Preview of Chapter 4 Financial Accounting Seventh Edition Kimmel Weygandt Kieso 4 1 Timing Timing Issues Issues Accountants divide the economic life of a business into artificial time periods Periodicity Assumption Jan 4 2 Feb Mar Apr Generally a month a quarter or a year Fiscal year vs calendar year Dec LO 1 Explain the revenue recognition principle and the expense recognition principle Timing Timing Issues Issues The Revenue Recognition Principle Companies recognize revenue in the accounting period 4 3 LO 1 Explain the revenue recognition principle and the expense recognition principle Timing Timing Issues Issues Example Example A customer booked a ticket with USAirways on January 15 and paid cash to USAirways on February 14 The flight took place on April 15 According to the revenue recognition principle in which month should USAirways recognize this revenue 4 4 LO 1 Explain the revenue recognition principle and the expense recognition principle Timing Timing Issues Issues 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 4 5 LO 1 Explain the revenue recognition principle and the expense recognition principle Timing Timing Issues Issues Illustration 4 1 Partial Let the expenses follow the revenues 4 6 LO 1 Explain the revenue recognition principle and the expense recognition principle Timing Timing Issues Issues Accrual versus Cash Basis of Accounting Accrual Basis Accounting Transactions recorded in the periods in which the events occur Revenues are recognized when services performed Expenses are recognized when incurred 4 7 LO 2 Differentiate between the cash basis and the accrual basis of accounting Timing Timing Issues Issues Accrual versus Cash Basis of Accounting Cash Basis Accounting Revenues are recognized only when cash is received Expenses are recognized only when cash is paid Prohibited under generally accepted accounting principles GAAP 4 8 LO 2 Differentiate between the cash basis and the accrual basis of accounting Timing Timing Issues Issues Illustration Suppose that Fresh Colors paints a large building in 2013 In 2013 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 2014 Illustration 4 2 Partial 2013 4 9 2014 LO 2 Differentiate between the cash basis and the accrual basis of accounting The The Basics Basics of of Adjusting Adjusting Entries Entries Adjusting entries 4 10 ensure that are required includes one income statement account and one balance sheet account never include LO 3 Explain why adjusting entries are needed and identify the major types of adjusting entries Types Types of of Adjusting Adjusting Entries Entries Deferrals 1 Prepaid expenses 2 Unearned revenues Illustration 4 3 Categories of adjusting entries Accruals 4 11 1 Accrued revenues 2 Accrued expenses LO 3 Explain why adjusting entries are needed and identify the major types of adjusting entries Types Types of of Adjusting Adjusting Entries Entries Trial Balance Each account is analyzed to determine whether it is complete and upto date Illustration 4 4 4 12 LO 3 Explain why adjusting entries are needed and identify the major types of adjusting entries Adjusting Adjusting Entries Entries for for Deferrals Deferrals Deferrals are either Prepaid expenses OR 4 13 Unearned revenues LO 4 Prepare adjusting entries for deferrals Adjusting Adjusting Entries Entries for for Prepaid Prepaid Expenses Expenses Payment of cash that is recorded as an asset because service or benefit will be received in the future such as Prepaid Insurance 12 000 Cash Cash Payment 12 000 BEFORE Expense Recorded Prepayments often occur in regard to rent insurance 4 14 supplies equipment advertising buildings LO 4 Prepare adjusting entries for deferrals Adjusting Adjusting Entries Entries for for Prepaid Prepaid Expenses Expenses Adjusting entries for prepaid expenses Illustration 4 5 4 15 LO 4 Prepare adjusting entries for deferrals Adjusting Adjusting Entries Entries for for Prepaid Prepaid Expenses Expenses 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 2 500 1 000 1 500 4 16 Illustration 4 6 Partial LO 4 Prepare adjusting entries for deferrals Adjusting Adjusting Entries Entries for for Prepaid Prepaid Expenses Expenses Illustration On October 4 Sierra Corporation paid 600 for a oneyear 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 Illustration 4 7 Partial 4 17 LO 4 Prepare adjusting entries for deferrals Adjusting Adjusting Entries Entries for for Prepaid Prepaid Expenses Expenses Let s practice Do Brief Exercises BE 4 4 and 4 6 4 4 Foley Advertising Co s trial balance at Dec 31 shows Supplies 8800 and Supplies Expense 0 On December 31 there are 1 100 of Supplies on hand Prepare the adjusting entry at Dec 31 and using t accounts enter the balance in the accounts post the adjusting entry and indicate the adjusted balance in each account 4 18 LO 4 Prepare adjusting entries for deferrals 4 19 4 6 On July 1 2014 Seng Co pays 12 400 to Nance Insurance Co for a 2 yr insurance contract Both companies have fiscal years ending December 31 For Seng Co journalize and post the entry on July 1 and the adjusting entry on Dec 31 Adjusting Adjusting Entries Entries for for Prepaid Prepaid Expenses Expenses Depreciation 4 20 Buildings equipment and motor vehicles long lived assets are recorded as rather than an expense in the year acquired Companies report a portion of the cost of a long lived asset as an depreciation during each period of the asset s useful life Depreciation does not attempt to report the actual change in the value of the asset LO 4 Prepare adjusting entries for deferrals Adjusting Adjusting Entries Entries for for Prepaid Prepaid Expenses Expenses Illustration For Sierra Corporation assume that depreciation on the office equipment is 480 a year or 40 per month Oct 31 Illustration 4 8 Partial 4 21 LO 4 Prepare adjusting entries