Chapter 3 Adjusting the Accounts
The Year • Calendar Year is January 1 through December 31 • Fiscal year is any 12-month period • I.E. ATA’s year is July 1 through June 30
Cash Basis vs. Accrual • Cash Basis is when a company only records when cash has been received or paid out. • Accrual Basis records events as they happen • **Cash accounting is not in accordance with GAAP***
Revenue Recognition • Revenue is recognized only when the services have been performed. • However, if we receive money ahead of time, we increase the liability account—”Unearned Revenue”
Matching Principle • We always need to match the expenses that were needed to produce the revenue
Adjusting Entries • Certain accounts are not the same at the end of an accounting period. • Deferrals , accounts recorded as assets and have been used up. • Pre-Paid Insurance • Supplies • Large assets that have depreciated (or lost some of their value)
Pre-Paid Insurance • We paid insurance for a period of time and recorded the entire amount as the asset, Pre-Paid Insurance. • If we paid for insurance for $600 for 12 months, then we use up $50 each month • At the end of the month we record the used up part like this: • Insurance Expense $50.00 (Debit) • Pre-Paid Insurance $50.00 (Credit)
You Try • Leo Jewelers purchased Insurance on January 1 for $1500/yr. On April 1, he is adjusting his account. • How many months have been used ___?____ • Figure the amount used up_____?________ • What is the entry ______?__________ • How much insurance is left ______?____
Supplies • When you buy supplies for your business, you add it to the asset account, supplies. • However, as you go through the year, your supplies as used, so you don’t have as many at the end of a month, year or quarter.
So What Now • You take an inventory of your supplies • You determine that you have $100 of pencils left. • You bought $250.00 of supplies in the beginning. • How many pencils did you use? • The adjusting entry is: • Supplies Expense ? (Debit) • Supplies ? (Credit)
This poor computer isn’t worth what it used to be!!! Many large assets lose their value Examples are: Furniture, Cars, Technology These assets have depreciated in value First, we need to know two things: A contra asset account is an account that offsets an asset but is still noted on the balance sheet. Accumulated Depreciation is a contra-asset account.
Second • The book value of any depreciable asset is calculated by taking the original value – depreciation. • If you bought office equipment for $5,000 and it has depreciated $1,000, then the book value is $4,000 (5,000-1,000).
Adjusting Entry • On the previous example, Smith Bros bought office equipment for $5,000 and it has depreciated $1,000 in the past year. We do adjusting entries at the end of the year (important note) • Entry • Depreciation Expense-Office Equip $1,000 (Dr) • Accumulated Depreciation-Office Equipment $1,000(Cr)
Unearned Revenue • Examples: Magazine Subscriptions, Airline Tickets, Consulting Projects, Architectural contracts. • Unearned Revenue is a liability account. • It is adjusted when the service is performed or completed. The adjusting entry can be for the entire amount of a partial part.
Pioneer Advertising Agency • Pioneer Advertising Agency received $1,200 on October 2 from R. Knox for advertising services expected to be completed by December 31. • The first entry: • Cash $1,200 (Dr) • Unearned Revenue $1,200 (Cr).
Adjusting Entry • At the end of March Pioneer completed one month’s worth of the services. • We want to take one-month of the liability away so… • Unearned Revenue $400 (Dr) • Service Revenue $400(cr) • ? How much is in Unearned Revenue Now?
You do it! • Buhl Company has Unearned Revenue of $10,000. • At the end of the month, Buhl has performed 2/5 of the services. • What is the amount of revenue earned? • What is the entry? • How much is still unearned?
Accruals • To account for revenue and expenses that should be put into an accounting period but because of timing they have not been recorded.
Revenue not yet recorded • Might have happened on the day the financial statements are being prepared so we record it with an adjusting entry • Accounts Receivable (Dr.) • Service Revenue (Cr)
Accrued Expenses • Examples are interest that has accrued but doesn’t need to be paid yet. • Salaries that have been earned but do not need to be paid yet.
Accrued Interest • Let’s say we went to the bank to get money for your business and you signed a note for $5,000 at 12% annual interest. • How do we record this money when received?
At the End of the Month • We have accrued 1 month of interest of 1/12. • We would then take $5,000 x 12% x 1/12. • We should come out with ? • The adjusting entry is • Interest Expense ? (Dr.) • Interest Payable ?(Cr)
You Do It! • Calvin and Hobbes borrowed $30,000 from a local bank on a 15 year note. The annual interest rate is 10%. • What is the interest for a year? • What is the interest for ½ year? • What is entry to record the interest for 6 months?
Accrued Salaries • Many companies pay every other week. The accounting period may end in between pay periods. We must account for the days that were performed but not yet paid.
Example • Carter just paid everyone on October 26 and the next payday is November 9. • They are preparing statements at the end of October. Therefore 3 days of work were performed after October 26. • If their total payroll for 5 days of work is $2,000, how much was performed in 3 days?
Next, the Adjusting Entry • Salaries Expense 1,200 (Dr) Salaries Payable 1,200 (Cr) Then when the entire amount is paid on Nov 9 Salaries Payable $1,200 (Dr) Salaries Expense $ 800 (Dr) Cash 2,000 (Cr.)
Finally!!! • The adjusted trial balance • Take each account in the ledger • Write their balance • Debits in total should equal credits in total.
Examples • Page 112 • Page 113 • E3-6 Page 128 • E3-9 Page 129
Test Review • Define • Accrual • Book Value • Depreciation • Contra-Asset • Deferrals • Fiscal Year • Prepaid Expenses • Unearned Revenue • Adjusting Entries
Analyze • Amount of adjusting entries. • Accounts to enter adjusting entries. • Problem similar to P3-1A