Chapter 2
Chapter 2
Chapter 2
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Acconting cycle
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Quick check- overview chapter 1
What is the accounting term of these definitions?
1. A list of all a company’s accounts with their account
numbers.
2. A system of accounting where every transaction
affects at least two accounts.
3. Summary device that is shaped like a capital “T” with
debits posted on the left side of the vertical line and
credits on the right side of the vertical line. A
“shorthand” version of a ledger.
4. A list of all the ledger accounts with their balances at
a point in time.
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Quick check- overview chapter 1
Answer:
1. A list of all a company’s accounts with their account
numbers. Chart of accounts
2. A system of accounting where every transaction
affects at least two accounts. Double – entry
system
3. Summary device that is shaped like a capital “T” with
debits posted on the left side of the vertical line and
credits on the right side of the vertical line. A
“shorthand” version of a ledger. T - account
4. A list of all the ledger accounts with their balances at
a point in time. The trial balance
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Learning objective
Differentiate between accrual and cash-basis
accounting.
Define and apply the accounting period concept,
revenue recognition and matching principles, and
time period concept.
Explain why adjusting entries are needed
Journalize and post adjusting entries
Explain the purpose of and prepare an adjusted trial
balance
Prepare the financial statements from the adjusted
trial balance
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Chapter’s contents
2.1 Accrual Accounting Versus Cash-Basis
Accounting
2.2 Other Accounting Principles
2.3 Why We Adjust the Accounts
2.4 Two Categories of Adjusting Entries
2.5 The Adjusted Trial Balance
2.6 The Financial Statements
2.7 Ethical Issues in Accrual Accounting
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2.1 Accrual Accounting Versus Cash-
Basis Accounting
Look at the picture, explain the difference between
the accrual basis and the cash basis:
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2.1 Accrual Accounting Versus Cash-
Basis Accounting
Accrual basis Cash basis
Records the effect of each Records only cash receipts
transaction as it occurs, and cash payments, that
that is: is:
• Revenues are recorded • Revenues are recorded
when earned when cash is received
• Expenses are recorded • Expenses are recorded
when incurred. when cash is paid
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2.1 Accrual Accounting Versus Cash-
Basis Accounting
Example 1: Smart Touch purchased $200 of office
supplies on account on May 15, 2013, and paid the
account in full on June 3, 2013. On the accrual basis,
the business records this transaction as follows:
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2.1 Accrual Accounting Versus Cash-
Basis Accounting
Example 2: Smart Touch performed service and
earned revenue on May 20,2013, but did not collect
cash until June 5, 2013. Under the accrual basis, the
business records:
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2.1 Accrual Accounting Versus Cash-
Basis Accounting
Answer:
1. Accrual basis
2. Cash basis
3. Accrual basis.
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2.2 Other Accounting Principles
2.2.1 The Accounting Period Concept
2.2.2 The Revenue Recognition Principle
2.2.3 The Matching Principle
2.2.4 The Time-Period Concept
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The Accounting Period Concept and
The Time-Period Concept
The time period (or periodicity) concept assumes
that the economic life of a business can be divided
into artificial time periods — generally a month, a
quarter, or a year.
The basic accounting period is one year, and
most businesses prepare annual financial
statements.
Calendar year: from January 1 through December
31.
Fiscal year: which ends on a date other than
December 31.
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The Revenue Recognition
Principle
Record revenue when it has been earned
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The Revenue Recognition
Principle
The amount of revenue to record.
Record revenue for the actual value of the item or service
transferred to the customer.
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The Matching Principle
measures all the expenses incurred during the period,
and
matches the expenses against the revenues of the
period.
Revenues expenses
earned are offset incurred in
this month against.... earning the
revenue
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Self check
1. Applying the revenue recognition principle
Northwest Magazine sells subscriptions for $36 for 12
issues. The company collects cash in advance and then
mails out the magazines to subscribers each month.
Requirement:
Apply the revenue recognition principle to determine
a. when Northwest Magazine should record revenue
for this situation.
b. the amount of revenue Northwest Magazine
should record for three issues.
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Self check
2. Applying the matching principle
Suppose on January 1 you prepaid apartment rent of
$5,700 for the full year.
Requirement: At July 31, what are your two account
balances for this situation?
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2.3 Why We Adjust the Accounts?
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2.3 Why We Adjust the Accounts?
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2.4 Two Categories of Adjusting Entries
Prepaid/deferrals Accrual
• The cash payment • Records an expense
occurs before an before the cash
expense is recorded payment.
• Or the cash receipt • Or it records the
occurs before the revenue before the cash
revenue is earned is received.
• Three types: • Two types:
Prepaid expenses Accrued expenses
Depreciation Accrued revenues
Unearned revenues
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Practice in group
Classify these adjusting entries which are prepaid or accrual:
a) Dr Rent expense f) Dr Accounts receivable
Cr Prepaid rent Cr Service revenue
b) Dr Interest expense g) Dr Depreciation expense
Cr Interest payable Cr Accumulated
c) Dr Unearned service revenue depreciation
Cr Service revenue
d) Dr Salary expense
Cr Salary payable
e) Dr Supplies expense
Cr Supplies
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Answer
Prepaid: a, c, e, g
Accrual: b, d, f
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2.4 Two Categories of Adjusting Entries
Adjusting Entries
Prepaid Expenses
Asset (prepaid) Expense
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2.4 Two Categories of Adjusting Entries
Prepaid Expenses
Answer :
• On May 1, 2013, the journal entry:
Dr Prepaid rent $3,000
Cr Cash $3,000
• On May 31, 2013, the adjusting entries:
Dr Rent expense $1,000
Cr Prepaid rent 1,000
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2.4 Two Categories of Adjusting Entries
Contra Adjusting Entries
asset
Depreciation
Accumulated depreciation Depreciation expense
Credit Debit
Adjusting Adjusting
Entry (-) Entry (+)
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2.4 Two Categories of Adjusting Entries
Depreciation
Answer:
• On May 3, 2013, the journal entry:
Dr Furniture $18,000
Cr Cash 18,000
• On May 31, 2013, the adjusting entries:
Dr Depreciation expense - furniture $300
Cr Accumulated depreciation - furniture 300
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2.4 Two Categories of Adjusting Entries
Accrued expenses
Liability Expense
Credit Debit
Adjusting Adjusting
Entry (-) Entry (+)
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2.4 Two Categories of Adjusting Entries
Accrued expenses
Answer:
• On May 15, 2013, the journal entry:
Dr Salary expense $900
Cr Cash $900
• On May 31, 2013, the adjusting entries:
Dr Salary expense $900
Cr Salary payable $900
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2.4 Two Categories of Adjusting Entries
Adjusting Entries
Accrued revenues
Assets (Accounts Receivable) Revenues
Debit Credit
Adjusting Adjusting
Entry (+) Entry (-)
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2.4 Two Categories of Adjusting Entries
Adjusting Entries
Unearned revenues
Assets (Accounts Receivable) Revenues
Debit Credit
Adjusting Adjusting
Entry (+) Entry (-)
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2.4 Two Categories of Adjusting Entries
Smart Touch at May 31
Information for adjustments at May 31, 2013:
a) Prepaid rent expired, $1,000.
b) Supplies used, $100.
c) Depreciation on furniture, $300.
d) Depreciation on building, $200.
e) Accrued salary expense, $900.
f) Accrued interest on note, $100.
g) Accrued service revenue, $400.
h) Service revenue that was collected in advance and
now has been earned, $200.
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2.4 Two Categories of Adjusting Entries
Adjusting entry
a) Dr Rent expense ($3,000 x 1/3) $1,000
Cr Prepaid rent $1000
b) Dr Supplies expense 100
Cr Supplies 100
c) Dr Depreciation expense - furniture $300
Cr Accumulated depreciation - furniture $300
d) Dr Depreciation expense - building $200
Cr Accumulated depreciation - building $200
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2.4 Two Categories of Adjusting Entries
Adjusting entry
e) Dr Salary expense $900
Cr Salary payable $900
f) Dr Interest expense 100
Cr Interest payable 100
g) Dr Accounts receivable $400
Cr Service revenue $400
h) Dr Unearned service revenue $200
Cr Service revenue $200
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2.4 Two Categories of Adjusting Entries
Ledger Accounts in T-account form
ASSETS LIABILITIES
Cash Accounts payable
Bal 4,800 Bal 18,200
Accounts receivable Salary payable
2,200 (e) 900
(g) 400
Bal 2,600 Bal 900
Supplies Interest payable
700 (b) 100 (f) 100
Bal 600 Bal 100
Prepaid rent Unearned service revenue
3,000 (a) 1,000 (h) 200 600
Bal 2,000 Bal 400
Furniture Notes payable
Bal 18,000 Bal 20,000
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2.4 Two Categories of Adjusting Entries
Ledger Accounts in T-account form
Building
Bal 48,000
Accumulated depreciation - furniture
(c) 300
Bal 300
Accumulated depreciation - building
(d) 200
Bal 200
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2.4 Two Categories of Adjusting Entries
Ledger Accounts in T-account form
OWNER’S EQUITY REVENUES
EXPENSES
Rent expense Salary expense
(a)1,000 900
(e) 900
Bal Bal 1,800
1,000
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2.4 Two Categories of Adjusting Entries
Ledger Accounts in T-account form
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2.5 The Adjusted Trial Balance
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2.6 The Financial Statements
SMART TOUCH LEARNING
Income Statement
Month Ended May 31, 2013
Revenue:
Service Revenue 7,600
Expenses:
Salary expense 1,800
Rent expense 1,000
Utilities expense 400
Depreciation expense - furniture
300
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2.6 The Financial Statements
SMART TOUCH LEARNING
Statement of Owner's Equity
Month Ended May 31, 2013
36,900
Drawing (1,000)
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2.7 Ethical Issues in Accrual
Accounting
Self - study
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Quick check - end chapter 2
1. Adjusting the accounts is the process of
a. subtracting expenses from revenues to measure net
income.
b. recording transactions as they occur during the
period.
c. updating the accounts at the end of the period.
d. zeroing out account balances to prepare for the next
period.
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Quick check - end chapter 2
2. Which types of adjusting entries are natural
opposites?
a. Net income and net loss
b. Expenses and revenues
c. Prepaids and accruals
d. Prepaids and depreciation
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Quick check - end chapter 2
2. Which types of adjusting entries are natural
opposites?
a. Net income and net loss
b. Expenses and revenues
c. Prepaids and accruals
d. Prepaids and depreciation
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Quick check - end chapter 2
3. Get Fit Now gains a client who prepays $540 for a
package of six physical training ses- sions. Get Fit Now
collects the $540 in advance and will provide the training
later. After four training sessions, what should Get Fit
Now report on its income statement?
a. Service revenue of $360
b. Service revenue of $540
c. Unearned service revenue of $360
d. Cash of $180
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Quick check - end chapter 2
4. Assume you prepay Get Fit Now for a package of six
physical training sessions. Which type of account should
you have in your records?
a. Accrued revenue
b. Accrued expense
c. Prepaid expense
d. Unearned revenue
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Quick check - end chapter 2
5. The adjusted trial balance shows
a. amounts that may be out of balance.
b. amounts ready for the financial statements.
c. assets, liabilities, and owner’s equity only.
d. revenues and expenses only.
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THANK FOR YOUR ATTENTION
Try your best – No pain No gain
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