4-1

4
Accrual Accounting Concepts

Kimmel ● Weygandt ● Kieso

Financial Accounting, Eighth Edition
4-2
 CHAPTER OUTLINE
LEARNING OBJECTIVES

Explain the accrual basis of accounting and the

1 reasons for adjusting entries.

2 Prepare adjusting entries for deferrals.

3 Prepare adjusting entries for accruals.

4 Prepare an adjusted trial balance and closing entries.

4-3
 Explain the accrual basis of accounting and
LEARNING
OBJECTIVE 1 the reasons for adjusting entries.

Accountants divide the economic life of a business into

artificial time periods (Periodicity Assumption).
.....
Jan. Feb. Mar. Apr. Dec.

 Generally a month, a quarter, or a year.

 Fiscal year vs. calendar year.
▼ HELPFUL HINT
An accounting time period
that is one year long is
called a fiscal year.

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 Periodicity Assumption

Review Question
What is the periodicity assumption?

a. Companies should recognize revenue in the

accounting period in which it is earned.

b. Companies should match expenses with revenues.

c. The economic life of a business can be divided into

artificial time periods.

d. The fiscal year should correspond with the calendar

year.
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 REVENUE RECOGNITION PRINCIPLE

Companies recognize
revenue in the accounting
period in which the
performance obligation is
satisfied.

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 REVENUE RECOGNITION PRINCIPLE

Illustration: Assume Conrad Dry Cleaners cleans clothing

on June 30, but customers do not claim and pay for their
clothes until the first week of July. The journal entries for
June and July would be:

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 EXPENSE RECOGNITION PRINCIPLE

ILLUSTRATION 4-1

“Let the expenses follow the revenues.”

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 EXPENSE RECOGNITION PRINCIPLE

ILLUSTRATION 4-1
GAAP relationships in
revenue and expense
recognition

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 INVESTOR INSIGHT Apple Inc.

Reporting Revenue Accurately

The Until recently, electronics manufacturer Apple was
required to spread the revenues from iPhone sales over the
two-year period following the sale of the phone. Accounting
standards required this because Apple was obligated to provide
software updates after the phone was sold. Since Apple had
service obligations after the initial date of sale, it was forced to
spread the revenue over a two-year period. As a result, the
rapid growth of iPhone sales was not fully reflected in the
revenue amounts reported in Apple’s income statement. A new
accounting standard now enables Apple to report much more of
its iPhone revenue at the point of sale. It was estimated that
under the new rule revenues would have been about 17%
higher and earnings per share almost 50% higher.
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 ACCRUAL VERSUS CASH BASIS

Accrual-Basis Accounting
► Transactions recorded in the periods in which the
events occur.
► Revenues are recognized when services performed,
even if cash was not received.
► Expenses are recognized when incurred, even if cash
was not paid.

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 ACCRUAL VERSUS CASH BASIS

Cash-Basis Accounting
► Revenues are recognized only when cash is
received.
► Expenses are recognized only when cash is paid.

► Not in accordance with generally accepted

accounting principles (GAAP).

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 ACCRUAL VERSUS CASH BASIS

Illustration: Suppose that Fresh Colors paints a large

building in 2016. In 2016, it incurs and pays total expenses
(salaries and paint costs) of $50,000. It bills the customer
$80,000, but does not receive payment until 2017.

2016 2017

ILLUSTRATION 4-2
Accrual-versus cash-basis accounting
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 Periodicity Assumption

Review Question
Which one of these statements about the accrual basis of
accounting is false?
a. Companies record events that change their financial
statements in the period in which events occur, even if cash
was not exchanged.
b. Companies recognize revenue in the period in which the
performance obligation is satisfied.
c. This basis is in accord with generally accepted accounting
principles.
d. Companies record revenue only when they receive cash, and
record expense only when they pay out cash.
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 THE NEED FOR ADJUSTING ENTRIES

Adjusting entries
 ensure that the revenue recognition and expense
recognition principles are followed.
 are required every time a company prepares
financial statements.
 includes one income statement account and one
balance sheet account.

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 THE NEED FOR ADJUSTING ENTRIES

Review Question
Adjusting entries are made to ensure that:
a. expenses are recognized in the period in which they
are incurred.
b. revenues are recognized in the period in which the
performance obligation is satisfied.
c. balance sheet and income statement accounts have
correct balances at the end of an accounting period.
d. All of the above.

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 TYPES OF ADJUSTING ENTRIES

Deferrals:
1. Prepaid expenses: Expenses paid in cash and
recorded as assets before they are used or consumed.
2. Unearned revenues: Cash received before service
are performed.
Accruals:
1. Accrued revenues: Revenues for services
performed but not yet received in cash or recorded.
2. Accrued expenses: Expenses incurred but not yet
paid in cash or recorded.
ILLUSTRATION 4-3
Categories of adjusting entries
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 TYPES OF ADJUSTING ENTRIES

Trial Balance –
Each account is
analyzed to
determine
whether it is
complete and
up-to-date.

ILLUSTRATION 4-4
Trial balance

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LO 1
 DO IT! 1 Timing Concepts

Below is a list of concepts in the left column, with descriptions of the

concepts in the right column. There are more descriptions provided than
concepts. Match the description of the concept to the concept.

f Accrual-basis accounting.
1. ____ (a) Monthly and quarterly time
e Calendar year.
2. ____ periods.
c Periodicity assumption.
3. ____ (b) Efforts (expenses) should
b Expense recognition principle.
4. ____ be matched with results
(revenues).
(c) Accountants divide the economic life of a business into time periods.
(d) Companies record revenues when they receive cash and record expenses
when they pay out cash.
(e) An accounting time period that starts on January 1 and ends on December
31.
(f) Companies record transactions in the period in which the events occur.
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 Prepare adjusting entries for
LEARNING
OBJECTIVE 2 deferrals.

To defer means to postpone or delay.

Journalize
Analyze
Trial and Post
business Journalize Post
Balance Adjusting
transactions
Entries

Adjusted
Financial Closing Post-Closing
Trial
Statements Entries Trial Balance
Balance

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 Deferrals

Deferrals are either:

 Prepaid expenses
OR
 Unearned revenues.

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 PREPAID EXPENSES

Expenses paid in cash before they are used or consumed.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

 insurance  rent
 supplies  equipment
 advertising  buildings

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 PREPAID EXPENSES

Prepaid Expenses
 Costs that expire either with the passage of time or
through use.
 Adjusting entry results in an increase (a debit) to an
expense account and a decrease (a credit) to an asset
account.

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 PREPAID EXPENSES

Adjusting entries for prepaid expenses

ILLUSTRATION 4-5
Adjusting entries for
prepaid expenses

 Increases (debits) an expense account and

 Decreases (credits) an asset account.

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 Supplies

Illustration: Sierra Corporation purchased supplies costing $2,500

on October 5. Sierra recorded the purchase by increasing (debiting)
the asset Supplies. This account shows a balance of $2,500 in the
October 31 trial balance. An inventory count at the close of business
on October 31 reveals that $1,000 of supplies are still on hand.

Oct. 31 Supplies Expense 1,500

Supplies 1,500
($2,500 – 1,000 = $1,500)
ILLUSTRATION 4-6

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 Insurance

Illustration: On October 4, Sierra Corporation paid $600 for a one-

year fire insurance policy. Coverage began on October 1. Sierra
recorded the payment by increasing (debiting) Prepaid Insurance.
This account shows a balance of $600 in the October 31 trial balance.
Insurance of $50 ($600 ÷ 12) expires each month.

Oct. 31 Insurance Expense 50

Prepaid Insurance 50

ILLUSTRATION 4-7

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 Depreciation

 Buildings, equipment, and motor vehicles (long-lived

assets) are recorded as assets, rather than an
expense, in the year acquired.
 Depreciation is the process of allocating the cost of
an asset to expense (depreciation) over its useful life.
 Depreciation does not attempt to report the actual
change in the value of the asset.

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 Depreciation

Illustration: For Sierra Corporation, assume that depreciation on

the office equipment is $480 a year, or $40 per month.

Oct. 31 Depreciation Expense 40

Accumulated Depreciation-Equipment 40

ILLUSTRATION 4-8

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 Depreciation

Statement Presentation
 Accumulated Depreciation- ▼ HELPFUL HINT
Equipment is a contra asset All contra accounts have
increases, decreases,
account. and normal balances
opposite to the account
 Appears just after the account it to which they relate.

offsets (Equipment) on the

balance sheet. ILLUSTRATION 4-9
Balance sheet presentation of
accumulated depreciation

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 PREPAID EXPENSES

ILLUSTRATION 4-10
Accounting for prepaid expenses

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 UNEARNED REVENUES

Receipt of cash recorded as a liability before services are

performed.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

 rent  magazine subscriptions
 airline tickets  customer deposits

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 UNEARNED REVENUES

 Adjusting entry is made to record the revenue for

services performed during the period and to show the
liability that remains.
 Adjusting entry results in a decrease (a debit) to a
liability account and an increase (a credit) to a
revenue account.

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 UNEARNED REVENUES

Adjusting entries for unearned revenues

ILLUSTRATION 4-11

 Decrease (a debit) to a liability account.

 Increase (a credit) to a revenue account.

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 UNEARNED REVENUES

Illustration: Sierra Corporation received $1,200 on October 2 from

R. Knox for guide services for multi-day trips expected to be
completed by December 31. Unearned Service Revenue shows a
balance of $1,200 in the October 31 trial balance. From an evaluation
of the service Sierra performed for Knox during October, the company
determines that it has earned $400 in October.

Oct. 31 Unearned Service Revenue 400

Service Revenue 400
ILLUSTRATION 4-12

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 UNEARNED REVENUES

ACCOUNTING FOR UNEARNED REVENUES

Reason for Accounts Before Adjusting

Examples Adjustment Adjustment Entry

Rent, magazine Unearned Liabilities Dr. Liabilities

subscriptions, Revenues overstated. Cr. Revenues
customer recorded in Revenues
deposits for liability accounts understated.
future service. are now
recognized as
revenue for
services
performed.

ILLUSTRATION 4-13
Accounting for unearned revenues

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 ACCOUNTING ACROSS THE ORGANIZATION

Turning Gift Cards into Revenue

Those of you who are marketing majors (and even most of you
who are not) know that gift cards are among the hottest marketing
tools in merchandising today. Customers purchase gift cards and
give them to someone for later use. In a recent year, gift-card
sales were expected to exceed $124 billion. Although these
programs are popular with marketing executives, they create
accounting questions. Should revenue be recorded at the time the
gift card is sold, or when it is exercised? How should expired gift
cards be accounted for? In a recent balance sheet, Best Buy
reported unearned revenue related to gift cards of $406 million.
Source: “2014 Gift Card Sales to Top $124 Billion, But Growth Slowing,”
PRNewswire (December 10, 2014).

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 DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond, Inc. on March 31, 2017, includes these selected
accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment
$5,000
Unearned Service Revenue
9,200
An analysis of the accounts shows the following.
1. Insurance expires at the rate of $100 per month.
2. Supplies on hand total $800.
3. The equipment depreciates $200 a month.
4. During March, services were performed for $4,000 of the unearned
service revenue reported.
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Prepare the adjusting entries for the month of March.
 DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond, Inc. on March 31, 2017, includes these selected
accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment
$5,000
Unearned Service Revenue
9,200
Prepare the adjusting entries for the month of March.
1. Insurance expires at the rate of $100 per month.
Insurance Expense 100
SOLUTION
Prepaid Insurance 100
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 DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond, Inc. on March 31, 2017, includes these selected
accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment
$5,000
Unearned Service Revenue
9,200
Prepare the adjusting entries for the month of March.
2. Supplies on hand total $800.
Supplies Expense 2,000
SOLUTION
Supplies 2,000
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 DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond, Inc. on March 31, 2017, includes these selected
accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment
$5,000
Unearned Service Revenue
9,200
Prepare the adjusting entries for the month of March.
3. The equipment depreciates $200 a month.
Depreciation Expense
SOLUTION 200
Accumulated Depreciation 200
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 DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond, Inc. on March 31, 2017, includes these selected
accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment
$5,000
Unearned Service Revenue
9,200
Prepare the adjusting entries for the month of March.
4. During March, services were performed for $4,000 of the unearned
service revenue reported.
Unearned Service Revenue 4,000
SOLUTION
Service Revenue 4,000
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 Prepare adjusting entries for
LEARNING
OBJECTIVE 3 accruals.

Increase both a balance sheet and an income statement

account.
Journalize
Analyze
Trial and Post
business Journalize Post
Balance Adjusting
transactions
Entries

Adjusted
Financial Closing Post-Closing
Trial
Statements Entries Trial Balance
Balance

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 Adjusting Entries for Accruals

Made to record:
 Revenues for services performed and

OR
 Expenses incurred

in the current accounting period that have not been

recognized through daily entries.

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 ACCRUED REVENUES

Revenues for services performed but not yet received in

cash or recorded.
Adjusting entry results in:

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

 rent
 interest
 services performed

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 ACCRUED REVENUES

Accrued Revenues
An adjusting entry serves two purposes:
1. Shows the receivable that exists, and

2. Records the revenues for services performed.

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 ACCRUED REVENUES

Adjusting entries for accrued revenues

ILLUSTRATION 4-14

 Increases (debits) an asset account.

 Increases (credits) a revenue account.

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 ACCRUED REVENUES

Illustration: In October, Sierra Corporation performed guide

services for $200 that were not billed to clients before October
31.

Oct. 31 Accounts Receivable 200

Service Revenue 200

ILLUSTRATION 4-15

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 ACCRUED REVENUES

ACCOUNTING FOR ACCRUED REVENUES

Reason for Accounts Before Adjusting

Examples Adjustment Adjustment Entry

Interest, rent, Services Assets understated. Dr. Assets

services performed performed but not Revenues Cr. Revenues
but not collected. yet received in understated.
cash or recorded.

ILLUSTRATION 4-16
Accounting for accrued
revenues

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 ACCRUED EXPENSES

Expenses incurred but not yet paid in cash or

recorded.
Adjusting entry results in:

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

 Interest  utilities
 taxes  salaries

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 ACCRUED EXPENSES

An adjusting entry serves two purposes:

1. Records the obligations, and

2. Recognizes the expenses.

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 ACCRUED EXPENSES

Adjusting entries for accrued expenses

ILLUSTRATION 4-17

 Increases (debits) an expense account.

 Increases (credits) a liability account.

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 Accrued Interest

Illustration: Sierra Corporation signed a three-month note

payable in the amount of $5,000 on October 1. The note requires
Sierra to pay interest at an annual rate of 12%.
ILLUSTRATION 4-18
$5,000 x 12% x 1/12 = $50 Formula for computing
interest

Oct. 31 Interest Expense 50

Interest Payable 50
ILLUSTRATION 4-19

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 Accrued Salaries

Illustration: Sierra Corporation last paid salaries on October 26;

the next payment of salaries will not occur until November 9. The
employees receive total salaries of $2,000 for a five-day work
week, or $400 per day. Thus, accrued salaries at October 31 are
$1,200 ($400 × 3 days).
ILLUSTRATION 4-20

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 Accrued Salaries

Illustration: Sierra Corporation last paid salaries on October 26;

the next payment of salaries will not occur until November 9. The
employees receive total salaries of $2,000 for a five-day work
week, or $400 per day. Thus, accrued salaries at October 31 are
$1,200 ($400 × 3 days).

Oct. 31 Salaries and Wages Expense 1,200

Salaries and Wages Payable 1,200
ILLUSTRATION 4-21

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 ACCRUED EXPENSES

ILLUSTRATION 4-22
Accounting for accrued
expenses

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 PEOPLE, PLANET, AND PROFIT INSIGHT
Got Junk?
Do you have an old computer or two in your garage? How about
an old TV that needs replacing? Many people do. Approximately
163,000 computers and televisions become obsolete each day.
Yet, in a recent year, only 11% of computers were recycled. It is
estimated that 75% of all computers ever sold are sitting in
storage somewhere, waiting to be disposed of. Each of these old
TVs and computers is loaded with lead, cadmium, mercury, and
other toxic chemicals. If you have one of these electronic gadgets,
you have a responsibility, and a probable cost, for disposing of it.
Companies have the same problem, but their discarded materials
may include lead paint, asbestos, and other toxic chemicals.

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 SUMMARY OF BASIC RELATIONSHIPS

ILLUSTRATION 4-23
Summary of adjusting entries

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 DO IT! 3 Adjusting Entries for Accruals

Micro Computer Services Inc. began operations on August 1, 2017.

At the end of August 2017, management attempted to prepare
monthly financial statements. The following information relates to
August.
1. At August 31, the company owed its employees $800 in
salaries that will be paid on September 1.
2. On August 1, the company borrowed $30,000 from a bank on a
15-year mortgage. The annual interest rate is 10%.
3. Revenue for services performed but unrecorded for August
totaled $1,100.
Prepare the adjusting entries needed at August 31, 2017.
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 DO IT! 3 Adjusting Entries for Accruals

Micro Computer Services Inc. began operations on August 1, 2017.

At the end of August 2017, management attempted to prepare
monthly financial statements. Prepare the adjusting entries needed
at August 31, 2017.
1. At August 31, the company owed its employees $800 in
salaries that will be paid on September 1.

SOLUTION

Salaries and Wages Expense 800

Salaries and Wages Payable 800

4-59 LO 3
 DO IT! 3 Adjusting Entries for Accruals

Micro Computer Services Inc. began operations on August 1, 2017.

At the end of August 2017, management attempted to prepare
monthly financial statements. Prepare the adjusting entries needed
at August 31, 2017.
2. On August 1, the company borrowed $30,000 from a bank
on a 15-year mortgage. The annual interest rate is 10%.

SOLUTION

Interest Expense 250

Interest Payable 250

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 DO IT! 3 Adjusting Entries for Accruals

Micro Computer Services Inc. began operations on August 1, 2017.

At the end of August 2017, management attempted to prepare
monthly financial statements. Prepare the adjusting entries needed
at August 31, 2017.
3. Revenue for services performed but unrecorded for
August totaled $1,100.

SOLUTION

Accounts Receivable 1,100

Service Revenue 1,100

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 Prepare an adjusted trial balance
LEARNING
OBJECTIVE 4 and closing entries.

Analyze
Trial Adjusting
business Journalize Post
Balance Entries
transactions

Journalize
Adjusted Prepare Prepare a
and post
trial financial post-closing
closing
balance statements trial balance
entries

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 PREPARE ADJUSTED TRIAL BALANCE

After all adjusting entries are journalized and posted the

company prepares another trial balance from the ledger
accounts (Adjusted Trial Balance).

The adjusted trial balance’s purpose is to prove the equality

of debit balances and credit balances in the ledger.

The adjusted trial balance is the primary basis for the

preparation of the financial statements.

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 ILLUSTRATION 4-26
Adjusted trial balance

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 PREPARE ADJUSTED TRIAL BALANCE

Review Question
Which of the following statements is incorrect concerning
the adjusted trial balance?
a. An adjusted trial balance proves the equality of the
total debit balances and the total credit balances in
the ledger after all adjustments are made.
b. The adjusted trial balance provides the primary basis
for the preparation of financial statements.
c. The adjusted trial balance lists the account balances
segregated by assets and liabilities.
d. The adjusted trial balance is prepared after the
adjusting entries have been journalized and posted.
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 PREPARING FINANCIAL STATEMENTS

Financial
Financialstatements
statementsare
areprepared
prepareddirectly
directlyfrom
from the
the
Adjusted
AdjustedTrial
Trial Balance.
Balance.

Retained
Income Balance
Earnings
Statement Sheet
Statement

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 ILLUSTRATION 4-27
Preparation of the income statement and retained
4-67
4-68 earnings statement from the adjusted trial balance
 ILLUSTRATION 4-28
Preparation of the balance sheet
from the adjusted trial balance
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 QUALITY OF EARNINGS

Quality of Earnings – company provides full and

transparent information.
Earnings Management - the planned timing of revenues,
expenses, gains, and losses to smooth out bumps in net
income. Companies may manage earnings by:
 one-time items to prop up earnings numbers.
 inflating revenue numbers in the short-run.
 improper adjusting entries.

As a result of the Sarbanes-Oxley Act, many companies are trying

to improve the quality of their financial reporting.

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 DO IT! 4a Trial Balance

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 DO IT! 4a Trial Balance

(a) Determine the net income for the quarter April 1 to June 30.

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 DO IT! 4a Trial Balance

(b) Determine the total assets and total liabilities at June 30,
2017.

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 DO IT! 4a Trial Balance

(c) Determine the balance in Retained Earnings at June 30,

2017.

Retained earnings, April 1 $ 0

Add: Net income 2,490
Less: Dividends 600
Retained earnings, June 30 $1,890

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 CLOSING THE BOOKS

At the end of the accounting period, companies transfer the

temporary account balances to the permanent
stockholders’ equity account—Retained Earnings.

ILLUSTRATION 4-29
Temporary versus permanent accounts

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 Preparing Closing Entries

In addition to updating Retained Earnings to its correct

ending balance, closing entries produce a zero balance in
each temporary account.
ILLUSTRATION 4-30
The closing process

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4-76 ILLUSTRATION 4-31 LO 4
 Preparing Closing Entries

Illustration 4-32
Posting of closing entries

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 Preparing a Post-Closing Trail Balance

The purpose of the post-closing trial balance is to prove

the equality of the permanent account balances that the
company carries forward into the next accounting period.

All temporary accounts will have zero balances.

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 SUMMARY OF THE ACCOUNTING CYCLE

1.
1. Analyze
Analyze business
business transactions
transactions

9.
9. Prepare
Prepare aa post-closing
post-closing 2.
2. Journalize
Journalize the
the
trial
trial balance
balance transactions
transactions

8.
8. Journalize
Journalize and
and post
post 3.
3. Post
Post to
to ledger
ledger accounts
accounts
closing
closing entries
entries

7.
7. Prepare
Prepare financial
financial 4.
4. Prepare
Prepare aa trial
trial balance
balance
statements
statements

6.
6. Prepare
Prepare an
an adjusted
adjusted trial
trial 5.
5. Journalize
Journalize and
and post
post
balance
balance adjusting
adjusting entries:
entries:
Deferrals/Accruals
Deferrals/Accruals

ILLUSTRATION 4-33
Required steps in the accounting cycle
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 SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33
Required steps in the accounting cycle

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 SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33
Required steps in the accounting cycle

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 SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33
Required steps in the accounting cycle

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 SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33
Required steps in the accounting cycle

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 SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33
Required steps in the accounting cycle

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 SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33
Required steps in the accounting cycle

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 SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33
Required steps in the accounting cycle

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 SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33
Required steps in the accounting cycle

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 SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33
Required steps in the accounting cycle

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 KEEPING AN EYE ON CASH

Sierra Corporation’s income statement shows net income of

$2,860. Net income and net cash provided by operating
activities often differ.

 Net income on a cash basis is

referred to as “Net cash
provided by operating
activities.”
 The statement of cash flows,
reports net cash provided by
operating activities.

Illustration 4-27

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 KEEPING AN EYE ON CASH

The difference for Sierra is $2,840 ($5,700 - $2,860). The

following summary shows the causes of this difference.

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 DO IT! 4b Closing Entries

Hancock Company has the following balances in selected accounts of its

adjusted trial balance.
Accounts Payable $27,000 Dividends $15,000
Service Revenue 98,000 Retained Earnings 42,000
Rent Expense 22,000 Accounts Receivable 38,000
Salaries and Wages Expense 51,000 Supplies Expense 7,000
Prepare the entries to close the revenue and expense accounts.
SOLUTION
Service Revenue 98,000
Income Summary 98,000
Income Summary 80,000
Salaries and Wages Expense 51,000
Rent Expense 22,000
Supplies Expense 7,000
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 DO IT! 4b Closing Entries

Hancock Company has the following balances in selected accounts of its

adjusted trial balance.
Accounts Payable $27,000 Dividends $15,000
Service Revenue 98,000 Retained Earnings 42,000
Rent Expense 22,000 Accounts Receivable 38,000
Salaries and Wages Expense 51,000 Supplies Expense 7,000
Prepare the entries to close income summary and dividends.
SOLUTION
Income Summary 18,000
Retained Earnings 18,000
Retained Earnings 15,000
Dividends 15,000

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 APPENDIX 4A: Describe the purpose
LEARNING
OBJECTIVE *5 and the basic form of a worksheet.

Worksheet
 A multiple-column form that may be used in the
adjustment process and in preparing financial
statements.
 Manual or computer spreadsheet.
 A working tool, not a permanent accounting record.
 Neither a journal nor a part of the general ledger.

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 SIERRA CORPORATION ILLUSTRATION 4A-1
Worksheet Form and procedure
for a worksheet
For the Month Ended October 31,
2017 Adjusted Income
Trial Balance Adjustments Trial Balance Statement Balance Sheet
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200
Supplies 2,500
Prepaid Insurance 600
Equipment 5,000
Notes Payable 5,000
Accounts Payable 2,500
Unearned Service Revenue 1,200
Common Stock 10,000
Dividends 500
Service Revenue 10,000

Salaries & Wages Exp. 4,000

Rent Expense 900
Totals 28,700 28,700

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 SIERRA CORPORATION ILLUSTRATION 4A-1
Worksheet Form and procedure
for a worksheet
For the Month Ended October 31,
2017 Adjusted Income
Trial Balance Adjustments Trial Balance Statement Balance Sheet
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200 15,200
Supplies 2,500 (a) 1,500 1,000 1,000
Prepaid Insurance 600 (b) 50 550 550
Equipment 5,000 5,000 5,000
Notes Payable 5,000 5,000 5,000
Accounts Payable 2,500 2,500 2,500
Unearned Service Revenue 1,200 (d) 400 800 800
Common Stock 10,000 10,000 10,000
Dividends 500 500 500
Service Revenue 10,000 (d) 400 10,600 10,600
(e) 200
Salaries & Wages Exp. 4,000 (g)1,200 5,200 5,200
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense (a) 1,500 1,500 1,500
Insurance Expense (b) 50 50 50
Accumulated Depreciation (c) 40 40 40
Depreciation Expense (c) 40 40 40
Accounts Receivable (e) 200 200 200
Interest Expense (f) 50 50 50
Interest Payable (f) 50 50 50
Salaries and Wages Payable (g) 1,200 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590
Net Income 2,860 2,860
Totals 10,600 10,600 22,450 22,450

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 A Look at IFRS

LEARNING Compare the procedures for adjusting

OBJECTIVE 6 entries under GAAP and IFRS.

KEY POINTS
Similarities
 Companies applying IFRS also use accrual-basis accounting to
ensure that they record transactions that change a company’s
financial statements in the period in which events occur.
 Similar to GAAP, cash-basis accounting is not in accordance
with IFRS.

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 A Look at IFRS

KEY POINTS
Similarities
 IFRS also divides the economic life of companies into artificial
time periods. Under both GAAP and IFRS, this is referred to as
the periodicity assumption.
 The general revenue recognition principle required by GAAP
that is used in this textbook is similar to that used under IFRS.
 Revenue recognition fraud is a major issue in U.S. financial
reporting. The same situation occurs in other countries, as
evidenced by revenue recognition breakdowns at Dutch
software company Baan NV, Japanese electronics giant NEC,
and Dutch grocer Ahold NV.
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 A Look at IFRS

KEY POINTS
Differences
 Under IFRS, revaluation (using fair value) of items such as land
and buildings is permitted. IFRS allows depreciation based on
revaluation of assets, which is not permitted under GAAP.
 The terminology used for revenues and gains, and expenses
and losses, differs somewhat between IFRS and GAAP. For
example, income under IFRS includes both revenues, which
arise during the normal course of operating activities, and gains,
which arise from activities outside of the normal sales of goods
and services.

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 A Look at IFRS

KEY POINTS
Differences
 Under IFRS, expenses include both those costs incurred in the
normal course of operations as well as losses that are not part
of normal operations. This is in contrast to GAAP, which defines
each separately.

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 A Look at IFRS

LOOKING TO THE FUTURE

The IASB and FASB are completing a joint project on revenue
recognition. The purpose of this project is to develop comprehensive
guidance on when to recognize revenue. It is hoped that this approach
will lead to more consistent accounting in this area. For more on this
topic, see www.fasb.org/project/revenue_recognition.shtml.

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 A Look at IFRS

IFRS Practice
IFRS:
a) uses accrual accounting.
b) uses cash-basis accounting.
c) allows revenue to be recognized when a customer makes
an order.
d) requires that revenue not be recognized until cash is
received.

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 A Look at IFRS

IFRS Practice
Which of the following statements is false?
a) IFRS employs the periodicity assumption.
b) IFRS employs accrual accounting.
c) IFRS requires that revenues and costs must be capable of
being measured reliably.
d) IFRS uses the cash basis of accounting.

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 A Look at IFRS

IFRS Practice
Accrual-basis accounting:
a) is optional under IFRS.
b) results in companies recording transactions that change a
company’s financial statements in the period in which
events occur.
c) has been eliminated as a result of the IASB/FASB joint
project on revenue recognition.
d) is not consistent with the IASB conceptual framework.

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 COPYRIGHT

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