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  1. INTRODUCTORY ACCOUNTING UNIT 7: Accrual Accounting and Adjusting Entries TouchText • Deferrals and Accruals • Depreciation and Amortization • Adjusting Entries: Journal and Ledger • The Worksheet Problems and Exercises Next

  2. Accounting Bases • There are two bases for keeping accounting records: • Cash Basis: Record transactions only when cash changes hands • Only possible for certain small businesses. • Accrual Basis: Record transactions when ownership is transferred between buyer and seller. • Required for all (large) businesses. Dictionary Back Next

  3. Accrual Accounting: When to Recognize Revenues and Costs Recognition Rule: In accounting, purchases and sales occur exactly when legal title to the item(s) changes owner. Revenue from Sale Dictionary Customer Orders Item Customer Receives Item Customer Sends $$$ Time >> Time >> Business Buys Item Business Sends Item Business Receives $$$ Cost of Sale Matching Rule: Costs incurred to make/buy the item are matched to the time at which it is sold (using the Recognition Rule). Time-based expenses are matched to the time at which the expenses are incurred. (*The recognition and matching rules become important when the transaction occurs over two different accounting periods.) Back Next

  4. Accruals An Accrual occurs when a transaction precedes the cash transfer. Dictionary Transaction Cash Time >> Time >> • Accrual (Liability): When the business has incurred a cost or expense that it hasn’t paid yet. • Examples: Accrued Interested (on a loan); Accrued Taxes Payable, etc. • Accrual (Asset): When a business is owed something, usually for work already performed. • Examples: Accounts Receivable. Back Next

  5. Deferrals An Deferral occurs when a cash transfer precedes the associated transaction. Dictionary Cash Transaction Time >> Time >> • Deferral (Liability): When a customer has pre-paid for goods or services not yet provided. • Examples: Unearned Revenues. • Accrual (Asset): When a business has pre-paid for something. • Examples: Pre-paid expenses. Back Next

  6. Deferrals and Accruals Deferrals EVENT or TRANSACTION CASH Dictionary • Deferred (pre-paid) expenses = Asset • Deferred (unearned) income = Liability EVENT or TRANSACTION Accruals CASH • Accrued (payable) expenses = Liability • Accrued (receivable) income = Asset Back Next

  7. Example: Assets CPF (2010) Advanced Payment … Prepaid Expenses Accrued Dividend Income Dictionary Back Next

  8. Example: Liabilities CPF (2010) Accrued Expenses Income Tax Payable Dictionary Deferred Gain on Sale … Back Next

  9. Deferrals & Time Over time, deferred assets become expenses; and deferred liabilities become revenues. Dictionary Deferred Assets Expenses Time Deferred Liabilities Revenues Back Next

  10. Deferrals & Time: Example Over time, deferred assets become expenses; and deferred liabilities become revenues. Dictionary Cash Activity/ Transaction Cash Activity/ Transaction Back Next

  11. Accruals & Time Over time, accrued assets become cash IN; and accrued liabilities become cash OUT. Dictionary Accrued Assets Cash IN Time Accrued Liabilities Cash OUT Back Next

  12. Accruals & Time: Example Over time, accrued assets become cash IN; and accrued liabilities become cash OUT. Dictionary Activity/ Transaction Cash Activity/ Transaction Cash Back Next

  13. When to Recognize and Record Deferrals & Accruals • Deferrals (money first) • Record when cash changes hands • Update periodically (monthly?) and at end of accounting cycle (quarterly/yearly?) • Accruals (transaction/event first) • Enter periodically (monthly?) and update and end of accounting cycle (quarterly/yearly?) • Update and record when cash changes hands Dictionary Back Next

  14. Depreciation Depreciation is the process of writing down the value of fixed (long-term) assets over time, as they are used up. The most common way to depreciate fixed assets is the straight-line method. Dictionary Example: A truck is bought for $25,000. Its useful life is estimated at 8 years, after which it can be sold for $9,000. Back Next

  15. Depreciation Example: Adjusting Entries in the Journal Example: A truck is bought for $25,000. Its useful life is estimated at 8 years, after which it can be sold for $9,000. Dictionary Back Next

  16. Depreciation Example: Adjusting Entries in the Ledger Dictionary Back Next

  17. Straight Line Depreciation Illustrated Dictionary Back Next

  18. Amortization • Amortization is just like depreciation, except it is for non-physical fixed assets. • Intangible Assets: Above book value paid for acquired assets. • Long-Term Capital Leases: Multi-year leases on buildings, airplanes, etc. Dictionary Amortization is not too common in SE Asian balance sheets, because most local businesses grow internally instead of through acquisition. Back Next

  19. Adjusting Entries • At the end of the accounting cycle (quarter/year), the accountant must make Adjusting Entries to the account balances. • Deferrals and Accruals must be up-to-date. • Depreciation and Amortization must be entered. • Other accounts must be updated as necessary. Dictionary Adjusting Entries never involve cash. They are entered in the Journal and then posted to the Ledger, just as all other transactions. Ledger (update account balances) Journal (enter transactions) Post to Ledger Back Next

  20. Adjusting Entries: Example Journal and Ledger Example: At the end of the accounting period, there remains ½ month’s rent expense (@ $400/mo.) that hasn’t yet been paid. Dictionary Journal Ledger When making adjusting entries, new accounts may have to be created. In this example, Rent (E) already existed, but the Rent Payable (L) account had to be created. Back Next

  21. Adjusting Entries: Example The Worksheet Dictionary New Accounts Back Next

  22. Adjusting Entries: Rules for Worksheet Dictionary Back Next

  23. Completing the Worksheet Adjustments are added/subtracted to the debit/credit balance to get the Adjusted Trial Balance. Dictionary Back Next

  24. End of Unit 7 Questions and Problems The following adjustments need to be made to the accounts from the previous Unit 6. Journalize the adjustments, post them to the Ledger, and then complete the Worksheet. Dictionary ½ month of rent due (rent = $400/month). ½ month of salaries due (salaries = $600/month). Physical inventory reveals inventory of only $2,400 (not $2,520). The balance of office supplies is now only $55 (not $135). Furniture depreciation = $110. Computer depreciation = $360. Fee income of $240 has been earned but not paid by the customer. Interest due on the bank loan = $205. Back Next

  25. End of Unit 7 Questions and Problems To complete the exercise, set up the following new accounts: Dictionary Back End