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Chapter 4 - Accrual Accounting

Concept

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Learning Objectives:
1. Accrual Accounting Concepts

2. Types of Adjusting Entries

3. Adjusted Trial Balance

4. Financial Statements

5. Closing Entries

6. Post-Closing Trial Balance

7. The Accounting Cycle

8. Key Terms

1 - Accrual Accounting Concepts

Accrual Basis of Accounting

Transactions are recorded when they occur, regardless of when cash is

received or paid. This method provides a more accurate financial picture

Chapter 4 - Accrual Accounting Concept 1

 over time.

Revenue Recognition Principle: Revenue is recorded when it is earned,

not when cash is received.

Expense Recognition (Matching Principle): Expenses are recorded when

they are incurred, aligning with the revenues they help generate.

Cash Basis of Accounting

Transactions are recorded only when cash is exchanged. This method can
result in misleading financial information since it doesn’t reflect liabilities or
receivables that have occurred.

Adjusting Entries

Adjustments are made at the end of the accounting period to ensure

revenues and expenses are recorded in the correct period. Adjusting
entries ensure the financial statements reflect the true financial position.

2 - Types of Adjusting Entries

1. Prepayments

Chapter 4 - Accrual Accounting Concept 2

 Prepaid Expenses: Payments made for expenses in advance (e.g., rent or
insurance). Initially recorded as assets and gradually expensed as time
passes or the service is used.

Adjusting Entry: Debit expense account and credit prepaid expense

account.

Deferred Revenues: Cash received for services not yet provided (e.g.,
advance payment for a subscription). Initially recorded as liabilities and
recognized as revenue when the service is performed.

Adjusting Entry: Debit liability account and credit revenue account.

2. Accruals

Accrued Expenses: Expenses that have been incurred but not yet
recorded (e.g., wages payable or interest payable).

Adjusting Entry: Debit expense account and credit liability account.

Accrued Revenues: Revenues earned but not yet recorded (e.g., services
provided but not billed).

Adjusting Entry: Debit asset (receivables) account and credit revenue

account.

3 - Adjusted Trial Balance

Definition: A trial balance prepared after adjusting entries are made to reflect
updated balances. It lists all account balances, including the adjustments,
ensuring that total debits equal total credits.

Purpose: Serves as the main source for preparing financial statements, as it

reflects the true balances of all accounts after adjustments.

Chapter 4 - Accrual Accounting Concept 3

 4 - Financial Statements
Income Statement: Summarizes revenues and expenses over a specific
period to show the net income or loss.

Statement of Changes in Equity: Shows changes in retained earnings,

reflecting net income and any dividends declared.

Balance Sheet (Statement of Financial Position): Provides a snapshot of a

company’s assets, liabilities, and equity at a specific date, ensuring that Assets
= Liabilities + Equity .

Order of Preparation:

1. Income Statement: Provides net income or loss.

2. Statement of Changes in Equity: Uses net income from the income

statement to calculate the final equity.

3. Balance Sheet: Prepared last, showing the overall financial position based
on updated asset, liability, and equity balances.

5 - Closing Entries
Temporary Accounts: Revenue, expense, and dividends declared accounts
are temporary and reset to zero at the end of each accounting period.

Permanent Accounts: Asset, liability, and equity accounts carry over into the
next period and are not closed.

Chapter 4 - Accrual Accounting Concept 4

 Closing Process:

1. Close all revenue accounts by debiting revenue and crediting Income

Summary.

2. Close all expense accounts by debiting Income Summary and crediting

each expense.

3. Close Income Summary to Retained Earnings.

4. Close dividends declared to Retained Earnings.

6 - Post-Closing Trial Balance

Definition: Prepared after all closing entries are posted, listing only the
permanent accounts (assets, liabilities, and equity) with their balances.

Chapter 4 - Accrual Accounting Concept 5

 Purpose: Ensures that debits equal credits after the closing entries and that all
temporary accounts have been closed.

7 - The Accounting Cycle

Steps

1. Analyze Business Transactions: Determine the impact on financial

accounts.

2. Journalize Transactions: Record in the general journal.

3. Post to Ledger Accounts: Transfer journal entries to the general ledger.

4. Prepare a Trial Balance: Ensure debits equal credits.

5. Journalize and Post Adjusting Entries: Make adjustments for accruals and
prepayments.

6. Prepare Adjusted Trial Balance: Reflect the updated account balances.

7. Prepare Financial Statements: Based on the adjusted trial balance.

8. Journalize and Post Closing Entries: Close temporary accounts.

9. Prepare Post-Closing Trial Balance: Ensure permanent accounts are

correctly balanced.

IFRS vs ASPE

Chapter 4 - Accrual Accounting Concept 6

 8 - Key Terms
Accrual Accounting: Recording transactions when they occur, regardless of
cash flow.

Prepaid Expenses: Payments made for expenses not yet incurred.

Deferred Revenues: Cash received before providing a service.

Accrued Revenues/Expenses: Revenues or expenses incurred but not yet

recorded.

Closing Entries: Entries made to reset temporary accounts for the new
accounting period.

Post-Closing Trial Balance: Ensures all permanent accounts are balanced

after closing entries.

Chapter 4 - Accrual Accounting Concept 7