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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:
$
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B. DefinitionsAn ACCRUAL is an expense that has NOT been paid or a revenue that has NOT been received.
I. Identifying accounts to be adjusted:
Accruals and Deferrals
Examples of accruals:Expense: salaries, interest, taxes
Revenue: services (performed on account)
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I. Identifying accounts to be adjusted:
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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II. AccrualsC. Reversing Entries -- Appendix to Chap 4
What?Which?
accrualscash AFTER event $
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II. AccrualsC. Reversing Entries -- Appendix to Chap 4
What?Which?When?
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II. AccrualsC. Reversing Entries -- Appendix to Chap 4
What?Which?When?
Why? helps next year
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II. AccrualsC. Reversing Entries -- Appendix to Chap 4
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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III. DeferralsA. 4. Consider this example:
Supplies Supplies Expense
Bal. 100Pur. 400
a. ASSET Method
Supplies Expense 450Supplies 450
450
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III. DeferralsA. 4. Consider this example:
Supplies Supplies Expense
Bal. 100Pur. 400
a. ASSET Method
Supplies Expense 450Supplies 450
450450
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III. DeferralsA. 4. Consider this example:
Supplies Supplies Expense
Bal. 100Pur. 400
a. ASSET Method
Supplies Expense 450Supplies 450
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:
Supplies Supplies Expense
Bal. 100Pur. 400
Ending Inventory = $50
a. EXPENSE Method
Supplies 50Supplies Expense 50
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III. DeferralsA. 5. Re-consider the example:
Supplies Supplies Expense
Bal. 100Pur. 400
Ending Inventory = $50
a. EXPENSE Method
Supplies 50Supplies Expense 50
50 50
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III. DeferralsA. 5. Re-consider the example:
Supplies Supplies Expense
Bal. 100Pur. 400
Ending Inventory = $50
a. EXPENSE Method
Supplies 50Supplies Expense 50
50 50Unused
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III. DeferralsA. 4. b. Decision tree conclusion
Expense
Method
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Comparison of Methods
Supplies Supplies Expense
Bal. 100Pur. 400
450450
ASSET METHOD
Supplies Supplies Expense
Bal. 100Pur. 400
EXPENSE METHOD
50 50
exactly thesame results
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Comparison of Methods
Key to administering methods is
CONSISTENCY
J F M A M J J A S O N D
20x1 20x2
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Comparison of Methods
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...
Supplies Supplies Expense
Bal. 100Pur. 400
AJE 450AJE 450
ASSET METHOD
Supplies Supplies Expense
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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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
800800
B = $400
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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
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:
Unearned Fees Fees Earned
9/1 1,200
a. LIABILITY Method
Unearned Fees 400Fees Earned 400
$1,2004 mo 8 mo$400 $800
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III. DeferralsB. 5. Re-consider the example of the lawyers:
Unearned Fees Fees Earned
9/1 1,200
a. LIABILITY Method
Unearned Fees 400Fees Earned 400
$1,2004 mo 8 mo$400 $800
400 400
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III. DeferralsB. 5. Re-consider the example of the lawyers:
Unearned Fees Fees Earned
9/1 1,200
a. LIABILITY Method
Unearned Fees 400Fees Earned 400
$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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Comparison of Methods
Unearned Fees Fees Earned
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
Unearned Fees Fees Earned
9/1 1,200AJE 400 AJE 400C2 400
Unearned Fees Fees Earned
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!