account Titles and Explanation Monthly Adjusting Entry for Insurance Jan. 31 Insurance Expense Unexpired Insurance Adjusting entry to record insurance expense for January.
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Debit 200

Credit

200

Converting Assets to Expenses

Balance Sheet Cost of assets that benefit future periods.

Income Statement Cost of assets used this period to generate revenue.

Unexpired Insurance 1/1 2,400 1/31 200 Bal. 2,200

Insurance Expense 1/31 200

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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 assets usefulness is partially consumed during the period.

Depreciation Expense (debit)

At end of period . . .

Accumulated Depreciation (credit)

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Depreciation Is Only an Estimate

On May 2, 2011, JJs Lawn Care Service purchased a lawn mower with a useful life of 50 months for $2,500 cash.

Cost of the asset expense (per = Estimated useful life period)

Using the straight-line method, calculate the monthly depreciation expense. Depreciation

$50 = $2,500
50
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Depreciation Is Only an Estimate

JJs Lawn Care Service would make the following adjusting entry.

GENERAL JOURNAL
Date Account Titles and Explanation Accumulated Depreciation: Equipment To record one month's depreciation. Debit 50 50 Credit

May 31 Depreciation Expense: Equipment

Contra-asset
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Depreciation Is Only an Estimate

JJs $15,000 truck is depreciated over 60 months. Calculate monthly depreciation and make the journal entry.

GENERAL JOURNAL
Date Account Titles and Explanation Accumulated Depreciation: Truck To record one month's depreciation. Debit 250 250 Credit

May 31 Depreciation Expense: Truck

$15,00060 months = $250 per month

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Depreciation Is Only an JJ's Lawn Care Service Estimate Partial Balance Sheet

Accumulated depreciation would May 31, 2001 appear on the balance sheet as Assets Cash $ 3,925 follows:
Accounts receivable Equipment $ 2,500 Less: Accum. depr. 50 Truck $ 15,000 Less: Accum. depr. 250
Cost - Accumulated Depreciation = Book Value

75 2,450

L N A

Ow 14,750 J To
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Converting Liabilities to Revenue

End of Current Period Prior Periods Current Period Future Periods

Transaction Collect cash in advance of earning revenue (creates a liability).

Adjusting Entry Recognizes portion earned as revenue, and Reduces balance of liability account.

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Converting Liabilities to Revenue

$6,000 Rental Contract Coverage for 12 Months $500 Monthly Rental Revenue Jan. 1 Dec. 31

On January 1, Webb Co. received $6,000 in advance for a one-year rental contract.
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Converting Liabilities to Revenue

Initially, revenues that benefit more than one accounting period are recorded as liabilities.

GENERAL JOURNAL
Date Account Titles and Explanation Unearned Rent Revenue Collected $6,000 in advance for rent. Debit 6,000 6,000 Credit

Jan. 1 Cash

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Converting Liabilities to Revenue

Over time, the revenue is recognized as it is earned.

GENERAL JOURNAL
Date Account Titles and Explanation Monthly Adjusting Entry for Rent Revenue Jan. 31 Unearned Rent Revenue Rental Revenue Adjusting entry to record rental revenue for January.
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Debit 500

Credit

500

Converting Liabilities to Revenue

Balance Sheet Liability for future periods. Income Statement Revenue earned this period.

Unearned Rental Revenue

1/31

500

1/1 6,000 Bal. 5,500

Rental Revenue 1/31 500

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Accruing Unpaid Expenses

End of Current Period Prior Periods Current Period Future Periods

Adjusting Entry Recognizes expense incurred, and Records liability for future payment.

Transaction Pay cash in settlement of liability.

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Accruing Unpaid Expenses

$3,000 Wages Expense

Monday, May 29

Wednesday, May 31

Friday, June 2

On May 31, Webb Co. owes wages of $3,000. Payday is Friday, June 2.
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Accruing Unpaid Expenses

Initially, an expense and a liability are recorded.

GENERAL JOURNAL
Date Account Titles and Explanation Wages Payable Adjusting entry to accrue wages owed to employees. Debit 3,000 3,000 Credit

May 31 Wages Expense

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Accruing Unpaid Expenses

Balance Sheet Liability to be paid in a future period.

Income Statement Cost incurred this period to generate revenue.

Wages Payable 5/31 3,000

Wages Expense 5/31 3,000

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Accruing Unpaid Expenses

$5,000 Weekly Wages $3,000 Wages Expense $2,000 Wages Expense

Monday, May 29

Wednesday, May 31

Friday, June 2

Lets look at the entry for June 2.

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Accruing Unpaid Expenses

The liability is extinguished when the debt is paid.

GENERAL JOURNAL
Date Account Titles and Explanation Wages Payable (accrued in May) Cash Weekly payroll for May 29-June 2.
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Debit 2,000 3,000

Credit

June 2 Wages Expense (for June)

5,000

Accruing Uncollected Revenue

End of Current Period Prior Periods Current Period Future Periods

Adjusting Entry Recognizes revenue earned but not yet recorded, and Records receivable.

Transaction Collect cash in settlement of receivable.

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Accruing Uncollected Revenue

$170 Interest Revenue

Saturday, Jan. 15

Monday, Jan. 31

Tuesday, Feb. 15

On Jan. 31, the bank owes Webb Co. interest of $170. Interest is paid on the 15th day of each month.
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Accruing Uncollected Revenue

Initially, the revenue is recognized and a receivable is created.

GENERAL JOURNAL
Date Account Titles and Explanation Interest Revenue Adjusting entry to record interest revenue. Debit 170 170 Credit

Jan. 31 Interest Receivable

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Accruing Uncollected Revenue

Balance Sheet Receivable to be collected in a future period. Income Statement Revenue earned this period.

Interest Receivable 1/31 170

Interest Revenue 1/31 170

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Accruing Uncollected Revenue

$320 Monthly Interest $170 Interest Revenue $150 Interest Revenue

Saturday, Jan. 15

Monday, Jan. 31

Tuesday, Feb. 15

Lets look at the entry for February 15.

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Accruing Uncollected Revenue

The receivable is collected in a future period.

GENERAL JOURNAL
Date Account Titles and Explanation Interest Revenue (for February) Interest Receivable (accrued Jan. 31) To record interest received.
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Debit 320

Credit 150 170

Feb. 15 Cash

Accruing Income Taxes Expense: The Final Adjusting Entry

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 Income Taxes Payable Estimated income taxes applicable to taxable income earned in December.
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Debit 780

Credit 780

Dec. 31 Income Taxes Expense

Adjusting Entries and Accounting Principles

Costs are matched with revenue in two ways: Direct association of costs with specific revenue transactions. Systematic allocation of costs over the useful life of the expenditure.
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The Concept of Materiality

An item is material if knowledge of the item might reasonably influence the decisions of users of financial statements.

Many companies immediately charge the cost of immaterial items to expense.

Supplies

Light bulbs

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Effects of the Adjusting Entries

Income Statement Adjustment Type I Converting Assets to Expenses Type II Converting Liabilities to Revenue Type III Accruing Unpaid Expenses Type IV Accruing Uncollected Revenue Revenue Expenses No effect Increase Increase Net Income Assets Balance Sheet Liabilities Owners' Equity Decrease Increase Decrease Increase

Decrease Decrease No effect No effect Decrease

No effect Increase

No effect Increase Increase

Decrease No effect Increase Increase No effect

No effect Increase

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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.
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End of Chapter 4

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