Chapter 3

Differentiate between accrual and cash-basis

accounting

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Accrual Basis

Cash Basis

Revenues are
recognized when
earned and expenses
are recognized when
incurred.

Revenues are
recognized when
cash is received and
expenses recorded
when cash is paid.

Not GAAP
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Accrual Revenue recognized

when services provided

Cash Revenue recognized

when cash is received

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Accrual Expense recognized

when incurred

Cash Expense recognized

when cash is paid

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Define and apply the accounting period concept,

revenue, and matching principles

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Businesses prepare financial statements for

specific periods to evaluate performance
Basic accounting period = one year
Calendar year
Fiscal year

Interim periods
Financial statements of less than one year
Monthly
Quarterly
Semiannually

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When to record revenue?

When it is earned
When service is provided or product delivered
This is not necessarily the time when cash is received

What amount of revenue should be recorded?

Value of item or service transferred to customer

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Measure all expenses incurred during the

accounting period
Match the expenses against the revenues earned
during the same period

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Requires that accounting information be reported

at regular intervals
Accounts are updated at the end of each
accounting period

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Explain why adjusting entries are needed

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Prepared at end of an accounting period

Assign:
Revenues to the period when earned
Expenses to the period when incurred

Update asset and liability accounts

Need to properly measure:
Net Income
Assets & Liabilities

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Never involve
cash

Either increase
revenue or
increase an
expense

Accrued
means amount
must be
recorded
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Journalize and post adjusting entries

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Prepaid
expenses

Depreciation

Accrued
expenses

Accrued
revenues

Unearned
revenues

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Advance payments of expenses

Examples:
Rent
Insurance
Supplies

Recorded as an asset
Adjusting entry records amount used as an
expense

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GENERAL JOURNAL
DATE

Apr

REF

DESCRIPTION

1 Prepaid Rent
Cash

DEBIT

CREDIT

4,800
4,800

Prepaid rent for 6 months

Prepaid rent
4/1

4,800

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GENERAL JOURNAL
DATE

REF

DESCRIPTION

DEBIT

Apr 30 Rent expense

Prepaid rent
To record rent expired in April

Prepaid rent
4/1

4,800 4/30

Bal

4,000

CREDIT

800
800

Rent expense
800

4/30

800

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Plant assets
Long-lived tangible assets used in business operations

Examples:
Land, buildings, equipment, and furniture

Depreciation
Allocation of a plant assets cost to expense over its
useful life
Land is not depreciated

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GENERAL JOURNAL
DATE

12

REF

DESCRIPTION

31 Depreciation expense

DEBIT

$$$$

Accumulated depreciation

Contra-asset
account

CREDIT

$$$$

Amount
calculated based
on depreciation
method

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Contra asset
Normal credit balance
Always paired with related account

Holds sum of all depreciation recorded on a plant

asset
Book value:
Cost minus accumulated depreciation

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Expenses incurred before payment is made

Results in a liability

Opposite of a prepaid expense

Examples:
Salaries
Interest

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GENERAL JOURNAL
DATE

REF

DESCRIPTION

Dec 31 Interest expense

Interest payable
To record accrued interest

DEBIT

CREDIT

$$$$
$$$$$

GENERAL JOURNAL
DATE

REF

DESCRIPTION

Dec 31 Salaries expense

DEBIT

CREDIT

$$$$

Salaries payable

$$$$

To record accrued salaries

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Revenue earned before cash is received

Results in a receivable

GENERAL JOURNAL
DATE

REF

DESCRIPTION

Dec 31 Accounts receivable

DEBIT

CREDIT

$$$$

Service revenue

$$$$

To record accrued revenues

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Cash is collected before revenue is earned

Results in a liability as the company owes a product or
service or they will have to give the money back

Also called deferred revenue

BEFORE

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GENERAL JOURNAL
DATE

Dec

REF

DESCRIPTION

1 Cash

DEBIT

CREDIT

$$$$

Unearned revenue

$$$$

To record cash received before service is provided

GENERAL JOURNAL
DATE

REF

DESCRIPTION

Dec 31 Unearned revenue

Service revenue

DEBIT

CREDIT

$$$$
$$$$

To record earned portion of

unearned revenue
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To properly measure net income on the income

statement
Each adjusting entry affects a revenue or an expense

To update the balance sheet

Each adjusting entry affects an asset or a liability

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Category of Adjusting Entry

Debit

Credit

Prepaid expense

Expense

Asset

Depreciation

Expense

Contra asset

Accrued expense

Expense

Liability

Accrued revenue

Asset

Revenue

Unearned revenue

Liability

Revenue

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Explain the purpose of and prepare an adjusted

trial balance

Prepared after adjusting entries are posted

Useful step in preparing financial statements
Often appears on a work sheet
Tool accountants use at end of period

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Any Company
Worksheet
December 31, 2010
Trial Balance

Account Title
Cash
Supplies
Equipment
Accum. depr. - Equip.
Accounts payable
Interest payable
Note payable
Josie Smith, Capital
Josie Smith, W/D
Service revenue
Rent expense
Supplies expense
Depreciation expense
Interest expense
Totals

Dr.
5,400
700
17,000

Cr.

Adjustments

Adjusted
Trial Balance

Dr.

Dr.

Cr.
a. 500

1,000
200

200

b. 1,000

2,000

c. 100

100
9,000
6,000

9,000
6,000

1,000

1,000
12,000

12,000

4,000

100
27,200

Cr.

a. 500
b. 1,000
c. 100
27,200
1,600

1,600

4,000
500
1,000
200
28,300

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28,300

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Prepare the financial statements from the adjusted

trial balance

Income
statement

Reports revenue and expenses

Determines net income

Statement of
retained
earnings

Shows why Retained earnings

changed during the period
Computes ending Retained
earnings

Balance sheet

Reports assets, liabilities and

stockholders equity
Needs ending Retained earnings to
balance

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Any Company
Worksheet
December 31, 2010
Adjusted
Trial Balance
Account Title
Cash
Supplies
Equipment
Accum. depr. - Equip.
Accounts payable
Interest payable
Note payable
Common stock
Retained earnings
Service revenue
Rent expense
Supplies expense
Depreciation expense
Interest expense
Totals

Dr.
5,400
200
17,000

Cr.

2,000
200
100
3,000
6,000
5,000
12,000
4,000
500
1,000
200
28,300

Balance sheet

Income statement

28,300
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Any Company
Income Statement
Year ended December 31, 2010
Revenue:
Service revenue
Expenses:
Rent expense
Depreciation expense
Supplies expense
Interest expense
Total expenses
Net income

$ 12,000
$ 4,000
1,000
500
200
5,700
$ 6,300

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Any Company
Statement of Retained Earnings
Year ended December 31, 2010
Retained earnings, January 1, 2010
$ 5,000
Add: Net income
6,300
Retained earnings, December 31, 2010
$11,300

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Any Company
Balance Sheet
December 31, 2010
Assets
Cash
Supplies
Equipment
Less: Accumulated depreciation
Total assets

$5,400
200
17,000
(2,000)

15,000
20,600

Liabilities
Accounts payable
Interest payable
Notes payable
Total liabilities

200
100
3,000
3,300

Stockholders' Equity
Common stock
Retained earnings
Total stockholders' equity
Total liabilities & stockholders' equity

6,000
11,300
17,300
20,600

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