accounting transactions deffered expenses

8/4/2019 Accounting Transactions Deffered Expenses

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The easiest method for determining if an expense should be classifiedas a deferred expense is simply to determine when the businessintends to make use of the expense. If the incurred expense is not to beutilized during the current month, it should be recorded as a deferredexpense and an asset to the business. Lets use the example of officesupplies: suppose you purchase $3000 of office supplies, and you only use$1500 during the current month. How do you account for the remaining$1500 of supplies? They must be shown as a deferred expense. A failureto properly account for the actual status of an expense item, will distort theprofit and loss sheet, and in turn the balance sheet. Although many smallbusinesses do not properly record such transactions, larger more corporatelevel accounting methods will require accurate recorded transactions ofprepaid or deferred expenses.

Adjusting Journal Entries

All adjusting entries (other than error corrections) will alwaysinvolve at least one account on the balance sheet and atleast one account on the income statement.

I. Deferral Adjustments

A deferral involves a past exchange of cash that has initiallybeen recorded on the balance sheet rather than on theincome statement. The name deferral comes about becausethe recording on the income statement is deferred

(postponed) to a later time.A. Deferred Expenses

A deferred expense is initially recorded on the balance sheetas an asset than being immediately expensed. An adjustingentry becomes necessary as the asset is consumed andbecomes an expense.

1. Illustration for a short-term asset

> Past exchange of cash

Asset XXXCash XXX

> Adjusting entry necessary as the asset is consumed

Expense XXX (Incomestatement)

Asset XXX (Balance sheet)


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Example:The supplies account currently shows a $300 balance.

A count of the supplies determines that only $250 remains.

Supplies Expense 50Supplies 50

2. Illustration for a long-term asset

The adjusting entry for long-term assets differs in thatinstead of

reducing the asset directly, a contra account is usedthat is

subtracted from the asset on the balance sheet.


Asset XXXCash XXX

> Adjusting entry necessary as the asset is consumed

Depreciation Expense XXX (Incomestatement)

Accumulated Depreciation XXX(Balance sheet)

Example:Current year depreciation is $2,500.

Depreciation Expense 2,500 Accumulated Depreciation 2,500

Note: Accumulated depreciation is a contra accountthat is

subtracted from the asset on the balance sheet. Ithas a normal credit balance.

B. Deferred Revenues

A revenue cannot be recorded until the income has beenearned. Cash received in advance of income realizationshould be initially recorded in a liability account such as"Unearned Revenue". An adjusting entry later becomesnecessary as the revenue is earned. The liability should bereduced and the revenue recorded.


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Cash XXXUnearned Revenue XXX

> Adjusting entry necessary as revenue is earned

Unearned Revenue XXX (Balancesheet)

Revenue XXX (Incomestatement)

Example: Adams CPA previously received $500 forbookkeeping services

in advance of providing the services. Adams has

now earned$300 of the money.

Unearned Revenue 300Revenue 300

II. Accrual Adjustments

An accrual involves a future exchange of cash that must berecorded on the income statement before cash isexchanged.

A. Accrued Expenses> Adjusting entry

Expense XXX (Incomestatement)

Liability XXX (Balance sheet)

> Future exchange of cash

Liability XXXCash XXX

Example:Interest accrued on a loan at the end of the month is

$550.

Interest Expense 550Interest Payable 550


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B. Accrued Revenues

> Adjusting entry

Receivable XXX (Balancesheet)

Revenue XXX (Incomestatement)

> Future exchange of cash

Cash XXXReceivable XXX

Example:Performed $400 of services for a customer on account.

Accounts Receivable 400Revenue 400

Depreciation Calculations

This page illustrates the computation of the straight-line

and double-declining balance methods of depreciationusing the following example.

Cost of Asset

10,500

Salvage Value

500

Life 5

years

1. Straight-Line Depreciation

Note that the straight line calculation considerssalvage value up front

in the calculation.

10,500 cost - 500 salvage value = 2,000 per

year

-------------------------------

5 year life


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Depreciation Accumulated

Book

Year Cost Expense

Depreciation Value

---- -------- ------------- ------------

- --------

1 10,500 2,000 2,000

8,500

2 10,500 2,000 4,000

6,500

3 10,500 2,000 6,000

4,500

4 10,500 2,000 8,000

2,500

5 10,500 2,000 10,000

500

2. Double-declining Balance Depreciation

The double-declining balance method ignoressalvage value

in the initial calculation. However,

depreciation expense will be

limited if the calculated amount would result

in the book value

dropping below the salvage value. For

example, suppose an asset

has a prior book value of $600 and a salvage

value of $500. In

this case, depreciation expense is limited to

the remaining

$100 book value in excess of salvage value.

Also, each year comparisons are made between the

declining balance rate

calculations and straight-line depreciation of

the remaining book value.

A switch to the straight-line calculation is made

in the year in which

the straight-line calculation exceeds the

declining balance rate

calculation.

> DDB rate = 1/Life x 2 = 1/5 x 2 = 40%

> Declining balance rate depreciation = Beginning

of period carrying value

x DDBrate

Calculations

-----------------------------------

------------------

Year DDB

Straight-Line

---- ---------------------- -------

------------------


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1 10,500 x 40% = 4,200 (10,500

- 500)/5 = 2,000

2 6,300 x 40% = 2,520 ( 6,300

- 500)/4 = 1,450

3 3,780 x 40% = 1,512 ( 3,780

- 500)/3 = 1,093

4 2,268 x 40% = 907 ( 2,268

- 500)/2 = 884

5 1,361 x 40% = 544 ( 1,361

- 500)/1 = 861

Note: Switch to straight-line in year 5

since its calculation

exceeds the DDB calculation.

Depreciation Accumulated

Book

Year Cost Expense

Depreciation Value

---- -------- ------------- ------------

- --------1 10,500 4,200 4,200

6,300

2 10,500 2,520 6,720

3,780

3 10,500 1,512 8,232

2,268

4 10,500 907 9,139

1,361

5 10,500 861 10,000

500

accounting transactions deffered expenses

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