chapter 17 accounting for accruals and deferrals · 2014-01-24 · chapter 17 accounting for...
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o Understand Accrual and Deferrals
o Accrued Expense
o Accrued Revenue
o Deferred Expense
o Deferred Revenue
Chapter 17 Accounting for Accruals and
Deferrals
Accruals and Deferrals
• Accruals
Expenses incurred and revenue earned in the
current accounting period but not recorded as of
the end of the period
Accrual Basis
Applies the matching principles of accounting
Record revenue in the period earned
(regardless of when cash changes hands)
Record expenses in the same period that
generated the revenue
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• Deferrals
Expenses and revenue that have been recorded in
the current accounting period but are not incurred
or earned until a future period
Accrued Expenses• Expenses that build up or accumulate during the current period but will
not be paid until the next period; AKA accrued liabilities
• Recorded in the current period
Debit to an expense account
Credit to a liability account
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Assume that Bluff City Supply Company pays its employees every Friday
for a normal five-day workweek and that the weekly payroll is $20,000.
Dec. 31, 20X1, is a Wednesday. The week’s salaries will be paid on Friday,
Jan. 2, 20X2. Daily salaries are $20,000 ÷ 5 days = $4,000. Employees
are owed for Monday, Tuesday and Wednesday, the last 3 days of the
accounting period. The following entry is prepared on Dec. 31, 20X1:
20X1
Dec.31 Salaries Expense 12,000
Salaries Payable 12,000
Paying Accrued Salaries Expense-No Reversing
Entry
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• Assume that Bluff City Supply Company pays its employees every
Friday for a normal five-day workweek and that the weekly payroll is
$20,000. Dec. 31, 20X1, is a Wednesday. The following entry was
prepared on Dec. 31, 20X1:
20X1
Dec.31 Salaries Expense 12,000
Salaries Payable 12,000
• On Friday, Jan. 2, 20X2, Bluff City paid the payroll for the week and
prepared the following journal entry:
20X2
Jan.2 Salaries Expense 8,000
Salaries Payable 12,000
Cash 20,000
Paying Accrued Salaries Expense-Reversing Entry Used
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• Assume that Bluff City Supply Company pays its employees every
Friday for a normal five-day workweek and that the weekly payroll is
$20,000. Dec. 31, 20X1, is a Wednesday. The following entry was
prepared on Dec. 31, 20X1:
20X1
Dec.31 Salaries Expense 12,000
Salaries Payable 12,000
• On Thursday, Jan. 1, 20X2, Bluff City made the following reversing
entry (an exact opposite of the adjusting entry):
20X2
Jan.1 Salaries Payable 12,000
Salaries Expense 12,000
• On Jan. 2, 20X2, makes the following entry to payment of salaries:
20X2
Jan.2 Salaries Expense 20,000
Cash 20,000
Adjusting for Accrued Interest Expense
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• Assume that on Nov. 1, 20X1, Bluff City Supply Company borrowed
$12,000 on a 90-day, 14% note.
• The due date of the note is Jan. 30, 20X2.
• An adjusting entry must be made on Dec. 31, 20X1, to record the
accrued interest.
• The accrued interest is calculated for the period of Nov. 1 to Dec. 31,
20X1.
• Interest = $12,000 × .14 × 60 days ÷ 360 days = $280
• The following adjusting entry is prepared:
20X1
Dec.31 Interest Expense 280
Interest Payable 280
Paying Accrued Interest Expense-No Reversing Entry
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• On Jan. 30, 20X2, Bluff City Supply Company must repay the note and
the total amount of interest.
• We need to compute the interest for the current period; the 30 days in
January.
• Interest = $12,000 × .14 × 30 days ÷ 360 days = $140
• The following entry is prepared on January 30, 20X2, to repay the note
and the total amount of interest:
20X2
Jan.30 Notes Payable 12,000
Interest Expense 140
Interest Payable 280
Cash 12,420
Paying Accrued Interest Expense-Reversing Entry
Used
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• Assume on Jan. 1, 20X2, Bluff City made the following reversing entry:
20X2
Jan.1 Interest Payable 280
Interest Expense 280
• On Jan. 2, 20X2, makes the following entry to pay the note and
total amount of interest:
20X2
Jan.2 Notes Payable 12,000
Interest Expense 420
Cash 12,420
Accrued Revenue
• Revenue that has been earned but will not be received until the next
accounting period. Must be recorded in the current period to properly
match revenue and expenses.
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• Assume that on Nov. 1, 20X1, Burroughs Company entered into a three-
month lease agreement with White Company. Terms of the lease require
that full payment of $1,800 for all three months be made by White on Jan.
31, 2X02. On Dec. 31, 20X1, Burroughs will have earned two months of
interest (November and December). An adjusting entry must be prepared
for the accrued revenue as of Dec.31, 20X1.• $1,800 ÷ 3 months = $600/month; $600/month × 2 months = $1,200
20X2
Dec.31 Rent Receivable 1,200
Rent Income 1,200
Recording the Receipts of Accrued Revenue-No
Reversing Entry
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• On Jan. 31, 20X2, Burroughs will receive the full $1,800 due from White.
• Burroughs must record the receipt of $1,800, record one month’s rent
income earned in 20X2, and remove the receivable from the books.
• The following entry is prepared on Jan. 31, 20X2, to record the cash
receipt and the current period’s revenue:
20X2
Jan.31 Cash 1,800
Rent Receivable 1,200
Rent Income 600
Recording the Receipts of Accrued Revenue-Reversing Entry Used
• Assume that on Nov. 1, 20X1, Burroughs Company entered into a three-month
lease agreement with White Company.
• Terms of the lease require that full payment of $1,800 for all three months be
made by White on Jan. 31, 2X02.
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• On Dec. 31, 20X1, Burroughs recorded the following adjusting entry for 2
months of accrued interest:
20X1
Dec.31 Rent Receivable 1,200
Rent Income 1,200
• Assume on Jan. 1, 20X2, Burroughs made the following reversing entry:
20X2
Jan.1 Rent Income 1,200
Rent Receivable 1,200• On Jan. 31, 20X2, makes the following entry to record receipt of the total amount of rent:
20X2
Jan.31 Cash 1,800
Rent Income 1,800
Summary of Accruals
• An accrual always adds to the expense or the revenue.
• The adjusting entry for an accrual always creates a balance sheet
account-either a payable or a receivable.
• An accrual adjustment can always be reversed.
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Deferred Expenses
• An advance payment for goods or services that benefit more than
one accounting period
• The prepayment can be initially recorded in two different ways:
As an asset
As an expense
• The end-of-period adjustment depends on the way in which the
deferred expense was initially recorded.
• Both methods result in the same amount of expense being allocated
to the two accounting periods involved.
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Deferred Expenses Recorded as Assets
On Oct. 1, 20X1, Bluff City Supply Company purchased casualty
and theft insurance for a period of one year at a cost of $3,600.
Bluff prepared the following entry to record the purchase of the
insurance:20X1
Oct.1 Prepaid Insurance 3,600
Cash 3,600
• The amount of insurance that expires each month is $3,600 ÷ 12
months = $300. On Dec. 31, 20X1, Bluff records the following entry
to transfer 3 months of insurance (Oct. to Dec.) from the asset
account to an expense account:
20X1
Dec.
3
1Insurance Expense 900
Prepaid Insurance 900
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Deferred Expenses Recorded as Expenses• On October 1, 20X1, Bluff City Supply Company purchased casualty
and theft insurance for a period of one year at a cost of $3,600.
• Bluff prepared the following entry to record the purchase of the
insurance:
20X1
Oct.1 Insurance Expense 3,600
Cash 3,600
20X1
Dec.
3
1Prepaid Insurance 2,700
Insurance Expense 2,700
Reversing Entries for Deferred Expenses Recorded Initially
as Expenses• If the initial entry for a deferred expense was recorded as an expense,
the adjusting entry will create an asset. The fact that this asset account
was created as part of the adjusting process allows you to reverse the
adjustment.
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On Dec. 31, 20X1, Bluff records the following entry to transfer 9
months of insurance (Jan. to Sep. of 20X2) from the expense account
to the asset account:
20X1
Dec.
3
1Prepaid Insurance 2,700
Insurance Expense 2,700
The following entry is prepared on January 1, 20X2, to reverse the
adjustment:20X2
Jan.1 Insurance Expense 2,700
Prepaid Insurance 2,700
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Deferred Revenue
• Revenue that has been received in the current period but will
not be fully earned until the future.
• Must be pushed off to future periods to match revenue and
expenses properly.
• Can be initially recorded in two different ways
As a liability
As revenue
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• The end-of-period adjustment depends on the way in which the
deferred revenue was initially recorded.
• Both methods result in the same amount of revenue being
allocated to the two accounting periods involved.
Deferred Revenue
How would the New York
Yankees organization record
money collected in advance
from season ticket sales?
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• Money collected in advance is unearned revenue because no
goods or services have been delivered or provided.
• Unearned revenue is a liability, and is recognized as revenue
only as the goods or services are provided.
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Deferred Revenue Recorded as a Liability• On Apr. 1, 20X1, Laurel Publishers receives in advance annual subscriptions
that total $120,000. Laurel records the cash receipt as a liability and records
the following entry:
20X1
Apr. 1 Cash 120,000
Unearned Subscriptions Income 120,000
The Unearned Subscriptions Income account is a liability account with a
normal credit balance. Per month Laurel earns $120,000 ÷ 12 months =
$10,000.
On Dec. 31, 20X1, Laurel records the following entry to transfer 9
months of subscriptions received (Apr. to Dec.) from the liability account
to a revenue account:
20X1
Dec. 31 Unearned Subscriptions Income 90,000
Subscriptions Income 90,000
Deferred Revenue Recorded as Revenue
• On Apr. 1, 20X1, Laurel Publishers receives in advance annual
subscriptions that total $120,000. Laurel records the cash receipt as
revenue and records the following entry:
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•20X1
•Apr. •1 •Cash •120,000
•Subscriptions Income •120,000
Per month, Laurel earns $120,000 ÷ 12 months = $10,000.
On Dec. 31, 20X1, Laurel records the following entry to transfer 3
months of subscriptions not yet earned (Jan. to Mar. of 20X2) from the
revenue account to a liability account:
20X1
Dec. 31 Subscriptions Income 30,000
Unearned Subscriptions Income 30,000
Reversing Entries for Deferred Revenue Recorded Initially
as Revenue• If the initial entry for deferred revenue was recorded as revenue, the adjusting entry will
create a liability.
• The fact that this liability account was created as part of the adjusting process allows you to
reverse the adjustment.
• Laurel recorded the following entry to receive $120,000 of subscriptions on April 1, 20X1:
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20X1
Apr. 1 Cash 120,000
Subscriptions Income 120,000
Laurel prepared the following adjusting entry on Dec. 31, 20X1:
20X1
Dec. 31 Subscriptions Income 30,000
Unearned Subscriptions Income 30,000
The following entry is prepared on January 1, 20X2, to reverse the adjustment:
20X2
Jan. 1 Unearned Subscriptions Income 30,000
Subscriptions Income 30,000
Summary of Reversing Entries
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ReverseDo Not
Reverse
All accruals
Deferred expenses initially recorded
as expenses
Deferred revenue initially recorded
as revenue
Deferred expenses initially recorded
as assets
Deferred revenue initially recorded
as a liability
Comparison of Methods for Recording Deferred RevenueReceived advance subscriptions of $120,000 for 12 issues of a magazine.
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Comparison of Methods for Recording Deferred RevenueReceived advance subscriptions of $120,000 for 12 issues of a magazine.
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Joining the Pieces
Accruals and
Deferrals
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