Accrual Accounting Concepts
FOR INSTRUCTOR USE ONLY
CHAPTER LEARNING OBJECTIVES
1. Explain the accrual basis of accounting and the reasons for adjusting entries. The reve-
nue recognition principle dictates that companies recognize revenue when a performance
obligation has been satisfied. The expense recognition principle dictates that companies rec-
ognize expenses in the period when the company makes efforts to generate those revenues.
Under the cash basis, companies record events only in the periods in which the company re-
ceives or pays cash. Accrual-based accounting means that companies record in the periods in
which the events occur, events that change a company's financial statements even if cash has
not been exchanged.
Companies make adjusting entries at the end of an accounting period. These entries ensure
that companies record revenues in the period in which the performance obligation is satisfied
and that companies recognize expenses in the period in which they are incurred. The major
types of adjusting entries are prepaid expenses, unearned revenues, accrued revenues, and
2. Prepare adjusting entries for deferrals. Deferrals are either prepaid expenses or unearned
revenues. Companies make adjusting entries for deferrals at the statement date to record the
portion of the deferred item that represents the expense incurred or the revenue for services
performed in the current accounting period.
3. Prepare adjusting entries for accruals. Accruals are either accrued revenues or accrued
expenses. Adjusting entries for accruals record revenues earned and expenses incurred in the
current accounting period that have not been recognized through daily entries.
4. Prepare an adjusted trial balance and closing entries. An adjusted trial balance is a trial
balance that shows the balances of all accounts, including those that have been adjusted, at
the end of an accounting period. The purpose of an adjusted trial balance is to show the effects
of all financial events that have occurred during the accounting period.
One purpose of closing entries is to transfer net income or net loss for the period to Retained
Earnings. A second purpose is to “zero-out” all temporary accounts (revenue accounts, ex-
pense accounts, and Dividends) so that they start each new period with a zero balance. To
accomplish this, companies “close” all temporary accounts at the end of an accounting period.
They make separate entries to close revenues and expenses to Income Summary, Income
Summary to Retained Earnings, and Dividends to Retained Earnings. Only temporary accounts
The required steps in the accounting cycle are (a) analyze business transactions, (b) journalize
the transactions, (c) post to ledger accounts, (d) prepare a trial balance, (e) journalize and post
adjusting entries, (f) prepare an adjusted trial balance, (g) prepare financial statements, (h)
journalize and post-closing entries, and (i) prepare a post-closing trial balance.