4-1

Chapter
THE ACCOUNTING
4 CYCLE: ACCRUALS
AND DEFERRALS

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 At the end of the 4-2

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

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 4-3

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., 2005

 4-4

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 revenues
revenues

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 4-5

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
Recognizes
advance
advanceof of portion
portion
incurring
incurring of
ofasset
assetconsumed
consumed
expense
expense
(creates
(createsan an as
asexpense,
expense,and and
asset).
asset).
McGraw-Hill/Irwin

Reduces
Reduces balance
balance
© The McGraw-Hill Companies, Inc., 2005
 4-6

Converting
Converting Assets
Assets to
to Expenses
Expenses

Examples Include:
Depreciation
Supplies
Expiring Insurance Policies

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 4-7

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., 2005
 4-8

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., 2005

 4-9

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., 2005
 4-10

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

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 4-11

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., 2005
 4-12

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., 2005
 4-13

Depreciation
Depreciation Is
Is Only
Only an
an Estimate
Estimate
On May 2, 2005, 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 © The McGraw-Hill Companies, Inc., 2005
McGraw-Hill/Irwin
 4-14

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., 2005
 4-15

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., 2005
McGraw-Hill/Irwin
 4-16

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., 2005

 4-17

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
Recognizes
in
inadvance
advanceof of portion
portion
earning
earning earned
earnedas asrevenue,
revenue,
revenue
revenue and
and
(creates
(createsaa 
Reduces
Reducesbalancebalance
liability).
liability). of
of
McGraw-Hill/Irwin liability
liability account.
account.
© The McGraw-Hill Companies, Inc., 2005
 4-18

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., 2005

 4-19

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., 2005
 4-20

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., 2005

 4-21

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., 2005
 4-22

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., 2005

 4-23

Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
End of Current Period
Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry Transaction
Transaction

Recognizes
Recognizes Pay
Paycash
cashin in
expense
expense settlement
settlementof of
incurred,
incurred,and
and liability.
liability.

Records
Recordsliability
liabilityfor
for
future
futurepayment.
payment.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 4-24

Accruing
Accruing Unpaid
Unpaid Expenses
Expenses

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

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 4-25

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 of
of $3,000.
$3,000.
Pay
Pay day
day is
is Friday,
Friday, June
June 2.
2.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 4-26

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., 2005

 4-27

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., 2005

 4-28

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., 2005
 4-29

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., 2005
 4-30

Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
End of Current Period
Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry Transaction
Transaction
Recognizes
Recognizes Collect
Collectcash
cash
revenue
revenue in
insettlement
settlement
earned
earned but
butnot
notyet
yet of
of receivable.
receivable.
recorded,
recorded,and
and
Records
Recordsreceivable.
receivable.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 4-31

Accruing
Accruing Uncollected
Uncollected Revenue
Revenue

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

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 4-32

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., 2005
 4-33

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., 2005

 4-34

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., 2005

 4-35

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., 2005
 4-36

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.
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 4-37

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., 2005

 4-38

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 of
of costs
costs
over
over the
the “useful
“useful life”
life” of
of the
the
expenditure.
expenditure.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 4-39

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., 2005
 Effects of the Adjusting Entries
4-40

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., 2005
 4-41

Adjusted
Adjusted Trial
Trial Balance
Balance
JJ's Lawn Care Service
Adjusted Trial Balance All balances
May 31, 2005
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., 2005

 4-42

Exercise
Exercise 4.7
4.7
Sweeney & Associates, a large marketing firm, adjusts its accounts at the end of each
month. The following information is available for the year ending December 31, 2011:
1. A bank loan had been obtained on December 1. Accrued interest on the loan at
December 31 amounts to $1,200. No interest expense has yet been recorded.
2. Depreciation of the firm’s office building is based on an estimated life of 25 years. The
building was purchased in 2007 for $330,000.
3. Accrued, but unbilled, revenue during December amounts to $64,000.
4. On March 1, the firm paid $1,800 to renew a 12-month insurance policy. The entire
amount was recorded as Prepaid Insurance.
5. The firm received $14,000 from King Biscuit Company in advance of developing a six-
month marketing campaign. The entire amount was initially recorded as Unearned
Revenue. At December 31, $3,500 had actually been earned by the firm.
6. The company’s policy is to pay its employees every Friday. Since December 31 fell on
a
Wednesday, there was an accrued liability for salaries amounting to $2,400.
a. Record the necessary adjusting journal entries on December 31, 2011.
b. By how much did Sweeney & Associates’s net income increase or decrease as a result
of the adjusting entries performed in part a? (Ignore income taxes.)
© The McGraw-Hill Companies, Inc., 2005
McGraw-Hill/Irwin
 4-43

Exercise
Exercise 4.9
4.9
For each of the following items, provide the journal entry (if one is needed) to record the
initial transaction and provide the adjusting entry, if any, required on May 31, the end of
the fiscal year.

a. On May 1, borrowed $300,000 cash from National Bank by issuing a 12% note
payable due in three months.
b. On May 1, paid rent for six months beginning May 1 at $30,000 per month.
c. On May 2, sold season tickets for a total of $910,000 cash. The season includes 70
racing days: 20 in May, 25 in June, and 25 in July.
d. On May 4, an agreement was reached with Snack-Bars, Inc., allowing that company to
sell refreshments at the track in return for 10 percent of the gross receipts from
refreshment sales.
e. On May 6, schedules for 20 racing days in May and first 10 racing days in June were
printed and paid for at a cost of $12,000.
f. On May 31, Snack-Bars, Inc. reported that gross receipts from refreshment sales in
May had been $165,000 and that 10% owed to Glenwood Speedway would be remitted
on June 10.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 4-44

Problem
Problem 4.3
4.3
Gunflint Adventures operates an airplane service that takes fishing parties to a remote lake resort in
northern Manitoba, Canada. Individuals must purchase their tickets at least one month in advance
during the busy summer season. The company adjusts its accounts only once each month. Selected
balances appearing in the company’s June 30 adjusted trial balance appear as follows:
Debit Credit
Prepaid airport rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,200
Unexpired insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,500
Airplane . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240,000
Accumulated depreciation: airplane . . . . . . . . . . . . . . . . . . . . . . . . . . . . $36,000
Unearned passenger revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90,000
Other Information
1. The airplane is being depreciated over a 20-year life with no residual value.
2. Unearned passenger revenue represents advance ticket sales for bookings in July and August at $300 per ticket.
3. Six months’ airport rent had been prepaid on May 1.
4. The unexpired insurance is what remains of a 12-month policy purchased on February 1.
5. Passenger revenue earned in June totaled $75,000.
Instructions
a. Determine the following: 1. The age of the airplane in months. 2. The monthly airport rent expense.
3. The amount paid for the 12-month insurance policy on February 1.
b. Prepare the adjusting entries made on June 30 involving the following accounts:
1. Depreciation Expense: Airplane 2. Airport Rent Expense 3. Insurance Expense 4. Passenger Revenue Earned

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 4-45

End
End of
of Chapter
Chapter 44

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005