copyright © 1999 by m. ray gregg. all rights reserved. 1 adjusting the accounts supplies bal. 100...

Copyright © 1999 by M. Ray Gregg. All Rights Reserved.

1

Adjusting the Accounts

Supplies

Bal. 100Pur. 400


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“Cash” vs. “Accrual”

Cash Accrual

Revenuereceived

Expenses paid


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“Cash” vs. “Accrual”

Cash Accrual

Revenuereceived earned

Expenses paid incurred

GAAP requires using the ACCRUAL basis


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Why make Adjusting Journal Entries?


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Why make Adjusting Journal Entries?

Better Financial Statements

(every adjusting entry will have

one Balance Sheet and

one Income Statement effect)


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Matching Concept

Revenue

Expenses

Time (period)


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I. Identifying accounts to be adjusted:

Accruals and Deferrals

accruals deferralscash AFTER event cash BEFORE event

Deferrals have been recorded; accruals have not.

A. Timing of cash changing hands:

$


8


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B. DefinitionsAn ACCRUAL is an expense that has NOT been paid or a revenue that has NOT been received.


Accruals and Deferrals

Examples of accruals:Expense: salaries, interest, taxes

Revenue: services (performed on account)


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Accruals and DeferralsB. DefinitionsA deferral is a delay of the recognition of an expense already paid or of a revenue already received.

Examples of deferrals:

Expense: supplies, insurance, rent (tenant)

Revenue: subscriptions, rent (landlord)


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II. AccrualsA. EXPENSES

1. Example

Salaries increase as employees work each day, yet, for convenience, salaries are recorded when PAID. Since the cash is paid after the event, salaries are an example of accrued expense.

Salaries Expense incurred Salaries Payable incurred

The adjusting entry necessary when payday and the end of the fiscal period are on different days would be:


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II. Accruals2. Decision tree conclusion

Accrued Expense


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II. AccrualsA. REVENUE

1. Example

A CPA firm is auditing a client’s records; the engagement begins in mid-November and lasts through the end of February. As work is being performed each day, revenue is earned. Since the cash will not be collected until completion of the engagement (after the event), this is an example of accrued revenue.

The adjusting entry necessary on the CPA’s records at the end of the year when financial statements are about to be prepared would be:

Accounts Receivable earned Service Revenue earned

11/15 2/2812/31


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II. Accruals2. Decision tree conclusion

Accrued Revenue


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II. AccrualsC. Reversing Entries -- Appendix to Chap 4

What?


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What?Which?

accrualscash AFTER event $


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What?Which?When?


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What?Which?When?

Why? helps next year


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All ACCRUALS need to be reversed.

Watch for new rule and apply it here,too.

What?Which?When?

Why?

What else? More Soon


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II. AccrualsC. Reversing Entries

Accruals

Accr

uals


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III. DeferralsA. (Prepaid) EXPENSES 1. Examples from chapters 1 and 2:

supplies, insurance, rent

2. Two methods of accounting for deferred (prepaid) expenses

a. ASSET METHOD

(Chapter 3 and homework)

b. EXPENSE METHOD

(Appendix and in class)


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III. DeferralsA. 3. Identifying method for deferred EXPENSES

a. Where was initial transaction recorded?

b. Where is the balance of the account

before adjustment?

Which method would we be using . . .

Prepayment Asset Expense

for insurance _______ ________

for supplies _______ ________

for rent _______ ________


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III. DeferralsA. 4. Consider this example:

Supplies Supplies Expense

Bal. 100Pur. 400

Ending Inventory = $50

a. ASSET Method

Supplies Expense 450Supplies 450


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Bal. 100Pur. 400

a. ASSET Method


450


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Bal. 100Pur. 400

a. ASSET Method


450450


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Bal. 100Pur. 400

a. ASSET Method


450450

Bal. = 50

Used


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III. DeferralsA. 4. b. Decision tree conclusion

Asset

Method


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III. DeferralsA. 5. Re-consider the example:


Bal. 100Pur. 400


a. EXPENSE Method

Supplies 50Supplies Expense 50


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Bal. 100Pur. 400


a. EXPENSE Method


50 50


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Bal. 100Pur. 400


a. EXPENSE Method


50 50Unused


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III. DeferralsA. 4. b. Decision tree conclusion

Expense

Method


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Comparison of Methods


Bal. 100Pur. 400

450450

ASSET METHOD


Bal. 100Pur. 400

EXPENSE METHOD

50 50

exactly thesame results


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Key to administering methods is

CONSISTENCY

J F M A M J J A S O N D

20x1 20x2


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Key to administering methods is

CONSISTENCY

20x1 20x2


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Reversing entries necessary?

“Rule” becomes “old rule” -- won’t work.

These are DEFERRALS -- not accruals.


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III. A. 6. Reversing Entries

New Rule: One rule -- two ways to say it.a. If an ADJUSTING entry creates (first entry in the account) the balance in a BALANCE SHEET account, a reversing entry would be advantageous.


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III. A. 6. Reversing Entries

New Rule: One rule -- two ways to say it.

b. If the direction of a deferral ADJUSTING entry is BALANCE SHEET to INCOME STATEMENT, it should NOT be reversed.

If the direction of a deferral ADJUSTING entry is INCOME STATEMENT to BALANCE SHEET, it should be reversed.


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III. A. 6. Reversing EntriesConsider the SUPPLIES example...


Bal. 100Pur. 400

AJE 450AJE 450

ASSET METHOD


Bal. 100Pur. 400

EXPENSE METHOD

AJE 50AJE 50C2 450

C2 450

NO

YES!!


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AJE 50C2 450

Supplies Expense

III. A. 6. Reversing EntriesConsider the SUPPLIES example...

Supplies

Bal. 100Pur. 400

EXPENSE METHOD

AJE 50

Nature = Asset

R 50

R 50


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Expense

Meth

od


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? ? ? ? ? ? ? ? ? ? ? ? ? ? ?

You should try one …

… about Prepaid Insurance

… on your own time.

Solution on class web page.

Now turn to middle of page 6


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III. DeferralsB. REVENUE 1. Examples

landlords, magazine companies, lawyers

Assume that attorneys Jones, Fraud, and Swindle, whose year ends December 31, received $1,200 on September 1 for one year’s service in advance.

1/1 12/31 12/31

$1,200

9/1


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III. DeferralsB. REVENUE 1. Examples

landlords, magazine companies, lawyers

Assume that attorneys Jones, Fraud, and Swindle, whose year ends December 31, received $1,200 on September 1 for one year’s service in advance.

2. Two methods of accounting for deferred revenue

When CASH was debited, what was credited?

a. LIABILITY METHODb. REVENUE METHOD


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III. DeferralsB. 3. Identifying method for deferred REVENUE

a. Where was initial transaction recorded?

b. Where is the balance of the account

before adjustment?


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III. DeferralsB. 4. Consider the example of the lawyers:

Unearned Fees Fees Earned

9/1 1,200

a. REVENUE Method

Fees Earned 800Unearned Fees 800

$1,2004 mo 8 mo$400 $800

earned unearned


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9/1 1,200

a. REVENUE Method


$1,2004 mo 8 mo$400 $800

800800

B = $400


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9/1 1,200

a. REVENUE Method


$1,2004 mo 8 mo$400 $800

800800

B = $400

unearned


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III. DeferralsB. 4. b. Decision tree conclusion

RevenueMethod


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III. DeferralsB. 5. Re-consider the example of the lawyers:


9/1 1,200

a. LIABILITY Method

Unearned Fees 400Fees Earned 400

$1,2004 mo 8 mo$400 $800


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9/1 1,200

a. LIABILITY Method


$1,2004 mo 8 mo$400 $800

400 400


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9/1 1,200

a. LIABILITY Method


$1,2004 mo 8 mo$400 $800

400 400earnedB=800unearned


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III. DeferralsB. 4. b. Decision tree conclusion

LiabilityMethod


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9/1 1,200AJE 400 AJE 400

Liability Method

Revenue MethodUnearned Fees Fees Earned

9/1 1,200AJE 800AJE 800

exactly thesame results


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Comparison of MethodsLiability Method

Revenue Method


9/1 1,200AJE 400 AJE 400C2 400


9/1 1,200AJE 800AJE 800C2 400

NO

YES!!


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III. DeferralsB. 6. Reversing Entries Necessary?

RevenueMethod


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Reversing Entry

Revenue MethodUnearned Fees Fees Earned

9/1 1,200AJE 800AJE 800C2 400

R 800

R 800

Nature = Liability


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? ? ? ? ? ? ? ? ? ? ? ? ? ? ?

You should try one …

… about Unearned Tuition

… on your own time.

Solution on class web page.


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Plant Assets

Plant Assets (long-lived assets) are also forms of deferrals.

The remainder of the notes in the handout are on the class web page. Check it out.


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Hopefully, you learned a great deal today.

Use the decision tree as a learning tool this week!

Have a great week!

copyright © 1999 by m. ray gregg. all rights reserved. 1 adjusting the accounts supplies bal. 100...

Documents

ray gregg

revenue slide

expense slide

account slide

landlord slide

accrual basis slide

example of accrued revenue

tenant revenue