Accrual Accounting and Cash Flows

➢ During 2022 June corporation made sales of €4,100 (assume all on account) and
collected cash of €4,900 from customers. Operating expenses totalled €2,800 of
which €2,100 were paid in cash. At year end - June's customers owed the company
€750 and June owed creditors €1,300. All amounts are in millions
1. For these facts show what June's Corp reported on the following financial
statements at year end:
– Income statement
– Balance sheet
2. Suppose June Corp had used the cash basis of accounting. What would they have
reported for these facts

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Accrual Accounting and Cash Flows

Income Statement: Sales Revenues 4,100

Operating Expenses (2,800)

Balance Sheet: Accounts receivable 750

Accounts Payable 1,300

Cash basis would report only the cash collections of €4,900 from
customers and the payment of operating expenses (€2,100). Their
balance sheet would have included neither accounts receivable nor
accounts payable.

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Recognition
➢ A customer pays FedEx €9,000 on September 15th for a
shipment in October? When will FedEx earn the revenue?
– The cash is received in September, but the performance (shipping)
is only in the next month. Only when the service for the customer is
completed has FedEx earned the revenue, hence here in October.
➢ FedEx receives €1,500 rent payment for storing a shipment
for a customer on October 1st for the next three months. Has
FedEx earned revenue on October 1st?
– No, FedEx has received cash in advance, the revenue must be
recognised monthly when the service performance has been
satisfied, until then FedEx has a liability – an unearned revenue –
an obligation to satisfy the contract.
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Recognition

➢ FedEx has prepaid €4,500 for the following 3 months

office rent on 1st September. Has FedEx incurred and
expense on 1st September?
– No FedEx has paid cash in advance, there is no expense. This
prepaid rent is an asset as FedEx has a future economic benefits
from it (using the office space each month)
➢ A store has bought shirts for sale in August. In September,
all the shirts are sold. When has the store incurred an
expense?
– The expense matches the revenues, hence in September when the
shirts are sold the asset is converted to an expense on the income
statement.
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Accrual Accounting „everyday business“

„Everyday Business“ ➢ Everyday Business Journal entry

performed a consulting service September 13, 2023:
charging their customer Accounts Receivable 1,000
„Business Everywhere“ Sales Revenue 1,000
€1,000, granting them 30
days payment terms. The ➢ Business Everywhere Sep. 13,
invoice was sent on September 2023
13, 2023. Consulting Expense 1,000
➢ Journalize the transaction Accounts payable 1,000
for both Everyday B. and
Business E. 5
Accrued Revenue / Sale on Account

On June 15, our company is hired to wash towels each

month. Washing services start immediately.
Our company is paid €600 per month with the first
payment on July 15.
During June, our company will earn half a month‘s fee for
work done from June 15 – June 30.

Which entry does our washing company have to perform

on June 30?

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Accruals – Example: Accrued Revenue

JOURNAL
Date Debit Credit
Jun 30 Accounts Receivable (BS) 300
Service Revenue (IS) 300

To accrue service revenue for services

delivered during the second half of
June. Collection will follow mid of July.

→ 2nd entry? When? What?

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Accruals – Example: Accrued Revenue

JOURNAL
Date Debit Credit
Jun 30 Accounts Receivable (BS) 300
Service Revenue (IS) 300

July 15 cash 600

Accounts Receivable 300
Service Revenue 300

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Accrued Expense

On June 15, “Grand” hires a company to wash towels

each month. Washing services start immediately.
The company pays a lump sum of €600 per month, but
the first payment is effected only on July 15.

Which adjusting entry does “Grand” have to perform on

June 30?

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Accruals: Accrued Expense
JOURNAL
Date Debit Credit
Jun 30 Cleaning Expense (IS) 300
Accounts Payable (BS) 300
To accrue expenses for services received
during the second half of June. Payment
will follow mid July.

→ 2nd entry?
➢Cr. Cash (BS) 600
Dr. Accounts payable (BS) 300 (15-30 June)
➢AND
➢Dr. Expense for cleaning vehicles (P&L) 300 (1-15 July)

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Deferrals: Prepaid Expense

Suppose a company prepays three months’store rent

(€3,000) on June 1 → the company pays in advance!, i.e.
before consumption / before the event of ‘using the floor
space’ takes place.

1. What is the journal entry on June 1?

2. What is the adjusting entry at the end of June?

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 Deferrals: Prepaid Expense

JOURNAL

Date Accounts and

Deferred expense → receivable
explanation Debit Credit

Jun 1 Prepaid rent (BS) → 1st entry: 3,000

Cash (BS) cash 3,000
Paid three months’ rent in advance

Jun 30 Rent expense (IS) → 2nd entry: 1,000

Prepaid rent (BS) expense 1,000
To record rent expense

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 Defferal: Usage of Supplies

➢ On June 2nd CRP paid €850 Cash for cleaning supplies and
recorded the purchase
JOURNAL

Date Accounts and explanation Debit Credit

Jun 2 Supplies (Inventory) € 850

Cash 850
➢ On June 30th a count indicates that €450 of the supplies
remain on stock
Jun 30 Supplies Expense (€850-450) €400
Supplies 400
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 Deferrals: Unearned Revenue

On 15 June a company engaged ‘Shine Brite Car Wash’ to wash 100

vehicles and immediately paid a flat rate of €400 for the services.
By the end of June “Shine Brite Cash Wash” had preformed the service
for 50 vehicles.
JOURNAL

Date → 1st entry: Debit Credit

Jun 15 Cash (BS) cash 400

Unearned service revenue (BS) 400
Received cash for services in
advance. Deferred revenue → liability
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Deferrals: Unearned Revenue

When revenue is effectively earned, the liability is

reduced, revenue can now be recognised in P&L.

JOURNAL

Date Debit Credit

Jun 30 Unearned service revenue (BS) 200

Service revenue (P&L) 200

To record one half of the revenue

that has been earned in June. → 2nd entry:
Revenue earned
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Quiz
On January 1 of the current year, Bambi paid €1,200 rent to cover six months (Jan-
June). Bambi recorded this transaction as follows:

Journal Entry
Date Accounts Debit Credit

Jan 1 Prepaid Rent 1,200

Cash 1,200

Bambi adjusts the accounts at the end of each month. Based on these facts, the adjusting
entry at the end of January should include
a. A credit to prepaid rent for €1,000
b. A credit to prepaid rent for €200
c. A debit to prepaid rent for €1,000
d. A debit to prepaid rent for €200

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Quiz

Assume the same facts as in the previous What effect does the adjusting entry in
question. the previous question have on Bambi’s net
Bambi‘s adjusting entry at the end of income for February?
February should include a debit to Rent
Expense in the amount of: a. Increase by €200
b. Decrease by €200
a. €200 c. Increase by €400
b. €1,000 d. Decrease by €400
c. €400
d. €0

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On April 1 2023 Rural Insurance Company sold a one-year insurance policy covering the year
ending March 31, 2024. Rural collected the full €2,700 on April 1 2023. Rural made the
following journal entry to record the receipt of cash in advance
Journal Entry
Date Accounts Debit Credit

Apr 1 Cash 2,700

Unearned Revenue 2,700

➢ Nine months have passed and Rural has made no adjusting entries. Based on these facts the
adjusting entry needed by Rural on December 31, 2023, must be:
a. Insurance revenue 675
Unearned Revenue 675
b. Unearned Revenue 2,025
Insurance Revenue 2,025
c. Insurance revenue 2,025
Unearned Revenue 2,025
d. Unearned Revenue 675
Insurance Revenue 675

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Quiz
On January 1 of the current year, Matt Ltd paid €600 to cover the next six months insurance (Jan-
June). Matt recorded this transaction as follows:

Journal Entry
Date Accounts Debit Credit
Jan 1 Prepaid Insurance 600

Cash 600

Matt adjusts the accounts at the end of each month. Based on these facts, the adjusting entry at the end
of January should include

a. A credit to prepaid insurance for €600

b. A credit to prepaid insurance for €100
c. A debit to prepaid insurance for €6000
d. A debit to prepaid Insurance for €100

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Quiz

Assume the same facts as in the previous

What effect does the adjusting entry in
question.
the previous question have on Matts net
Matt adjusting entry at the end of income for February?
February should include a debit to
Insurance Expense in the amount of:
a. Increase by €100
b. Decrease by €100
a. €100
c. Increase by €200
b. €600
d. Decrease by €200
c. €200
d. €0

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Quiz

The unearned revenue account of Super Inc. began 2022 with a normal
balance of $2,000 and ended 2022 with a normal balance of $17,000.
During 2022 the Unearned revenue account was credited for $26,000
that Super will earn later. Based on these facts, how much revenue did
Super earn in 2022?

a. $11,000
b. $28,000
c. $2,000
d. $26,000

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Journalize the adjusting entries at the end of the year for MY
Company, who only adjusts its accounts by the end of the
financial year:

a. The business has an interest expense of €3,400 that it must pay at

the beginning of the following year
b. Interest revenue of €3,000 has been earned but not yet received
c. On July 1 when €14,400 for rent was collected in advance, cash
was debited and Unearned Rent Revenue was credited, the tenant
was paying for a years‘ rent.
d. Salary expense is €2,500 per day Mo-Fr. It is paid each Friday.
Dec. 31 falls on a Wednesday
e. The unadjusted balance of the supplies account is €3,500. The total
cost of supplies remaining on hand is €1,300
f. End of December MY paid €1,800 for next year's fire-insurance

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Journal Adjusting Entries Dec. 31

Date ACCOUNT TITLES DEBIT CREDIT

a. Interest Expense 3,400
Interest Payable 3,400
b. Interest Receivable 3,000
Interest Revenue 3,000
c. Unearned rent revenue 7,200
Rent Revenue 7,200
d. Salary Expense 7,500
Salaries payable 7,500
e. Supplies Expense 2,200
Supplies (Inventory) 2,200
f. Prepaid insurance 1,800
Cash 1,800

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 Depreciation – Example, Indirect Method
On June 2, a company purchased equipment on account for €48,000.
Expected useful life 5 years, linear method of Depreciation, no residual
value. The monthly depreciation is therefore €800 (48000/60) and
records it using the indirect method.
JOURNAL

Date Debit Credit

Jun 2 Equipment (BS) 48,000

Accounts payable (BS) 48,000

Jun 30 Depreciation expense (P&L) 800

Accumulated depreciation 800

Equipment (Contra-asset account on BS!)
Usage of equipment for 1 month 24