Chapter - 3

Completing accounting
cycle
 Accrual- versus Cash-Basis Accounting

Accrual-Basis Accounting
 Transactions recorded in the periods in which the events occur.
 Companies recognize revenues when they perform services rather
than when they receive cash.
 Expenses are recognized when incurred (rather than when paid).
 In accordance with International financial reporting standard (IFRS).

LO 1
 Accrual- versus Cash-Basis Accounting

Cash-Basis Accounting
 Revenues recognized when cash is received.
 Expenses recognized when cash is paid.
 Cash-basis accounting is not in accordance with international
financial reporting standard).

LO 1
 Recognizing Revenues and Expenses

REVENUE RECOGNITION PRINCIPLE

• Recognize revenue in the accounting period in which the performance
obligation is satisfied.

EXPENSE RECOGNITION PRINCIPLE

• Match expenses with revenues in the period when the company makes efforts
that generate those revenues.

LO 1
 The Need for Adjusting Entries

Adjusting Entries
 Ensure that the revenue recognition and expense recognition
principles are followed.
 Necessary because the trial balance may not contain up-to-date and
complete data.
 Required every time a company prepares financial statements.
 Will include one income statement account and one balance sheet
account.

LO 1
Types of Adjusting Entries
Categories of adjusting entries

Deferrals Accruals

1. Prepaid Expenses. Expenses 1. Accrued Revenues.

paid in cash before they are Revenues for services
used or consumed. performed but not yet received
in cash or recorded.

2. Unearned Revenues. 2. Accrued Expenses.

Cash received before services Expenses incurred but not yet
are performed. paid in cash or recorded.

LO 1
 Prepare adjusting entries for deferrals.

• Deferrals are expenses or revenues that are recognized at a date later

than the point when cash was originally exchanged.

• There are two types:

 Prepaid expenses
 Unearned revenues

LO 2
 a. Prepaid Expenses

• Payment of cash, that is recorded as an asset to show the service or

benefit the company will receive in the future.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

 insurance  rent
 supplies  equipment
 advertising  buildings

LO 2
 Prepaid Expenses cont..

 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.

LO 2
 b. Unearned Revenues

• Receipt of cash that is recorded as a liability because the service has not been
performed.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

 Rent  Magazine subscriptions
 Airline tickets  Customer deposits

LO 2
 Unearned Revenues cont...

 Adjusting entry is made to record the revenue for services performed during
the period and to show the liability that remains at the end of the period.

 Results in a decrease (debit) to a liability account and an increase (credit)

to a revenue account.

LO 2
 Prepare adjusting entries for accruals

Accruals are made to record

 Revenues for services performed but not yet recorded at the statement date.
 Expenses incurred but not yet paid or recorded at the statement date.

LO 3
 a. Accrued Revenues

• Revenues for services performed but not yet received in cash or recorded.

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

 Rent
 Interest
 Services

LO 3
 Accrued Revenues cont..

 Adjusting entry shows the receivable that exists and records the revenues
for services performed.
 Adjusting entry:
► Increases (debits) an asset account and
► Increases (credits) a revenue account.

LO 3
b. Accrued Expenses

Expenses incurred but not yet paid in cash or recorded.

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

 Rent  Taxes
 Interest  Salaries

LO 3
 Accrued Expenses cont...

 Adjusting entry records the obligation and recognizes the expense.

 Adjusting entry:
► Increase (debit) an expense account and
► Increase (credit) a liability account.

LO 3
Summary of Basic Relationships

LO 3
 Prepare a worksheet

Worksheet
 Multiple-column form used in preparing financial
statements.
 Not a permanent accounting record.
 May be a computerized worksheet using an electronic
spreadsheet program such as Excel.
 Prepared using a five step process.
 Use of worksheet is optional.

LO 1
Steps in Preparing a Worksheet
Preparing Financial Statements from a Worksheet

 Income statement is prepared from the income statement

columns.
 Balance sheet and owner’s equity statement are
prepared from the balance sheet columns.
 Companies can prepare financial statements before they
journalize and post adjusting entries.

LO 1
Preparing Adjusting Entries from a Worksheet

 Adjusting entries are prepared from the adjustments

columns of the worksheet.
 Journalizing and posting of adjusting entries follows the
preparation of financial statements when a worksheet is
used.

LO 1
 Prepare closing entries and a post-closing trial balance.

At the end of the accounting period, the company makes the accounts ready for
the next period.

LO 2
 Preparing Closing Entries

Closing entries formally recognize in the ledger the transfer of

 net income (or net loss) and
 owner’s drawings to owner’s capital.

Companies generally journalize and post closing entries only at the end of the annual
accounting period.
Closing entries produce a zero balance in each temporary account.

LO 2
Preparing Closing Entries

Illustration 4-9
Diagram of closing
process—proprietorship

Owner’s Capital is a
permanent account. All
other accounts are
temporary accounts.

LO 2
 Preparing Closing Entries

CLOSING
ENTRIES
ILLUSTRATED

Illustration 4-10
Closing entries
journalized
 Posting
Closing
Entries

Illustration 4-11

LO 2
Preparing a Post-Closing Trial Balance

Purpose is to prove the equality of the permanent account balances

carried forward into the next accounting period. Illustration 4-12
Post-closing trial balance

LO 2
LEARNING Explain the steps in the accounting cycle
6
OBJECTIVE and how to prepare correcting entries.

Illustration 4-15
1.
1. Analyze
Analyze business
business transactions
transactions

9.
9. Prepare
Prepare aa post-closing
post-closing 2.
2. Journalize
Journalize the
the
trial
trial balance
balance transactions
transactions

8.
8. Journalize
Journalize and
and post
post 3.
3. Post
Post to
to ledger
ledger accounts
accounts
closing
closing entries
entries

7.
7. Prepare
Prepare financial
financial 4.
4. Prepare
Prepare aa trial
trial balance
balance
statements
statements

6.
6. Prepare
Prepare an
an adjusted
adjusted trial
trial 5.
5. Journalize
Journalize and
and post
post
balance
balance adjusting
adjusting entries
entries

LO 3