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Timing Issues
Accountants divide the economic life of a business into
artificial time periods (Time Period Assumption).

Jan.

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Feb.

Mar.

Apr.

.....

Dec.

Generally a month, a quarter, or a year.

Also known as the Periodicity Assumption

SO 1 Explain the time period assumption.

Timing Issues
Fiscal and Calendar Years

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Monthly and quarterly time periods are called interim

periods.

Public companies must prepare both quarterly and

annual financial statements.

Fiscal Year = Accounting time period that is one year

in length.

Calendar Year = January 1 to December 31.

SO 1 Explain the time period assumption.

Timing Issues
Accrual- vs. Cash-Basis Accounting
Accrual-Basis Accounting

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Transactions recorded in the periods in which the

events occur.

Revenues are recognized when earned, rather than

when cash is received.

Expenses are recognized when incurred, rather

than when paid.

SO 2 Explain the accrual basis of accounting.

Timing Issues
Accrual- vs. Cash-Basis Accounting
Cash-Basis Accounting

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Revenues recognized when cash is received.

Expenses recognized when cash is paid.

Cash-basis accounting is not in accordance with

generally accepted accounting principles (GAAP).

SO 2 Explain the accrual basis of accounting.

Timing Issues
Recognizing Revenues and Expenses
Revenue Recognition Principle
Recognize revenue in the
accounting period in which it
is earned.
In a service enterprise,
revenue is considered to be
earned at the time the
service is performed.

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SO 2 Explain the accrual basis of accounting.

Timing Issues
Recognizing Revenues and Expenses
Expense Recognition Principle
Match expenses with
revenues in the period
when the company makes
efforts to generate those
revenues.
Let the expenses follow
the revenues.

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SO 2 Explain the accrual basis of accounting.

The Basics of Adjusting Entries

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Adjusting entries are necessary because the trial

balance may not contain up-to-date and complete
data.

Ensure that the revenue recognition and expense

recognition principles are followed.

Required every time a company prepares financial

statements.

Will include one income statement account and

one balance sheet account.

SO 3 Explain the reasons for adjusting entries.

The Basics of Adjusting Entries

Types of Adjusting Entries
Illustration 3-2
Categories of adjusting entries

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Deferrals

Accruals

1. Prepaid Expenses.
Expenses paid in cash and
recorded as assets before
they are used or consumed.

3. Accrued Revenues.
Revenues earned but not yet
received in cash or
recorded.

2. Unearned Revenues.
Cash received and recorded
as liabilities before revenue
is earned.

4. Accrued Expenses.
Expenses incurred but not
yet paid in cash or recorded.

SO 4 Identify the major types of adjusting entries.

The Basics of Adjusting Entries

Types of Adjusting Entries
Trial Balance
Each account is
analyzed to
determine
whether it is
complete and upto-date.

Illustration 3-3

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SO 4 Identify the major types of adjusting entries.

The Basics of Adjusting Entries

Prepaid Expenses
Payment of cash, that is recorded as an asset because
service or benefit will be received in the future.
Cash Payment

BEFORE

Expense Recorded

Prepayments often occur in regard to:

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insurance

rent

supplies

equipment

advertising

buildings

SO 5 Prepare adjusting entries for deferrals.

The Basics of Adjusting Entries

Prepaid Expenses

Expire either with the passage of time or through use.

Adjusting entry:

Increase (debit) to an expense account and

Decrease (credit) to an asset account.

Illustration 3-4

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SO 5 Prepare adjusting entries for deferrals.

The Basics of Adjusting Entries

Illustration: Pioneer Advertising Agency
purchased supplies costing $2,500 on
October 5. Pioneer recorded the payment
by increasing (debiting) the asset
Supplies. This account shows a balance
of $2,500 in the October 31 trial balance.
An inventory count at the close of
business on October 31 reveals that
$1,000 of supplies are still on hand.
Oct. 31

Supplies expense
Supplies

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1,500
1,500
SO 5 Prepare adjusting entries for deferrals.

The Basics of Adjusting Entries

Illustration 3-5

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SO 5

The Basics of Adjusting Entries

Illustration: On October 4, Pioneer
Advertising Agency paid $600 for a oneyear fire insurance policy. Coverage
began on October 1. Pioneer recorded
the payment by increasing (debiting)
Prepaid Insurance. This account shows a
balance of $600 in the October 31 trial
balance. Insurance of $50 ($600 / 12)
expires each month.
Oct. 31

Insurance expense

50

Prepaid insurance
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50

SO 5 Prepare adjusting entries for deferrals.

The Basics of Adjusting Entries

Illustration 3-6

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SO 5

The Basics of Adjusting Entries

Depreciation

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Buildings, equipment, and vehicles (assets with long

lives) are recorded as assets, rather than an expense,
in the year acquired.

Companies report a portion of the cost of the asset as

an expense (depreciation expense) during each period
of the assets useful life.

Depreciation does not attempt to report the actual

change in the value of the asset.

SO 5 Prepare adjusting entries for deferrals.

The Basics of Adjusting Entries

Illustration: For Pioneer Advertising,
assume that depreciation on the
equipment is $480 a year, or $40 per
month.
Oct. 31
Depreciation expense
Accumulated depreciation

40
40

Accumulated Depreciation is called a contra asset account.

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SO 5 Prepare adjusting entries for deferrals.

The Basics of Adjusting Entries

Statement Presentation

Accumulated Depreciation is a contra asset account.

Appears just after the account it offsets (Equipment)

on the balance sheet.

Normal balance of a contra asset account is a credit.

Illustration 3-8

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SO 5 Prepare adjusting entries for deferrals.

The Basics of Adjusting Entries

Illustration 3-9

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SO 5 Prepare adjusting entries for deferrals.

The Basics of Adjusting Entries

Unearned Revenues
Receipt of cash that is recorded as a liability because the
revenue has not been earned.
Cash Receipt

BEFORE

Revenue Recorded

Unearned revenues often occur in regard to:

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Rent

Magazine subscriptions

Airline tickets

Customer deposits

SO 5 Prepare adjusting entries for deferrals.

The Basics of Adjusting Entries

Unearned Revenues

Adjusting entry is made to record the revenue that

has been earned and to show the liability that remains.

Results in a decrease (debit) to a liability account

and an increase (credit) to a revenue account.
Illustration 3-10

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SO 5 Prepare adjusting entries for deferrals.

The Basics of Adjusting Entries

Illustration: Pioneer Advertising Agency received $1,200 on
October 2 from R. Knox for advertising services expected to be
completed by December 31. Unearned Service Revenue shows a
balance of $1,200 in the October 31 trial balance. Analysis reveals
that the company earned $400 of those fees in October.
Oct. 31

Unearned service revenue

Service revenue

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400
400

SO 5 Prepare adjusting entries for deferrals.

The Basics of Adjusting Entries

Illustration 3-12

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SO 5 Prepare adjusting entries for deferrals.

The Basics of Adjusting Entries

Accrued Revenues
Revenues earned but not yet received in cash or recorded.

Revenue Recorded

BEFORE

Cash Receipt

Accrued revenues often occur in regard to:

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Rent

Interest

Services performed

SO 6 Prepare adjusting entries for accruals.

The Basics of Adjusting Entries

Accrued Revenues

Adjusting entry shows the receivable that exists and

records the revenues earned.

Adjusting entry:

Increases (debits) an asset account and

Increases (credits) a revenue account.

Illustration 3-13

3-26

SO 6

The Basics of Adjusting Entries

Illustration: In October Pioneer Advertising
Agency earned $200 for advertising services
that had not been recorded.
Oct. 31
Accounts receivable

200

Service revenue

200

On November 10, Pioneer receives cash of

$200 for the services performed.
Nov. 10

Cash

200

Accounts receivable
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200

SO 6 Prepare adjusting entries for accruals.

The Basics of Adjusting Entries

Illustration 3-15

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SO 6 Prepare adjusting entries for accruals.

The Basics of Adjusting Entries

Accrued Expenses
Expenses incurred but not yet paid in cash or recorded.
Expense Recorded

BEFORE

Cash Payment

Accrued expenses often occur in regard to:

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Rent

Taxes

Interest

Salaries

SO 6 Prepare adjusting entries for accruals.

The Basics of Adjusting Entries

Accrued Expenses

Adjusting entry records the obligation and recognizes

the expense.

Adjusting entry:

Increase (debit) an expense account and

Increase (credit) a liability account.

Illustration 3-16

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SO 6

The Basics of Adjusting Entries

Illustration: Pioneer Advertising Agency signed a three-month
note payable in the amount of $5,000 on October 1. The note
requires Pioneer to pay interest at an annual rate of 12%.

Oct. 31

Interest expense
Interest payable

3-31

50
50

SO 6 Prepare adjusting entries for accruals.

The Basics of Adjusting Entries

Illustration: Pioneer Advertising Agency last paid salaries on
October 26; the next payment of salaries will not occur until
November 9. The employees receive total salaries of $2,000 for a
five-day work week, or $400 per day. Thus, accrued salaries at
October 31 are $1,200 ($400 x 3 days).
Illustration 3-19

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SO 6 Prepare adjusting entries for accruals.

The Basics of Adjusting Entries

Illustration 3-20

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SO 6

The Basics of Adjusting Entries

Illustration 3-21

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SO 6 Prepare adjusting entries for accruals.

The Basics of Adjusting Entries

Summary of Basic Relationships
Illustration 3-22

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SO 6 Prepare adjusting entries for accruals.

The Adjusted Trial Balance

Adjusted Trial Balance

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Prepared after all adjusting entries are journalized

and posted.

Purpose is to prove the equality of debit balances

and credit balances in the ledger.

Is the primary basis for the preparation of financial

statements.

SO 7 Describe the nature and purpose of the adjusted trial balance.

3-37

The Financial Statements

Financial
FinancialStatements
Statementsare
areprepared
prepareddirectly
directlyfrom
fromthe
the
Adjusted
AdjustedTrial
TrialBalance.
Balance.

Balance
Sheet

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Income
Statement

Owners
Equity
Statement

SO 7 Describe the nature and purpose of the adjusted trial balance.

Illustration 3-26

3-39

SO 7

Illustration 3-27

3-40

SO 7