MODULE TITLE: Establishing and Maintaining an Accrual Accounting System

At the end of this module the trainee will be able to

 Manage the chart of accounts
 Process invoices, adjustment notes and other general ledger transactions
 Identify and process bad debts
 Manage debt recovery
 Prepare and produce reports and trial balance
What is the Objectives the course?
To describe the meaning of Deferrals and Accruals, accounting treatment, and other aspects. In
addition to this course, explain about:

 identify the reasons why adjusting entries must be made

 Describe the basic characteristics of the accrual basis and cash basis of accounting
 Identify the classes and types of adjusting entries
 Prepare adjusting entries
Introduction
Financial statements reflect revenues when earned and expenses when incurred. This is known
as accrual basis of accounting. Accrual basis of accounting uses the adjusting process to
recognize revenues when earned and to match expenses with revenues. This means the
economic effects of revenues and expenses are recorded when earned or incurred, not when cash
is received or paid. The cash basis of accounting means revenues are recognized when cash is
recorded and that expenses are recorded when cash is paid.

Definitions and key concepts—the accrual basis accounting applies these principles:
A. define the cash basis and the accrual basis of accounting:
1. Cash basis—an accounting method in which an expense is recorded when cash is paid
and revenue is recorded when cash is received. Cash-basis accounting is not in
accordance with GAAP.
2. Accrual basis—an accounting method in which an expense is recorded when it is
incurred and revenue is recorded when it is earned. it is the basis of accounting in
which transactions that change a company’s financial statements are recorded in the
periods in which the events occur.
B. Define the matching principle.
1. Matching principle—the accounting principle that states that revenue earned during
an accounting period should be offset by the expenses that were incurred in earning
that revenue. The principle that efforts (expenses) be matched with accomplishments
(revenues).
2. how to apply the matching principle—at the end of the accounting period expenses
and revenues must be examined to find out what amounts belong to the period
regardless of when the related cash payments and receipts occur which means you
will need to adjust both expenses and revenues in order to apply the matching
principle.
3. to determine accurate net income:
all recognized revenues
 all matched expenses
recognized - matched expenses = accurate net income for the period
revenues

C. define the time period assumption:

1. An assumption that the economic life of a business can be divided into artificial time
periods.
2. owners and managers as well as other users need timely results of operations of a
business:
a) Management usually wants monthly financial statements.
b) Internal revenue service (IRS) requires all businesses to file annual tax returns.
D. fiscal and calendar years:
1. Accounting time periods are generally a month, a quarter, or a year. Monthly and
quarterly time periods are called interim periods—less than one year.
2. Fiscal year—an accounting period that is one year in length. a fiscal year usually
begins on the first day of a month and ends twelve months later on the last day of a
month.
3. Calendar year—an accounting period that extends from January 1 to December 31.
E. define the revenue recognition principle:
1. The principle that revenue be recognized in the accounting period in which it is
earned.
2. In a service enterprise, revenue is considered to be earned at the time the service is
performed.
F. Define accruals and deferrals.
1. Accruals—expenses incurred and revenue earned in the current accounting period but
not paid and received as of the end of the period. to accrue means to build up or to
accumulate. Thus, an accrual is a buildup or accumulation of revenue or an expense
that has not been recorded by a routine journal entry.
2. Deferrals—expenses and revenues that have been recorded in the current accounting
period but are not incurred or earned until a future period. To defer means to put off
or to postpone. Thus a deferral is a putting off or a postponement of revenue or an
expense that has been recorded by a routine journal entry but belongs to the future.
G. Define the going concern concept—financial reports of a business are prepared with the
expectation that the business will remain in operation indefinitely. Since this concept
assumes that a business will continue indefinitely into the future, by accruing expenses
and revenues, it is understood that the business has a future.
H. the basics of adjusting entries:
1. Adjusting entries are entries made at the end of an accounting period to ensure that
the revenue recognition and matching principles are followed.
2. Adjusting entries are required every time financial statements are prepared and are
dated as of the balance sheet date.
3. adjusting entries are needed because:
 a) Some events are not journalized daily because it is in expedient to do so.
Examples are the consumption of supplies and the earning of wages by
employees.
b) Some costs are not journalized during the accounting period because they expire
with the passage of time rather than through recurring daily transactions.
Examples are equipment deterioration, and rent and insurance expiring.
c) some items may be unrecorded. An example of a utility bill that will not be
received and/or paid until the next accounting period.
Types of adjusting entries:
4. prepayments:
a) Prepaid expenses—expenses paid in cash and recorded as assets (or expenses as
shown in the chapter appendix—alternative treatment of prepaid expenses) before
they are used or consumed. Depreciation of plant assets falls into this category.
b) Unearned revenues—cash received and recorded as liabilities (or revenues as
shown in the chapter appendix—alternative treatment of unearned revenues)
before revenue is earned.
5. accruals:
a) Accrued revenues—revenues earned but not yet received in cash or recorded.
b) Accrued expenses—expenses incurred but not yet paid in cash or recorded.

ii. Accounting for accrued expenses—adjusting entries for accruals. The accrual of expenses
creates liabilities. Expenses that have been incurred but not yet recorded at the end of an
accounting period require an adjusting entry to recognize both the proper amount of expense
for the period on the income statement and the proper amount of liabilities on the balance
sheet. Accrued expenses are also called accrued liabilities because accrued expenses have
not been paid as of the end of the period and thus represent a liability of the firm. Helpful
hint to remember what is done with accruals: the “a” in accrual means add to expense or
revenue as the adjusting entry will be adding to expenses or to revenues.

A. explain accrued salaries and the adjustment needed:

1. How accrued salaries occur—accrued salaries occur only when the last day of the
payroll period and the last day of the accounting period are different days.
2. steps to accrue salaries:
a. Determine the days to accrue: be careful determining the number of days to
accrue salaries. Best way to determine the number of days to accrue is to set up a
calendar of the week and notate what day the year ends. You are accruing the
expense for the current year (2014) not the following year (2015). if $20,000 is
the weekly payroll, the daily amount for a five-day work week would be $4,000:

2014 2015
Dec. 29 30 31 Jan. 1 2
Monday Tuesday Wednesday Thursday Friday total
 $4,000 $4,000 $4,000 $4,000 $4,000 $20,000
$12,000 is accrued $8,000 is not accrued

b. Determine the amount to accrue: $20,000 is total payroll ÷ 5 days = $4,000 per
day x 3 days (Dec. 29 – Dec. 31) = $12,000.
c. prepare the adjusting entry:
general journal page 1
Date account title P.R. debit credit
2014 adjusting entries
Dec. 31 salaries expense 12,000.00
salaries payable 12,000.00

3. An adjusting entry, such as one for an accrued expense, affects both the income
statement and the balance sheet) as it results in an increase (debit) to an expense
account and an increase (credit) to a liability account. in the case of an accrued
expense such as accrued salaries, the income statement is affected because an expense
account (salaries expense) is debited; a balance sheet account is affected because a
liability account (salaries payable) is credited

Solve the follow problem

1. The transactions for the year 2006 for MK. Company have already been recorded.
This problem shows how to prepare adjusting entries for December 2006.

Dec. 31 a note payable of $6,000 has been outstanding since September 1, 2000.
Under the terms of the note, the note plus interest (12%) is to be paid on March 1,
2001. no interest has been recorded on the note.
Dec. 31 wages of $650 for December will be paid in January.
Dec. 31 services were performed for a client for $800. The client has not been
billed yet.
Dec. 31 advertising costs of $105 for December will be paid in January.
Date account debit credit
2000
Dec. 31 interest expense 240
interest payable 240
Dec. 31 wages expense 650
wages payable 650
Dec. 31 accounts receivable 800
service revenue 800
Dec. 31 advertising expense 105
accounts payable 105
 2. The transactions for the year 2000 for comfort furniture co. have been recorded in
the accounting system. This assignment requires you to prepare adjusting entries
for comfort furniture co. for December 2000.

Dec. 31. wages owed but unpaid at the end of December were $5,000.
Dec. 31. the company signed a 12%, six-month note for $6,000 on November 1, 2000.
No interest has been recorded for November and December.
Dec. 31. service provided to a customer for $350 has not been recorded.
Dec. 31. advertising cost of $90 for December has not been recorded.
date account debit credit
2000
Dec. 31 wages expense 5,000
wages payable 5,000
Dec. 31 interest expense 120
interest payable 120
Dec. 31 accounts receivable 350
service revenue 350
Dec. 31 advertising expense 90
accounts payable 90
Adjustment of allowance for doubtful debt accounts receivable should be presented in the
balance sheet at net realizable value, i.e. the most probable amount that the company will be able
to collect.
Net realizable value for accounts receivable is computed like this:
Accounts receivable - gross amount $ 100,000
Less: allowance for bad debts 3,000
Accounts receivable - net realizable value $ 97,000

Chart of accounts
Objective 3:- Illustrate chart of account & nature of an account
The number of accounts maintained by a specific enterprise is affected by the nature of its
operation, its volume of business, the extent to which details are needed for taxing authorities,
managerial decisions credit purpose etc...
Chart of account is the listing of the accounts in the ledger it is used as a reference or index. To
illustrate
Balance sheet Income statement
1. Assets 22. Salaries payable
11. Cash 3. Owners equity
12. Account receivable 31. X-capital
14. Supplies 32. Y-capital
15. Prepaid rent 33. Income summary
18. Photographic equipment 4. Revenue
19. Accumulated deprecation 41. Sales
2. Liabilities 5. Expense
21. Account payable 51. Supplies expense
52. Salary expense
53. Rent expense
54. Depreciation expense
55. Miscellaneous expense
Note:-
 The first digit represents the account division
 The second digit represents the position of the account in the division.

The initial preparation of the ledger based on the chart of accounts is often referred to as opening
the ledger.
Nature of accounts
Objective 4:- Describe the nature of an account
The simplest form of an account has three parts
1. Title:- the name of the item recorded
2. The space of recording increase
3. The space of recording decrease

Title
Left side Right side
Debit (charge) Credit

The left side of the account is called the debit side & the right side is called Credit. The amount
entered in the left side to be debited (charge) & the amount entered in the right side to be
credited. Every business transaction affects a minimum of two accounts (the concept of double
entry system).
Normal Balances of accounts (the rule of debit & credit)

Increase Decrease Normal balance

1. Balance sheet account
 Asset Debit Credit Debit
 Liability Credit Debit Credit
 Owners equity
 Capital stock Credit Debit Credit
 Retained earning Credit Debit Credit
 Drawing & dividend Debit Credit Debit
2. Income statement
 Revenue Credit Debit Credit
 Expense Debit Credit Debit
 Journal & Ledger
Describe Journal & Accounts
Journal
The information is initially entered in a record called a journal. The process of recording a
transaction in the journal is called journalizing & the form of presentation is called journal
entry.
Example 1:- Carl Davis establishes a business venture by initially depositing $ 3,500 cash in
bank account. Journal entry to record the given transaction is

Cash $3,500
Carl Davis capital $3,500

The data in the journal entry are transferred to the appropriate account by a process known as
posting.
Cash Owners equity

$3,500 $3500

An entry composed of two or more debits or two or more credits is called a compound journal
entry. The flow of accounting data from the time a transaction occurs to its recording in the
ledger may be presented as.

Business
transactio
n Business
occurs
documen
t Entry
prepared recorded
in Entry
the journ posted to
al
the ledge
r

N.B:- The transactions are entered in chronological order in a journal.

 General journal and general ledger
A general ledger, which is simply a collection of your account charts, is a simple and effective
way to view spending and to keep your business on track. The general ledger is used in
combination with accounting journal entries. In other word a ledger is a book (or record) for
collecting chronological transaction data from a journal, and organizing entries by account.

The ledger provides the transaction history and current balance in each accounting system
account, throughout the accounting period. At the end of the period, ledgers therefore serve as
the authoritative source of data for building a firm's financial accounting reports, including the
income statement and balance sheet
The format of ledger account and posting process
The process of posting journal entries to ledger accounts is very simple. No new information is
needed to prepare ledger accounts. The information that has already been recorded in the journal
is just transferred to the relevant ledger accounts.
For the purpose of posting, we can divide a journal entry into two parts – a debit part and a credit
part. Both the parts essentially contain one or more accounts. The amount of the account in the
debit part of the entry is written on the debit side of the account and the amount of the account in
the credit part of the entry is written on the credit side of the account in the ledger.
To understand the process of posting and to illustrate the format of ledger accounts, we would
take a transaction, prepare a journal entry and then transfer it to the ledger accounts.

Example
Transaction: On January 1, 2015, US Company sold goods to customers for cash $25,000.
The journal entry of the above transaction and its posting to ledger accounts is illustrated below:
The debit part of the above journal entry is cash account and the credit part is sales account. So
the amount of the journal entry ($25,000) is written on the debit side of the cash account and
credit side of the sales account. All journal entries are posted to ledger accounts in a similar way.

Example:
The Moon Service Inc. engaged in the following transactions during the month of November
2015:
Nov. 01: Issued 20,000 shares of common stock at $20 per share
Nov. 03: Paid office rent for the moth of November $500.
Nov. 06: Purchased office supplies $250.
Nov.12: purchase office equipment $4500 on account.
Nov. 16: Purchased business car for $25,000. Paid $10,000 cash and issued a note for the
balance.
Nov. 21: Billed clients $24,000 on account.
Nov. 25: Declared dividends $3,000. The amount of dividends will be distributed in December.
Nov. 28: Paid utility bills for the month of November $180.
Nov. 29: Received $20,000 cash from clients billed on November 21.
Nov. 30: Paid salary for the month of November $7,500
Required: Record the above transactions in a general journal.
Solution:
We can prepare ledger accounts using journal entries of Moon Service Inc. prepared on the
journal entries page.