acct 100 chapter 3 adjusting the accounts accrual accounting and the financial statements 2...

ACCT 100

Chapter 3

Adjusting the Accounts

Accrual Accounting and the Financial Statements 2

Objectives of the Chapter

I. Introduce the accrual accounting concept.

II. Introduce the adjusting entries.


I. Accrual Accounting

1. The time-period concept, the revenue recognition and the matching principles.

2. Accrual versus cash basis accounting.


The Time-Period Concept (Periodicity)

Income and financial position of a business are reported periodically, not until the end of life of a business.

Income Measurement And Profit Analysis 5

Revenue Recognition Principle (SFAS No. 5) (-An Accrual Basis)

Revenue is recognized when it is earned and realized.

Earned : the entity has substantially accomplished what it must do to be entitled to compensation.

Realized: goods are exchanged for cash or claims.

In general, these conditions are met at time of sale (delivery) or when services are rendered regardless whether cash is collected or not.


The Matching Principle

If revenues are recognized in a period, all related expenses should be recognized in the same period regardless whether expenses are paid or not.

The related expenses include traceable costs (i.e., product costs), period costs, (i.e.,

interest and rent expenses) and estimated/allocation expenses (i.e., depreciation expense and bad debt expense).


Accrual vs. Cash Basis Accounting Accrual-basis accounting:

Revenues are recognized based on revenue recognition principle (i.e., recognized when realized and earned regardless whether cash is collected or not).

Expenses are recognized based on matching principle.

Note: revenue and expense recognize before cash settlement.

Accrual vs. Cash Basis Accounting (contd.) Cash-basis accounting:

The accountant does not record a transaction until cash is received or paid.

Cash-basis accounting is NOT acceptable for financial reporting.



II. Adjusting Entries

Due to the periodicity concept, financial reports are prepared periodically.

Based on revenue recognition principle, adjusting entries are prepared at the end of a period to recognize revenues earned during the period but not yet recorded (i.e., accrued revenues).


Adjusting Entries (contd.)

Based on the matching principle, the accrued expenses (i.e., expenses incurred but not yet paid/recorded) and estimated expenses (i.e., depreciation expense and bad debt expense) are recorded at the end of a period.


Types of Adjusting Entries

A. Accruals

B. Deferrals

C. Estimated Expenses


A. Accruals

Unrecorded revenues or expenses (i.e., revenues earned or expenses occurred but not yet recorded).

a. Accrued expenses.

b. Accrued revenues.


a. Accrued Expenses- An Example

A one-year note payable was issued on 11/1/x1 to purchase an equipment. The full amount of the note is $2,400. The annual interest rate is 10% and interests are paid on 4/30/x2 and 11/1/x2.

11/1/x1 Equipment2,400 Note Payable 2,400Adjusting Entry:12/31/x1 Interest Expense 40 Interest payable 40


b. Accrued Revenues – An Example A one year note was received from a credit sale

with a face amount of $3,000 and an annual interest rate of 12% on 9/1/x1. Interests are received on 3/1/x2 and 9/1/x2.

9/1/x1 Note Receivable 3,000

Sales Revenue3,000

Adjusting Entry:

12/31/x1 Interest Receivable 120

Interest Revenue 120


B. Deferrals

Postponing the recognition of Revenues or expenses

a. Unearned revenues

b. Prepaid expenses


a. Unearned Revenues

Receiving $2,400 for a one-year advanced rent payment from a tenant on 12/1/x1

(B/S Approach)12/1/x1Cash 2,400

Unearned Rent2,400

12/30/x1Unearned Rent 200

Rent Revenue200

(I/S Approach)12/1/x1Cash 2,400

Rent Revenue2,400

12/30/x1Rent Revenue 2,200

Rent Unearned 2,200


b. Prepaid Expense

Prepaid a 12 month insurance premium of $1,200 on 11/1/x1

(B/S Approach)Prepaid Insur. 1,200

Cash1,200

12/31/x1Insurance Exp. 200

Prepaid Insurance200

(I/S Approach)Insurance Exp. 1,200

Cash1,200

12/31/x1Prepaid Insur. 1,000

Insurance Exp.1,000


C. Estimated Expenses (based on the matching principle)Depreciation Expense12/31 Depreciation Expense XXX

Accumulated Depreciation XXX

Bad Debt Expense12/31 Bad Debt Expense XXX

Allowance for B/D XXX

Income Tax Expense12/31 Income Tax Expense XXX

Income Tax Payable XXX


Example (from Financial Accounting by Harrison and Horngren): Information for Adjustments at 4/30/ 19x1 (a) Prepaid rent expired, $1,000.

(b) Supplies on hand, $400 (balance of supplies equals $700 before adjustment).

(c) Depreciation on furniture, $275.

(d) Accrued salary expense, $950.

(e) Accrued service revenue, $250.

(f) Amount of unearned service revenue that has been earned, $150.

(g) Accrued income tax expense, $540.

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Adjusting Entries (a) Rent Expense 1,000

Prepaid Rent 1,000To record rent expense.

(b) Supplies Expense 300Supplies 300

To record supplies used.

(c) Depreciation Exp. - Furniture 275Accumulated Depr. - Furniture 275

To record depreciation on furniture.

(d) Salary Expense 950Salary Payable 950

To accrue salary expense.

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Exhibit 3-9 Panel B (contd.)

(e) Accounts Receivable 250Service Revenue 250

To accrue service revenue.

(f) Unearned Service Revenue 150Service Revenue 150

To record unearned revenue that has been earned.

(g) Income Tax Expense 540Income Tax Payable 540

To accrue income tax expense.

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acct 100 chapter 3 adjusting the accounts accrual accounting and the financial statements 2...

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