CHAPTER 4
Accrual Accounting Concepts
Learning Objectives
2. Prepare adjusting entries for deferrals.
4. Prepare an adjusted trial balance and closing entries.
*5. Describe the purpose and the basic form of a worksheet.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy
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ASSIGNMENT CHARACTERISTICS TABLE
Problem
Number
Description
Difficulty
Level
Time
Allotted (min.)
1A
Record transactions on accrual basis; convert revenue to
cash receipts.
Simple
20–30
2A
Prepare adjusting entries, post to ledger accounts, and
prepare adjusted trial balance.
Simple
40–50
3A
Prepare adjusting entries, adjusted trial balance, and
financial statements.
Simple
50–60
4A
Prepare adjusting entries and financial statements; identify
accounts to be closed.
Moderate
40–50
5A
Prepare adjusting entries.
Moderate
30–40
6A
Prepare adjusting entries and a corrected income
statement.
Moderate
30–40
7A
Journalize transactions and follow through accounting
cycle to preparation of financial statements.
Moderate
60–70
ANSWERS TO QUESTIONS
1. (a) Under the periodicity assumption, an accountant is required to determine the effect of each
accounting transaction on a specific accounting period.
(b) An accounting time period that is one year in length is referred to as a fiscal year.
LO 1 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Measurement and Reporting
2. The two generally accepted accounting principles that pertain to adjusting the accounts are:
The revenue recognition principle, which states that revenue should be recognized in the time
period in which the performance obligation is satisfied.
The expense recognition principle, which states that expenses be matched with revenues in the
period when the company makes efforts to generate those revenues.
LO 1 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Measurement
3. The law firm should recognize the revenue in April. The revenue recognition principle states that
revenue should be recognized in the accounting period in which the performance obligation is
satisfied.
LO 1 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Measurement
4. Expenses of $4,700 should be deducted from the revenues in April. Under the expense
recognition principle efforts (expenses) should be matched with results (revenues).
LO 1 BT: AP Diff: M TOT: 2 min. AACSB: Analytic AICPA FC: Measurement
5. No, adjusting entries are required by the revenue and expense recognition principles.
LO 1 BT: C Diff: E TOT: 1 min. AACSB: None AICPA FC: Measurement
6. The financial information in a trial balance may not be up–to–date because:
(1) Some events are not journalized daily because it is not useful or efficient to do so.
(2) The expiration of some costs occurs with the passage of time rather than as a result of
recurring daily transactions.
(3) Some items may be unrecorded because the transaction data are not known.
LO 1 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Measurement and Reporting
7. The two categories of adjusting entries are deferrals and accruals. Deferrals consist of revenues
collected before services are provided and expenses paid before they are incurred. Accruals
consist of revenues for services performed prior to collection and expenses incurred prior to
payment.
LO 1 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Measurement and Reporting
8. In a prepaid expense adjusting entry, expenses are debited and assets are credited.
LO 2 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting
9. No. Depreciation is the process of allocating the cost of an asset to expense over its useful life.
Depreciation results in the presentation of the book value of the asset, not its fair value.
LO 2 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Measurement and Reporting
10. Depreciation expense is an expense account whose normal balance is a debit. This account
shows the cost that has expired during the current accounting period. Accumulated depreciation
is a contra asset account whose normal balance is a credit. The balance in this account is the
depreciation that has been recognized from the date of acquisition to the balance sheet date.
LO 2 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Reporting
11. Equipment ……………………………………………………………………… $15,000
Less: Accumulated depreciation—equipment ……………………. 7,000 $8,000
LO 2 BT: AP Diff: E TOT: 2 min. AACSB: Analytic AICPA FC: Reporting
12. In an unearned revenue adjusting entry, liabilities are debited and revenues are credited.
LO 2 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting
13. The sale of a three-year maintenance contract on December 29, 2016 will have no effect on the
2016 income statement but receipt of $100,000 on December 29, 2016, 2017, and 2018 will
increase an asset, Cash, and a liability, Unearned Service Revenue. As Abe Technologies
provides service to its customer during 2017, 2018, and 2019, the liability will decrease and
revenue will be recognized. Accrual accounting rules require that revenue be recognized as the
performance obligation is satisfied rather than when cash is received.
LO 2 BT: AN Diff: H TOT: 4 min. AACSB: Analytic AICPA FC: Reporting
Questions Chapter 4 (Continued)
14. This promotion plan sounds like a bad idea for two reasons:
(1) GAAP requires that the sale of a gift card be recorded as Unearned Sales Revenue (a
liability) rather than Sales Revenue. Revenue recognition is delayed until the gift card is
used or expires. Ed’s plan will not help the company meet its target revenue unless
customers use the cards by year-end.
(2) Selling a $50 card for $45 will probably not help the company meet its target net income.
Although this promotion may result in additional sales revenue as the cards are used, the
income resulting from the cards will be much less than usual since they eliminate $5 of
normal gross profit.
LO 2 BT: AN Diff: H TOT: 5 min. AACSB: None AICPA FC: Reporting
15. An asset is debited and a revenue is credited.
LO 3 BT: C Diff: M TOT: 1 min. AACSB: None AICPA FC: Reporting
16. An expense is debited and a liability is credited.
LO 3 BT: C Diff: M TOT: 1 min. AACSB: None AICPA FC: Reporting
17. Net income was understated $270 because prior to adjustment revenues are understated by
$780 and expenses are understated by $510. The difference in this case is $270 ($780 – $510).
LO 3 BT: AN Diff: H TOT: 4 min. AACSB: Analytic AICPA FC: Reporting
18. The entry is:
Jan. 9 Salaries and Wages Expense …………………………………. 5,100
Salaries and Wages Payable ………………………………….. 1,100
Cash ……………………………………………………………. 6,200
LO 3 BT: AP Diff: M TOT: 2 min. AACSB: Analytic AICPA FC: Reporting
19. (a) Accrued revenues. (d) Accrued expenses or prepaid expenses.
(b) Unearned revenues. (e) Prepaid expenses.
(c) Accrued expenses. (f) Accrued revenues or unearned revenues.
LO 2 & 3 BT: AN Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting
20. (a) Salaries and Wages Payable. (d) Supplies Expense.
(b) Accumulated Depreciation. (e) Service Revenue.
(c) Interest Expense. (f) Service Revenue.
LO 2 & 3 BT: AP Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting
21. Disagree. An adjusting entry affects only one balance sheet account and one income statement
account.
22. Apple reports Accounts Receivable. This suggests that it records revenue when it has delivered
goods, even though it hasn’t received payment. If it used a cash basis it wouldn’t record revenue
until cash was received, and it would therefore not establish receivables.
LO 1 & 3 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting
23. Financial statements can be prepared from an adjusted trial balance because the balances of all
accounts have been adjusted to show the effects of all financial events that have occurred during
the accounting period.
LO 4 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting
24. (a) Information presented on an accrual basis is useful because it reveals important information
about the relationship between efforts and results. This information is useful in predicting
future results. Trends in revenues and expenses are thus more meaningful.
(b) Information presented on a cash basis is useful for predicting the future availability of cash.
Cash basis financial statements provide useful information about a company’s sources and
uses of cash.
LO 1 & 4 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Reporting
25. The amount shown in the adjusted trial balance column for an account equals the account
balance in the ledger after adjusting entries have been journalized and posted.
LO 4 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting
Questions Chapter 4 (Continued)
26. (1) (Dr) Individual revenue accounts and (Cr) Income Summary.
(2) (Dr) Income Summary and (Cr) Individual expense accounts.
LO 4 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Reporting
27. Financial information is used by managers to direct and evaluate a company’s performance. The
sooner such information is made available; the sooner changes can be made to get a company
28. Income Summary is a temporary account that is used in the closing process. The account is
29. The post-closing trial balance contains only balance sheet accounts. Its purpose is to prove the
30. The accounts that will not appear in the post-closing trial balance are: Depreciation Expense;
31. The steps that involve journalizing are (1) journalize the transactions, (2) journalize the adjusting
32. The three trial balances are the (1) trial balance, (2) adjusted trial balance, and (3) post-closing
33. Earnings management is the planned timing of revenues, expenses, gains, and losses to smooth out
bumps in net income. Such action is undertaken to help a company meet target financial numbers.
34. Examples of ways a company can manage earnings include the following.
Use of “one–time” items to prop up earnings numbers. A company may decide to sell property
that has appreciated in value in order to record a gain on the sale. Such a gain will increase the
current year’s net income but future income will probably not include a similar increase.
*35. The worksheet is a working paper designed to make it easier to prepare adjusting entries and
*36. The columns of the worksheet from left to right are two columns each for the trial balance,
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 4-1
Cash
Net Income
(a)
(b)
$–100
0
$0
–20
BRIEF EXERCISE 4-2
(a) Prepaid Insurance—to recognize insurance expired during the period.
(b) Depreciation Expense—to allocate the cost of an asset to expense
BRIEF EXERCISE 4-3
Item
(1)
Type of Adjustment
(2)
Accounts Before Adjustment
(a)
Prepaid Expenses
Assets Overstated
Expenses Understated
(d)
Unearned Revenues
Liabilities Overstated
Revenues Understated
BRIEF EXERCISE 4-4
Dec. 31 Supplies Expense …………………………………….. 7,700
Supplies …………………………………………….. 7,700
BRIEF EXERCISE 4-5
Dec. 31 Depreciation Expense ………………………………. 2,750
Depreciation Expense
Accumulated Depreciation—
Equipment
12/31 2,750
12/31 2,750
BRIEF EXERCISE 4-6
July 1 Prepaid Insurance …………………………………….. 12,400
Cash …………………………………………………. 12,400
7/1 12,400
12/31 3,100
12/31 3,100
12/31 Bal. 9,300
BRIEF EXERCISE 4-7
July 1 Cash ………………………………………………………… 12,400
Unearned Service Revenue ………………… 12,400
BRIEF EXERCISE 4-8
(a) Dec. 31 Interest Expense ………………………………… 300
Interest Payable ………………………….. 300
BRIEF EXERCISE 4-9
Account
(1)
Type of Adjustment
(2)
Related Account
(a)
Accounts Receivable
Accrued Revenues
Service Revenue
(b)
Prepaid Insurance
Prepaid Expenses
Insurance Expense
(c)
Equipment
Not required
(d)
Accum. Depreciation—
Equipment
Prepaid Expenses
Depreciation Expense
(e)
Notes Payable
Not required
Interest Payable
Accrued Expenses
Interest Expense
(g)
Unearned Service
Revenue
Unearned Revenues
Service Revenue
BRIEF EXERCISE 4-10
LEVIN CORPORATION
Income Statement
For the Year Ended December 31, 2017
Revenues
Service revenue …………………………………………….. $32,000
Expenses
Salaries and wages expense ………………………….. $14,000
Rent expense ………………………………………………… 3,900
BRIEF EXERCISE 4-11
LEVIN CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2017
Retained earnings, January 1 …………………………………………………. $17,200
Add: Net income ………………………………………………………………….. 10,400
BRIEF EXERCISE 4-12
Account
(a)
(b)
Accumulated Depreciation
Depreciation Expense
Balance Sheet
Income Statement
BRIEF EXERCISE 4-13
The accounts that will appear in the post-closing trial balance are:
BRIEF EXERCISE 4-14
(a) Closing Entries
July 31 Service Revenue ……………………………….. 16,000
Income Summary ………………………… 16,000
(To close revenue account)
(b)
Retained Earnings
1,300
7/1 Bal. 20,000
4,100
7/31 Bal. 22,800
BRIEF EXERCISE 4-15
The proper sequencing of the required steps in the accounting cycle is as
follows:
2. (e) Journalize the transactions.
4. (d) Prepare a trial balance.
6. (b) Prepare an adjusted trial balance.
8. (f) Journalize and post closing entries.
SOLUTIONS TO DO IT! EXERCISES
DO IT! 4-1
DO IT! 4-2
1. Insurance Expense ……………………………………………….. 300
2. Supplies Expense …………………………………………………. 1,600
3. Depreciation Expense …………………………………………… 200
4. Unearned Service Revenue ……………………………………. 4,000
Service Revenue ……………………………………………… 4,000
DO IT! 4-3
1. Salaries and Wages Expense ………………………………… 1,100
2. Interest Expense ($20,000 X .09 X 1/12) ………………….. 150
3. Accounts Receivable ……………………………………………. 1,600
Service Revenue ……………………………………………… 1,600
DO IT! 4-4a
Income statement: Service Revenue, Utilities Expense
Balance sheet: Accounts Receivable, Accumulated Depreciation, Notes
Payable, Common Stock.
LO 4 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting
DO IT! 4-4b
Dec. 31 Service Revenue ………………………………………………. 108,000
Dec. 31 Income Summary ……………………………………………… 72,000
Salaries and Wages Expense ……………………… 40,000
Rent Expense …………………………………………….. 18,000
Dec. 31 Income Summary ……………………………………………… 36,000
SOLUTIONS TO EXERCISES
EXERCISE 4-1
The revenue recognition principle requires that companies recognize
revenue in the accounting period in which the performance obligation is
satisfied.
(a) Since the sales effort is not complete until the flight actually occurs,
revenue should not be recognized until December. Southwest Airlines
should recognize the revenue in December when the customer has
been provided with the flight.
EXERCISE 4-2
(a) 8. Going concern assumption.
(b) 1. Economic entity assumption.
(c) 7. Full disclosure principle.
EXERCISE 4-3
(a) Revenue recognition principle.
(b) Periodicity assumption.
EXERCISE 4-4
$ 33,640
Cash basis earnings.
+ 3,400
Accounts receivable arise from sales that have been made,
thus revenue must be recognized for balance outstanding at
the end of the current year.
– 2,800
Accounts receivable collected in current year, for sales made
in previous year must be deducted from earnings.
– 1,460
Supplies on hand at the end of the previous year should be
expensed this year, this decreases earnings.
– 2,000
Wages owing at the end of the current year should be
accrued, thus reducing earnings.
+ 2,400
Wages owed at the end of the previous year should not be
earnings.
– 1,400
Other unpaid amounts owed at the end of the current year
should be accrued, thus reducing earnings.
+ 1,100
increasing earnings.
$ 34,180
Accrual basis earnings.
Other unpaid amounts owed at the end of the previous year
should not be deducted from the current year’s earnings, thus