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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5
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

Interim periods
◦ Financial statements of less than one year
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
When to record revenue?
◦ When it is earned

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
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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

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
Prepaid rent for 6 months
DEBIT
CREDIT
4,800
4,800
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

Depreciation
◦ Allocation of a plant asset’s cost to expense over its
useful life
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GENERAL JOURNAL
DATE
12
REF
DESCRIPTION
31 Depreciation expense
DEBIT
CREDIT
$$$$
Accumulated depreciation
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$$$$
20

Contra asset
◦ Normal credit balance
◦ Always paired with related account


Holds sum of all depreciation recorded on a plant
asset
Book value:
◦ Cost minus accumulated depreciation
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
Expenses incurred before payment is made
◦ Results in a liability

Opposite of a prepaid expense
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GENERAL JOURNAL
DATE
REF
DESCRIPTION
Dec 31 Interest expense
Interest payable
To record accrued interest
DEBIT
CREDIT
$$$$
$$$$$
GENERAL JOURNAL
DATE
REF
DESCRIPTION
Dec 31 Salaries expense
DEBIT
CREDIT
$$$$
Salaries payable
$$$$
To record accrued salaries
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

Revenue earned before cash is received
Results in a receivable
GENERAL JOURNAL
DATE
REF
DESCRIPTION
Dec 31 Accounts receivable
Service revenue
DEBIT
CREDIT
$$$$
$$$$
To record accrued revenues
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
Cash is collected before revenue is earned
◦ Results in a liability as the company owes a product or
service or they will have to give the money back

Also called deferred revenue
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GENERAL JOURNAL
DATE
Dec
REF
DESCRIPTION
DEBIT
CREDIT
1 Cash
$$$$$
Unearned revenue
$$$$$
To record cash received before service is provided
GENERAL JOURNAL
DATE
REF
DESCRIPTION
Dec 31 Unearned revenue
DEBIT
CREDIT
$$$$
Service revenue
$$$$
To record earned portion of
unearned revenue
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

To properly measure net income on the income
statement
To update the balance sheet
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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
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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
Common stock
Retained earnings
Service revenue
Rent expense
Supplies expense
Depreciation expense
Interest expense
Totals
Dr.
5,400
700
17,000
Cr.
Adjustments
Dr.
Cr.
a. 500
1,000
200
Adjusted
Trial Balance
Dr.
5,400
200
17,000
2,000
200
100
3,000
6,000
5,000
12,000
b. 1,000
c. 100
3,000
6,000
5,000
12,000
a. 500
b. 1,000
c. 100
4,000
100
27,200
27,200
1,600
1,600
Cr.
4,000
500
1,000
200
28,300
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28,300
31
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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