Chapter 3
Adjusting the Accounts
The Year
• Calendar Year is January 1 through December 31
• Fiscal year is any 12-month period– I.E. ATA’s year is July 1 through June 30
Cash Basis vs. Accrual
• Cash Basis is when a company only records when cash has been received or paid out.
• Accrual Basis records events as they happen
• **Cash accounting is not in accordance with GAAP***
Revenue Recognition
• Revenue is recognized only when the services have been performed.
• However, if we receive money ahead of time, we increase the liability account—”Unearned Revenue”
Matching Principle
• We always need to match the expenses that were needed to produce the revenue
Adjusting Entries
• Certain accounts are not the same at the end of an accounting period.– Deferrals , accounts recorded as assets and have
been used up.• Pre-Paid Insurance• Supplies• Large assets that have depreciated (or lost some of
their value)
Pre-Paid Insurance
• We paid insurance for a period of time and recorded the entire amount as the asset, Pre-Paid Insurance.
• If we paid for insurance for $600 for 12 months, then we use up $50 each month
• At the end of the month we record the used up part like this:– Insurance Expense $50.00 (Debit)• Pre-Paid Insurance $50.00 (Credit)
You Try
• Leo Jewelers purchased Insurance on January 1 for $1500/yr. On April 1, he is adjusting his account.
• How many months have been used ___?____• Figure the amount used up_____?________• What is the entry ______?__________• How much insurance is left ______?____
Supplies
• When you buy supplies for your business, you add it to the asset account, supplies.
• However, as you go through the year, your supplies as used, so you don’t have as many at the end of a month, year or quarter.
So What Now
• You take an inventory of your supplies• You determine that you have $100 of pencils
left.• You bought $250.00 of supplies in the
beginning.• How many pencils did you use?• The adjusting entry is:– Supplies Expense ? (Debit)
• Supplies ? (Credit)
This poor computer isn’t worth what it used to be!!!
Many large assets lose their valueExamples are: Furniture, Cars, TechnologyThese assets have depreciated in value
First, we need to know two things:A contra asset account is an account that offsets
an asset but is still noted on the balance sheet. Accumulated Depreciation is a contra-asset account.
Second
• The book value of any depreciable asset is calculated by taking the original value – depreciation.
• If you bought office equipment for $5,000 and it has depreciated $1,000, then the book value is $4,000 (5,000-1,000).
Adjusting Entry
• On the previous example, Smith Bros bought office equipment for $5,000 and it has depreciated $1,000 in the past year. We do adjusting entries at the end of the year (important note)
• Entry– Depreciation Expense-Office Equip $1,000 (Dr)• Accumulated Depreciation-Office Equipment
$1,000(Cr)
Do It
• Page 126 3-2 (1-3) only• Do this in your notebook (15 minutes)
Unearned Revenue
• Examples: Magazine Subscriptions, Airline Tickets, Consulting Projects, Architectural contracts.
• Unearned Revenue is a liability account.• It is adjusted when the service is performed or
completed. The adjusting entry can be for the entire amount of a partial part.
Pioneer Advertising Agency
• Pioneer Advertising Agency received $1,200 on October 2 from R. Knox for advertising services expected to be completed by December 31.
• The first entry:– Cash $1,200 (Dr)• Unearned Revenue $1,200 (Cr).
Adjusting Entry
• At the end of March Pioneer completed one month’s worth of the services.
• We want to take one-month of the liability away so…– Unearned Revenue $400 (Dr)• Service Revenue $400(cr)
– ? How much is in Unearned Revenue Now?
You do it!
• Buhl Company has Unearned Revenue of $10,000.
• At the end of the month, Buhl has performed 2/5 of the services.
• What is the amount of revenue earned?• What is the entry?• How much is still unearned?
Accruals
• To account for revenue and expenses that should be put into an accounting period but because of timing they have not been recorded.
Revenue not yet recorded
• Might have happened on the day the financial statements are being prepared so we record it with an adjusting entry
• Accounts Receivable (Dr.)– Service Revenue (Cr)
Accrued Expenses
• Examples are interest that has accrued but doesn’t need to be paid yet.
• Salaries that have been earned but do not need to be paid yet.
Accrued Interest
• Let’s say we went to the back to get money for our business and we signed a note for $5,000 at 12% annual interest.
• How did we record this money when received?
At the End of the Month
• We have accrued 1 month of interest of 1/12.• We would then take $5,000 x 12% x 1/12.• We should come out with ?• The adjusting entry is– Interest Expense ? (Dr.)• Interest Payable ?(Cr)
You Do It!
• Calvin and Hobbes borrowed $30,000 from a local bank on a 15 year note. The annual interest rate is 10%.
• What is the interest for a year?• What is the interest for ½ year?• What is entry to record the interest for 6
months?
Accrued Salaries
• Many companies pay every other week. The accounting period may end in between pay periods. We must account for the days that were performed but not yet paid.
Example
• Carter just paid everyone on October 26 and the next payday is November 9.
• They are preparing statements at the end of October. Therefore 3 days of work were performed after October 26.
• If their total payroll for 5 days of work is $2,000, how much was performed in 3 days?
Next, the Adjusting Entry
• Salaries Expense1,200 (Dr)Salaries Payable 1,200 (Cr)
Then when the entire amount is paid on Nov 9Salaries Payable $1,200 (Dr)
Salaries Expense $ 800 (Dr) Cash 2,000 (Cr.)
Finally!!!
• The adjusted trial balance• Take each account in the ledger• Write their balance• Debits in total should equal credits in total.
Examples
• Page 112• Page 113• E3-6 Page 128• E3-9 Page 129
Assignments
• P3-1A• P3-2A• P3-5A
Test Review
• Define– Accrual– Book Value– Depreciation– Contra-Asset– Deferrals– Fiscal Year– Prepaid Expenses– Unearned Revenue– Adjusting Entries
Analyze
• Amount of adjusting entries.• Accounts to enter adjusting entries.• Problem similar to P3-1A
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