2nd Term Adj Entries Ppt

Accrual Accounting Concepts Chapter 5

Study Objectives 1.

2.

3.

4.

Explain the revenue recognition principle and the matching principle. Differentiate between the cash basis and the accrual basis of accounting. Explain why adjusting entries are needed and identify the major types of adjusting entries. Prepare adjusting entries for prepayments.

Study Objectives 5. 6.

7. 8.

Prepare adjusting entries for accruals. Describe the nature and purpose of the adjusted trial balance Explain the purpose of closing entries. Describe the required steps in the accounting cycle.

Recall: Time Period Assumption

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Divides life of business into artificial time periods: monthly, quarterly, yearly

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1 Revenue Recognition Principle

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Dictates that revenue be recognized in the accounting period in which it is earned. Considered earned when the service has been provided or when the goods are delivered.

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1 Revenue Recognition Principle

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1 Matching Principle

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Requires that expenses be recorded in the same period in which the revenues they helped produce are recorded.

Differentiate Cash Basis from Accrual Basis of Accounting

Cash Basis

Revenue recorded only when cash is received. Expenses recorded only when cash is paid.

Cash Basis is not GAAP

GA AP

What is GAAP? 

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Generally Accepted Accounting Principles (GAAP) defines the standards by which accounting should be performed. Includes the standards, conventions, and rules accountants follow in recording and summarizing transactions, and in the preparation of financial statements.

Accrual Basis Accounting • Follows both . . . • Revenue Recognition Principle • Matching Principle

Accrual Basis is GAAP Revenue Realization Principle states that..

• Revenue is recorded only when earned not when cash is received Matching Principle states that…

• Expense is recorded only when incurred not when cash paid

Why is this so important?

Possible conclusions from the Cash Method?

Let’s Review Which principle dictates that efforts (expenses) be recorded with accomplishments (revenues)? a. Cost principle. b. Matching principle. c. Periodicity principle. d. Revenue recognition principle.

Let’s Review Which principle dictates that efforts (expenses) be recorded with accomplishments (revenues)? a. Cost principle. b. Matching principle. c. Periodicity principle. d. Revenue recognition principle.

Let’s Review When would revenue be recorded for the following scenario . . . Ad agency is hired for a project in May, does work in June and is paid in July? The answer is June!

Let’s Review When would expenses be recorded for this companion scenario . . . The Ad agency on this project incurs Php1,500 of expenses in May, Php3,000 in June, and none in July? The answer is June! Matching says the expenses should follow the revenue.

Let’s Review When would revenue be recorded for the following scenario . . . Sell plane ticket on September 1 for a flight on October 15? The answer is October – when the service is provided!

Let’s Review When would expenses be recorded for the following scenario . . . The airline pays pilot salaries on October 7th for the week ended September 30th? The answer is September – the pilots provided labor services for September flights during that month.

Now let’s discuss how accounting makes this happen ...

Explain Why Adjusting Entries are Needed and Identify the Major Types of Adjusting Entries

Adjusting Entries  

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Trial balance is not up to date. To produce accurate financial statements, we record adjusting entries . . . Revenues are recognized (recorded) when they are earned. Expenses are recognized (recorded) when they are incurred (used up).

Adjusting Entries

Adjusting entries ensure that Revenue Recognition and Matching Principles are followed!

Types of Adjusting Entries Prepayments: 

Prepaid expenses: Expenses paid in cash and recorded as assets before they are used or consumed. (cash paid in advance) 

Unearned Revenues: Cash received and recorded as liabilities before revenue is earned. (cash received in advance)

Types of Adjusting Entries Accruals: 

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Accrued revenues: Revenues earned but not yet received in cash or recorded (someone owes us).

Accrued expenses: Expenses incurred but not yet paid in cash or recorded (we owe someone else).

Prepare Adjusting Entries for Prepayments – Prepaid Expenses • Expenses paid in cash and recorded as assets before they are used or consumed. (paid in advance) • Prepaid expenses expire with the passage of time OR they are consumed (used) • Time: rent, insurance • Consumed: supplies

Prepaid Expenses

Amount equals cost of goods or services used up or expired

If not adjusted, expenses would be understated and assets overstated

Prepare Adjusting Entries for Prepayments – Prepaid Expenses • Start with the trial balance to find information to adjust prepayments • Let’s use the Sierra Corporation examples in the book . . .

Prepaid Expenses - Supplies

What is the entry when you purchase supplies?

Prepaid Expenses - Supplies Cash

Supplies

Supplies Expense

Oct 5 2,500 Oct 5 2,500

GENERAL JOURNAL

Debit Credit

Oct 5 Supplies Cash

2,500

Purchased Advertising Supplies

2,500

Prepaid Expenses - Supplies Oct. 31: Take inventory and it shows $1,000 of supplies still on hand

What is the adjusting entry?

Prepaid Expenses - Supplies Supplies

Cash Oct 5 2,500

Oct 5

Supplies Expense

2,500 Oct 31 1,500 Oct 31 1,500

Oct 31 1,000

GENERAL JOURNAL Oct 31 Supplies Expense Supplies 1,500 To record supplies used

Debit Credit 1,500

Supplies Expense October $1,500

November $1,800

December $1,410

January $1,425

February $1,601

March $1,435

April $1,530

May $1,592

June $1,622

July $1,652

August $1,427

September $1,557

Expense varies each month with usage

Prepaid Expenses - Insurance

What is the entry when you purchase the insurance policy?

Prepaid Expenses - Insurance Prepaid Insurance

Cash Oct 4

600

Oct 4

Insurance Expense

600

GENERAL JOURNAL Oct 4 Prepaid Insurance Cash Purchased one-year fire insurance policy.

Debit Credit 600 600

Prepaid Expenses - Insurance Oct. 31: You are at the end of the month. How much of the insurance policy has expired?

$600 / 12 months = $50 per month

What is the adjusting entry?

Prepaid Expenses - Insurance Prepaid Insurance

Cash Oct 4

600

Oct 4 Oct 31

GENERAL JOURNAL

600 Oct 31 50

Insurance Expense Oct 31

50

550

Debit Credit

Oct 31 Insurance Expense 50 Prepaid Insurance To record expired insurance coverage

50

Insurance Expense October Novembe Decembe January r r $50 $50 $50 $50 February $50

March $50

April $50

May $50

June $50

July $50

August $50

Septemb er $50

Policy Expense is the same each month

Depreciation Expense October Novembe Decembe January r r $40 $40 $40 $40 February $40

March $40

April $40

May $40

June $40

July $40

August $40

Septemb er $40

Let’s say expense is estimated at $480 per year

Depreciation Office Equipment Oct 2 5,000

Depreciation Expense Oct 31

Accumulated Depreciation

40

GENERAL JOURNAL Oct 31 Depreciation Expense Accumulated Depreciation

Oct 31 40

Debit Credit 40

To record monthly depreciation of annual $480 estimate

40

Adjustment for Depreciation CONTRA-ASSET ACCOUNT Accumulated Depreciation Adjusting Entry Credit

EXPENSE ACCOUNT Depreciation Expense Adjusting Entry Debit

Amount equals cost of asset allocated to accounting period

Balance Sheet Presentation Office equipment Less: accumulated depreciation Accumulated depreciation is a contra asset account, an offset against the fixed asset account.

$ 5,000 40 $4,960

Book Value

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4 Prepare Adjusting Entries for Prepayments – Unearned Revenues 

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Cash received and recorded as liabilities before revenue is earned. (cash received in advance) Earned when services are provided Rent, magazine subscriptions, customer deposits

Unearned Revenues

Amount equals price of services performed or goods delivered

If not adjusted, revenues would be understated and liabilities overstated

Unearned Revenues

What is the entry when you are paid in advance for services?

Unearned Revenues Unearned Revenue

Cash Oct 2 1,200

Revenue

Oct 2 1,200

Oct 3 10,000

GENERAL JOURNAL

Debit Credit

Oct 2 Cash

1,200 Unearned Revenue

1,200 To record customer payment received in advance of services

Unearned Revenues Oct. 31: Some of the work has been performed, $400 has been earned

What is the adjusting entry?

Unearned Revenues Unearned Revenue

Cash Oct 2 1,200

Oct 31

400 Oct 2 1,200

Oct 31

800

GENERAL JOURNAL Oct 31 Unearned Revenue Revenue To record revenue earned

Revenue

Oct 3 10,000 Oct 31 400 Oct 31 10,400 Debit Credit 400 400

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5 Prepare Adjusting Entries for Accruals – Accrued Revenues 

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Accrued revenues: revenues earned but not yet received in cash or recorded at the statement date Adjusting entry is required to show the receivable that exists at the balance sheet date

Accrued Revenues

Amount equals price of services performed

If not adjusted, revenues would be understated and assets understated

Accrued Revenues

What is the adjusting entry for $200 of services performed but not billed before October 31?

Accrued Revenues Accounts Receivable

Service Revenue

Oct 31 200

GENERAL JOURNAL Oct 31 Accounts Receivable Service Revenue To record revenue earned but not billed

Oct 3 10,000 Oct 31 400 Oct 31 200 Oct 31 10,600 Debit Credit 200 200

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5 Prepare Adjusting Entries for Accruals – Accrued Expenses 

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Accrued expenses: expenses incurred but not yet paid in cash or recorded at the statement date Adjusting entry is required to show the payable that exists at the balance sheet date

Accrued Expenses

Amount equals cost of expense incurred

If not adjusted, expenses would be understated and liabilities understated

Where is the interest expense for this note? Interest expense has not been recorded yet for this period, so we need an adjustment!

Accrued Expenses - Interest Oct. 31: Signed $5,000 note on Oct. 1st with annual interest rate of 12% Use formula to calculate interest:

What is the adjusting entry?

Accrued Interest Interest Expense Oct 31 50

GENERAL JOURNAL Oct 31 Interest Expense Interest Payable To record interest on notes payable

Interest Payable Oct 31

50

Debit Credit 50 50

Accrued Expenses - Salaries Oct. 31: Employees are paid every two weeks. There are 3 days of October that will not be paid until November. Wages are $2,000 for 5 days

What is the adjusting entry?

Accrued Salaries Salaries Expense Bal. 4,000 Oct 31 1,200

Salaries Payable Oct 31 1,200

Oct 31 5,200 GENERAL JOURNAL

Debit Credit

Oct 31 Salaries Expense Salaries Payable

1,200

To record accrued salaries ( $400 a day times 3 days )

1,200

Summary of Adjusting Entries

Note that each adjusting entry affects at least one balance sheet account and at least one income statement account!

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6 Describe the nature and purpose of the Adjusted Trial Balance Prepared after adjusting entries journalized and posted Shows balances of all accounts See the adjusting journal entry changes on next slide. . .

Adjusted Trial Balance Purpose is to prove the equality of total debit balances and total credit balances after the adjusting entries have been made.  Financial statements are prepared from the adjusted trial balance 

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7 Explain the Purpose of Closing Entries

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Closing entries transfer the temporary accounting balances to the permanent stockholders’ equity account – Retained Earnings.

Close Temporary Accounts Only Zero balance after closing entries!

Do not close!

Closing Entries

At the start of the next period, temporary account balances are zero so you can accumulate data separately from data in prior periods.

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8 Describe the required steps in the Accounting Cycle 

Steps are performed in sequence and are repeated in each accounting period . . .

Let’s Review Which is not a temporary account? a. Salaries expense. b. Service revenue. c. Accounts receivable. d. Dividends.

Let’s Review Which is not a temporary account? a. Salaries expense. b. Service revenue c. Accounts receivable. d. Dividends.

Let’s Review Which account will have a zero balance after closing entries? a. Service Revenue. b. Advertising Supplies. c. Prepaid Insurance. d. Accumulated Depreciation.

Let’s Review Which account will have a zero balance after closing entries? a. Service Revenue. b. Advertising Supplies. c. Prepaid Insurance. d. Accumulated Depreciation.

Let’s Review Which types of accounts will appear in the post-closing trial balance? a. Permanent accounts. b. Temporary accounts. c. Accounts shown in income statement. d. None of the above.

Let’s Review Which types of accounts will appear in the post-closing trial balance? a. Permanent accounts. b. Temporary accounts. c. Accounts shown in income statement. d. None of the above.

•Some of the amounts on the trial balance are out of date.

Adjusting entries 1.

Actual amount of repair supplies showed a balance of P850. Repair Supplies 1,500

Adjusting entries Repair Supplies 1,500

850

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What the balance should be

What the balance “should be” is determined from someone counting the supplies that remain in the business at the end of the year

Adjusting entries Repair Supplies 1,500

650 850 The required adjustment

Adjusting entries Repair Supplies Used 0

650

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What the balance should be

What the balance “should be” is the amount of supplies “used up” during the year

Adjusting entries

1.

Repair supplies used (Dr) Repair supplies (Cr)

650 650

Depreciation

What is the entry when you purchase equipment?

Depreciation 

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Following the matching principle, the cost of assets with long lives must be allocated over their useful lives As we use the asset, we recognize a portion of its cost as expense: depreciation Depreciation expense is an estimate It is an allocation of cost, NOT valuation

Adjusting entries 2.

Repair tools are depreciated at 10% per annum.

P1200 x .10 = 120 (Original cost x depreciation p.a.)

Adjusting entries 2.

Depreciation-tools 120 Accumulated Depreciation

120

Adjusting entries Straight-Line Method of Depreciation D=(Cost - Salvage Value) / number of year Where: D= depreciation Cost = original cost Salvage value = scrap value (the amount wherein the asset can be sold after its useful life) No. of Yrs = estimated number of useful life

Adjusting entries 3.

Given: n=5 yrs (F&F); 10yrs (service truck) c=6,500 (F&F); 20,000(service truck)

F&F: 6,500/5yrs = P1,300 per yr 1,300 x 4/12 = P433

a. Depreciation-F&F (Dr) Accum. Dep.-F&F (Cr)

433 433

Adjusting entries Service truck: 20,000 / 10 = P2,000 p.a. 2,000 x 4/12 = P666

b. Depreciation-Service Truck (Dr) Accum. Dep.-Servie Truck (Cr)

666 666

Depreciation Cash

Office Equipment

Depreciation Expense

Oct 2 5,000 Oct 2 5,000

GENERAL JOURNAL

Debit Credit

Oct 2 Office Equipment Cash

5,000

To record purchase of office equipment

5,000

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