1. Chapter THE ACCOUNTING
4 CYCLE:
Accruals and Deferrals
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

2. 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., 2002

3. Adjusting Entries
Adjusting 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., 2002

4. Types of Adjusting Entries
Types of Adjusting Entries
Converting
Converting Converting
Converting
assets to
assets to liabilities to
liabilities to
expenses
expenses revenue
revenue
Accruing
Accruing Accruing
Accruing
unpaid
unpaid uncollected
uncollected
expenses
expenses revenues
revenues
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

5. Converting Assets to Expenses
Converting Assets to Expenses
End of Current Period
Prior Periods Current Period Future Periods
Transaction
Transaction Adjusting Entry
Adjusting Entry
Paid future
Paid future Recognize portion
Recognize portion
expenses in
expenses in of asset consumed
of asset consumed
advance
advance
(creates an
(creates an as expense, and
as expense, and
asset).
asset). Reduce balance of
Reduce balance of
McGraw-Hill/Irwin
asset account. Companies, Inc., 2002
asset account.
© The McGraw-Hill

6. Converting Assets to Expenses
Converting Assets to Expenses
Examples Include:
Depreciation
Supplies
Expiring Insurance Policies
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

7. Converting Assets to Expenses
Converting Assets to Expenses
$2,400 Insurance Policy
Coverage for 12 Months
$200 Monthly Insurance Expense
Jan. 1 Dec. 31
On January 1, Webb Co. purchased a one-
On January 1, Webb Co. purchased a one-
year insurance policy for $2,400.
year insurance policy for $2,400.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

8. Converting Assets to Expenses
Converting Assets to Expenses
Initially, costs that benefit more than one
Initially, costs that benefit more than one
accounting period are recorded as assets.
accounting period are recorded as 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., 2002

9. Converting Assets to Expenses
Converting Assets to Expenses
The costs are expensed as they are used to
The costs are expensed as they are used to
generate revenue.
generate 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., 2002

10. Converting Assets to Expenses
Converting Assets to Expenses
Balance Sheet
Balance Sheet Income Statement
Income Statement
Cost of assets
Cost of assets Cost of assets
Cost of assets
that benefit
that benefit used this period to
used this period to
future periods.
future periods. generate revenue.
generate 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., 2002

11. The Concept of Depreciation
The Concept of Depreciation
Depreciable assets are physical objects
Depreciable assets are physical objects
that retain their size and shape but lose
that retain their size and shape but lose
their economic usefulness over time.
their economic usefulness over time.
Depreciation is the systematic allocation
Depreciation is the systematic allocation
of the cost of a depreciable asset to
of the cost of a depreciable asset to
expense.
expense.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

12. The Concept of Depreciation
The Concept of Depreciation
The portion of an asset’s utility that is used
The portion of an asset’s utility that is used
up must be expensed in the period used.
up must be expensed in the period 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)
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

13. Depreciation Is Only an Estimate
Depreciation Is Only an Estimate
On May 2, 2003, 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., 2002

14. Depreciation Is Only an Estimate
Depreciation Is Only an Estimate
JJ’s Lawn Care Service would make the
JJ’s Lawn Care Service would make the
following adjusting entry.
following adjusting 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
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

15. Depreciation Is Only an Estimate
Depreciation Is Only an Estimate
JJ’s $15,000 truck is depreciated over 60
JJ’s $15,000 truck is depreciated over 60
months as follows:
months as 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 months = $250 perMcGraw-Hill Companies, Inc., 2002
$15,000 ÷ 60 months = $250 per month
© The month
McGraw-Hill/Irwin

16. Accumulated depreciation would
Accumulated depreciation would
appear on the balance sheet as
appear on the balance sheet as
follows:
follows:
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

17. Converting Liabilities to Revenue
Converting Liabilities to Revenue
End of Current Period
Prior Periods Current Period Future Periods
Transaction
Transaction Adjusting Entry
Adjusting Entry
Collected
Collected  Recognize portion
 Recognize portion
from
from earned as revenue,
earned as revenue,
customers in
customers in and
and
advance
advance  Reduce balance of
 Reduce balance of
(creates a
(creates a liability account.
liability account.
liability).
liability).
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

18. Converting Liabilities to Revenue
Converting Liabilities to Revenue
Examples Include:
Airline Ticket Sales
Sports Teams’ Sales of
Season Tickets
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

19. Converting Liabilities to Revenue
Converting Liabilities to Revenue
$6,000 Rental Contract
Coverage for 12 Months
$500 Monthly Rental Revenue
Jan. 1 Dec. 31
On January 1, Webb Co. received $6,000 in
On January 1, Webb Co. received $6,000 in
advance for a one-year rental contract.
advance for a one-year rental contract.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

20. Converting Liabilities to Revenue
Converting Liabilities to Revenue
Initially, revenues that benefit more than one
Initially, revenues that benefit more than one
accounting period are recorded as liabilities.
accounting period are recorded as 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., 2002

21. Converting Liabilities to Revenue
Converting Liabilities to Revenue
Over time, the revenue is recognized as it is
Over time, the revenue is recognized as it 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., 2002

22. Converting Liabilities to Revenue
Converting Liabilities to Revenue
Balance Sheet
Balance Sheet Income Statement
Income Statement
Liability for
Liability for Revenue earned
Revenue earned
future periods.
future periods. this period.
this 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., 2002

23. Accruing Unpaid Expenses
Accruing Unpaid Expenses
End of Current Period
Prior Periods Current Period Future Periods
Adjusting Entry
Adjusting Entry Transaction
Transaction
 Recognize expense
 Recognize expense Liability will
Liability will
incurred, and
incurred, and be paid.
be paid.
 Record liability for
 Record liability for
future payment.
future payment.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

24. Accruing Unpaid Expenses
Accruing Unpaid Expenses
Hey, when
do we get
paid?
Examples Include:
Interest
Wages and Salaries
Property Taxes
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

25. Accruing Unpaid Expenses
Accruing Unpaid Expenses
$3,000 Wages
Expense
Monday, Wednesday, Friday,
May 29 May 31 June 2
On May 31, Webb Co. owes wages of
On May 31, Webb Co. owes wages of
$3,000. Pay day is Friday, June 2.
$3,000. Pay day is Friday, June 2.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

26. Accruing Unpaid Expenses
Accruing Unpaid Expenses
Initially, an expense and a liability are
Initially, an expense and a liability 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., 2002

27. Accruing Unpaid Expenses
Accruing Unpaid Expenses
Balance Sheet
Balance Sheet Income Statement
Income Statement
Liability to be
Liability to be Cost incurred this
Cost incurred this
paid in a future
paid in a future period to generate
period to 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., 2002

28. Accruing Unpaid Expenses
Accruing Unpaid Expenses
$5,000 Weekly Wages
$3,000 Wages $2,000 Wages
Expense Expense
Monday, Wednesday, Friday,
May 29 May 31 June 2
Let’s look at the entry for June 2.
Let’s look at the entry for June 2.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

29. Accruing Unpaid Expenses
Accruing Unpaid Expenses
The liability is extinguished when the debt is
The liability is extinguished when the debt 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., 2002

30. Accruing Uncollected Revenue
Accruing Uncollected Revenue
End of Current Period
Prior Periods Current Period Future Periods
Adjusting Entry
Adjusting Entry Transaction
Transaction
Recognize revenue
Recognize revenue Receivable
Receivable
earned but not yet
earned but not yet will be
will be
recorded, and
recorded, and collected.
collected.
Record receivable.
Record receivable.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

31. Accruing Uncollected Revenue
Accruing Uncollected Revenue
Examples Include:
Interest Earned
Work Completed But Not
Yet Billed to Customer
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

32. Accruing Uncollected Revenue
Accruing Uncollected Revenue
$170 Interest
Revenue
Saturday, Monday, Tuesday,
Jan. 15 Jan. 31 Feb. 15
On Jan. 31, the bank owes Webb Co.
On Jan. 31, the bank owes Webb Co.
interest of $170. Interest is paid on the 15 th
interest of $170. Interest is paid on the 15 th
day of each month.
day of each month.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

33. Accruing Uncollected Revenue
Accruing Uncollected Revenue
Initially, the revenue is recognized and a
Initially, the revenue is recognized and a
receivable is created.
receivable is 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., 2002

34. Accruing Uncollected Revenue
Accruing Uncollected Revenue
Balance Sheet
Balance Sheet
Income Statement
Income Statement
Receivable to
Receivable to
be collected in a
be collected in a Revenue earned
Revenue earned
future period.
future period. this period.
this period.
Interest Receivable Interest Revenue
1/31 170 1/31 170
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

35. Accruing Uncollected Revenue
Accruing Uncollected Revenue
$320 Monthly Interest
$170 Interest $150 Interest
Revenue Revenue
Saturday, Monday, Tuesday,
Jan. 15 Jan. 31 Feb. 15
Let’s look at the entry for February 15.
Let’s look at the entry for February 15.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

36. Accruing Uncollected Revenue
Accruing Uncollected Revenue
The receivable is collected in a future period.
The receivable is collected in a future 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., 2002

37. Accruing Income Taxes Expense: The
Accruing Income Taxes Expense: The
Final Adjusting Entry
Final Adjusting Entry
As a corporation earns taxable income, it
As a corporation earns taxable income, it
incurs income taxes expense, and also a
incurs income taxes expense, and also a
liability to governmental tax authorities.
liability to governmental tax 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., 2002

38. Adjusting Entries and Accounting
Adjusting Entries and Accounting
Principles
Principles
Costs are matched with revenue
Costs are matched with revenue
in two ways:
in two ways:
 Direct association of costs
 Direct association of costs
with specific revenue
with specific revenue
transactions.
transactions.
 Systematic allocation of costs
 Systematic allocation of costs
over the “useful life” of the
over the “useful life” of the
expenditure.
expenditure.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

39. The Concept of Materiality
The Concept of Materiality
An item is “material” if knowledge of the
An item is “material” if knowledge of the
item might reasonably influence the
item might reasonably influence the
decisions of users of financial statements.
decisions of users of financial statements.
Many companies
immediately charge
the cost of Lightbulbs
immaterial items to
expense.
Supplies
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

40. Effects of the Adjusting Entries
Make end-of-
Journalize year
Post entries to Prepare trial
transactions. adjustments.
the ledger balance.
accounts.
Recall from the accounting cycle
Recall from the accounting cycle
discussed in Chapter 3, that after
discussed in Chapter 3, that after
the adjusting entries are made, an
the adjusting entries are made, an
Prepare adjusted
adjusted trial balance is prepared.
adjusted trial balance is prepared. trial balance.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

41. End of Chapter 4
End of Chapter 4
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002