ADJUSTMENTS IN ACCOUNTING
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1 ADJUSTMENTS IN ACCOUNTING
2 Learning Objectives Understand the process of adjustments in accounting Explain the different types of adjustments Prepare adjusting entries 2
3 Income Statement Revenues recognized as cash is received. Revenues recognized as they are earned. Expenses recognized as cash is paid. Expenses recognized as they are incurred. Not considered GAAP. Mandated by GAAP. Cash-Basis Accounting vs. Accrual Basis Accounting
4 Matching The Most Important Accounting Principle Matching Principle Expenses should be recognized in the same accounting period as are the revenues they generated. (i.e., match revenues and expenses.)
5 The Need for Adjusting Entries Journal entries are made at the end of each accounting period to bring about a proper matching of revenues and expenses Economic events (i.e., transactions) have been ongoing but never recorded. Why not?
6 The Adjusting Process At the end of the period, the business reports its financial statements. This process begins with a trial balance. This is often referred to as an unadjusted because the accounts are not yet ready for the financial statements. Adjusting entries assign revenues to the period in which they are earned and expenses to the period which they are incurred.
7 FRAMEWORK FOR ADJUSTMENTS Adjustments Paid (or received) cash before expense (or revenue) Paid (or received) cash after expense (or revenue) recognized Prepaid (Deferred) expenses Unearned (Deferred) revenues Accrued expense Accrued revenues Depreciation
8 Adjustment Entries By the end of month the account needs to be adjusted.
9 Adjusting Journal Entries (AJEs) AJEs use the same recording format as regular journal entries. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit M/DD Account Name ### $$$ Account Name ### $$$ journal entry explanation
10 Every adjusting entry includes at least one balance sheet and at least one income statement account.
11 Adjustments 3 Types: Deferrals Accruals Depreciation
12 Deferrals A deferral is an adjustment for which the business paid or received cash in advance. It is a category of miscellaneous assets that typically expire or get used up in the near future. Examples include prepaid rent, prepaid insurance and supplies. There are also deferral adjustment for liabilities. Unearned service revenue is an example.
13 Adjusting Entries Classification Deferrals Accruals Prepaid expenses Unearned service revenue Accrued Expenses Accrued revenue
14 Prepaid Expense Therefore, prepaid expense are assets and not expenses, as they provide future benefits to the owners. A prepaid expense is an expense paid in advance. The prepayment will be used up in the near future.
15 Prepaid Expense An asset awaiting assignment to an expense. Prepaid Expense (debit) Journal entry when payment is made. Cash (credit)
16 Prepaid Expense An asset awaiting assignment to an expense. Journal entry when payment is made. Prepaid Expense (debit) The prepaid expense is consumed during the period. Cash (credit)
17 Prepaid Expense An asset awaiting assignment to an expense. Journal entry when payment is made. Prepaid Expense (debit) The prepaid expense is consumed during the period. Prepaid Expense (credit) AJE at end of period Cash (credit) Expense (debit)
18 Prepaid Expense - Example On September 1, 2015, Bob s Bait Shop prepaid its rent for the next twelve months. Rent is $200 per month. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit Prepare the proper initial journal entry.
19 Prepaid Expense Example On September 1, 2015, Bob s Bait Shop prepaid its rent for the next twelve months. Rent is $200 per month. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit 1-Sep Prepaid Rent 2,400 Cash 2,400 to record prepayment of twelve months of rent
20 Prepaid Expense Example Bob s fiscal year-end is December 31. Record the adjustment necessary on December 31 for the prepaid rent. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit Prepare the proper adjusting journal entry.
21 Prepaid Expense Example Bob s fiscal year-end is December 31. Record the adjustment necessary on December 31 for the prepaid rent. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit 31-Dec Rent Expense 800 Prepaid Rent 800 to record recognition of four months of rent expense $200 x 4 months = $800
22 Prepaid Expense Example Prepaid Insurance Premiums are paid in advance. Prepaid Subscriptions Magazine and newspaper subscriptions are always paid in advance. Supplies on Hand Supplies are charged to expense periodically.
23 Prepaid Expense Supplies on Hand Blank paper used in a copier is a great example of how supplies on hand transform from being an asset to becoming an expenses.
24 Accounting Estimates Some assets are not fully used up in a single fiscal period. A truck may last five years, but its value as a resource declines with time and usage.
25 Accounting Estimates Some assets are not fully used up in a single fiscal period. A truck may last five years, but its value as a resource declines with time and usage. Assets that benefit more than one year are called long-term or fixed assets.
26 Accounting Estimates The portion of an asset s utility that is used up must be expensed in the period used. Fixed Asset (debit) Journal entry when payment is made. Cash (credit)
27 Accounting Estimates The portion of an asset s utility that is used up must be expensed in the period used. Fixed Asset (debit) The asset s usefulness is partially consumed during the period. Journal entry when payment is made. Cash (credit)
28 Accounting Estimates The portion of an asset s utility that is used up must be expensed in the period used. Fixed Asset (debit) The asset s usefulness is partially consumed during the period. Accumulated Depreciation (credit) Journal entry when payment is made. Cash (credit) Depreciation Expense (debit) AJE at end of period
29 Accounting Estimates The portion of an asset s utility that is used up must be expensed in the period used. This is called a contra-asset account and has a credit balance. Accumulated Depreciation (credit) Depreciation Expense (debit) AJE at end of period
30 Accounting Estimates The portion of an asset s utility that is used up must be expensed in the period used. This is called a contra-asset account and has a credit balance. Accumulated Depreciation (credit) Balance Sheet Presentation Asset (at cost) $40,000 Less: Accumulated Depr. 5,000 Book Value $35,000 Depreciation Expense (debit) AJE at end of period
31 Accounting Estimates Definition of Book Value Asset cost - Accumulated Depreciation
32 Accounting Estimates Example On 31/12/14, Putnam Plumbing, recorded $2,000 of Depreciation Expense on a $10,000 truck. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit Prepare the proper adjusting journal entry.
33 Example Accounting Estimates On 31/12/14, Putnam Plumbing, recorded $2,000 of Depreciation Expense on a $10,000 truck. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit 31-Dec Depreciation Expense 2,000 Accumulated Depreciation 2,000 to record depreciation expense on truck for the year
34 Unearned Revenues Assets that have been received, but have not yet been earned. Unearned Revenue (credit) Journal entry when payment is received. Cash (debit)
35 Unearned Revenues Assets that have been received, but have not yet been earned. Unearned Revenue (credit) The unearned revenue is earned during the period. Journal entry when payment is received. Cash (debit)
36 Unearned Revenues Assets that have been received, but have not yet been earned. Unearned Revenue (credit) The unearned revenue is earned during the period. Unearned Revenue (debit) Journal entry when payment is received. AJE at end of period Cash (debit) Revenue (credit)
37 Unearned Revenues Example On 01/10/14, the Cookeville Gazette received $240 for a one-year subscription. The monthly subscription rate is $20. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit Prepare the proper initial journal entry.
38 Example Unearned Revenues On 01/10/14, the Cookeville Gazette received $240 for a one-year subscription. The monthly subscription rate is $20. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit 1-Oct Cash 240 Unearned Subscriptions 240 to record receipt of one-year subscription payment
39 Example Unearned Revenues The Cookeville Gazette s fiscal year-end is on 31/12/14 (three months later). Record the adjustment necessary at 31/12/14. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit Prepare the proper adjusting journal entry.
40 Example1 Unearned Revenues The Cookeville Gazette s fiscal year-end is on 31/12/14 (three months later). Record the adjustment necessary at 31/12/14. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit 31-Dec Unearned Subscriptions 60 Subscription Revenue 60 to record recognition of three months of subscription earned $20 x 3 months = $60
41 Accrued Assets/Revenues Assets and revenues that remain unrecorded at the end of the period. During the period, revenues are earned, but are not recorded at that time. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit
42 Accrued Assets/Revenues Assets and revenues that remain unrecorded at the end of the period. During the period, revenues are earned, but are not recorded at that time. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit Asset (debit) Revenue (credit) AJE at end of period
43 Accrued Assets/Revenues Example On 31/12/14, First Bank owes your company $100 of interest on your account. You will receive the interest on 10/01/15. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit Prepare the proper adjusting journal entry.
44 Accrued Assets/Revenues Example On 31/12/14, First Bank owes your company $100 of interest on your account. You will receive the interest on 10/01/15. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit 31-Dec Interest Receivable 100 Interest Revenue 100 to record interest earned but not yet received
45 Accrued Liabilities/Expenses Liabilities and expenses that remain unrecorded at the end of the period. During the period, expenses are incurred, but are not recorded at that time. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit
46 Accrued Liabilities/Expenses Liabilities and expenses that remain unrecorded at the end of the period. During the period, expenses are incurred, but are not recorded at that time. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit Expense (debit) Liability (credit) AJE at end of period
47 Accrued Liabilities/Expenses Example At 31/12/14, your company owes $235 of interest to Big Corp. You will not actually pay the interest until 10/01/15. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit Prepare the proper adjusting journal entry.
48 Accrued Liabilities/Expenses Example At 31/12/14, your company owes $235 of interest to Big Corp. You will not actually pay the interest until 10/01/15. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit 31-Dec Interest Expense 235 Interest Payable 235 to recognize interest owed to Big Corporation
49 Adjusting Journal Entries Question On 10/1/14, BeeBee Inc. pays $3,600 for a 12-month insurance policy. What kind of transaction would this be called? a. Accrued Liability b. Prepaid Expense c. Accounting Estimate d. Unearned Revenue
50 Adjusting Journal Entries Question On 10/1/14, BeeBee Inc. pays $3,600 for a 12-month insurance policy. What kind of transaction would this be called? a. Accrued Liability b. Prepaid Expense c. Accounting Estimate d. Unearned Revenue BeeBee has an asset that is awaiting assignment to an expense account.
51 Adjusting Journal Entries Question The last day of 1998 is on a Thursday. CeeCee Inc. will pay its employees on Friday. What kind of adjusting entry is required? a. Accrued Liability b. Accrued Asset c. Accounting Estimate d. Unearned Revenue
52 Adjusting Journal Entries Question The last day of 2014 is on a Thursday. CeeCee Inc. will pay its employees on Friday. What kind of adjusting entry is required? a. Accrued Liability b. Accrued Asset c. Accounting Estimate d. Unearned Revenue CeeCee has incurred an obligation to pay its workers after year-end.
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