accrual accounting & adjusting entries chapter 4
TRANSCRIPT
Chapter 4 Highlights
Examine Revenue Recognition and Matching Principles
What is an accrual? What type of accrual entries do we need? Prepare adjusting entries, closing entries
and an adjusted Trial Balance
Revenue Recognition
Accounting rule: revenue must be recorded in the books in the period it is “earned”
For example: If purchase a CD on May 1st but don’t pay for it until June
Record sale in May
Matching Principle
Expenses must be matched to revenue
i.e.. must record all expenses associated with the revenue you are recording
Not following either of this principles will distort results!
Cash Basis of Accounting
Revenue recorded only when cash received
Expense recorded only when cash paid
Accrual Basis of Accounting
Adheres to the Revenue recognition
principle Matching principle
Revenue recorded when earned, not only when cash received
Expense recorded when incurred, not only when cash paid
Adjusting Entries
Required to ensure matching and rev recognition followed
Normally req’d each time statements are prepared
Common Adjusting Entries
Prepaid Expense = item paid for that have not been used or consumed (ie shown as assets)
Example: autopac insurance
Unearned Revenue = cash rec’d and recorded before revenue has been earned
Should appear as a liability
Example: maintenance fees, deposits
Common Adjusting Entries
Accrued Revenue = revenue earned but not yet recorded and/or cash not rec’d yet
Example: Home builder
Accrued Expenses = expenses incurred but not yet billed or paid for
Example: place ad in the newspaper on April 27 not billed until May
On October 5 the company paid $2,500
for advertising supplies.
GENERAL JOURNAL Debit Credit
Oct 5 Advertising Supplies 2,500 Cash 2,500
Purchased advertising supplies
Advertising Supplies2,500Oct 5
Cash2,500Oct 5
Advertising Supplies Expense
Supplies
An inventory on October 31 reveals that $1,000 of supplies remain on hand; therefore, $1,500 of supplies had been used. ($2,500- $1,000) =$ 1,500
GENERAL JOURNAL Debit Credit
Oct 5 Advertising Supplies Expense 1,500 Advertising Supplies 1,500
To record advertising supplies consumed
Advertising Supplies2,500Oct 5
Cash2,500Oct 5
Advertising Supplies Expense
Supplies
1,500Oct 311,500Oct 31
Bal. 1,000
Oct $1,500
Mar $1,435
Apr $1,510
May $1,592
Feb $1,601
Nov $1,800
Dec $1,410
Jan $1,425
June $1,652
July $1,621
Aug $1,427
Sept $1,555
Advertising supplies expense is based on usage... so different amounts appear each month
Advertising Supplies Expense
Prepaid Expenses
On October 4 the company paid $600 for a 1-year
insurance policy. Coverage began October 1.
GENERAL JOURNAL Debit Credit
Oct 4 Prepaid Insurance 600 Cash 600
Purchased one-year policy effective October 1
Prepaid Insurance
600Oct 4
Cash600Oct 4
Insurance Expense
Prepaid ExpensesOn October 31st, $50 ($600/ 12 months)
of the insurance was used-up or expired.
GENERAL JOURNAL Debit Credit
Oct 31 Insurance Expense 50
Prepaid Insurance 50
Record insurance expense for the month
Prepaid Insurance
600Oct 4
Cash600Oct 4
Insurance Expense
50Oct 3150Oct 31
Insurance Policy
1 Year $ 600
Oct $50
Mar $50
Apr $50
May $50
Feb $50
Nov $50
Dec $50
Jan $50
June $50
July $50
Aug $50
Sept $50
22
Amortization
Allocate the cost of an asset to expense over its useful life
Amortization is an allocation concept, not a valuation concept
We’re not attempting to reflect the
actual change in value of an asset!
Office Equipment
Amortization= $480/year
Oct $40
Mar $40
Apr $40
May $40
Feb $40
Nov $40
Dec $40
Jan $40
June $40
July $40
Aug $40
Sept $40
GENERAL JOURNAL Debit Credit
Oct 31 Amortization Expense 40
Accumulated Amortization-Office Equip 40
To record monthly amortization
Accumulated Amortization is a contra asset account - an offset against the capital asset account
Accumulated Amortization-
Office Equipment40Oct 31
Office Equipment5000Oct 2
Amortization Expense
40Oct 31
25
Office equipment $ 5,000
Less : Accumulated amortization 40
4,960
Balance Sheet Presentation
Net book value
Unearned Revenues
Received on Oct. 2 $1,200 for advertising services expected to be completed by 12/ 31.
Unearned Service RevenueCash
1,200Oct 21,200Oct 2
Service Revenue
GENERAL JOURNAL Debit Credit
Oct 2 Cash 1,200
Unearned Service Revenue 1,200
Collected money for work to be performed by 12/31.
Unearned Revenues
During October $400 of the revenue was earned.
Unearned Service RevenueCash
1,200Oct 2
Service Revenue
1,200Oct 2
GENERAL JOURNAL Debit Credit
Oct 31 Unearned Service Revenue 400
Service Revenue 400
To record revenue earned
Oct. 31 400 Oct. 31 400
Bal. 800
Accrued Revenues
Earned $200 for advertising services to clients in October, but they were not billed until after October 31st.
GENERAL JOURNAL Debit Credit
Oct 31 Accounts Receivable 200
Service Revenue 200
Accounts Receivable
200Oct 31
Service Revenue
200Oct 31
Formula for Calculating Interest
Face Value of Note Interest
Timein Terms of One Year
Annual Interest
Rate
$ 5,000 X 12% 1/12 = $50
Interest expense is the cost a company incurs to use money:Information needed to compute interest expense: face value of note interest rate (always expressed in annual rate) the length of time note is outstanding
Interest Expense Interest Payable
Oct 31 50 Oct 31 50
GENERAL JOURNAL Debit Credit
Oct 31 Interest Expense 50 Interest Payable 50
Accrue interest expense for the month
Accrued Interest Expense
Salaries Expense Salaries Payable
Oct 31 1,200 Oct 31 1,200
GENERAL JOURNAL Debit Credit
Oct 31 Salaries Expense 1,200
Salaries Payable 1,200
Accrue salary expense for the month
Accrued Salaries Expense
Summary of Adjustments
Type of Adjustment Adjusting Entries
Prepd Exp. Dr. ExpCr. Assets
Unearned Rev. Dr. LiabCr. Rev.
Accrued Rev. Dr. AssetsCr. Rev.
Accrued Exp. Dr. Exp.Cr. Liab.
Adjusted Trial Balance
1st need to journalize the adjusting entries
Next post adjusting entries Prepare the “new” adjusted
Trial balance reflecting these changes
Note: all should still balance between Dr & Cr balances
Adjusted Trial Balance
Once adjusted TB has been prepared and reviewed create financial stmts
Note: Top of financial statement(s) should have 3 lines
1st – Organization name 2nd – Type of report 3rd – reporting period and
date
Closing the Books
Involves preparing the books for a new year of activity
I/S related accounts must be closed as they represent the activity for a period only
I.e. not cumulative
Closing the Books
Temporary accounts are closed (i.e. record entry to create a zero balance in that account) at the end of the period
All Rev & Exp are closed out to a summary acct. called “Income Summary” which is then closed out to Retained Earnings
Temporary Accounts
All revenue accounts
All expense accounts
Dividends
Retained Earnings is a permanent account; the others shown hereare temporary
Individual Expenses
Retained Earnings
Income Summary
Individual Revenues
Dividends
1
3
4
2
The Accounting Cycle Review
1.Analyze business transactions
2.Journalize the transactions
3.Post to ledger accounts
4.Prepare a trial balance
5.Journalize and post adjusting entries-prepayments and accruals
The Accounting Cycle Review
6. Prepare an adjusting trial balance
7. Prepare financial statements
8. Journalize and post closing
entries
9. Prepare a post-closing trial
balance