the accounting cycle: accruals and deferrals

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The Accounting Cycle:The Accounting Cycle:Accruals and DeferralsAccruals and DeferralsChapter 4

4-2

Adjusting entries are

needed whenever revenue or expenses affect more than one

accounting period.

Every adjusting

entry involves achange in either a

revenue or expense and an asset

or liability.

Adjusting EntriesAdjusting Entries

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Accruing unpaid

expenses

Converting liabilities to

revenue

Accruing uncollected

revenue

Types of Adjusting EntriesTypes of Adjusting Entries Converting

assets to expenses

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Prior Periods Current Period Future Periods

TransactionPaid cash in advance of incurring expense

(creates an asset).

End of Current Period

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

Converting Assets to Converting Assets to ExpensesExpenses

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1 Jan. 31 Dec.

$2,400 Insurance Policy Coverage for 12 Months

$200 Monthly Insurance Expense

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

Converting Assets to Converting Assets to ExpensesExpenses

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

1 Jan Unexpired Insurance 2,400Cash 2,400

Purchase a one-year insurance policy.

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

Converting Assets to Converting Assets to ExpensesExpenses

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

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Monthly Adjusting Entry for Insurance31 Jan Insurance Expense 200

Unexpired Insurance 200Insurance expense for January.

Converting Assets to Converting Assets to ExpensesExpenses

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Insurance Expense31/1 200

Unexpired Insurance1/1 2,400 31/1 200

Bal. 2,200

Income StatementCost of assets

used this period to generate revenue.

Balance SheetCost of assets

that benefit future periods.

Converting Assets to Converting Assets to ExpensesExpenses

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The Concept of The Concept of DepreciationDepreciationDepreciation is the systematic allocation of the cost of a depreciable asset to expense.

Cash (credit)

Fixed Asset (debit)

On date when initial payment is made . . .

The asset’s usefulness is

partially consumed during the

period. At end of period . . .

Depreciation Expense (debit)

Accumulated Depreciation

(credit)

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On 2 May 2009, 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.

$2,50050

=$50$50

Depreciationexpense (per

period)= Cost of the asset

Estimated useful life

Depreciation Is Only an Depreciation Is Only an EstimateEstimate

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JJ’s Lawn Care Service would make the following adjusting entry.

GENERAL JOURNAL

Date Account Titles and ExplanationPRDebit Credit

31 May Depreciation Expense: Equipment 50Accumulated Depreciation: Equipment 50

To record one month's depreciation.

Contra-asset

Depreciation Is Only an Depreciation Is Only an EstimateEstimate

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JJ’s $15,000 truck is depreciated over 60 months. Calculate monthly depreciation and

make the journal entry.

GENERAL JOURNAL

Date Account Titles and ExplanationPRDebit Credit

31 May Depreciation Expense: Truck 250Accumulated Depreciation: Truck 250

To record one month's depreciation.

$15,00060 months = $250 per month

Depreciation Is Only an Depreciation Is Only an EstimateEstimate

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Accumulated depreciation would appear on the balance sheet as

follows:

Depreciation Is Only an Depreciation Is Only an EstimateEstimate

Cost - Accumulated Depreciation = Book Value

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Prior Periods Current Period Future Periods

TransactionCollect cash in

advance of earning revenue

(creates a liability).

End of Current Period

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

Converting Liabilities to Converting Liabilities to RevenueRevenue

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1 Jan. 31 Dec.

$6,000 Rental Contract Coverage for 12 Months

$500 Monthly Rental Revenue

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

Converting Liabilities to Converting Liabilities to RevenueRevenue

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

1 Jan Cash 6,000Unearned Rent Revenue 6,000

Collected $6,000 in advance for rent.

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

Converting Liabilities to Converting Liabilities to RevenueRevenue

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

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Monthly Adjusting Entry for Rent Revenue31 Jan Unearned Rent Revenue 500

Rental Revenue 500Rental revenue for January.

Converting Liabilities to Converting Liabilities to RevenueRevenue

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Rental Revenue31/1 500

Unearned Rental Revenue31/1 500 1/1 6,000

Bal. 5,500

Income StatementRevenue earned

this period.

Balance SheetLiability for

future periods.

Converting Liabilities to Converting Liabilities to RevenueRevenue

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Prior Periods Current Period Future Periods

TransactionPay cash in

settlement of liability.

End of Current Period

Accruing Unpaid ExpensesAccruing Unpaid Expenses

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Monday,29 May

Friday, 2 June

$3,000 Wages Expense

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

Wednesday,31 May

Accruing Unpaid ExpensesAccruing Unpaid Expenses

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

31 May Wages Expense 3,000Wages Payable 3,000

To accrue wages owed to employees.

Initially, an expense and a liability are recorded.

Accruing Unpaid ExpensesAccruing Unpaid Expenses

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Wages Expense31/5 3,000

Wages Payable31/5 3,000

Income StatementCost incurred this period to generate

revenue.

Balance SheetLiability to be

paid in a future period.

Accruing Unpaid ExpensesAccruing Unpaid Expenses

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Monday,29 May

Friday, 2 June

$5,000 Weekly Wages

Let’s look at the entry for 2 June.

Wednesday,31 May

$2,000 Wages Expense

$3,000 Wages Expense

Accruing Unpaid ExpensesAccruing Unpaid Expenses

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The liability is extinguished when the debt is paid.

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

2 June Wages Expense (for June) 2,000Wages Payable (accrued in May) 3,000

Cash 5,000Weekly payroll for 29 May - 2 June

Accruing Unpaid ExpensesAccruing Unpaid Expenses

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Prior Periods Current Period Future Periods

TransactionCollect cash in settlement of receivable.

End of Current Period

Adjusting EntryRecognizes revenue earned but not yet recorded, andRecords receivable.

Accruing Uncollected Accruing Uncollected RevenueRevenue

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Saturday,15 Jan.

Tuesday, 15 Feb.

$170 Interest Revenue

On 31 Jan., the bank owes Webb Co. interest of $170. Interest is paid on the

15th day of each month.

Monday,31 Jan.

Accruing Uncollected Accruing Uncollected RevenueRevenue

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

31 Jan Interest Receivable 170Interest Revenue 170

To recognize interest revenue

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

Accruing Uncollected Accruing Uncollected RevenueRevenue

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Interest Revenue31/1 170

Interest Receivable31/1 170

Income StatementRevenue earned

this period.

Balance SheetReceivable to

be collected in a future period.

Accruing Uncollected Accruing Uncollected RevenueRevenue

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Saturday,15 Jan.

Tuesday, 15 Feb.

$320 Monthly Interest

$170 Interest Revenue

Let’s look at the entry for 15 February.

Monday,31 Jan.

$150 Interest Revenue

Accruing Uncollected Accruing Uncollected RevenueRevenue

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The receivable is collected in a future period.

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

15 Feb Cash 320Interest Revenue (for February) 150Interest Receivable (accrued 31 Jan) 170

To record interest received.

Accruing Uncollected Accruing Uncollected RevenueRevenue

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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 ExplanationPR Debit Credit

31 Dec Income Taxes Expense 780Income Taxes Payable 780

Estimated income taxes applicable to taxable income earned in December.

Accruing Income Taxes Accruing Income Taxes Expense: The Final Expense: The Final Adjusting EntryAdjusting Entry

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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.

Adjusting Entries and Adjusting Entries and Accounting PrinciplesAccounting Principles

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An item is “material” if knowledge of the item might reasonably influence the

decisions of users of financial statements.

Supplies

Light bulbs

Many companies immediately charge

the cost of immaterial items to

expense.

The Concept of MaterialityThe Concept of Materiality

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Effects of the Adjusting Effects of the Adjusting EntriesEntries

Adjustment Revenue Expenses Profit Assets Liabilities EquityType IConverting Assets to Expenses No effect Increase Decrease Decrease No effect DecreaseType IIConverting Liabilities to Revenue Increase No effect Increase No effect Decrease IncreaseType IIIAccruing Unpaid Expenses No effect Increase Decrease No effect Increase DecreaseType IVAccruing Uncollected Revenue Increase No effect Increase Increase No effect Increase

Income Statement Balance Sheet

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JJ's Lawn Care Service Adjusted Trial Balance

31 May 2009Cash 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 Share capital 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 31 May after

preparing the two

depreciation adjusting entries.

Adjusted Trial BalanceAdjusted Trial Balance

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End of Chapter 4End of Chapter 4