CHAPTER

THE ACCOUNTING
THREE CYCLE:
Accruals and Deferrals
PART II
DISCUSSION POINTS
Adjusting Entries
Types of Adjusting Entries
The Concept of Depreciation
Converting Liabilities to Revenue
Accruing Unpaid Expenses
Accruing Uncollected Revenue
Accruing Income Taxes Expense: The Final
Adjusting Entry
Adjusting Entries and Accounting Principles
 At the end of the
period, we need to
make adjusting entries
to get the accounts up
to date for the financial
statements.
 3.
3. 14
14Adjusting
Adjusting Entries
Entries

Adjusting Every
entries are adjusting
needed whenever entry involves a
revenue or expenses change in either a
affect more than one revenue or expense
accounting and an asset
period. or liability.
 3.15
3.15 Types
Types of
ofAdjusting
Adjusting Entries
Entries


 Converting
Converting 
 Converting
Converting
assets
assets to
to liabilities
liabilities to
to
expenses
expenses revenue
revenue


 Accruing
Accruing 
 Accruing
Accruing
unpaid
unpaid uncollected
uncollected
expenses
expenses revenues
revenues
 Converting
ConvertingAssets
Assets to
to Expenses
Expenses
End of Current Period
Prior Periods Current Period Future Periods

Transaction
Transaction Adjusting
AdjustingEntry
Entry
Paid
Paidfuture
future 
Recognize
Recognizeportion
portion
expenses
expensesin in of
ofasset
assetconsumed
consumed
advance
advance
(creates
(createsanan as
asexpense,
expense, and
and
asset).
asset). 
Reduce
Reducebalance
balanceof
of
asset
assetaccount.
account.
(Converting
(ConvertingAssets
Assets to
to Expenses,
Expenses, Cont’d)
Cont’d)

Examples Include:
Depreciation
Supplies
Expiring Insurance
Policies
Expired Rent
 (Converting
(ConvertingAssets
Assets to
to Expenses,
Expenses, Cont’d)
Cont’d)

Birr 2,400 Insurance Policy

Coverage for 12 Months

Birr 200 Monthly Insurance Expense

Jan. 1 Dec. 31

On
On January
January 1,1, Ghibe
Ghibe Co.
Co. purchased
purchased aa one-
one-
year
year insurance
insurance policy
policy for
for Birr
Birr 2,400.
2,400.
 (Converting
(ConvertingAssets
Assets to
to Expenses,
Expenses, Cont’d)
Cont’d)

Initially,
Initially, costs
costs that
that benefit
benefit more
more than
than one
one
accounting
accounting period
period are
are recorded
recorded as
as assets.
assets.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Jan. 1 Unexpired Insurance 2,400
Cash 2,400
Purchase a one-year insurance policy.
 (Converting
(ConvertingAssets
Assets to
to Expenses,
Expenses, Cont’d)
Cont’d)

The
The costs
costs are
are expensed
expensed asas they
they are
are used
used to
to
generate
generate revenue.
revenue.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Monthly Adjusting Entry for Insurance
Jan. 31 Insurance Expense 200
Unexpired Insurance 200
Insurance expense for January.
 (Converting
(ConvertingAssets
Assets to
to Expenses,
Expenses, Cont’d)
Cont’d)

Balance
Balance Sheet
Sheet Income
Income Statement
Statement
Cost
Cost of
of assets
assets Cost
Cost of
of assets
assets
that
that benefit
benefit used
used this
this period
period to
to
future
future periods.
periods. generate
generate revenue.
revenue.

Unexpired Insurance Insurance Expense

1/1 2,400 1/31 200 1/31 200
Bal. 2,200
 3.16
3.16 The
The Concept
Concept of
of Depreciation
Depreciation
Depreciable
Depreciable assets
assets are
are physical
physical objects
objects
that
that retain
retain their
their size
size and
and shape
shape but
but lose
lose
their
their economic
economic usefulness
usefulness over
over time.
time.

Depreciation
Depreciation isis the
the systematic
systematic allocation
allocation
of
of the
the cost
cost of
of aa depreciable
depreciable asset
asset to
to
expense.
expense.
 (The
(The Concept
Concept of
of Depreciation,
Depreciation, Cont’d)
Cont’d)
The
The portion
portion of
of an
an asset’s
asset’s utility
utility that
that is
is used
used
up
up must
must be
be expensed
expensed inin the
the period
period used.
used.

Fixed
Fixed The asset’s Accumulated
usefulness is Accumulated
Asset
Asset Depreciation
partially Depreciation
(debit)
(debit) (credit)
consumed (credit)
On date during the
period. At end of
when initial
payment is period . . .
made . . . Depreciation
Depreciation
Cash
Cash Expense
Expense
(credit)
(credit) (debit)
(debit)
 Depreciation
Depreciation Is
Is Only
Only an
an Estimate
Estimate
On May 2, 2013, AG Lawn Care Service
purchased a lawn mower with a useful
life of 50 months for Birr 2,500 cash.
Using the straight-line method, calculate
the monthly depreciation expense.
Depreciation
Cost of the asset
expense (per =
Estimated useful life
period)

Br. 50 = Br. 2,500

50
 Depreciation
Depreciation Is
Is Only
Only an
an Estimate
Estimate

AG
AG Lawn
Lawn Care
Care Service
Service would
would make
make the
the
following
following adjusting
adjusting entry.
entry.

GENERAL JOURNAL
P
Date Account Titles and Explanation RDebit Credit
May 31 Depreciation Expense: Tools & Eq. 50
Accumulated Depreciation: Tools & Eq. 50
To record one month's depreciation.

Contra-asset
Contra-asset
 Depreciation
Depreciation Is
Is Only
Only an
an Estimate
Estimate

AG’s
AG’s Birr
Birr 15,000
15,000 truck
truck is
is depreciated
depreciated over
over 60
60
months
months asas follows:
follows:

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
May 31 Depreciation Expense: Truck 250
Accumulated Depreciation: Truck 250
To record one month's depreciation.

$15,00060
$15,00060 months
months == $250
$250 per
per month
month
Accumulated
Accumulated depreciation
depreciation would
would
appear
appear on
on the
the balance
balance sheet
sheet as
as
follows:
follows:
 3.17
3.17 Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue
End of Current Period
Prior Periods Current Period Future Periods

Transaction
Transaction Adjusting
AdjustingEntry
Entry
Collected
Collected 
Recognize
Recognizeportion
portion
from
from earned
earnedas asrevenue,
revenue,
customers
customersin in and
and
advance
advance 
Reduce
Reducebalance
balanceofof
(creates
(createsaa liability
liabilityaccount.
account.
liability).
liability).
 (Converting
(Converting Liabilities
Liabilities to
to Revenue,
Revenue,
Cont’d)
Cont’d)

Examples Include:
Airline Ticket Sales
Magazine Subscriptions
Advertising received in
Advance
Rent received in Advance
Sports Teams’ Sales of
Season Tickets
 (Converting
(Converting Liabilities
Liabilities to
to Revenue,
Revenue,
Cont’d)
Cont’d)

Birr 6,000 Rental Contract

Coverage for 12 Months

Br. 500 Monthly Rental Revenue/Income

Jan. 1 Dec. 31

On
On January
January 1,
1, Ghibe
Ghibe Co.
Co. received
received Birr
Birr 6,000
6,000
in
in advance
advance for
for aa one-year
one-year rental
rental contract.
contract.
 (Converting
(Converting Liabilities
Liabilities to
to Revenue,
Revenue,
Cont’d)
Cont’d)

Initially,
Initially, revenues
revenues that
that benefit
benefit more
more than
than one
one
accounting
accounting period
period are
are recorded
recorded as
as liabilities.
liabilities.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Jan. 1 Cash 6,000
Unearned Rental Revenue 6,000
Collected Br. 6,000 for rent in advance
 (Converting
(Converting Liabilities
Liabilities to
to Revenue,
Revenue,
Cont’d)
Cont’d)

Over
Over time,
time, the
the revenue
revenue is
is recognized
recognized as
as itit is
is
earned.
earned.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Monthly Adjusting Entry for Rent Revenue
Jan. 31 Unearned Rental Revenue 500
Rental Revenue 500
Rental revenue for January.
 (Converting
(Converting Liabilities
Liabilities to
to Revenue,
Revenue,
Cont’d)
Cont’d)

Balance
Balance Sheet
Sheet Income
Income Statement
Statement
Liability
Liability for
for Revenue
Revenue earned
earned
future
future periods.
periods. this
this period.
period.

Unearned Rental Revenue Rental Revenue

1/31 500 1/1 6,000 1/31 500
Bal. 5,500
 3.18
3.18Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
End of Current Period
Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry Transaction
Transaction

Recognize
Recognizeexpense
expense Liability
Liabilitywill
will
incurred,
incurred, and
and be
bepaid.
paid.

Record
Recordliability
liabilityfor
for
future
futurepayment.
payment.
 (Accruing
(Accruing Unpaid
Unpaid Expenses,
Expenses, Cont’d)
Cont’d)
Hey, when
do we get
Examples Include: paid?
Accrued Interest
Wages and Salaries
Property Taxes
Utilities, etc.
 (Accruing
(Accruing Unpaid
Unpaid Expenses,
Expenses, Cont’d)
Cont’d)

Br. 3,000 Wages

Expense

Monday, Wednesday, Friday,

May 29 May 31 June 2

On
On May
May 31,31, Ghibe
Ghibe Co.
Co. owes
owes wages
wages of of Birr
Birr
3,000
3,000 for
for 33 working
working days.
days. Pay
Pay day
day is
is Friday,
Friday,
June
June 2.
2.
 (Accruing
(Accruing Unpaid
Unpaid Expenses,
Expenses, Cont’d)
Cont’d)

Initially,
Initially, an
an expense
expense and
and aa liability
liability are
are
recorded.
recorded.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
May 31 Wages Expense 3,000
Wages Payable 3,000
To accrue wages owed to employees.
 (Accruing
(Accruing Unpaid
Unpaid Expenses,
Expenses, Cont’d)
Cont’d)

Balance
Balance Sheet
Sheet Income
Income Statement
Statement
Liability
Liability toto be
be Cost
Cost incurred
incurred this
this
paid
paid in
in aa future
future period
period toto generate
generate
period.
period. revenue.
revenue.

Wages Payable Wages Expense

5/31 3,000 5/31 3,000
(Accruing
(Accruing Unpaid
Unpaid Expenses,
Expenses, Cont’d)
Cont’d)
Birr 5,000 Weekly Wages

Br. 3,000 Wages Br. 2,000 Wages

Expense Expense

Monday, Wednesday, Friday,

May 29 May 31 June 2

Let’s
Let’s look
look at
at the
the entry
entry for
for June
June 2.
2.
 (Accruing
(Accruing Unpaid
Unpaid Expenses,
Expenses, Cont’d)
Cont’d)

The
The liability
liability is
is settled
settled when
when the
the debt
debt is
is paid.
paid.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
June 2 Wages Expense (for June) 2,000
Wages Payable (accrued in May) 3,000
Cash 5,000
Weekly payroll for May 29-June 2.
 3.19
3.19Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
End of Current Period
Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry Transaction
Transaction

Recognize
Recognizerevenue
revenue Receivable
Receivable
earned
earnedbut
butnot
notyet
yet will
will be
be
recorded,
recorded, and
and collected.
collected.

Record
Recordreceivable.
receivable.
 (Accruing
(Accruing Uncollected
Uncollected Revenue,
Revenue, cont’d)
cont’d)

Examples Include:
Interest Earned
Rent Earned
Work Completed But
Not Yet Billed to
Customer
 (Accruing
(Accruing Uncollected
Uncollected Revenue,
Revenue, cont’d)
cont’d)

Br. 170 Interest

Revenue

Saturday, Monday, Tuesday,

Jan. 15 Jan. 31 Feb. 15
On
On Jan.
Jan. 31,
31, the
the bank
bank owes
owes Ghibe
Ghibe Co.
Co.
interest
interest of
of Br.
Br. 170.
170. Interest
Interest is
is paid
paid on
on the
the
15
15thth day
day of
of each
each month.
month.
 (Accruing
(Accruing Uncollected
Uncollected Revenue,
Revenue, cont’d)
cont’d)

Initially,
Initially, the
the revenue
revenue isis recognized
recognized and
and aa
receivable
receivable is
is created.
created.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Jan. 31 Interest Receivable 170
Interest Revenue 170
To recognize interest revenue.
 (Accruing
(Accruing Uncollected
Uncollected Revenue,
Revenue, cont’d)
cont’d)

Balance
Balance Sheet
Sheet
Income
Income Statement
Statement
Receivable
Receivable toto
be
be collected
collected in
in aa Revenue
Revenue earned
earned
future
future period.
period. this
this period.
period.

Interest Receivable Interest Revenue

1/31 170 1/31 170
 (Accruing
(Accruing Uncollected
Uncollected Revenue,
Revenue, cont’d)
cont’d)
Birr 320 Monthly Interest

Br. 170 Interest Br. 150 Interest

Revenue Revenue

Saturday, Monday, Tuesday,

Jan. 15 Jan. 31 Feb. 15

Let’s
Let’s look
look at
at the
the entry
entry for
for February
February 15.
15.
 (Accruing
(Accruing Uncollected
Uncollected Revenue,
Revenue, cont’d)
cont’d)

The
The receivable
receivable is
is collected
collected in
in aa future
future period.
period.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Feb. 15 Cash 320
Interest Revenue (for February) 150
Interest Receivable (accrued Jan. 31) 170
To record interest received.
 3.20
3.20Accruing
Accruing Income
Income Taxes
Taxes Expense:
Expense:
The
The Final
FinalAdjusting
Adjusting Entry
Entry
As
As aa corporation
corporation earns
earns taxable
taxable income,
income, itit
incurs
incurs income
income taxes
taxes expense,
expense, and
and also
also aa
liability
liability to
to governmental
governmental tax
tax authorities.
authorities.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Dec. 31 Income Taxes Expense 780
Income Taxes Payable 780
Estimated income taxes applicable to
taxable income earned in December.
3.21
3.21Adjusting
Adjusting Entries
Entries and
andAccounting
Accounting
Principles
Principles
Costs
Costs are
are matched
matched with
with revenue
revenue
in
in two
two ways:
ways:

 Direct
Direct association
association of
of costs
costs
with
with specific
specific revenue
revenue
transactions.
transactions.


 Systematic
Systematic allocation
allocation ofof costs
costs
over
over the
the “useful
“useful life”
life” of
of the
the
expenditure.
expenditure.
 The
The Concept
Concept of
of Materiality
Materiality

An
An item
item is
is “material”
“material” ifif knowledge
knowledge ofof the
the
item
item might
might reasonably
reasonably influence
influence the
the
decisions
decisions of of users
users of
of financial
financial statements.
statements.

Many companies
immediately charge
the cost of Lightbulbs
immaterial items to
expense.
Supplies
 Effects of the Adjusting Entries

Make end-of-
Journalize year
Post entries to Prepare trial
transactions. adjustments.
the ledger balance.
accounts.

Recall
Recall from
from the
the accounting
accounting cycle
cycle
discussed
discussed in in Chapter
Chapter 3,
3, that
that after
after
the
the adjusting
adjusting entries
entries are
are made,
made, anan
Prepare adjusted
adjusted
adjusted trial
trial balance
balance is
is prepared.
prepared. trial balance.
 Review
Review Questions
Questions

Q.Make an adjusting entries to accrue: interest revenue of Birr

50, commission revenue earned (Birr 100), rental revenue
(Birr 200).
A.
Dr. Interest Receivable 50.00
Credit Interest Revenue 50.00
Dr. Commission receivable 100.00
Cr. Commission Revenue 100.00
Dr. Rent Receivable 200.00
Cr. Rent Revenue 200.00