Chapter 04—The Accounting Cycle: Accruals and Deferrals
Financial and Managerial Accounting, 18e 4-1
4 THE ACCOUNTING CYCLE: ACCRUALS AND DEFERRALS
Chapter Summary
In order for revenues and expenses to be reported in the accounting period in which they
are earned or incurred, adjusting entries must be made at the end of the accounting period.
Adjusting entries are made so the revenue recognition and matching principles are followed.
The chapter includes a thorough review of various adjusting entries. The adjustments are
classified into four categories: converting assets to expenses; converting liabilities to revenue;
accruing unpaid expenses and; accruing uncollected revenues. The categories are discussed and
illustrated in this order.
We continue our illustration of Overnight Auto Service by examining numerous adjusting
entries of each type that would be applicable for this service business. We detail the adjusting
journal entries required as well as the financial statement impact of the adjustments. We explain
that the adjusting entries are needed to satisfy the realization and matching principles. The
concept of materiality is introduced and its relevance to the adjusting entries is explained.
Learning Objectives
1. Explain the purpose of adjusting entries.
2. Describe and prepare the four basic types of adjusting entries.
3. Prepare adjusting entries to convert assets to expenses.
4. Prepare adjusting entries to convert liabilities to revenue.
5. Prepare adjusting entries to accrue unpaid expenses.
6. Prepare adjusting entries to accrue uncollected revenue.
7. Explain how the principles of realization and matching relate to adjusting entries.
8. Explain the concept of materiality.
9. Prepare an adjusted trial balance and describe its purpose.
Chapter 04—The Accounting Cycle: Accruals and Deferrals
4-2 Instructor’s Resource Manual
Brief Topical Outline
A. Adjusting entries
1. The need for adjusting entries
2. Types of adjusting entries
3. Adjusting entries and timing differences
4. Characteristics of adjusting entries
5. Year-end at Overnight Auto Service
6. Converting assets to expenses
a. Prepaid expenses
b. Shop supplies
c. Insurance policies—see Your Turn (page 151)
d. Recording prepayments directly in the expense accounts
7. The concept of depreciation
a. What is deprecation?
b. Depreciation is only an estimate—see Case in Point (page 153)
c. Depreciation of Overnight’s building
d. Depreciation of tools and equipment
e. Depreciation—a noncash expense
8. Converting liabilities to revenue
a. Recording advance collections directly in the revenue accounts
9. Accruing unpaid expenses
a. Accrual of wages (or salaries) expense
b. Accrual of interest expense
10. Accruing uncollected revenue
11. Accruing income taxes expense: the final adjusting entry—see International
Case in Point (page 159)
a. Income taxes in unprofitable periods
B. Adjusting entries and accounting principles
1. The concept of materiality
a. Materiality and adjusting entries
b. Materiality is a matter of professional judgment—see Pathways Connection and
Your Turn (page 162)
2. Effects of the adjusting entries—see Ethics, Fraud, & Corporate Governance
(page 165)
C. Concluding remarks
Chapter 04—The Accounting Cycle: Accruals and Deferrals
Financial and Managerial Accounting, 18e 4-3
Topical Coverage and Suggested Assignments
Class
Meetings
on Chapter
Topical
Outline
Coverage
Discussion
Questions*
Brief
Exercises*
Exercises*
Problems*
Critical
Thinking
Cases*
1
A
1, 2, 3
1, 2
2, 3, 6
1
2
A
8, 9
4, 5
7, 9
3, 4
1
3
B – C
10, 11
9, 10
10, 11
6
2
*Homework assignment (to be completed prior to class)
Comments and Observations
Teaching Objectives for Chapter 4
In Chapter 4 we cover the numerous accounting activities, both analytical and procedural, that
take place at the end of a fiscal year. In covering this chapter, our teaching objectives are to:
1. Explain the need for adjusting entries in accrual accounting.
2. Illustrate the four basic types of adjusting entries.
3. Review in sequence the steps in the complete accounting cycle.
4. Introduce the principle of materiality and discuss its relevance to adjusting entries.
General Comments
The need for adjusting entries stems from the most basic concepts of accrual accounting,
the concepts that revenue is recognized when it is earned and that expenses are recognized when
the related goods and services are used. We find that students who do not fully understand the
nature and purpose of adjusting entries have difficulty with other accrual accounting concepts
throughout the course. We find Exercises 2, 3, 5, and 9 particularly useful. Exercise 2 illustrates
the effects of the four basic types of adjusting entries upon both the income statement and
balance sheet. Exercise 3 focuses upon those adjustments that apportion previously recorded
amounts, while Exercise 5 illustrates adjustments needed to accrue unrecorded amounts.
Exercise 9 demonstrates that the need for adjusting entries arises from transactions spanning
more than one accounting period. We also like Exercise 6, which focuses upon unearned revenue
in the accounting records of Delta Airlines.
We personally spend quite a bit of class time on materiality, as we consider it to be one
of the most important concepts in accounting. The chapter has several good assignments on
materiality, including Discussion Questions 7 and 10, and Case 2. We always assign at least two
of these and discuss them in class.
An aside Some students may ask why the word “debit” is abbreviated “Dr.” in the
columnar headings of the worksheet, as there is no “r” in “debit.” The word “debit” is derived
from the Latin verb debere, which means “to owe.” “Credit” stems from the Latin verb credere,
Chapter 04—The Accounting Cycle: Accruals and Deferrals
4-4 Instructor’s Resource Manual
meaning “to entrust” or “to lend.” In modern usage, of course, the term debit has come to mean
any entry in the left-hand side of a ledger account, and credit has come to mean any entry in the
right-hand side.
Supplemental Exercises
Group Exercise
Assign each group a specific well-known publicly traded company such as Walmart,
Target, Lowes, Home Depot, Coca-Cola, PepsiCo, etc. Instruct students on the process to locate
their assigned company’s consolidated financial statements and footnotes on the SEC website.
Have each group share a brief presentation including 1) accounts on the balance that indicate that
the company uses adjusting entries (i.e. accounts that evidence that accruals or deferrals have
been recorded) and 2) what management tells financial statement readers about such accounts in
the footnote disclosures.
Internet Exercise
Visit the Microsoft home page. Under the Company section, click “Investors.” Click
“Annual Reports.” Access the annual report for 2015. Find the footnotes to the statements and
read the disclosures in Note 18 titled “Contingencies.” Hint: Use the Control + F function to
search for Note 18. Regarding the events described, do you think Microsoft is providing
adequate disclosure to its stockholders?
Chapter 04—The Accounting Cycle: Accruals and Deferrals
Financial and Managerial Accounting, 18e 4-5
CHAPTER 4 NAME #
10-MINUTE QUIZ A SECTION
Indicate the best answer for each question in the space provided.
1. Joseph Jewelers purchased display shelves on March 1 for $36,000. If this asset has an estimated
useful life of five years, what is the book value of the display shelves on April 30?
a $600.
b $34,800.
c $33,600.
d $900.
2. The adjusting entry to recognize an unrecorded expense is necessary:
a When an expense is paid in advance.
b When an expense has been neither paid nor recorded as of the end of the accounting period.
c Whenever an expense remains unpaid at the end of an accounting period.
d Because the accountant is likely to forget to pay these unrecorded expenses.
3. Before any month-end adjustments are made, the net income of Lawrence Company is $550,000.
However, the following adjustments are necessary: office supplies used, $35,000; services
performed for clients but not yet recorded or collected, $12,300; interest accrued on note payable
to bank, $14,100. After adjusting entries are made for the items listed above, Lawrence
Company’s net income would be:
a $541,400.
b $488,600.
c $583,200.
d $513,200.
4. Of the following adjusting entries, which one results in an increase in liabilities and the
recognition of an expense at the end of an accounting period?
a The entry to accrue salaries owed to employees at the end of the period.
b The entry to record revenue earned but not yet collected or recorded.
c The entry to record earned portion of rent previously received in advance from a tenant.
d The entry to write off a portion of unexpired insurance.
5. The CPA firm auditing Indian Company found that net income had been overstated. Which of the
following errors could be the cause?
a Failure to record depreciation expense for the period.
b No entry made to record purchase of land for cash on the last day of the year.
c Failure to record payment of an account payable on the last day of the year.
d Failure to make an adjusting entry to record revenue which had been earned but not yet billed
to customers.
Chapter 04—The Accounting Cycle: Accruals and Deferrals
4-6 Instructor’s Resource Manual
CHAPTER 4 NAME #
10-MINUTE QUIZ B SECTION
Manhattan Park adjusts its books each month and closes its books on December 31 each year. The trial
balance at January 31, 2018, before adjustments, follows:
Debit Credit
Cash …………………………………………………………………………….. $ 6,600
Supplies ……………………………………………………………………….. 5,400
Unexpired Insurance ……………………………………………………… 12,600
Equipment ……………………………………………………………………. 72,000
Accumulated Depreciation: Equipment …………………………... $ 18,000
Unearned Admission Revenue ……………………………………….. 12,000
Capital Stock ………………………………………………………………… 20,000
Retained Earnings, January 1, 2018 ………………………………… 38,200
Admissions Revenue …………………………………………………….. 27,600
Salaries Expense …………………………………………………………… 8,100
Utilities Expense …………………………………………………………… 5,700
Rent Expense ……………………………………………………………….. 5,400 _________
$115,800 $115,800
1. Refer to the above data. According to attendance records, $8,200 of the Unearned Admission
Revenue has been earned in January. Compute the amount of admissions revenue to be shown in
the January income statement:
a $35,800. b $19,400. c $8,200. d $3,800.
2. Refer to the above data. At January 31, the amount of supplies on hand is $2,300. What amount
is shown on the January income statement for supplies expense?
a $2,300. b $5,400. c $3,100. d $7,700.
3. Refer to the above data. The equipment has an original estimated useful life of six years.
Compute the book value of the equipment at January 31 after the proper January adjustment is
recorded:
a $1,000. b $71,000. c $53,000. d $60,000.
4. Refer to the above data. Employees are owed $1,200 for services since the last payday in January
to be paid the first week of February. No adjustment was made for this item. As a result of this
error:
a Assets at January 31 are overstated.
b January net income is overstated.
c Liabilities at January 31 are overstated.
d Owners’ equity at January 31 is understated.
5. Refer to the above data. On August 1, 2017, the park purchased a 12-month insurance policy.
The necessary adjusting entry at January 31 includes which of the following entries? (Hint: The
company has adjusted its books on a monthly basis.)
a A debit to Insurance Expense for $1,050.
b A credit to Unexpired Insurance for $11,550.
c A credit to Unexpired Insurance for $1,800.
d A debit to Unexpired Insurance for $10,800.
Chapter 04—The Accounting Cycle: Accruals and Deferrals
Financial and Managerial Accounting, 18e 4-7
CHAPTER 4 NAME #
10-MINUTE QUIZ C SECTION
Scorpio Travel adjusts its books each month and closes its books on December 31 each year. The trial
balance at January 31, 2017, before adjustments, follows:
Debit Credit
Cash …………………………………………………………………………….. $ 3,300
Supplies ……………………………………………………………………….. 2,700
Unexpired Insurance ……………………………………………………… 6,300
Equipment ……………………………………………………………………. 36,000
Accumulated Depreciation: Equipment …………………………... $9,000
Unearned Admission Revenue ……………………………………….. 6,000
Capital Stock ………………………………………………………………… 7,500
Retained Earnings, January 1, 2017 ………………………………… 21,600
Admissions Revenue …………………………………………………….. 13,800
Salaries Expense …………………………………………………………… 4,050
Utilities Expense …………………………………………………………… 2,850
Rent Expense ……………………………………………………………….. 2,700 ________
$57,900 $57,900
1. Refer to the above data. According to attendance records, $4,800 of the Unearned Admission
Revenue has been earned in January. Compute the balance in the following accounts after the
proper adjustment is made.
Unearned Admission Revenue account balance $__________
Admission Revenue account balance $__________
2. Refer to the above data. At January 31, the amount of supplies still on hand was determined to be
$675. What amount should be reported in the January income statement for supplies expense?
$__________
3. Refer to the above data. The equipment has an original useful life of eight years. Compute the
book value of the equipment at January 31 after the proper January adjustment is recorded.
$__________
4. Refer to the above data. $900 is owed to employees for work since the last payday in January, to
be paid the first week of February. What is the effect on January net income if the accountant
fails to make any January 31 adjustment for this item? $__________
5. Refer to the above data. On June 1, 2016, the park purchased a 12-month insurance policy. Give
the adjusting entry to record insurance coverage expiring in January. (Hint: The company adjusts
its books on a monthly basis.)
Chapter 04—The Accounting Cycle: Accruals and Deferrals
4-8 Instructor’s Resource Manual
CHAPTER 4 NAME #
10-MINUTE QUIZ D SECTION
The accountant for Rose’s Emporium, Inc. prepared the following trial balance at January 31, 2018, after
one month of operations:
Debit Credit
Cash ………………………………………………………………………………………………. $ 5,700
Accounts Receivable ……………………………………………………………………….. 4,500
Unexpired Insurance ……………………………………………………………………….. 2,100
Office Equipment ……………………………………………………………………………. 18,000
Unearned Consulting Fees ……………………………………………………………….. $ 3,300
Capital Stock ………………………………………………………………………………….. 15,600
Retained Earnings, January 1, 2018 ………………………………………………….. 0
Dividends ………………………………………………………………………………………. 3,300
Consulting Fees Earned …………………………………………………………………… 26,800
Salaries Expense……………………………………………………………………………… 7,700
Utilities Expense …………………………………………………………………………….. 1,700
Rent Expense ………………………………………………………………………………….. 2,100
Supplies Expense ……………………………………………………………………………. ___600 ______
$45,700 $45,700
Additional information items:
a Consulting services rendered to a client in January, not yet billed or recorded, $2,400.
b Portion of insurance expiring in January, $300.
c Income taxes expense for January of $2,500.
d The office equipment has a life of 5 years.
Instructions. Prepare adjusting entries for a through d.
Adjusting Entries
Jan. 31
Chapter 04—The Accounting Cycle: Accruals and Deferrals
Financial and Managerial Accounting, 18e 4-9
SOLUTIONS TO CHAPTER 4 10-MINUTE QUIZZES
QUIZ A
1 B
QUIZ B
QUIZ C
1
2
4
5
Chapter 04—The Accounting Cycle: Accruals and Deferrals
4-10 Instructor’s Resource Manual
QUIZ D
Adjusting Entries
Jan 31
Accounts Receivable
Consulting Fees Earned
Insurance Expense
Unexpired Insurance
Depreciation Expense
Accumulated Depreciation
Chapter 04—The Accounting Cycle: Accruals and Deferrals
Financial and Managerial Accounting, 18e 4-11
Assignment Guide to Chapter 4
Brief
Exercises
Exercises
Problems
Cases
Net
Item Number
1 – 10
1 – 15
1
2
3
4
5
6
7
8
1
2
3
4
Time estimate (in minutes)
< 10
< 15
20
40
25
30
30
30
60
20
30
25
10
10
Difficulty rating
E
E
E
M
S
M
M
M
S
S
M
M
E
E
Learning Objectives:
1, 2, 3, 4, 5, 6,
7, 8, 9, 10, 11,
12, 13, 14, 15
1. Explain the purpose of
adjusting entries.
2. Describe and prepare the
four basic types of
1, 2, 3, 4, 5, 6,
7, 8, 9, 12, 13,
1, 2, 3, 4
1, 2, 3, 4, 5, 7,
to accrue unpaid expenses.
1, 2, 3, 4, 5, 7,
8, 9, 10, 12, 13,
to accrue uncollected
revenue.
1, 2, 3, 4, 5, 7,