Lecture

3
Accounting Cycle (II) - Accruals

To complete accounting cycle, two journal entries are more additional j needed:

Adjusting Entries Closing Entries

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Adjusting Entries

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Prior Periods

Current Period

Future Periods

Business Transactions

Revenues or expenses not recognized in business transactions but should be included to reflect a firms performance

Journal Entries
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Adjusting Entries
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Revenue Recognition Principle

- The earning process is substantially completed - Cash has been collected or collectivity is reasonably assured

Matching Principle
- Expenses are recorded when the assets or costs are incurred (used up) for generating revenue

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Costs are matched with revenue in two ways: Direct association of costs with specific revenue transactions. Systematic allocation of costs over the useful life of the expenditure expenditure.
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G General lR Rules l
Every adjusting entry involves a change in either a revenue or expense and an asset or liability.
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Cash is not involved in adjusting entry

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Types of Adjusting Entries

Converting assets to expenses Converting liabilities to revenue Accruing unpaid expenses Accruing uncollected revenue

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1. Converting Assets to Expenses

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Converting g Assets to Expenses p

End of Current Period Prior Periods Current Period Future Periods

Transaction Paid cash in advance of incurring expense (creates an asset).

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Adjusting Entry Recognizes portion of asset consumed as expense, and Reduces balance of asset account.

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C Converting ti A Assets t t to Expenses E

Examples Include: Insurance Depreciation

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Converting Assets to Expenses

$2,400 Insurance Policy Coverage for 12 Months $200 Monthly Insurance Expense

Jan 1 Jan.

Dec 31 Dec.

On January 1,NUS corporation purchased a one-year insurance policy for $2,400.

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Converting Assets to Expenses

Initially, I iti ll costs t that th t benefit b fit more than th one accounting period are recorded as assets.

GENERAL JOURNAL
Date Jan. Account Titles and Explanation Cash Purchase a one one-year year insurance policy policy.
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Debit 2,400

Credit 2,400

1 Prepaid Insurance Expense

Converting Assets to Expenses

Th costs The t are expensed d as they th are used d to t generate revenue.

GENERAL JOURNAL
Date Account Titles and Explanation Monthly Adjusting Entry for Insurance Jan. 31 Insurance Expense Prepaid Insurance Expense Insurance expense for January. by Vincent Chen 200 200
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Debit

Credit

Converting Assets to Expenses

Balance Sheet Cost of assets that benefit future periods. Income Statement Cost of assets used this period to generate revenue.

Prepaid Insurance Expense

1/1 2,400 , Bal. 2,200

1/31

200

Insurance Expense 1/31 200

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The Concept of Depreciation

Depreciable assets are physical objects that retain their size and shape but lose their t e eco economic o c usefulness use u ess o over e t time. e

Depreciation is the systematic allocation of the cost of a depreciable p asset to expense. p

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The Concept of Depreciation

The p portion of an assets utility y that is used up must be expensed in the period used.
Fixed Asset (debit) On date when initial payment is made . . . Cash (credit)
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The assets usefulness is partially consumed during the period. p

Depreciation Expense (d bit) (debit)

At end of period . . .
Accumulated Depreciation (credit)
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Depreciation Is an Estimate
On May 2, 2008, NUS purchased a lawn mower with a useful life of 50 months for $2,500 cash. Using the straight-line method, calculate th monthly the thl d depreciation i ti expense.
Depreciation Cost of the asset expense (per ( = Estimated useful life period) $2 500 = $2,500 $50 by Vincent Chen 50
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Depreciation Is an Estimate
NUS would ld make k th the f following ll i adjusting dj ti entry. t

GENERAL JOURNAL
Date Account Titles and Explanation Accumulated Depreciation: Equipment To record one month's depreciation. Debit 50 50 Credit

May 31 Depreciation Expense: Equipment

Contra-asset

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Depreciation Is an Estimate
NUS $15 NUSs $15,000 000 t truck ki is d depreciated i t d over 60 months as follows:
GENERAL JOURNAL
Date Account Titles and Explanation Accumulated Depreciation: Truck To record one month's depreciation.
by Vincent Chen $15,00060 months = $250 per month 20

Debit 250

Credit 250

May 31 Depreciation Expense: Truck

Accumulated depreciation would appear on the balance sheet as f ll follows:

Equipment E i t $ 2,500 2 500 Less: Accum. depr. 50 Truck $ 15,000 15 000 Less: Accum. depr. 250 2,450 14,750

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Exercise 1

ABC corporation ti rents t a warehouse h f for its it completed l t d inventory i t of f customized engines. Rent of $60,000, covering a one-year period beginning February 1, 2008 was paid on February 1, 2008.

Please prepare the necessary adjusting entry for 2008

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2. Converting Liabilities to Revenue

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Converting Liabilities to Revenue

End of Current Period Prior Periods Current Period Future Periods

Transaction Collect cash in advance of earning revenue (creates a liability).

Adjusting Entry Recognizes portion earned as revenue, , and Reduces balance of liability account account.
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Converting Liabilities to Revenue

Examples Include: Rental Airline Ticket Sales Sports Teams Sales of Season Tickets
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Converting Liabilities to Revenue

$6,000 Rental Contract Coverage g for 12 Months $500 Monthly Rental Revenue

Jan 1 Jan.

Dec 31 Dec.

On January 1, NUS received $6,000 in advance for a one-year rental contract.

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Converting Liabilities to Revenue

Initially, I iti ll revenues that th t benefit b fit more than th one accounting period are recorded as liabilities.

GENERAL JOURNAL
Date Jan. Account Titles and Explanation 1 Cash Unearned Rental Revenue Collected $6,000 $6 000 in advance for rent rent.
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Debit 6,000

Credit 6,000

Converting Liabilities to Revenue

O Over time, ti the th revenue is i recognized i d as it is i earned.

GENERAL JOURNAL
Date Account Titles and Explanation Monthly Adjusting Entry for Rent Revenue Jan. 31 Unearned Rental Revenue Rental Revenue Rental revenue for January. by Vincent Chen 500 500
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Debit

Credit

Converting Liabilities to Revenue

Balance Sheet Liability Li bilit for f future periods. Income Statement Revenue earned R d this period.

Unearned Rental Revenue

1/31

500

1/1 6,000 Bal. 5,500

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Rental Revenue 1/31 500

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Exercise 2

ABC corporation ti provides id monthly thl maintenance i t to t its it customers t on certain custom engines. Most customers pay for this service monthly, but one customer paid $6,000 on September 1, 2008 for y services through g August g 31, , 2009. monthly

Please prepare the necessary adjusting entry for 2008

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3. Accruing Unpaid Expenses

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Accruing Unpaid Expenses

End of Current Period Prior Periods Current Period Future Periods

Adjusting Entry Recognizes expense incurred, and Records liability for future payment.
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Transaction Pay cash in settlement of liability.

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Accruing Unpaid Expenses

Examples Include: Wages and Salaries I Income Taxes T Interest Expense

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Accruing Unpaid Expenses

$3,000 Wages Expense

Monday, May 29

Wednesday, May 31

Friday, June 2

On May 31,NUS owes wages of $3,000. Payday is Friday, June 2.

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Accruing Unpaid Expenses

I iti ll an expense and Initially, d a liability li bilit are recorded.

GENERAL JOURNAL
Date Account Titles and Explanation W ages Payable To accrue w ages ow ed to employees employees.
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Debit 3,000

Credit 3,000

May 31 W ages Expense

Accruing Unpaid Expenses

Balance Sheet Liability to be paid in a future period. Income Statement Cost incurred this period to generate revenue.

Wages Payable 5/31 3,000

Wages Expense 5/31 3,000

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Accruing Unpaid Expenses

$5 000 Weekly Wages $5,000 $3,000 $3 000 W Wages Expense $2,000 $2 000 W Wages Expense

Monday, Monday May 29

Wednesday, Wednesday May 31

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Friday, Friday June 2

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Lets look at the entry for June 2.

Accruing Unpaid Expenses

Th li The liability bilit is i extinguished ti i h d when h the th debt d bt is i paid.

GENERAL JOURNAL
Date Account Titles and Explanation W ages Payable (accrued in May) Cash W eekly payroll for May 29-June by Vincent Chen 2. Debit 2,000 3,000 5 000 5,000
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Credit

June 2 W ages Expense (for June)

Accruing Unpaid Expenses

As a corporation A ti earns taxable t bl income, i it incurs income taxes expense, and also a li bilit t liability to governmental t lt tax authorities. th iti
GENERAL JOURNAL
Date Account Titles and Explanation Income Taxes Payable E ti Estimated t d income i taxes t applicable li bl to t taxable income earned in December. by Vincent Chen
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Debit 780

Credit 780

Dec. 31 Income Taxes Expense

Exercise 3

ABC corporation ti borrowed b d $100 $100,000 000 f from th the b bank k on A August t1 1, 2008. Interest will be paid annually at 12%.

Please prepare the necessary adjusting entry for 2008

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4. Accruing Uncollected Revenue

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Accr ing Uncollected Re Accruing Revenue en e

Examples Include: Interest Revenue Work Completed But Not Yet et Billed ed to Custo Customer e

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Accruing Uncollected Revenue

$170 Interest Revenue

Saturday, S t d Jan. 15

Monday, M d Jan. 31

Tuesday, T d Feb. 15

On Jan. 31, the bank owes NUS interest of $170. Interest is paid on the 15th day of each month.
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Accruing Uncollected Revenue

I iti ll the Initially, th revenue is i recognized i d and da receivable is created.

GENERAL JOURNAL
Date Account Titles and Explanation Interest Revenue To recognize interest revenue. revenue
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Debit 170

Credit 170

Jan. 31 Interest Receivable

Accruing Uncollected Revenue

Balance Sheet Receivable to be collected in a future period. Income Statement Revenue earned R d this period.

Interest Receivable 1/31 170

Interest Revenue 1/31 170

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Accruing Uncollected Revenue

$320 Monthly Interest $170 Interest Revenue $150 Interest Revenue

Saturday, Jan. 15

Monday, Jan. 31

Tuesday, Feb. 15

Lets look at the entry for February 15 15.

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Accruing Uncollected Revenue

Th receivable The i bl is i collected ll t d in i a future f t period. i d

GENERAL JOURNAL
Date Account Titles and Explanation Interest Revenue (for February) Interest Receivable (accrued Jan. 31) To record interest received.
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Debit 320

Credit 150 170

Feb. 15 Cash

Exercise 4

ABC corporation ti completed l t d an auto t engine i f for a customer t on December 20, 2008. The bill for the $10,000 engine was sent out to the customer on January 15, 2009.

Please prepare the necessary adjusting entry for 2008

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Effects of the Adjusting Entries

Journalize transactions.

Post entries to the ledger g accounts.

Prepare trial balance.

Make end-ofyear adjustments.

Lets look at NUSs adjusted trial balance balance.

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Prepare adjusted 49 trial balance.

Adjusted Trial Balance

NUS Adjusted Trial Balance May 31, 2008 Cash $ 3,925 Accounts receivable 75 T l & equipment Tools i t 2 650 2,650 $ 50 Accum. depreciation: tools & eq. Truck 15,000 250 Accum. depreciation: truck Notes payable 13,000 Accounts payable 150 Capital stock 8,000 Dividends 200 Sales revenue 750 Gasoline expense 50 Depreciation exp.: tools & eq. 50 Depreciation exp.: exp : truck 250 Total $ 22,200 $ 22,200
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All balances are taken from the ledger g accounts on May 31 after preparing the two depreciation adjusting entries. (pp19,20) 50

Summary
The reasoning to make adjusting entries Four types of adjusting entries How do those adjusting entries affect the preparation p epa at o for o t trial a ba balance a ce

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