the accounting cycle accruals and deferrals
DESCRIPTION
The Accounting Cycle Accruals and Deferrals. Chapter 4. A DJUSTING ENTRIES. Adjusting entries are. Every adjusting. needed whenever revenue or expenses affect more than one. entry involves a change in either a revenue or expense. and an asset or liability. accounting period. - PowerPoint PPT PresentationTRANSCRIPT
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PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA
Copyright © 2012 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
The Accounting CycleThe Accounting CycleAccruals and DeferralsAccruals and Deferrals
Chapter 4
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Adjusting
entries are
needed whenever
revenue or expenses
affect more than oneaccounting
period.
Every adjusting
entry involves achange in either a
revenue or expense and an asset
or liability.
AADJUSTING ENTRIESDJUSTING ENTRIES
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Adjusting EntriesAdjusting Entries
Adjusting Entries are journal entries recorded at the end of an accounting period to adjust income and expense accounts so that they comply with the Accrual Concept of accounting.
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AACCRUAL CONCEPTCCRUAL CONCEPT
Business transactions are
recorded when they occur.
NOT when the related payments are
received or made.
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Accrual Accrual CConceptoncept
Accrual Concept, requires that;
Revenues of the business are recognised in the accounts when earned.
Expenses are recognised when incurred.
NOT when the money is received or paid.
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Accrual Accrual CConcept – oncept – EExamplexample-1-1
An airline company sells its tickets weeks before the flight is due.
BUTIt does not record the payments as
revenue because the event on which the revenue is based has not occurred yet.
Once the service has being provided, we can make the adjusting entry. (i.e. We can record it as received)
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AccrualAccrual C Concept – oncept – EExamplexample-- 2 2
A business records its utility bills as soon as it receives them.
Not when the bills are paid, because the service has already been used.
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AdjustAdjustiing Entrng Entriieses
Adjusting Entries are necessary when accrual basis accounting is used.
Adjusting entries allow businesses to adhere to the Matching Principle.
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TThe MATCHINGhe MATCHING P PRINCIPLERINCIPLE
This principle, requires a company to match expenses with the related revenues in order to report the company`s profitability during the accounting period.
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The MatcThe Matchinghing Pr Principleinciple
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The MatchThe Matchiing Prng Priincnciipleple
A hospital pays £20,000 per month to 5 of its doctors.
Monthly sales are £ 500,000.
£100,000 (£20,000 x 5) worth of monthly salaries should be matched with £500,000 of revenue generated.
Net profit for this month would be:500,000-100,000
-------------------
£ 400,000
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The MatchThe Matchiing Prng Priincnciipleple
The objective is to match the income receivable and the expenditure payable to the appropriate accounting period.
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TTYPESYPES of A of ADJUSTINGDJUSTING E ENTRIESNTRIES
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Type 1: PrepaType 1: Prepaiid d EExpensesxpenses
Prepaid expenses are the type of expenses which are paid in cash and recorded as assets prior to being used.
Prepaid expenses are also known as deferred expenses
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Adjusting Entries for Adjusting Entries for “Prepaid Expenses”“Prepaid Expenses”
• Let`s say you prepaid £15,000 for your property insurance on 1st September of the current year.
• Make the appropriate adjustment as of the end of the accounting period. (i.e. 31/12/2012)
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Original Entry: On September 1 the following entry would be recorded when the insurance was prepaid:
Cash 15,000
Prepaid Insurance 15,000
Dec. 31
Debit Credit
Prepaid Insurance
15,00015,000 15,00015,000
Debit Credit
Cash
15,00015,000
AdjustAdjustiing Entrng Entriies for es for “Prepa“Prepaiid Expenses”d Expenses”
DRCR
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AdjustAdjustiing Entrng Entriies for es for “Prepa“Prepaiid Expenses”d Expenses”
Prepaid Insurance is an asset account – it is an amount owned by the company that has economic value.
We will recognise PrepaidInsurance under current assets.
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AnalyzAnalyziing an Adjustng an Adjustiing Entry:ng Entry:
•Each month, a portion of the prepaid insurance expires.
•At the end of the accounting period, the Prepaid Insurance and Insurance Expense accounts must be updated for the insurance that has expired (been used).
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Analyzing an Adjusting Entry:Analyzing an Adjusting Entry:(Example 1)(Example 1)What accounts are involved?
• When something is “used up” it indicates an expense account.
• In this case, we need to debit Insurance Expense for the expired insurance. • Furthermore, the asset, Prepaid Insurance, has decreased so we will credit this asset.
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£15,000 for 12 months = £1,250/month
Policy purchased on Sept 1.
Months that have expired between purchase and fiscal year-end 4 months (Sept, Oct, Nov, Dec)
Amount of adjustment =(£1,250/month X 4 months) £ 5,000
(£15,000/12 )
Analyzing an Adjusting Entry:Analyzing an Adjusting Entry:
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Let’s record the adjusting entry;
Prepaid Insurance £5,000
Insurance Expense £5,000 Dec. 31
Debit Credit
Prepaid Insurance
15,00015,0005,0005,000
Debit Credit
Insurance Expense
£1£100,000,000
DRCR
5,0005,000
£5,000£5,000
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The Concept of DepreciationThe Concept of Depreciation (Example 2)(Example 2)
Depreciation is the systematic allocation of the cost of a depreciable asset to expense.
Depreciation is the systematic allocation of the cost of a depreciable asset to expense.
Cash (credit)
Cash (credit)
Fixed Asset (debit)
Fixed Asset (debit)
On date when initial payment is made . . .
The asset’s usefulness is
partially consumed during the
period.At end of period . . .
Depreciation Expense (debit)
Depreciation Expense (debit)
Accumulated Depreciation
(credit)
Accumulated Depreciation
(credit)
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On May 2, 2011, JJ’s Lawn Care Service purchased a lawn mower with a useful
life of 50 months for $2,500 cash.
Using the straight-line method, calculate the monthly depreciation
expense.
$2,50050
=$50$50
Depreciationexpense (per
period)=
Cost of the assetEstimated useful life
Depreciation Is Only an Depreciation Is Only an EstimateEstimate
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JJ’s Lawn Care Service would make the following adjusting entry.
JJ’s Lawn Care Service would make the following adjusting entry.
GENERAL JOURNAL
Date Account Titles and ExplanationPRDebit Credit
May 31 Depreciation Expense: Equipment 50
Accumulated Depreciation: Equipment 50
To record one month's depreciation.
Contra-asset Contra-asset
Depreciation Is Only an Depreciation Is Only an EstimateEstimate
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JJ’s $15,000 truck is depreciated over 60 months. Calculate monthly depreciation and
make the journal entry.
JJ’s $15,000 truck is depreciated over 60 months. Calculate monthly depreciation and
make the journal entry.
GENERAL JOURNAL
Date Account Titles and ExplanationPRDebit Credit
May 31 Depreciation Expense: Truck 250
Accumulated Depreciation: Truck 250
To record one month's depreciation.
$15,00060 months = $250 per month$15,00060 months = $250 per month
Depreciation Is Only an Depreciation Is Only an EstimateEstimate
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Accumulated depreciation would appear on the balance sheet as
follows:
Accumulated depreciation would appear on the balance sheet as
follows:
Depreciation Is Only an Depreciation Is Only an EstimateEstimate
Cost - Accumulated Depreciation = Book ValueCost - Accumulated Depreciation = Book Value
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JJ's Lawn Care Service Adjusted Trial Balance
May 31, 2011Cash 3,925$ Accounts receivable 75 Tools & equipment 2,650 Accum. depreciation: tools & eq. 50$ Truck 15,000 Accum. depreciation: truck 250 Notes payable 13,000 Accounts payable 150 Capital stock 8,000 Dividends 200 Sales revenue 750 Gasoline expense 50 Depreciation exp.: tools & eq. 50 Depreciation exp.: truck 250 Total 22,200$ 22,200$
All balances are taken from
the ledger accounts on May 31 after
preparing the two
depreciation adjusting entries.
Adjusted Trial BalanceAdjusted Trial Balance
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TTYPESYPES of A of ADJUSTINGDJUSTING E ENTRIESNTRIES
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TTypeype 2: U 2: Unearnednearned R Revenuesevenues
Unearned Revenues are payments for future services to be performed or goods to be delivered.
At the end of each accounting period, adjusting entries must be made to recognize the portion of unearned revenues that have been earned during the period.
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Adjusting Entries for Adjusting Entries for ““UUnearned nearned RRevenues”evenues”
Suppose that you are the owner of an Insurance company and on November 30th a customer pays £1,800 for an insurance policy to protect her delivery vehicles for six months.
Make the appropriate adjustment as of the end of the accounting period. (i.e. 31/12/2012)
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Adjusting Entries for Adjusting Entries for ““UUnearned nearned RRevenues”evenues”
Initially, the insurance company records this transaction by;
increasing an asset account (cash) with a debit
increasing a liability account (unearned revenue) with a credit.
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Adjusting Entry:
Unearned Insurance £ 1,800
Cash £1,800Nov. 30
Debit Credit
Cash
1,8001,800 1,8001,800
Debit Credit
Unearned Insurance
££ 1,8001,800
Adjusting Entries for Adjusting Entries for ““UUnearned nearned RRevenues”evenues”
DRCR
££ 1,8001,800
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Adjusting Entries for Adjusting Entries for ““UUnearned nearned RRevenues”evenues”
After one month on 31 December 2012, the insurance company makes an adjusting entry;
To decrease (debit) unearned revenue
To increase (credit) revenue by an amount equal to one sixth of the initial payment.
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Adjusting Entry:
Vehicle Insurance Revenue
£ 300
Unearned Insurance
300
Dec. 31
Debit Credit
Vehicle Insurance Revenue
1,800
Debit Credit
Unearned Insurance
$300$300
Adjusting Entries for Adjusting Entries for ““UUnearned nearned RRevenues”evenues”
DRCR
£ 300
$1,500$1,500
300300
(£1,800 / 6months)= 300 per
month
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Adjusting Entries for Adjusting Entries for ““UUnearned nearned RRevenues”evenues”
If we do not include adjusting entries to show the earning of previously unearned revenues ;
We overstate total liabilities and understate total revenues and net income.
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TTYPESYPES of A of ADJUSTINGDJUSTING E ENTRIESNTRIES
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TTypeype 3: 3: AAccrued Rccrued Revenuesevenues
An asset class for goods or services that have been sold or completed but that have not yet been billed and/or paid for.
Accrued revenue is income that has been incurred but not received
Accrued revenue is also called accrued assets.
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Adjusting Entries for Adjusting Entries for ““AAccrued ccrued RRevenues”evenues”
ABC Ltd. sold £1,000 of products to a customer who is not required to pay for 60 days.
The sale is recorded by ABC Ltd. on the income statement as revenue and on the balance sheet as a current asset
Even though no money will be received until later. (The sale process is occurred)
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Initial Entry:
Revenue £ 1,000
Receivables (Current Asset) £ 1,000Dec. 31
Debit Credit
Receivables
1,0001,000 1,0001,000
Debit Credit
Revenue
1,0001,000
Adjustıng Entries for “accrued revenues”Adjustıng Entries for “accrued revenues”
DRCR
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Adjusting Entries for “accrued revenues”Adjusting Entries for “accrued revenues”
The concept of accrued revenue is needed in order to properly match revenues with expenses.
The absence of accrued revenue would tend to show excessively low initial revenue levels. Thus, low profits for a business
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Adjusting Entries for Adjusting Entries for ““AAccrued ccrued RRevenues”evenues”
For example; Muffin Ltd. rented its office to Cookie
Ltd. for £500 a month.
Muffin Ltd. has not received December rent of £500 from Cookie Ltd.
What figure of rent receivable should be shown as income for Muffin Ltd. for the year ended 31/12/2012
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Adjusting Entry: The adjusting entry at the end of December is to debit rent receivable and credit rental revenue by £500.
Rental Revenue £500
Rent Receivable (Current Asset) £500Dec. 31
Debit Credit
Rent Receivable
500500 500500
Debit Credit
Rental Revenue
500500
Adjusting Entries for Adjusting Entries for ““AAccrued ccrued RRevenues”evenues”
DRCR
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Adjusting Entries for Adjusting Entries for ““AAccrued ccrued RRevenues”evenues”
After one month, on January 2013 Muffin Ltd. received the rental income of £500 form Cookie Ltd.
What would be the double entry?
To increase (debit) as cash is received.
To decrease (credit) as rent is paid by Cookie Ltd.
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Adjusting Entry: The adjusting entry on January 2013 is to debit Cash / Bank and credit Receivable`s account for £500.
£500
Cash or Bank £500Jan. 31
Debit Credit
Rent Receivable
500500
Debit Credit
Cash / Bank
--
Adjusting Entries for Adjusting Entries for ““AAccrued ccrued RRevenues”evenues”
DRCR Rent Receivable
500500
--
500500
500500
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TTYPESYPES of A of ADJUSTINGDJUSTING E ENTRIESNTRIES
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TTypeype 4: 4: AAccrued Expenses ccrued Expenses
Accrued Expense is an expense incurred but not yet paid.
A journal entry is created to record the expense, as well as an offsetting liability (which is usually classified as a current liability in the balance sheet).
The absence of a journal entry result in reported profits being too high in that period. (as expense will not be reported in the FS)
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Adjusting Entries for Adjusting Entries for ““AAccrued Expenses”ccrued Expenses”
Examples of expenses that are commonly accrued include:
Interest on loans, for which no lender invoice has yet been received
Goods received and consumed or sold, for which no supplier invoice has yet been received
Services received, for which no supplier invoice has yet been received
Wages incurred, for which payment to employees has not yet been made
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Adjusting Entries for Adjusting Entries for ““AAccrued Expenses”ccrued Expenses”
For example; Green Ltd. enters into a rental agreement to
use the trucks of Car & Cars Ltd.The term states that Green Ltd. will pay
monthly rentals of £2,000 at the end of each month.
The lease started on July 1st, 2012. On July 31, the rent for the month has not yet been paid and no record for rent expense was made.
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Adjusting Entries for Adjusting Entries for ““AAccrued Expenses”ccrued Expenses”
What would be the necessary adjusting entry for rent expense?
In this case, Green Ltd. has already incurred (consumed/used) the expense. Even if it has not yet been paid, it should be recorded as an expense.
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Adjusting Entry: The adjusting entry at the end of July is to debit rent expense and credit rent payable for £2,000.
Rent Payable £ 2,000
Rent Expense £ 2,000July. 31
Debit Credit
Rent Expense
2,0002,000 2,0002,000
Debit Credit
Rent Payable
2,0002,000
Adjusting Entries for Adjusting Entries for ““AAccrued Expenses”ccrued Expenses”
DRCR
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Adjusting Entries for Adjusting Entries for ““AAccrued Expenses”ccrued Expenses”
Expense recognition principle, requires expenses to be recognized when incurred regardless of when paid.
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SUMMARYSUMMARY
Prepaid expenses
Depreciation
Accrued revenues
Debit Expense
Credit Asset (Prepaid)
Debit Depreciation Expense
Credit Accumulated Depreciation
Debit Receivable
Credit Revenue
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SUMMARYSUMMARY
Accrued expenses
Unearned revenues
Debit Expense
Credit Liability
Debit Liability (Unearned)
Credit Revenue
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End of Chapter 4End of Chapter 4