ACC1100 Chap.3 Accrual Accounting and Adjusting Entries
Accrual Accounting and Adjusting Entries
Accrual accounting recognises income when earned and expenses when incurred, even when cash occurs in another period. This chapter diagnoses whether recognition leads cash or cash leads recognition, then records accrued income, accrued expenses, prepaid expenses and income received in advance. Every balance-day adjustment links one income-statement account with one asset or liability account and excludes cash.
The method finishes by tracing omission effects through profit, equity and financial position before preparing adjusted statements. Students compare both common original-recording approaches for prepayments, because the adjustment may focus on the amount consumed or earned, or instead on the portion still unused or unearned.
A closing-balance calculation provides an independent check on the journal entry and its statement consequences. The timeline remains the fastest diagnostic when account labels feel ambiguous.
What this chapter covers
- 01
Cash basis and accrual basis
- 02
Recognition timing
- 03
Accrued expenses and payables
- 04
Accrued income and receivables
- 05
Prepaid expenses
- 06
Income received in advance
- 07
Original-recording alternatives
- 08
Balance-day journal entries
- 09
Omission effects across statements
- 10
Adjusted trial balance and report order
Worked example · free
Adjust a prepaid support contract
- +1Four months of the twelve-month service have been consumed by 31 December.
- +2Support expense is $21,600 x 4/12 = $7,200.
- +2The closing prepaid asset is $21,600 - $7,200 = $14,400.
- +2Debit Support Expense $7,200 and credit Prepaid Support $7,200.
- +1If omitted, expense is understated while profit, equity and assets are overstated by $7,200.
Key terms
- Recognition
- Including an item in the financial statements when the relevant economic activity is earned or incurred.
- Accrued income
- Income earned before receipt or recording, creating a receivable asset.
- Accrued expense
- Expense incurred before payment or recording, creating a payable liability.
- Prepaid expense
- Cash paid before a benefit is consumed, leaving an asset for the unused portion.
- Unearned income
- Cash received before the service is earned, leaving a liability for the undelivered portion.
- Adjusted trial balance
- The ledger-balance list prepared after all balance-day entries are posted.
- Balance day
- The reporting date at which timing differences are assessed and adjusted.
Accrual Accounting and Adjusting Entries FAQ
Why does an adjusting entry never include cash?
A balance-day adjustment corrects recognition timing after cash has already moved or before it will move. The entry records the income or expense in the proper period and pairs it with an asset or liability. If cash were included again, the records would duplicate a past payment or prematurely record a future one.
How can I distinguish an accrual from a prepayment?
Place recognition and cash on a timeline. If income is earned or expense incurred before cash, the item is an accrual and adds a receivable or payable. If cash happens first, the unused or unearned part is a prepayment represented by an asset or liability until recognition catches up.
What happens when a prepaid expense adjustment is omitted?
When the original payment was recorded as an asset, omission leaves too much asset and too little expense. Profit and equity are therefore overstated by the same amount. Cash does not change at balance day because the original payment was already recorded when the contract began. State every direction and amount explicitly.
Why does the original recording method matter?
A prepayment may initially be placed entirely in an asset or liability account, or entirely in an expense or income account. The balance-day entry must correct whichever starting treatment was used. That is why one scenario adjusts the amount consumed or earned while another adjusts the portion still unused or unearned.
Which statements should be prepared after adjustment?
After posting all adjustments, use the adjusted trial balance to prepare reports in dependency order. Income and expense accounts produce profit in the income statement. Profit moves into the statement of changes in equity, and its closing equity amount then enters the balance sheet with assets and liabilities.
Exam move
For every adjustment, draw two points: the cash date and the recognition date or service period. Label whether cash leads or follows. Calculate the earned or consumed portion before naming accounts, then inspect how the original cash movement was recorded. Write the two-account entry and complete a four-line omission table for expense or income, profit, asset or liability, and equity. Finally, confirm that cash is absent.
Practise both original-recording alternatives for prepayments so you understand why the adjustment amount can be earned, used, unearned or unused depending on the starting account. Recalculate the closing asset or liability independently from the remaining time or service units. Agreement between the entry approach and the closing-balance approach gives you a stronger control than repeating one calculation twice.
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