Chapter 3 Notes

Accrual Accounting and Income

Learning Objectives:
1. Explain how accrual accounting differs from cash-basis accounting
2. Apply the revenue recognition and expense recognition (matching) principles
3. Adjust the accounts
4. Construct financial statements
5. Close the books
6. OMIT: Analyze and evaluate a company’s debt-paying ability
7. OMIT: Describe data visualization and two basic chart types

Revenue Recognition Principle

• Revenue: increase in net assets from day to day operations
• Gain: increase in net assets from peripheral or incidental transactions
• Net Assets = Assets – Liabilities
o Increase in Net Assets: either Assets increase or Liabilities decrease
 For Revenues and Gains an Increase in Net Assets is either
• Cash ↑ or AR ↑ or NR ↑ or Unearned Revenue ↓

Revenues / Gains
Dr Cr ↑ Revenue → NI → RE

• Revenue Recognition Principle: explains the timing and measurement of

revenues/gains for firms.
o Timing: when to recognize the revenue.
 Recognize revenue when EARNED.
 Earned: when a good is transferred or a service is performed

o Measurement: What amount of revenue to recognize.

 Cash realized today or the today’s realizable cash equivalent of
future payments.
 Realized: cash has been received
 Realizable: cash is expected to be received and can be measured.

Revenue Before Cash Received Same Time as Cash After Cash Received
Recognized? (Accrual) Received (Deferral)
Journal Entries 2 Journal Entries: 1 Journal Entries: 2 Journal Entries:
Required: 1. ↑ Receivable; 1. ↑ Cash; 1. ↑ Cash;
↑ Revenue ↑ Revenue ↑ Liability

2. ↑ Cash; 2. ↓ Liability;
↓ Receivable ↑ Revenue

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 1
Matching Principle (Expense Recognition Principle)
• Expense: decrease in net assets from day to day operations
• Loss: decrease in net assets from peripheral or incidental transactions
• Net Assets = Assets – Liabilities
o Decrease in Net Assets: either Assets decrease or Liabilities increase

Expenses / Losses
Dr Cr Expense → NI → RE

• Matching Principle: explains the timing and measurement of expenses/losses for

firms.
o Timing: when to incur the expenses/losses.
 Direct Matching: match expenses with revenues recognized in the
same accounting period
• Expense follows the revenue; the revenue must be
recognized before the expense can be matched.
 Example: Our firm sells cars. Before we sell the car, the cost of the
car is considered to be an asset called inventory. When we sell a
car, we recognize Sales Revenue. Then we must incur the expense
of the cost of the car by removing the cost of the car from Inventory
and increasing Cost of Goods Sold. The COGS only increased
because we increased our Sales Revenue.

 Indirect Matching: match expenses with a particular period

instead of a revenue.
• Examples: Depreciation on a building, CEO salary, Utility
expense, Rent expense, Insurance expense.

o Measurement: What amount of expense to incur.

 Cash paid today or today’s cash equivalent of future payments.

Expense Before Cash Paid Same Time as After Cash Paid

Incurred? (Accrual) Cash paid (Deferral)
Journal Entries 2 Journal Entries: 1 Journal Entries: 2 Journal Entries:
Required:
1. ↑ Expense; 2. ↑ Expense; 1. ↑ Prepaid Asset;
↑ Liability ↓ Cash ↓ Cash

2. ↓ Liability; 2. ↑ Expense;
↓ Cash ↓ Prepaid Asset

Activity #1

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 2
Accrual Basis Accounting versus Cash Basis Accounting
• Accrual basis accounting
o Revenues are recognized when they meet revenue recognition principle
o Expenses are incurred when they meet matching principle.
o Accounting Ph.D. research shows:
 Accrual Basis Accounting results in “smooth” earnings.
 Accrual Basis Accounting Net Income which is a better indicator of
future cash flows.

• Cash Basis accounting

o Revenues are recognized when cash is
o Expenses are incurred when cash is
 Real accounts: Cash and Equity
 Nominal Accounts: Revenue, Expense, Withdrawal by owners (all close
to equity)
o Accounting Ph.D. research shows:
 Cash Basis Accounting results in “lumpy” earnings.
 Cash Basis Accounting is not indicative of what resources were
given up or revenues earned during a period of time.

Which Basis of Accounting is Best?

• Cash basis financial statements are easier to prepare; however, accrual basis
financial statements are required under Generally Accepted Accounting Principles
(GAAP).
• Accounting researchers have generally determined that accrual-based income
statements and balance sheets are more informative of current operations AND
more predictive of future profitability (and even more predictive of future cash
flows).
• Note that public companies MUST use accrual basis accounting.
• Private companies (such as sole proprietorships, partnerships and private
corporations) can use EITHER Cash OR Accrual Basis. However, if a private
company has a lot of bank financing, the bank may require annual financial
statements that are prepared in accordance with GAAP (which means the
financial statements would need to be accrual basis financial statements).

In this class, we will ALWAYS USE ACCRUAL BASIS ACCOUNTING (which is

in accordance with GAAP).

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 3
Example of Accrual versus Cash Basis Accounting
Assume that Cortana has invested $1,500 in her business. She will buy and sell radar jammers to
Elites. Cortana can purchase radar jammers for $12 and sell them for $20. She starts out on her
first day. She leases a booth for $300 a day from the Arbiter (the Arbiter extends credit and lets
Cortana pay for the booth at the end of the week). Cortana purchases 100 radar jammers for $12
each ($1,200). Cortana is able to sell all 100 of the radar jammers for $20 each (total of $20 *
100 radar jammers or $2,000). However, only 25 jammers are sold for cash and the remaining 75
jammers are sold on credit and Cortana will get the money at the end of the week.

First, let's consider how much cash Cortana has at the end of day 1.

Starts with $1,500

Rents booth no effect on cash (Cortana doesn't have to pay until later)
Purchases radar jammers minus $1,200
Sells 25 jammers for cash add $500 (25 jammers for $20 each)
Sells 75 jammers on credit no effect on cash (Cortana won't collect cash until later)
Ending Cash Balance $800

The cash that Cortana has is the same regardless of whether she is using accrual or cash basis
accounting. However, the Income Statement and Balance Sheet will look very different:

INCOME STATEMENT FOR DAY 1:

Accrual Basis Cash Basis
Revenue (100 jammers X $25) $2,000 Revenue (25 jammers X $25) $500
Less expenses:
Cost of jammers ($12 x 100) $1,200 Cost of jammers ($12 x 100) $1,200
Booth fee $300 Booth fee (didn't pay yet) $ 0 .
Net Income $500 Net Loss ($700)

BALANCE SHEET AT THE END OF DAY 1:

Accrual Basis Cash Basis
Cash $800 Cash $800
A/R ($20 X 75 jammers) $1,500 A/R $0
Inventory $0 Inventory $0
Total Assets $2,300 Total Assets $800

Accounts Payable (booth fee) $300 Accounts Payable $0

Owner's Equity (original investment) $1,500 Owner's Equity $1,500
Retained Earnings (the net income) $500 R/E (the net loss) ($700)
Total Liabilities & Equity $2,300 Total Liabilities & Equity $800

Note that net income is drastically different depending on whether the accrual basis or the cash
basis of accounting is used. Cash basis Net Income is simply the cash received for revenues less
the cash paid out for expenses. Accrual basis Net Income recognizes revenue EARNED and
expenses INCURRED regardless of when the cash is exchanged. Also, note that the balance
sheet is very different. While the cash account is the same regardless of the method used, Cash
Basis Balance Sheets do NOT recognize accounts receivable or accounts payable.

Activity #2

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 4
 12 Steps of Accounting Cycle (continued from Chapter 2)

1. 2. 3. 4.
5. End of Period 6. Adj. Journal Entries (AJE) 7. Post to Ledger 8. Adjusted TB
9. Prepare FS 10. Closing Entries (CJE) 11. Post to Ledger 12. Post-closing TB

Step 5. End of Period

• End of Period: artificial time period like end of quarter or fiscal year.
• Going Concern Assumption: assumes firm will have infinite life
o To know how well the business did, we would have to shut down the
business, selling all assets, paying all liabilities, and returning remainder to
owners.
o But we don’t want our firm to go out of business so we assume….
• Periodicity Assumption: breaks life of firm into artificial time periods for the
purpose of creating financial statements.
o Ensures accounting information is reported in regular intervals

Step 6. Record Adjusting Entries (AJE)

• Adjusting Journal Entries: journal entries made at the end of the accounting
period to bring all accounts up to date so that financial statements can be prepared
on an accrual basis.
o Update all unrecorded Revenues and Expenses due to the passage of

o Ensure that Revenue Recognition & Expense Recognition (Matching)

Principles are being followed. These two principles make up the accrual
basis of accounting.

o Required by Going Concern and Periodicity Assumptions.

• Rules of Adjusting Entries:

1. Do not include cash in adjusting entry
2. Every adjusting entry always affects:
 at least one account (asset, liability, or equity account)
 and at least one account (revenue or expense account)

• Adjusting entries are either Accruals or Deferrals

o Accruals: when revenue recognized or expense incurred before cash
changes hands
o Deferrals: Cash changes hands before the revenue is recognized or the expense is
incurred.

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 5
 • Accrued revenues (assets): revenue is recognized before cash is received
o Happens when
 1) time has passed and customer has received some service/goods
 and 2) the customer intends to pay in the future.
o At end of period, the adjusting entry will:
 1) recognize the correct amount of revenue earned
 and 2) adjust the firm’s assets (increase receivables) to reflect how much
the firm will receive in the future from the customer.

Example 1: On Oct 1, 2021, Sparky invests $20,000 in a Note Receivable earning

8% interest annually. The note matures on Sept 30, 2022. Principal and interest
to be received at maturity. Sparky’s year-end is Dec 31. Provide the required
AJE, use GJEF.

10/1/2021 Note Receivable (CD) 20,000

Cash 20,000

Suppose the company didn’t recognize the revenue until it received the cash. How
would the assets, liabilities, equity and net income be affected in 2021 and 2022?
Assets Liabilities Equity NI Assets Liabilities Equity NI
12/31/2021 12/31/2021 12/31/2021 2021 12/31/2022 12/31/2022 12/31/2022 2022
↓ 400 OK ↓ 400 ↓ 400 OK OK OK ↑ 400

Rev ↓ Rev ↑

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 6
 • Accrued expenses (liabilities): expenses incurred before cash is paid
o Happens when
 1) time has passed and firm has received some service or goods
 and 2) firm intends to pay in the future.
o At the end of the period, the adjusting entry will
 1) incur the correct amount of expense due to the passage of time
 and 2) adjust (increase) the firm’s liabilities to reflect how much it owes.

Example 2: Sparky pays employees every other Friday. Employees work 5 days
(M-F) and earn $1,000/day. Fiscal year-end and Dec 31, 2021 falls on the second
Wednesday in the pay period. Provide the required AJE and the entry on Jan 2,
2022 (pay day), use GJEF.

Suppose the company didn’t incur the expense until it paid the cash on Jan 2,
2022. How would the assets, liabilities, equity and net income be affected in
2021 and 2022?
Assets Liabilities Equity NI Assets Liabilities Equity NI
12/31/2021 12/31/2021 12/31/2021 2021 12/31/2022 12/31/2022 12/31/2022 2022
OK ↓ 8k ↑ 8k ↑ 8k OK OK OK ↓ 8k

↓ Exp ↑ Exp

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 7
 • Deferred revenues (aka Unearned Revenues): cash is received before revenue is
recognized
o Happens when
 1) customer prepays the firm for service or goods; creating a liability
(Unearned Revenue) on the firm’s books
 and 2) time has passed and customer has received some or all of the
prepaid service or goods thus reducing the firm’s liability.
o At end of period, the adjusting entry will
 1) recognize the correct amount of revenue earned due to passage of time
 and 2) adjust the firm’s obligation (decrease liabilities) to provide
goods/services in the future.

Example 3: College Rentals, Inc. receives $1,800 for 6 months rent from a tenant
on November 1, 2021, with the original journal entry crediting a real account.
Determine the original journal entry; then provide the necessary adjusting entry
on December 31, 2021.

Suppose the company forgot to do the adjusting entry. How would the assets,
liabilities, equity and net income be affected in 2021 and 2022?

Assets Liabilities Equity NI Assets Liabilities Equity NI

12/31/2021 12/31/2021 12/31/2021 2021 12/31/2022 12/31/2022 12/31/2022 2022
NE ↑ 600 ↓ 600 ↓600 NE OK OK ↑600
Rev ↓ Rev ↑

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 8
 • Deferred expenses (aka Prepayments): cash is paid before the expense is
incurred.
o Happens when
 1) firm prepays for future service or goods
 and 2) time has passed and firm has received some or all of the prepaid
service or goods.
o At the end of the period, the adjusting entry will
 1) incur the correct amount of expense due to the passage of time
 and 2) adjust the unexpired costs (decrease the prepaid asset) that will be
used in future periods.

Example 4: Torchy’s Tacos paid $2400 for a two-year insurance policy on

October 1, 2021, with the original journal entry debiting a real account.
Determine the original journal entry; then provide the necessary adjusting entries
on December 31, 2021 and 2022.

Suppose the company forgot to do both adjusting entries. How would the assets,
liabilities, equity and net income be affected in 2021 and 2022?
Assets Liabilities Equity NI Assets Liabilities Equity NI
12/31/2021 12/31/2021 12/31/2021 2021 12/31/2022 12/31/2022 12/31/2022 2022
↑ 300 NE ↑ 300 ↑300 ↑ 1500 NE ↑1500 ↑1200
↓ Exp ↓ Exp

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 9
Overview of Accrual and Deferral Adjusting Entries

• Accruals: when revenue recognized or expense incurred before cash changes

hands.
o Accrued Revenues

End of Period ?????? Receivable xxx

AJE ??????? Revenue xxx

o Accrued Expense

End of Period ?????? Expense xxx

AJE ??????? Payable xxx

• Deferrals: Cash changes hands before the revenue is recognized or the expense is
incurred.

o Deferred Revenues

End of Period Unearned Revenue xxx

AJE Revenue xxx

o Deferred Expenses

End of Period ?????? Expense xxx

AJE Prepaid ?????? Expense xxx

ABCD:

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 10
Special types of adjusting entries
o Estimated items: expenses such as depreciation and bad debts whose
amounts are a function of unknown future events or developments.

 Depreciation-When a fixed asset is acquired, its cost is recorded in an

asset account. As the asset helps to generate revenue, the cost is converted
to an expense.

At this point we will review the simplest type of depreciation, straight line.

Straight Line Depreciation expense =Historical Cost – Est. Salvage Value

Est. Useful Life

Example 5: Truck cost $19,000, salvage value $2,000, estimated useful life is 4 years,
and acquired on August 1 of this year. Provide the journal entries to acquire the truck and
the adjusting entry at December 31.

8/1 Equipment (Truck) 19,000

Cash 19,000

SL Depr. Exp. = 19,000 HC -2,000 salvage= 4,250 per year *5/12 = 1,770
4 years useful life

12/31 Depreciation Expense 1,770

Accumulated Depr. 1,770

Equipment (Truck) Accumulated Depreciation

$19,000 $1,770

Presentation on Balance Sheet

Equipment $19,000
Less: Accumulated Depreciation <1,770>
Book Value of Equipment 17,230

Activity #3 (AJE only)

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 11
 Step 7. Post AJE to the General Ledger

Step 8. Prepare an Adjusted Trial Balance

• Adjusted Trial Balance: a listing of all accounts (real and nominal) and their
balances at the end of the period after adjusting entries have been recorded.
• Goal is to ensure Debits = Credits

Activity #3 (Adjusted Trial Balance)

You just completed the first 8 of the 12 Steps of the Accounting Cycle. Write them in
order.
1. 2. 3. 4.
5. 6. 7. 8.

Do you see a pattern forming in the steps? What is it? Do you think it will continue?

Step 9: Prepare Financial Statements!!!!

• Use the Adjusted Trial Balance to prepare statements
• Statement always prepared in the following order:
1. Income Statement or Statement of Comprehensive Income
2. Retained Earnings Statement or Statement of Changes in Equity
3. Balance Sheet
4. Statement of Cash Flows

Income Retained Cash Flow

Statement Earnings Balance Sheet Statement
Statement
Revenues $ XX Beg. R.E. (Jan 1) $ XX Assets = Liabilities + Equity C.F. Operations $ XX
- COGS (XX) + Net Income (CY) XX + C.F. Investing XX
Gross Profit XX - Dividends Declared (XX) + C.F. Financing XX
- Operating Exp (XX) End. RE (Dec 31) $ XX CS + RE +/- OCI Change in Cash XX
+/- Gain/Loss XX + Beg. Cash (Jan 1) XX
Inc B-4 Tax XX End. Cash (Dec 31) XX
- Inc Tax Exp (XX)
NET INCOME $ XX

Activity #4 & #5

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 12
Classified Balance Sheet – Splits Assets & Liabilities into Current & Long-term
1. Assets: Probable future economic benefits (resources) owned by or owed to the firm.
Listed in order of Liquidity: how quickly it converts into cash
a. Current Assets: converted into cash, sold or used up during current period (≤ 12 mos.).
i. Cash & Cash Equivalents
ii. Short-Term Investments: investments in stocks and bonds
iii. Accounts Receivable: amounts owed to firm by customers for credit
sales
iv. Inventory: cost of goods held for resale to customers
v. Prepaid Expenses & Supplies: goods/services paid for in advance, not
used yet

b. Long-term Investments:
i. Investments in Stocks and Bonds
ii. Investments in speculative real estate
iii. Life insurance policy on key executives

c. Plant, Property & Equipment (Fixed Assets): acquired for use in business
rather than resale to customers. Relatively long useful lives.
i. Land: does not have a limited useful life
ii. Building/Equipment
iii. Furniture/Fixtures/Vehicles
iv. Accumulated Depreciation: contra PPE account that shows how much of
the assets useful life has expired.

d. Intangible Assets (or Other Assets):

i. Patent, copyright, trademark, trade name, franchise, licenses,
ii. Goodwill: does not have limited useful life

2. Liabilities: Probable future sacrifice of economic benefits; amounts firm owes

a. Current Liabilities - requires the use of current assets to settle within ≤ 12 months.
i. Accounts Payable: amounts owed to suppliers, no interest
ii. Wages Payable: amounts owed to employees
iii. Unearned Revenues: amount of goods and services owed to customers
iv. Notes Payable: amounts owed to creditors, interest bearing

b. Long-term Liabilities:
i. Notes Payable: amounts owed to creditors, interest bearing
ii. Bonds Payable: interest bearing long term debt

3. Stockholders Equity: claims of owners against the net assets of the firm. (Assets -
Liabilities = SHE)
a. Contributed Capital: original investment by owners
i. Common Stock
ii. Additional Paid in Capital (APIC)
b. Retained Earnings: earnings over the life of the firm, less dividends declared.

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 13
 Step 10: Record Closing Journal Entries (CJE)
• Closing Journal Entries: reduced all nominal (temporary) accounts to zero by
closing them through Retained Earnings (or Income Summary then RE)
o Nominal (Temporary) accounts:
 Income Statement: all revenues, gains, expenses, losses, and their
contra and adjunct accounts
 Statement of RE: dividends declared
• Why do closing entries?
o In preparation for recording the transactions of the next period, all the
nominal accounts must have a balance of zero.
• Net income (loss) for the period is transferred to owner’s equity (RE) by closing
all Income Statement accounts into Retained Earnings
• 3 Closing Entries:
1) Close each nominal account with
(must list each account separately)
12/31 Sales Revenue 10,000
Interest Revenue 300
Gain on Sale of Equipment 500
Retained Earnings 10,800

2) Close each nominal account with ,

EXCEPT: Dividends Declacred (must list each account separately)

12/31 Retained Earnings 7,250

COGS 4,500
Insurance Expense 750
Rent Expense 1,200
Sales Discounts 800

3) Close out the Dividend Declared account to

12/31 Retained Earnings 650
Dividends Declared 650

Step 11. Post-Closing Journal Entries to General Ledger

Step 12. Prepare a Post-Closing Trial Balance

• contains only real accounts to make sure that debits equal credits.

The 12 Steps of the Accounting Cycle

1. 2. 3. 4.
5. 6. 7. 8.
9. 10. 11. 12.
Activity #6

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 14
Sample financial statements:
Raider Company
Income Statement
For the Year Ended December 31, 2022
(in thousands of dollars)

Sales Revenue $708,255

Cost of Goods Sold 525,305
Gross Profit $182,950
Less Operating Expenses:
Salary Expense 78,025
Advertising Expense 17,500
Insurance Expense 9,800
Rent Expense 13,355
Depreciation Expense 3,420
Amortization Expense 450 122,550
Net Income $ 60,400

Raider Company
Retained Earnings Statement
For the Year Ending December 31, 2022
(in thousands of dollars)

Retained Earnings, January 1, 2022 $128,800

Net Income for the year 60,400
Less: Dividends Declared (18,000)
Retained Earnings, December 31, 2022 $171,200

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 15
 Raider Company
Balance Sheet
As of December 31, 2022
(in thousands of dollars)

Assets
Current Assets:
Cash $52,950
Accounts Receivable 76,080
Inventory 62,150
Office Supplies 480
Prepaid Insurance 2,650
Total Current Assets $194,310
Property, Plant, and Equipment:
Land $20,000
Building 22,100
Equipment 15,570
Less: Accumulated Depreciation (10,420)
Property, Plant, and Equip., net 47,250
Patent 5,000 52,250
Total Assets $246,560

Liabilities

Current Liabilities:
Accounts Payable $22,420
Note Payable (short-term) 4,000
Salaries Payable 2,140
Unearned Revenue 1,800
Total Current Liabilities $30,360
Long-term Liabilities:
Note Payable (long-term) 8,000
Bonds Payable 12,000 20,000
Total Liabilities $50,360

Stockholders’ Equity

Common Stock 25,000

Retained Earnings 171,200 196,200
Total Liabilities and Equity $246,560

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 16
 ACCT 2300 – Chapter 3 - Learning Objectives and Activities

LEARNING IN CLASS ESTIMATED

LO# OBJECTIVE ACTIVITIES PROBLEMS TIME POINTS
Explain how accrual
accounting differs from
1. Activity 2 1
cash-basis accounting

Apply the revenue

recognition and expense
2. recognition (matching) Activity1 2
principles

Adjust the accounts

3. Activity 3 3-5
Construct financial
Activities 4 &
4. statements 6-8
5
Close the books
5. Activity 6 9 & 10
OMIT: Analyze and
evaluate a company’s
6.
debt-paying ability

OMIT: Describe data

7. visualization and two
basic chart types

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 17
Activity #1 – Revenue and expense transactions
Goin’ Band just started a business and has the following revenue and expense transactions
for July. Provide the journal entry for each transaction.
JOURNAL ENTRIES - Good journal entry format is required.
1. On July 6, made a sale to a customer (for cash) of $10,000. The inventory
originally cost us $7,500.

2. On July 10, made a sale to a customer (on account) of $15,000. The inventory
originally cost us $10,000.

3. On July 12, we paid utilities of $6,000.

4. On July 15, we rented a truck for a day for $1,000 "on account" (agreed to pay
vendor at a later point in time).

5. On July 20, we received $13,000 from customers on account.

6. On July 25, we paid our workers $8,000 in wages.

7. On July 31, we made a sale to a customer of $16,000. The customer paid $5,000
in cash and the remainder was "on account". The inventory originally cost us
$7,000.

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 18
Activity #2– Accrual Basis versus Cash Basis

During 2022, Red Raiders made cash sales of $876,000 and sales on account (credit
sales) of $224,000. The firm’s cost of goods sold was $260,000. All other expenses
incurred for the year were $175,000. Also during 2022, Red Raiders paid $410,000 for
its inventory and $150,000 for everything else.

1. Calculate Red Raiders’ Accrual basis Net Income for 2022.

Revenues:
Sales
Sales
Total Revenues
Less Expenses:

Total Expenses
Net Income

2. Calculate Red Raiders’ Cash basis Cash from Operations for 2022.

Cash Revenues:
Sales
Less: Cash Expenses:
Cash Paid for
Cash Paid for
Total Expenses
Cash from Operations

3. How would the Net Income and Cash from Operations change if the $50,000 of the
sales on account (credit sales) had also been received in cash this period?

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 19
Activity #3– AJE and Adjusted TB
Below is Raiderland’s Trial Balance Worksheet for year ended December 31, 2022.
Unadjusted TB Adjusting JE Adjusted TB
Account Title Debit Credit Debit Credit Debit Credit
Cash $6,000 $6,000
Supplies 500
Prepaid Rent 1,200
Land 13,500 13,500
Accounts Payable $4,000 4,000
Unearned Revenues 1,400

Note Payable 5,000 5,000

Common Stock 6,000 6,000
Retained Earnings 4,000 4,000
Dividends Declared 1,000 1,000
Revenues 10,100
Salaries Expense 7,500
Miscellaneous Exp 800 800

Totals $30,500 $30,500

Using good journal entry format, provide the following adjusting entries and then update
TB.
1. The cost of supplies on hand at the end of December was $100.

2. Salaries earned by employees but not paid as of December 31, totaled $650.

3. The company had prepaid its annual rent of $1,200 on December 1.

4. $500 of the unearned revenue account was still not earned as of December 31.

5. The note payable is a 14-month, 12% loan obtained from First National Bank on
December 1, 2022.

If Raiderland had not done the adjusting entries, how much would Net Income be over or
under stated?

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 20
Activity #4– Financial Statements Theory

List the first three financial statements in the order they are prepared. Then fill in the
information about each.

Articulation with other F/S

Statement listed Point in Accrual or What data from What statement
in order Time or Cash Based? this statement is is data
prepared. Period of articulated? articulated TO?
Time?

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 21
 Activity #5– Prepare Financial Statements
Using the information in Activity #3, prepare Raiderland’s Income Statement, Retained
Earnings Statement, and Balance Sheet. Fill in the missing date information.

Raiderland Raiderland
Income Statement Retained Earnings Statement
Dec 31, 2022 Dec 31, 2022
$ $

Less: Expenses:
Exp
Exp
Exp
Exp
Exp
Total Expenses

Raiderland
Balance Sheet
December 31, 2022
$
Current Assets: Current Liabilities:
Cash AP
Supplies Unearned Rev
Ppd Rent Salary Pay
Total Current Assets Interest Pay
Total Cur. Liab.

Long Term Assets: Long Term Liabilities:

Land Note Payable
Total Assets Total Liabilities

Equity:
Common Stock
Retained Earnings
Total Equity
Total Liabilities & Equity

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 22
Activity #6– CJE and Post-closing Trial Balance
Below is Raiderland’s Trial Balance Worksheet for year ended December 31, 2022.

Adjusted TB Closing JE Post-closing TB

Account Title Debit Credit Debit Credit Debit Credit
Cash $6,000 $6,000
Supplies 100 100
Prepaid Rent 1,100 1,100
Land 13,500 13,500
Accounts Payable 4,000 4,000
Unearned Revenues 500 500
Salary Payable 650 650
Interest Payable 50 50
Note Payable 5,000 5,000
Common Stock 6,000 6,000
Retained Earnings 4,000
Dividends Declared 1000
Revenues 11,000
Salaries Expense 8,150
Miscellaneous Exp 800
Supplies Expense 400
Rent Expense 100
Interest Expense 50
Totals $31,200 $31,200

Using good journal entry format, provide the three necessary closing entries and then
update TB. Complete the RE T-account

1. Close all nominal accounts with NB = Cr.

2. Close all nominal accounts with NB = Dr, except Dividends Declared.

3. Close Dividends Declared. Retained Earnings

What is the purpose of Closing Entries?

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 23
Extra Problem #1 – Conceptual Questions
Indicate whether each question is true or false. Also, write an explanation on why the statement is
false.
1. Revenue accounts will always start each new accounting period with zero beginning
balances.

2. Expense accounts will always start each new accounting period with a beginning balance
equal to all of the debit entries that were made into the expense account during the previous
accounting period.

3. Credit entries into the Sales Revenue account increase the account balance and will ultimately
increase Retained Earnings.

4. Debit entries into an expense account increase the expense account and will ultimately
decrease Retained Earnings.

5. The Cost of Goods Sold account is an asset account similar to the Inventory account.

6. Some of the revenue and expense accounts are used to prepare the Income Statement, and
some of the revenue and expense accounts appear on the Balance Sheet.

7. A company will have a Net Loss when the sum of all the expense accounts is greater than the
sum of all the revenue accounts.

8. When a sale is made to a customer on credit, there is no entry made to the Sales Revenue
account because no cash has been received.

9. The Retained Earnings amount needed for the Balance Sheet can be calculated as follows:
Retained Earnings at the beginning of the period, plus the sum of the revenue account
balances, less the sum of the expense account balances.

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 24
Extra Problem #2 – Accrual Basis versus Cash Basis

During the year, Double T earned cash sales of $280,000 and sales on account (credit
sales) of $850,000. Of the $850,000 sales on account, Double T collected $630,000 this
year, and expects to the rest next year. The firm’s incurred the following expenses during
year: cost of goods sold was $550,000; salary expense was $170,000; and all other
expense for the year were $140,000. During the year, Double T paid $510,000 for its
inventory, $152,000 to employees, and $133,000 for everything else.

1. Calculate Double T’s Accrual basis Net Income for this year.

2. Calculate Double T’s Cash basis Cash from Operations for this year.

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 25
Extra Problem #3 – Accrued and Deferred Revenues Adjusting Entries

Accrued Revenues:
On August 31, Harvey Dent signed lease agreement with Wayne Enterprises to lease one
of their buildings for 12 months (September 1, 2022 through August 31, 2023) at $2,500
rent per month. Wayne Enterprises agreed that Harvey Dent could pay September and
October Rent to Wayne Enterprises on November 1.

1. What are the entries needed on September 30 and October 31 for Wayne Enterprises?

Deferred Revenues:
On September 1, Dahl Publishing Co. received $2,400 for one year’s subscriptions in
advance (covering September 1, 2022, to August 31, 2023).

1. What is the initial entry needed on September 1, 2022?

2. What is the adjusting entry needed on September 30, 2022?

3. What are the t-account balances at September 30, 2022?

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 26
Extra Problem #4 – Accrued Expense Adjusting Entries

On November 1, 2022, Pyramid Company signed a note for a loan from its bank and
received cash. Interest is paid quarterly (every three months). The following are the
terms and other information pertaining to the loan:

Amount of the loan ...........................................................................$100,000

How long the loan is for (the term of the loan)..................................9 months
Interest rate of loan ............................................................................12%
Date of first interest payment to the bank ..........................................February 1, 2023
(Will pay November – January interest on February 1)

1. What is the original entry made to record the loan on November 1, 2022?

2. What is the adjusting entry needed November 30?

3. What is the interest payable balance at December 31 after all adjusting journal
entries?

4. What is the entry on February 1 when Pyramid Company makes the first interest
payment?

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 27
Extra Problem #5 – Deferred Revenue Adjusting Entries
Sports Enterprise, Inc. (SEI) owns a semi-pro football team. SEI sells season ticket packages in
September for their 10 home games. Of the 10 home games, 2 are in October, 5 in November and
3 in December. In September, SEI collected $500,000 for season ticket packages (for the 10
home games). You can assume this was all collected on September 30 (in reality, entries would
be made throughout the month of September as SEI collected the money -- but I won't have you
make the daily entries to record this!)
1. What is the original entry assuming all $500,000 of cash was received on September 30?

2. What is the adjusting entry needed on October 31?

3. What is the balance of the unearned revenue account at October 31 after the AJE? Can you
relate this to the future number of home games in the season package?

4. How much revenue will be recorded in November?

5. What is the adjusting entry needed on December 31?

6. What is the balance of the unearned revenue account at December 31 after all AJEs?
Unearned Revenue
$500,000 October 1 Beginning Balance

October 31 Balance

November 30 Balance

December 31 Balance

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 28
Extra Problem #6 – Deferred Expense Adjusting Entries

On August 1, Apex Inc. pays $7,200 in cash for one year’s property insurance in advance
(covering August 1, 2022, to July 31, 2023).

1. What is the initial entry needed on August 1, 2022?

2. What is the adjusting entry needed on August 31, 2022?

3. What are the t-account balances at August 31, 2022 after adjusting entries but
before August closing entries? (Note: journal entries above may involve other
accounts - for this part of the question, we just care about these accounts)

4. What is the adjusting entry needed on September 30, 2022?

5. What are the t-account balances at September 30, 2022 after adjusting entries but
before September closing entries?

6. What is ending balance of the prepaid insurance account at December 31, 2022
after all AJEs?

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 29
Extra Problem #7 – Depreciation Adjusting Entries

Purchase equipment on August 1, 2022 for $25,000.

Estimated useful life is 5 years (60 months); estimated salvage value is $1,000.

1. What is the adjusting entry needed on August 31, 2022?

2. What are the T-account balances at August 31, 2022 after the AJE but before
August closing entries?

3. What type of account is the Accumulated Depreciation account (e.g. equity

account, revenue account, etc)? What is the NORMAL balance of this account?

4. What is the adjusting entry needed on September 30, 2022?

5. What is the ending Accumulated Depreciation balance at October 31, 2022 after
all AJEs?

6. What is the book value (or "net book value") of the Equipment at October 31,
2022?

7. Which accounting principle is the reason we record depreciation expense?

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 30
Extra Problem #8– Impact of Making and NOT Making Adjusting Entries

A company is preparing its financial statements for the year ended December 31, 2022. The
following information must be taken into account:
a. On October 1, 2022, the company contracted with another firm to carry out maintenance
on their building for one year. Payment in advance of $9,900 for the first six months of
the contract was paid on October 1, 2022. It was expected that expense would be
incurred evenly over the six months. NOTE: Assume that the original entry of $9,900
cash/prepaid maintenance has been made, but NO adjusting entries have been made in
2022.
b. Annual property taxes of $4,800 are due to be paid on January 31, 2022. The taxes relate
to the 12 months from February 1, 2022, to January 31, 2023. NOTE: Assume that
nothing has been recorded and you are making the entry on December 31, 2022 for ALL
of 2022.

c. The company has $4,000 of depreciation expense to record for 2022 which has not yet
been recorded.

d. On October 1, 2022, the company contracted to carry out maintenance on an empty

building for one year. Payment in advance of $6,000 for the first six months of the
contract was received on October 1, 2022. It was expected that revenue would be earned
evenly over the six months. NOTE: Assume that the original entry of $6,000
cash/unearned revenue has been made, but NO adjusting entries have been made in
2022.

e. The company purchased $100,000 of CDs on April 1, 2022, and the company will
receive a full year’s interest at 6% on March 31, 2023. NOTE: Assume that no entry has
yet been made in 2022 for this interest.

1. Write the adjusting journal entry that should be made for EACH of the above items.

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 31
Extra Problem #8 – Impact of Making and NOT Making Adjusting Entries (continued)

2. Show the EFFECT of EACH adjustment on the accounting equation (use I, D and NE).

Entry Assets = Liabilities + Equity

a = +
b = +
c = +
d = +
e = +

3. What would be the effect on the income statement and balance sheet if the adjustments above
were NOT made before the year-end closing process on December 31, 2022? (Note: If net
income is overstated or understated, then owners’ equity will also be overstated or understated by
the same amount, since owners’ equity is “contributed capital + retained earnings”.)

Use “U’ for understated, “O” for overstated, “NE” for no effect
Effect on Balance Sheet Effect on Income Statement
Entry Assets Liab Equity Revenue Expenses Net Income
a
b
c
d
e

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 32
Extra Problem #9– Closing Entries, Posting, Income Statement, and Statement of RE
Given the adjusted T-accounts shown below, prepare the Income Statement, Statement of
RE and the necessary closing entries at 12/31/2022.
Equipment Accounts Payable Sales
$20,000 $2,000 $ 6,000
$1,000 $5,000 $4,000 $12,000
$1,000 $ 9,000
$21,000 $2,000 $27,000

Cost of Sales Salary Expense Dividends Declared

$2,000 $2,000 $1,500
$5,000
$4,000
$11,000 $2,000 $1,500

Retained Earnings
$5,000

INCOME STATEMENT STATEMENT OF RETAINED EARNINGS

Closing Entries Using good journal entry format (GJEF) provide the 3 closing entries.
1. Close all nominal accounts with NB = Cr.

2. Close all nominal accounts with NB = Dr, except Dividends Declared.

3. Close Dividends Declared.

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 33
Extra Problem #10 – Miscellaneous Questions

1. On February 5, Fudd Hunting Corporation sold merchandise for $40,000 that cost them
$22,000. Their customer paid $10,000 down and purchased the remainder on account. What
are the journal entries for Fudd Hunting Corporation? (Use good journal entry format.)

2. Retained Earnings for Fudd Hunting Corporation was $50,000 on July 1. During July,
revenues totaled $75,000 and expenses were $60,000. What was Fudd Hunting Corporation’s
Retained Earnings at July 31?

3. What is Fudd Hunting Corporation's net income given the following pre-closing Trial
Balance? (Note that the Trial Balance is in alphabetical order)
ACCOUNT NAME DEBIT CREDIT
Accounts Payable $8,000
Accounts Receivable $22,000
Cash $43,000
Common Stock $20,000
Cost of Goods Sold $18,000
Equipment $16,000
Interest Expense $100
Interest Payable $100
Inventory $4,000
Note Payable – Bank $29,000
Retained Earnings $10,000
Sales Revenue $39,000
Utilities Expense $1,000
Wages Expense $2,000
TOTAL $106,100 $106,100

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 34
Extra Problem #11 – Find missing information using T-accounts

The manager of Cottonwood Stars Inc. needs you to compute the following amounts:

# Amount? T-Account Used?

1. Amount of cash prepayments received from
customers this period.

2. Amount of rent expense this period

3. Amount of credit sales this period for

individual customers.

4. Amount of collections on account this

period for business customers.

Use the information in the table below to answer the questions.

Account Beginning Ending Additional
Balance Balance Information
AR-Business $110,000 $85,000 Business cash sales:$345,000
Business sales on account $456,000
Prepaid Rent $22,000 $27,000 Rent prepaid this period: $19,000
AR-Individual $175,000 $193,000 Individual cash sales:$290,000
Individual collections on account: $187,000
Unearned Rev. $76,000 $63,000 Service completed on prepayments: $42,000

Use T-accounts to determine the amounts needed by your manager.

AR- Business Prepaid Rent

AR-Individual Unearned Revenue

Fall 2022 – Copyright © Janet Huston, Ph.D., Texas Tech University ACCT 2300 Chapter 3 - Page 35