The GAAP revenue recognition and matching principles require that the revenue from a particular accounting period be matched with expenses that help cause that revenue. That way, external users will have a more accurate picture of profitability.

Table 3-5. Balance sheet

The accrual accounting setup provides for accounts to carry amounts into the future and then peel off as they enter the applicable period.

Figure 3-5 Balance sheet

Let’s look at the simple example of paying the insurance bill. The annual bill is $7,200 if paid in advance, $8,400 in two equal installments, or $800 on a monthly basis. Being prudent managers, we take the time value of money into account. We pay the $7,200 in June to cover the insurance bill for the entire 12 months. Our fiscal year ends December 31, so we’ll have to carry the insurance over.

When we’ve paid for the insurance, it’s an asset. When the month comes around, the portion of the asset covering the month converts to an expense. On the books, it will look like Table 3-6.

By the end of the year, the accumulated accounts will show the ledger entries in Table 3-7.

You can set some accounting systems do this automatically. With others, you have to remember to post the transaction monthly. At the start of the next year, the balance in the asset account must be carried forward while the expense account is cleared (Table 3-8).

Common adjusting entries involve carrying over payrollrelated data to the next accounting period. Thus, employee wages and taxes earned in the last period but not payable until the new period, along with the associated employer share of FICA and other taxes due, need an adjusting entry. Other adjustments include the need to accrue revenues and expenses related to interest, depreciation, inventory changes, dividends, or income tax payable. Finally, if your day-to-day books are

Table 3-6. Insurance: general journal and ledger accounts

Table 3-7. Insurance: ledger accounts

maintained on a cash basis, set up an accounts receivable and accounts payable balance.

Table 3-8. Insurance: ledger accounts

Back: The Balance Sheet

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