Chapter

4
The Accounting Cycle
Accruals and Deferrals

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 Learning
Learning Objective
Objective

To explain the purpose

of adjusting entries.

LO1
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 At the end of the
period, we need to
make adjusting entries
to get the accounts up
to date for the financial
statements.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Adjusting
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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To describe and
prepare the four basic
types of adjusting
entries.

LO2
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Types
Types of
of Adjusting
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 revenue
revenue

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To prepare adjusting
entries to convert
assets to expenses.

LO3
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Converting
Converting Assets
Assets to
to Expenses
Expenses
End of Current Period
Prior Periods Current Period Future Periods

Transaction
Transaction Adjusting
AdjustingEntry
Entry
Paid
Paidcash cashinin 
Recognizes
Recognizesportion
portion
advance
advanceof of of
ofasset
assetconsumed
consumed
incurring
incurring
expense
expense as
asexpense,
expense, and and
(creates
(createsan an 
Reduces
Reducesbalance
balanceof of
asset).
asset).
McGraw-Hill/Irwin
asset
assetaccount.
account.
© The McGraw-Hill Companies, Inc., 2008
 Converting
Converting Assets
Assets to
to Expenses
Expenses

Examples Include:
Depreciation
Supplies
Expiring Insurance Policies

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Converting
Converting Assets
Assets to
to Expenses
Expenses

$2,400 Insurance Policy

Coverage for 12 Months

$200 Monthly Insurance Expense

Jan. 1 Dec. 31

On
On January
January 1,
1, Webb
Webb Co.
Co. purchased
purchased aa one-
one-
year
year insurance
insurance policy
policy for
for $2,400.
$2,400.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Converting
Converting Assets
Assets to
to Expenses
Expenses

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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Converting
Converting Assets
Assets to
to Expenses
Expenses

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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Converting
Converting Assets
Assets to
to Expenses
Expenses

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 The
The Concept
Concept of
of Depreciation
Depreciation
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 Depreciation
usefulness is Depreciation
Asset
Asset Expense
partially Expense
(debit)
(debit) (debit)
consumed (debit)
On date during the
period. At end of
when initial
payment is period . . .
made . . . Accumulated
Accumulated
Cash
Cash Depreciation
Depreciation
(credit)
(credit) (credit)
(credit)
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Depreciation
Depreciation Is
Is Only
Only an
an Estimate
Estimate
On May 2, 2007, JJ’s 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
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Depreciation
Depreciation Is
Is Only
Only an
an Estimate
Estimate

JJ’s
JJ’s 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 R Debit Credit
May 31 Depreciation Expense: Equipment 50
Accumulated Depreciation: Equipment 50
To record one month's depreciation.

Contra-asset
Contra-asset
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Depreciation
Depreciation Is
Is Only
Only an
an Estimate
Estimate

JJ’s
JJ’s $15,000
$15,000 truck
truck is
is depreciated
depreciated over
over 60
60
months
months as as 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
© The
month
month
McGraw-Hill Companies, Inc., 2008
McGraw-Hill/Irwin
 Accumulated
Accumulated depreciation
depreciation would
would
appear
appear on
on the
the balance
balance sheet
sheet as
as
follows:
follows:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To prepare adjusting
entries to convert
liabilities to revenue.

LO4
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue
End of Current Period
Prior Periods Current Period Future Periods

Transaction
Transaction Adjusting
AdjustingEntry
Entry
Collect
Collectcash
cash 
Recognizes
Recognizesportion
portion
in
inadvance
advanceof of earned
earnedasasrevenue,
revenue,
earning
earning and
and
revenue
revenue 
Reduces
Reducesbalance
balanceofof
(creates
(createsaa
liability).
liability). liability
liabilityaccount.
account.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue

Examples Include:
Airline Ticket Sales
Sports Teams’ Sales of
Season Tickets

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue

$6,000 Rental Contract

Coverage for 12 Months

$500 Monthly Rental Revenue

Jan. 1 Dec. 31

On
On January
January 1,
1, Webb
Webb Co.
Co. received
received $6,000
$6,000 in
in
advance
advance for
for aa one-year
one-year rental
rental contract.
contract.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue

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 $6,000 in advance for rent.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue

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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To prepare adjusting
entries to accrue unpaid
expenses.

LO5
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
End of Current Period
Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry Transaction
Transaction

Recognizes
Recognizesexpense
expense Pay
Paycash
cashin in
incurred,
incurred, and
and settlement
settlementof of

Records
Recordsliability
liabilityfor
for liability.
liability.
future
futurepayment.
payment.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
Hey, when
do we get
paid?
Examples Include:
Interest
Wages and Salaries
Property Taxes

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses

$3,000 Wages
Expense

Monday, Wednesday, Friday,

May 29 May 31 June 2

On
On May
May 31,
31, Webb
Webb Co.
Co. owes
owes wages
wages ofof $3,000.
$3,000.
Payday
Payday is
is Friday,
Friday, June
June 2.
2.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses

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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses

$5,000 Weekly Wages

$3,000 Wages $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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses

The
The liability
liability is
is extinguished
extinguished 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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Learning
Learning Objective
Objective

To prepare adjusting
entries to accrue
uncollected revenue.

LO6
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
End of Current Period
Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry Transaction
Transaction

Recognizes
Recognizesrevenue
revenue Collect
Collectcash
cash
earned
earnedbut
butnot
notyet
yet in
insettlement
settlement
recorded,
recorded, and
and of
ofreceivable.
receivable.

Records
Recordsreceivable.
receivable.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue

Examples Include:
Interest Earned
Work Completed But Not
Yet Billed to Customer

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue

$170 Interest
Revenue

Saturday, Monday, Tuesday,

Jan. 15 Jan. 31 Feb. 15
On
On Jan.
Jan. 31,
31, the
the bank
bank owes
owes Webb
Webb Co.
Co.
interest of $170. Interest is paid on the 15
interest of $170. Interest is paid on the 15th th

day
day ofof each
each month.
month.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue

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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
$320 Monthly Interest

$170 Interest $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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue

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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Accruing
Accruing Income
Income Taxes
Taxes Expense:
Expense: The
The
Final
Final Adjusting
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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Learning
Learning Objective
Objective

To explain how the

principles of realization
and matching relate to
adjusting entries.

LO7
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Adjusting
Adjusting Entries
Entries and
and Accounting
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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Learning
Learning Objective
Objective

To explain the concept

of materiality.

LO8
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 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
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Learning
Learning Objective
Objective

To prepare an adjusted
trial balance and
describe its purpose.

LO9
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Effects of the Adjusting Entries

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

Let’s
Let’s look
look at
at JJ’s
JJ’s Lawn
Lawn Care
Care
Services’
Services’ adjusted
adjusted trial
trial balance.
balance. Prepare adjusted
trial balance.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Adjusted
Adjusted Trial
Trial Balance
Balance
JJ's Lawn Care Service
Adjusted Trial Balance All balances
May 31, 2007
Cash $ 3,925 are taken from
Accounts receivable
Tools & equipment
75
2,650
the ledger
Accum. depreciation: tools & eq. $ 50 accounts on
Truck 15,000
Accum. depreciation: truck 250 May 31 after
Notes payable 13,000 preparing the
Accounts payable 150
Capital stock 8,000 two
Dividends
Sales revenue
200
750
depreciation
Gasoline expense 50 adjusting
Depreciation exp.: tools & eq. 50
Depreciation exp.: truck 250 entries.
Total $ 22,200 $ 22,200

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 End
End of
of Chapter
Chapter 44

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008