1. The Accounting Cycle: Accruals and Deferrals Chapter 4McGraw-Hill/IrwinCopyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

2. 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 3. Types of Adjusting Entries Converting Converting assets to assets to expenses expenses Converting Converting liabilities to liabilities to revenue revenue Accruing Accruing unpaid unpaid expenses expenses Accruing Accruing uncollected uncollected revenue revenue 4-3 4. Converting Assets to Expenses End of Current Period Prior PeriodsTransaction Transaction Paid cash in Paid cash in advance of advance of incurring incurring expense expense (creates an (creates an asset). asset).Current PeriodFuture PeriodsAdjusting Entry Adjusting Entry Recognizes portion Recognizes portion of asset consumed of asset consumed as expense, and as expense, and Reduces balance of Reduces balance of asset account. asset account. 4-4 5. Converting Assets to Expenses $2,400 Insurance Policy Coverage for 12 Months $200 Monthly Insurance ExpenseJan. 1Dec. 31On January 1, Webb Co. purchased a On January 1, Webb Co. purchased a one-year insurance policy for $2,400. one-year insurance policy for $2,400. 4-5 6. Converting Assets to Expenses Initially, costs that benefit more than one Initially, costs that benefit more than one accounting period are recorded as assets. accounting period are recorded as assets.GENERAL JOURNAL DateAccount Titles and ExplanationJan. 1 Unexpired Insurance CashP R DebitCredit2,400 2,400Purchase a one-year insurance policy.4-6 7. Converting Assets to Expenses The costs are expensed as they are The costs are expensed as they are used to generate revenue. used to generate revenue. GENERAL JOURNAL DateAccount Titles and ExplanationP R DebitCreditMonthly Adjusting Entry for Insurance Jan. 31 Insurance Expense Unexpired Insurance200 200Insurance expense for January. 4-7 8. Converting Assets to Expenses Balance Sheet Balance Sheet Cost of assets Cost of assets that benefit that benefit future periods. future periods.Income Statement Income Statement Cost of assets Cost of assets used this period to used this period to generate revenue. generate revenue.Unexpired Insurance 1/1 2,400 1/31 200 Bal. 2,200Insurance Expense 1/31 2004-8 9. The Concept of Depreciation Depreciation is the systematic allocation of Depreciation is the systematic allocation of the cost of a depreciable asset to expense. the cost of a depreciable asset to expense. Fixed Fixed Asset Asset (debit) (debit) On date when initial payment is made . . . Cash Cash (credit) (credit)The assets usefulness is partially consumed during the period.Depreciation Depreciation Expense Expense (debit) (debit) At end of period . . .Accumulated Accumulated Depreciation Depreciation (credit) (credit) 4-9 10. Depreciation Is Only an Estimate On May 2, 2009, JJs 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 4-10 11. Depreciation Is Only an Estimate JJs Lawn Care Service would make the JJs Lawn Care Service would make the following adjusting entry. following adjusting entry. GENERAL JOURNAL DateAccount Titles and ExplanationMay 31 Depreciation Expense: Equipment Accumulated Depreciation: EquipmentP R DebitCredit50 50To record one month's depreciation.Contra-asset Contra-asset4-11 12. Depreciation Is Only an Estimate JJs $15,000 truck is depreciated over 60 months. Calculate monthly depreciation and make the journal entry. GENERAL JOURNAL DateAccount Titles and ExplanationMay 31 Depreciation Expense: TruckP R DebitCredit250Accumulated Depreciation: Truck250To record one month's depreciation.$15,000 60 months = $250 per month $15,000 60 months = $250 per month4-12 13. Depreciation Is Only an Estimate Accumulated depreciation would Accumulated depreciation would appear on the balance sheet as appear on the balance sheet as follows: follows:Cost - Accumulated Depreciation = Book Value Cost - Accumulated Depreciation = Book Value 4-13 14. Converting Liabilities to Revenue End of Current Period Prior PeriodsTransaction Transaction Collect cash in Collect cash in advance of advance of earning revenue earning revenue (creates a (creates a liability). liability).Current PeriodFuture PeriodsAdjusting Entry Adjusting Entry Recognizes portion Recognizes portion earned as revenue, earned as revenue, and and Reduces balance of Reduces balance of liability account. liability account.4-14 15. Converting Liabilities to Revenue $6,000 Rental Contract Coverage for 12 Months $500 Monthly Rental Revenue Jan. 1Dec. 31On January 1, Webb Co. received $6,000 in On January 1, Webb Co. received $6,000 in advance for a one-year rental contract. advance for a one-year rental contract. 4-15 16. Converting Liabilities to Revenue Initially, revenues that benefit more than one Initially, revenues that benefit more than one accounting period are recorded as liabilities. accounting period are recorded as liabilities.GENERAL JOURNAL DateAccount Titles and ExplanationJan. 1 Cash Unearned Rent RevenueP R DebitCredit6,000 6,000Collected $6,000 in advance for rent. 4-16 17. Converting Liabilities to Revenue Over time, the revenue is recognized Over time, the revenue is recognized as it is earned. as it is earned. GENERAL JOURNAL DateAccount Titles and ExplanationP R DebitCreditMonthly Adjusting Entry for Rent Revenue Jan. 31 Unearned Rent Revenue Rental Revenue500 500Rental revenue for January. 4-17 18. Converting Liabilities to Revenue Balance Sheet Balance Sheet Liability for Liability for future periods. future periods.Unearned Rental Revenue1/315001/1 6,000 Bal. 5,500Income Statement Income Statement Revenue earned Revenue earned this period. this period.Rental Revenue 1/31 5004-18 19. Accruing Unpaid Expenses End of Current Period Prior PeriodsCurrent PeriodFuture PeriodsTransaction Transaction Pay cash in Pay cash in settlement of settlement of liability. liability.4-19 20. Accruing Unpaid Expenses $3,000 Wages ExpenseMonday, May 29Wednesday, May 31Friday, June 2On May 31, Webb Co. owes wages of On May 31, Webb Co. owes wages of $3,000. Payday is Friday, June 2. $3,000. Payday is Friday, June 2. 4-20 21. Accruing Unpaid Expenses Initially, an expense and a liability are Initially, an expense and a liability are recorded. recorded. GENERAL JOURNAL DateAccount Titles and ExplanationMay 31 Wages Expense Wages PayableP R DebitCredit3,000 3,000To accrue wages owed to employees. 4-21 22. Accruing Unpaid Expenses Balance Sheet Balance Sheet Liability to be Liability to be paid in a future paid in a future period. period.Wages Payable 5/31 3,000Income Statement Income Statement Cost incurred this Cost incurred this period to generate period to generate revenue. revenue.Wages Expense 5/31 3,0004-22 23. Accruing Unpaid Expenses $5,000 Weekly Wages $3,000 Wages ExpenseMonday, May 29$2,000 Wages ExpenseWednesday, May 31Friday, June 2Lets look at the entry for June 2. Lets look at the entry for June 2. 4-23 24. Accruing Unpaid Expenses The liability is extinguished when the The liability is extinguished when the debt is paid. debt is paid. GENERAL JOURNAL DateAccount Titles and ExplanationJune 2 Wages Expense (for June) Wages Payable (accrued in May) CashP R DebitCredit2,000 3,000 5,000Weekly payroll for May 29-June 2. 4-24 25. Accruing Uncollected Revenue End of Current Period Prior PeriodsCurrent PeriodAdjusting Entry Adjusting Entry Recognizes revenue Recognizes revenue earned but not yet earned but not yet recorded, and recorded, and Records receivable. Records receivable.Future PeriodsTransaction Transaction Collect cash in Collect cash in settlement of settlement of receivable. receivable.4-25 26. Accruing Uncollected Revenue $170 Interest RevenueSaturday, Jan. 15Monday, Jan. 31Tuesday, Feb. 15On Jan. 31, the bank owes Webb Co. On Jan. 31, the bank owes Webb Co. interest of $170. Interest is paid on the interest of $170. Interest is paid on the 15th day of each month. 15th day of each month. 4-26 27. Accruing Uncollected Revenue Initially, the revenue is recognized and Initially, the revenue is recognized and a receivable is created. a receivable is created. GENERAL JOURNAL DateAccount Titles and ExplanationJan. 31 Interest Receivable Interest RevenueP R DebitCredit170 170To recognize interest revenue. 4-27 28. Accruing Uncollected Revenue Balance Sheet Balance Sheet Receivable to Receivable to be collected in a be collected in a future period. future period.Interest Receivable 1/31 170Income Statement Income Statement Revenue earned Revenue earned this period. this period.Interest Revenue 1/31 1704-28 29. Accruing Uncollected Revenue $320 Monthly Interest $170 Interest RevenueSaturday, Jan. 15$150 Interest RevenueMonday, Jan. 31Tuesday, Feb. 15Lets look at the entry for February 15. Lets look at the entry for February 15. 4-29 30. Accruing Uncollected Revenue The receivable is collected in a future The receivable is collected in a future period. period. GENERAL JOURNAL DateAccount Titles and ExplanationFeb. 15 CashP R DebitCredit320Interest Revenue (for February)150Interest Receivable (accrued Jan. 31)170To record interest received. 4-30 31. Accruing Income Taxes Expense: The Final Adjusting Entry As a corporation earns taxable income, it As a corporation earns taxable income, it incurs income taxes expense, and also a incurs income taxes expense, and also a liability to governmental tax authorities. liability to governmental tax authorities. GENERAL JOURNAL DateAccount Titles and ExplanationDec. 31 Income Taxes Expense Income Taxes PayableP R DebitCredit780 780Estimated income taxes applicable to taxable income earned in December. 4-31 32. Adjusting Entries and Accounting Principles Costs are matched with revenue Costs are matched with revenue in two ways: in two ways: Direct association of costs Direct association of costs with specific revenue with specific revenue transactions. transactions. Systematic allocation of costs Systematic allocation of costs over the useful life of the over the useful life of the expenditure. expenditure. 4-32 33. The Concept of Materiality An item is material if knowledge of the An item is material if knowledge of the item might reasonably influence the item might reasonably influence the decisions of users of financial statements. decisions of users of financial statements.Many companies immediately charge the cost of immaterial items to expense.Light bulbsSupplies 4-33 34. 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 RevenueRevenue Expenses No effect Increase IncreaseAssetsLiabilitiesDecrease Decrease No effectNo effect IncreaseNo effect Increase IncreaseNet IncomeBalance SheetNo effect DecreaseDecrease No effect IncreaseNo effect IncreaseIncreaseNo effectOwners' Equity Decrease Increase Decrease Increase4-34 35. Adjusted Trial Balance JJ's Lawn Care Service Adjusted Trial Balance May 31, 2009 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 $ 22,200All balances are taken from the ledger accounts on May 31 after preparing the two depreciation adjusting entries. 4-35 36. End of Chapter 44-36