Chapter

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THE ACCOUNTING
CYCLE:
Accruals and Deferrals

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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.

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Adjusting
Adjusting Entries
Entries
Adjusting
entries are
needed whenever
revenue or expenses
affect more than one
accounting
period.

McGraw-Hill/Irwin

Every
adjusting
entry involves a
change in either a
revenue or expense
and an asset
or liability.

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Types
Types of
of Adjusting
Adjusting Entries
Entries

Converting
Converting
assets
assets to
to
expenses
expenses

Converting
Converting
liabilities
liabilities to
to
revenue
revenue

Accruing
Accruing
unpaid
unpaid
expenses
expenses

Accruing
Accruing
uncollected
uncollected
revenues
revenues

McGraw-Hill/Irwin

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Converting
Converting Assets
Assets to
to Expenses
Expenses
End of Current Period
Prior Periods

Transaction
Transaction
Paid
Paidfuture
future
expenses
expensesin
in
advance
advance
(creates
(createsan
an
asset).
asset).
McGraw-Hill/Irwin

Current Period

Future Periods

Adjusting
AdjustingEntry
Entry

Recognize
Recognize portion
portion
of
ofasset
assetconsumed
consumed

as
as expense,
expense, and
and

Reduce
Reducebalance
balanceof
of
asset
The McGraw-Hill Companies, Inc.
asset account.
account.

Converting
Converting Assets
Assets to
to Expenses
Expenses

Examples Include:
Depreciation
Supplies
Expiring Insurance Policies

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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 oneoneyear
year insurance
insurance policy
policy for
for $2,400.
$2,400.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

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
Date
Jan.

Account Titles and Explanation

1 Unexpired Insurance
Cash

P
R Debit

Credit

2,400
2,400

Purchase a one-year insurance policy.

McGraw-Hill/Irwin

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Converting
Converting Assets
Assets to
to Expenses
Expenses
The
The costs
costs are
are expensed
expensed as
as they
they are
are used
used to
to
generate
generate revenue.
revenue.
GENERAL JOURNAL
Date

Account Titles and Explanation

P
R Debit

Credit

Monthly Adjusting Entry for Insurance

Jan. 31 Insurance Expense
Unexpired Insurance

200
200

Insurance expense for January.

McGraw-Hill/Irwin

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Converting
Converting Assets
Assets to
to Expenses
Expenses
Balance
Balance Sheet
Sheet

Income
Income Statement
Statement

Cost
Cost of
of assets
assets
that
that benefit
benefit
future
future periods.
periods.

Cost
Cost of
of assets
assets
used
used this
this period
period to
to
generate
generate revenue.
revenue.

Unexpired Insurance
1/1 2,400 1/31
200
Bal. 2,200
McGraw-Hill/Irwin

Insurance Expense
1/31
200

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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 is
is 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.

The
The Concept
Concept of
of Depreciation
Depreciation
The
The portion
portion of
of an
an assets
assets utility
utility that
that is
is used
used
up
up must
must be
be expensed
expensed in
in the
the period
period used.
used.
Fixed
Fixed
Asset
Asset
(debit)
(debit)
On date
when initial
payment is
made . . .
Cash
Cash
(credit)
(credit)
McGraw-Hill/Irwin

The assets
usefulness is
partially
consumed
during the
period.

Accumulated
Accumulated
Depreciation
Depreciation
(credit)
(credit)

At end of
period . . .
Depreciation
Depreciation
Expense
Expense
(debit)
(debit)

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Depreciation
Depreciation Is
Is Only
Only an
an Estimate
Estimate
On May 2, 2003, JJs 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
McGraw-Hill/Irwin

50

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Depreciation
Depreciation Is
Is Only
Only an
an Estimate
Estimate
JJs
JJs Lawn
Lawn Care
Care Service
Service would
would make
make the
the
following
following adjusting
adjusting entry.
entry.
GENERAL JOURNAL
Date

P
RDebit

Account Titles and Explanation

May 31 Depreciation Expense: Tools & Eq.

Credit

50

Accumulated Depreciation: Tools & Eq.

50

To record one month's depreciation.

Contra-asset
Contra-asset

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Depreciation
Depreciation Is
Is Only
Only an
an Estimate
Estimate
JJs
JJs $15,000
$15,000 truck
truck is
is depreciated
depreciated over
over 60
60
months
months as
as follows:
follows:
GENERAL JOURNAL
Date

Account Titles and Explanation

May 31 Depreciation Expense: Truck

Accumulated Depreciation: Truck

P
R Debit

Credit

250
250

To record one month's depreciation.

$15,00060
months
== $250
per
month
$15,00060
months
$250
per
monthCompanies, Inc.

The
McGraw-Hill
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.

Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue
End of Current Period
Prior Periods

Transaction
Transaction
Collected
Collected
from
from
customers
customers in
in
advance
advance
(creates
(createsaa
liability).
liability).
McGraw-Hill/Irwin

Current Period

Future Periods

Adjusting
AdjustingEntry
Entry

Recognize
Recognizeportion
portion
earned
earned as
asrevenue,
revenue,
and
and

Reduce
Reducebalance
balanceof
of
liability
liabilityaccount.
account.

The McGraw-Hill Companies, Inc.

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.

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.

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
Date
Jan.

Account Titles and Explanation

1 Cash
Unearned Rental Revenue

P
R Debit

Credit

6,000
6,000

Collected $6,000 in advance for rent.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

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
Date

Account Titles and Explanation

P
R Debit

Credit

Monthly Adjusting Entry for Rent Revenue

Jan. 31 Unearned Rental Revenue
Rental Revenue

500
500

Rental revenue for January.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue
Balance
Balance Sheet
Sheet

Income
Income Statement
Statement

Liability
Liability for
for
future
future periods.
periods.

Revenue
Revenue earned
earned
this
this period.
period.

Unearned Rental Revenue

1/31

500

McGraw-Hill/Irwin

1/1 6,000
Bal. 5,500

Rental Revenue
1/31
500

The McGraw-Hill Companies, Inc.

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

Current Period

Adjusting
Adjusting Entry
Entry

Recognize
Recognizeexpense
expense
incurred,
incurred,and
and

Record
Record liability
liabilityfor
for
future
futurepayment.
payment.
McGraw-Hill/Irwin

Future Periods

Transaction
Transaction
Liability
Liabilitywill
will
be
bepaid.
paid.

The McGraw-Hill Companies, Inc.

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.

Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
$3,000 Wages
Expense

Monday,
May 29

Wednesday,
May 31

Friday,
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.

Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
Initially,
Initially, an
an expense
expense and
and aa liability
liability are
are
recorded.
recorded.
GENERAL JOURNAL
Date

Account Titles and Explanation

May 31 Wages Expense

Wages Payable

P
R Debit

Credit

3,000
3,000

To accrue wages owed to employees.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
Balance
Balance Sheet
Sheet

Income
Income Statement
Statement

Liability
Liability to
to be
be
paid
paid in
in aa future
future
period.
period.

Cost
Cost incurred
incurred this
this
period
period to
to generate
generate
revenue.
revenue.

Wages Payable
5/31 3,000

McGraw-Hill/Irwin

Wages Expense
5/31 3,000

The McGraw-Hill Companies, Inc.

Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
$5,000 Weekly Wages
$3,000 Wages
Expense

Monday,
May 29

$2,000 Wages
Expense

Wednesday,
May 31

Friday,
June 2

Lets
Lets look
look at
at the
the entry
entry for
for June
June 2.
2.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

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
Date

Account Titles and Explanation

June 2 Wages Expense (for June)

Wages Payable (accrued in May)
Cash

P
R Debit

Credit

2,000
3,000
5,000

Weekly payroll for May 29-June 2.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

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

Current Period

Adjusting
Adjusting Entry
Entry

Recognize
Recognizerevenue
revenue
earned
earned but
butnot
notyet
yet
recorded,
recorded,and
and

Record
Record receivable.
receivable.
McGraw-Hill/Irwin

Future Periods

Transaction
Transaction
Receivable
Receivable
will
willbe
be
collected.
collected.

The McGraw-Hill Companies, Inc.

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.

Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
$170 Interest
Revenue

Saturday,
Jan. 15

Monday,
Jan. 31

Tuesday,
Feb. 15

On
On Jan.
Jan. 31,
31, the
the bank
bank owes
owes Webb
Webb Co.
Co.
th
interest
of
$170.
Interest
is
paid
on
the
15
interest of $170. Interest is paid on the 15 th
day
day of
of each
each month.
month.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
Initially,
Initially, the
the revenue
revenue is
is recognized
recognized and
and aa
receivable
receivable is
is created.
created.
GENERAL JOURNAL
Date

Account Titles and Explanation

Jan. 31 Interest Receivable

Interest Revenue

P
R Debit

Credit

170
170

To recognize interest revenue.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
Balance
Balance Sheet
Sheet
Receivable
Receivable to
to
be
be collected
collected in
in aa
future
future period.
period.
Interest Receivable
1/31
170

McGraw-Hill/Irwin

Income
Income Statement
Statement
Revenue
Revenue earned
earned
this
this period.
period.

Interest Revenue
1/31
170

The McGraw-Hill Companies, Inc.

Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
$320 Monthly Interest
$170 Interest
Revenue

Saturday,
Jan. 15

$150 Interest
Revenue

Monday,
Jan. 31

Tuesday,
Feb. 15

Lets
Lets look
look at
at the
the entry
entry for
for February
February 15.
15.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
The
The receivable
receivable is
is collected
collected in
in aa future
future period.
period.

GENERAL JOURNAL
Date

P
R Debit

Account Titles and Explanation

Feb. 15 Cash

Credit

320

Interest Revenue (for February)

150

Interest Receivable (accrued Jan. 31)

170

To record interest received.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

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
Date

Account Titles and Explanation

Dec. 31 Income Taxes Expense

Income Taxes Payable

P
R Debit

Credit

780
780

Estimated income taxes applicable to

taxable income earned in December.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

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.

The
The Concept
Concept of
of Materiality
Materiality
An
An item
item is
is material
material ifif knowledge
knowledge of
of 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
immaterial items to
expense.
McGraw-Hill/Irwin

Lightbulbs
Supplies

The McGraw-Hill Companies, Inc.

Effects of the Adjusting Entries

Journalize
transactions.

Post entries to
the ledger
accounts.

Make end-ofyear
adjustments.

Prepare trial
balance.

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, an
an
adjusted
adjusted trial
trial balance
balance is
is prepared.
prepared.
McGraw-Hill/Irwin

Prepare adjusted
trial balance.

The McGraw-Hill Companies, Inc.

End
End of
of Chapter
Chapter 44

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.