plain background power point slides chapter 3 using accrual accounting to measure income859

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©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Accrual Accounting and the Financial Statements

Chapter 3

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Learning Objective 1

Relate accrual accounting and cash flows.

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Accrual Accounting vs Cash Basis Accounting Accrual Accounting - records the

impact of a business event as it occurs

Cash Basis – records only transactions in which cash is received or paid

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The Time-Period Concept

Financial statements are prepared for specific periods and at regular intervals.

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Apply the revenue and matching principles.

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Revenue Principle

Revenue is recorded when it is earned.

The amount of revenue to record is the cash value of goods transferred to customer.

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The Matching Principle

Record all expenses incurred during the accounting period

Match expenses against revenues earned

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Update the financial statements by adjusting the accounts.

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Air & Sea Unadjusted Trial Balance April 30, 20x3

Account Debit CreditCash $24,800Accounts receivable 2,250Supplies 700Prepaid rent 3,000Furniture 16,500Accounts payable 13,100Unearned service revenue 450Common stock 20,000Retained earnings 11,250Dividends 3200 Service revenue $7,000Salary expense 950Utilities expense 400Total $51,800 $51,800

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Categories of Accounting Adjustments Deferrals Depreciation Accruals

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Prepaid Expenses: Rent

On April 1, 20x3, Air & Sea Travel prepays three months office rent.

3,000Prepaid Rent

3,000Cash

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Prepaid Expenses: Rent

What is the adjusting entry on April 30?

General Journal

Date Accounts and Explanations PR Debit Credit

April 30 Rent Expense 1,000Prepaid Rent 1,000

To record rent expense ($3,000 x 1/3)

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Prepaid Expenses: Supplies

On April 2, 20x3, Air & Sea Travel paid cash of $700 for office supplies.

700Supplies

700Cash

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Prepaid Expenses: Supplies

An inventory at month end indicated that $400 in office supplies remained.

4/2 700Supplies

4/30 300Bal. 400

Supplies Expense4/30 300Bal. 300

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Depreciation

Allocation of the cost of a plant asset to expense over the asset’s useful life

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Depreciation of Plant Assets

On April 3, the business purchased furniture on account for $16,500. The furniture is expected to last 5 years.

16,500Furniture Accounts Payable

16,500

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Straight-line method of depreciation allocates equal amounts each accounting period.

$16,000 ÷ 5 years = $3,300 per year

$3,300 ÷12 months = $275 per month

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What is the adjusting entry on April 30?

General Journal


April 30 Depreciation Expense, Furniture 275Accumulated Depreciation,Furniture 275

To record depreciation

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Book Value

The net amount of a plant asset (cost minus accumulated depreciation)

Furniture 16,500$ Less Accumulated Depreciation (275) 16,225$ Building 48,000$ Less Accumulated Depreciation (200) 47,800 Book value of plant assets 64,025$

Plant Assets of Air & Sea at April 30, 20x5

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Accrued Expense

A liability that arises from an expense that has not yet been paid.

Air & Sea Travel pays its employees a monthly salary of $1,900, half on the 15th and half on the last day of the month. If a payday falls on the weekend, Air & Sea pays the employee on the following Monday.

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Accrued Expenses

Salary Payable4/30 950Bal. 950

Bal. 1,9004/30 950

Salary Expense4/15 950

Cash4/15 950

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Accrued Revenue

A revenue that has been earned but not received in cash.

Bank One hires Air & Sea Travel on April 15 to arrange travel services on a monthly basis. Bank One will pay the travel agency $500 monthly, with the first payment on May 15.

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Accrued Revenues

Adjusting entry:

General Journal


April 30 Accounts Receivable 250Service Revenue 250

To accrue service revenue

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Unearned Revenue

An obligation arising from receiving cash before providing a service.

Plantation Foods engages Air & Sea Travel agreeing to pay the agency $450 monthly, beginning immediately. Air & Sea Travel collects the first amount on April 20 and earns one-third the last 10 days.

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Unearned Revenues

General Journal


April 20 Cash 450Unearned Revenue 450

Received advanced payment

General Journal


April 30 Unearned Revenue 150Revenue 150

To record revenue earned($450 x 1/3)

Air & Sea TravelWork Sheet

For the Month Ended April 30, 20x5

AccountUnadjusted Trial

Balance AdjustmentsAdjusted Trial

Balance Title Debit Credit Debit Credit Debit Credit

Cash 24,800 24,800 Accounts receivable 2,250 e. 250 2,500 Supplies 700 b. 300 400 Prepaid rent 3,000 a. 1000 2,000 Furniture 16,500 16,500 Accum depr, furn c. 275 275 Accounts payable 13,100 13,100 Salary payable d. 950 950 Income tax payable g. 540 540 Unearned svc rev. 450 f. 150 300 Common stock 20,000 20,000 Retained earnings 11,250 11,250

Dividends 3200 3,200 Service revenue $7,000 e. 250 $7,400

f. 150Salary expense 950 d. 950 1,900 Rent expense a. 1000 1,000 Supplies expense b. 300 300 Depr. Exp, furn. c. 275 275 Utilities expense 400 400 Income tax expense g. 540 540

Total $51,800 $51,800 3,465 3,465 53,815 53,815

Step 1Prepare

Unadjusted Trial BalanceStep 2

Plan Adjustments

Step 2Prepare Adjusted

Trial Balance

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Prepare the financial statements.

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Air & Sea Travel, Inc.Income Statement

Month Ended April 30, 20x5

Revenue:Service revenue $7,400

Expenses:Salary expense $1,900Rent expense 1,000Utilities expense 400Supplies expense 300Depreciation expense 275 3,875

Income before tax $3,525Income tax expense 540Net income $2,985

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Retained earnings, April 1, 20x5 $11,250Add: Net income 2,958

$14,235Less: Dividends ( 3,200)Retained earnings, April 30, 20x5 $11,035

Air & Sea Travel, Inc.Statement of Retained Earnings

Month Ended April 30, 20x5

Air & Sea Travel, Inc.Balance SheetApril 30, 20x5

AssetsCash $24,800Accounts receivable 2,500Supplies 400Prepaid rent 2,000Furniture $16,500 Less: Accumulated depreciation ( 275) 16,225

Total assets $45,925

LiabilitiesAccounts payable $13,100Salary payable 950Unearned revenue 300Income tax payable 540Total liabilities $14,890 Stockholders’ EquityCommon stock $20,000Retained earnings 11,035Total $31,031Total liabilities and stockholders’ equity $45,925

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Close the books.

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Closing Entries

Prepare the accounts for the next period’s transactions.

Transfer the revenue, expense, and dividends balances to Retained Earnings.

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Which AccountsNeed To Be Closed? Temporary accounts are closed

Revenue Expense Dividends

Permanent accounts are not closed Assets Liabilities Stockholders’ equity

Journalizing the Closing EntriesGeneral Journal


April 30 Service Revenue 7,400Retained Earnings 7,400

April 30 Retained Earnings 4,415Rent Expense 1,000Salary Expense 1,900Supplies Expense 300Depreciation Expense 275Utilities Expense 400Income Tax Expense 540

April 30 Retained Earnings 3,200Dividends 3,200

Posting the Closing Entries

Retained Earnings4,4153,200

11,250 7,40011,035

Rent Expense1,000 1,000

Other Expenses1,515 1,515

Service Revenue

7,400

7,000 250 1507,400

Dividends3,200 3,200

Salary Expense 950 9501,900 1,900

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Classifying Assets and Liabilities List assets and liabilities in order of

their relative liquidity. Liquidity - how quickly an item can

be converted to cash.

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Classifying Assets and Liabilities

Current assets

Long-term assets

Current liabilities

Long-term liabilities

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Use the current ratio and the debt ratio to evaluate a business.

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Current Ratio

Measures company’s ability to pay current liabilities with current assets

Total current assetsTotal current liabilities

Rule of thumb: A strong current ratio is 2.00

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The proportion of assets that is financed with debt.

Measures business’s ability to pay total liabilities

Total liabilitiesTotal assets

Debt Ratio

A low debt ratio is safer than a high debt ratio.

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End of Chapter 3

plain background power point slides chapter 3 using accrual accounting to measure income859

Documents

business event

financial statements

supplies expense

rent expense prepaid

cash flows

e general journal accoun

expensessalary expense

cash basis records