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VISUAL #3-1
ACCRUAL BASIS ACCOUNTING
(Follows GAAP)
requires that the
Income Statement
(for a period)
report
ALL REVENUES EARNED in period (Collected or Not)
Minus ALL EXPENSES INCURRED in period (Paid or Not)
Equals Net Income or Net Loss for the period
ACCOUNTS MUST BE ADJUSTED TO FOLLOW PRINCIPLES
3-1
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
GAAP
Revenue
Recognition
GAAP
Periodicity
GAAP
Expense
Recognition
(or Matching)
GAAP
Expense
Recognition
or Matching
VISUAL #3-2
DEFERRALS
The converse of statements in Visual #3-1 also applies.
Revenue not earned or expense not incurred results in Deferrals*
UNEARNED = LIABILITY *
A REVENUE not earned cannot be shown, even if collected.
An EXPENSE not incurred cannot be shown, even if paid.
PREPAID = ASSET *
*We defer or postpone the reporting of the collected revenues
(as revenues) and prepaid expenses (as expenses) until the
revenue is earned and the expense is incurred.
VISUAL #3-3
ADJUSTMENTS
TYPE GENERALIZED*
ENTRY AMOUNT
1A. Prepaid (deferred)
expenses—initially recorded as
assets
Dr. _________ Expense
Cr. the Asset* acct.
Amount used, or
consumed, or expired
1B. Prepaid (deferred)
expenses—that are depreciable
(plant assets)
Dr. Depreciation Expense
Cr. Accumulated
Depreciation
Portion of cost
allocated to this period
as depreciation
1C. Prepaid (deferred)
expenses—initially recorded as
expenses (alternate treatment—
appendix)
Dr. the Asset** acct.
Cr. ________ Expense
Amount left, or
not consumed, or
unexpired
2A. Unearned revenues—
(revenue received in advance)
initially record as liability
Dr. Unearned ________
Cr. the Revenue** acct. Amount earned to date
3-2
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
(unearned account)
2B. Unearned revenues—
(revenue received in advance)
initially recorded as a revenue
(alternate treatment—
appendix)
Dr. the Revenue** acct.
Cr. Unearned________
Amount still not
earned
3. Accrued expenses—
(expenses incurred but not yet
recorded)
Dr. _________ Expense
Cr. _________ Payable
Amount accrued
4. Accrued revenues
(revenues earned but not
yet recorded)
Dr. ________ Receivable
Cr. the Revenue** acct.
Amount accrued
*Note: (1) Each adjustment affects a Balance Sheet Account and an Income
Statement Account and (2) CASH NEVER appears in an adjustment.
**Title or account name varies.
3-3
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Alternate Demonstration Problem
Chapter Three
On July 1, 2013, Howard M. Tenant, Inc., rents office space from John Q.
Landlord for two years, starting immediately, at a rate of $100 per month, or
$2,400 in total. The full $2,400 was paid on this date. Record the original
transaction and the appropriate adjusting entries in 2013, 2014, and 2015
from the point of view of Tenant and Landlord.
Solution: Alternate Demonstration Problem
Chapter 3
Tenant Landlord
7/1/13
Prepaid Rent................ 2,400 Cash............................. 2,400
Cash 2,400 Unearned Rent
Rev...................... 2,400
12/31/13
Rent Expense.............. 600 Unearned Rent Rev. 600
Prepaid Rent........ 600 Rent Revenue 600
12/31/14
Rent Expense.............. 1,200 Unearned Rent Rev. 1,200
*Prepaid Rent....... 1,200 Rent Revenue 1,200
12/31/15
*Rent Expense............. 600 Unearned Rent Rev. 600
Prepaid Rent........ 600 Rent Revenue 600
An Alternative Solution (Based on the Appendix)
Tenant Landlord
7/1/13
Rent Expense.............. 2,400 Cash............................. 2,400
Cash...................... 2,400 Rent Rev............... 2,400
12/31/13
Prepaid Rent ............... 1,800 Rent Rev. 1,800
Rent Expense....... 1,800 Unearned Rent
Revenue............. 1,800
*12/31/14
Rent Expense.............. 1,200 Unearned Rent Rev. 1,200
Prepaid Rent........ 1,200 Rent Revenue 1,200
*12/31/15
Rent Expense.............. 600 Unearned Rent Rev. 600
Prepaid Rent........ 600 Rent Revenue 600
3-4
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
*Notice the adjustment is the same in 2014 and 2015 under both
approaches. This is because the adjustment in the appendix alternative
solution places all remaining unexpired/unearned amounts in the
asset/liability accounts to be considered for future adjustment.
3-5
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Another Alternate Demonstration Problem
Chapter Three
The trial balance of Large Company, Inc., at the end of its annual
accounting period is as follows:
LARGE COMPANY, INC.
Trial Balance
December 31, 2015
Cash........................................................................ $ 4,000
Accounts Receivable……………………………….. 400
Prepaid Insurance.................................................. 1,200
Supplies ................................................................. 2,100
Equipment ............................................................. 20,000
Accumulated Depreciation—Equipment.............. $ 2,000
C. Large, Capital .................................................... 19,000
C. Large, Withdrawals............................................ 2,000
Revenue.................................................................. 33,000
Salaries Expense................................................... 18,300
Rent Expense ........................................................ 6,000 ______
Totals...................................................................... $54,000 $54,000
Additional information:
1. Expired insurance, $400.
2. Unused supplies, per inventory, $800.
3. Estimated depreciation, $1,000.
4. Earned but unpaid salaries, $700.
5. Services completed for a client by year-end but the client has not been
billed for those services, $500
Required:
Prepare adjusting entries.
3-6
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Solution: Another Alternate Demonstration Problem
Chapter 3
Insurance Expense........................................... 400
Prepaid Insurance...................................... 400
Supplies Expense............................................ 1,300
Supplies...................................................... 1,300
$2,100 – 800 inventory = 1,300 supplies used
Depreciation Expense Equip........................... 1,000
Accumulated Depreciation Equip............. 1,000
Salaries Expense.............................................. 700
Salaries Payable........................................ 700
Accounts Receivable....................................... 500
Revenue...................................................... 500
3-7
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
