Name. Principles of Financial Accounting I. Adjusting the Accounts
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1 Name Principles of Financial Accounting I Adjusting the Accounts "Cash" Basis vs. "Accrual" Basis: Cash Accrual Revenue Expenses Generally Accepted Accounting Principles (GAAP) require using the basis. Why make Adjusting Journal Entries? Recall previous "promises." New Promise: Every adjusting entry will have _ Balance Sheet and one effect. INCOME STATEMENT attempts to accomplish: ESSENTIALS OF CONCEPT I. Identifying accounts to be adjusted: Accruals and Deferrals A. Perhaps the best way to distinguish deferrals and accruals is the timing of cash changing hands: 2. accruals cash AFTER event CA$H deferrals cash BEFORE event Deferrals have been recorded; accruals have not. B. Definitions An ACCRUAL is an expense or a revenue. Examples of accruals: Expense: Revenue: Copyright 1999 by M. Ray Gregg. All Rights reserved.
2 A DEFERRAL is a already paid or of a revenue. Examples of deferrals: Expense: Revenue: II. Accruals A. Expenses 1. Example Salaries increase as employees work each day, yet, for convenience, salaries are recorded when. Since the cash is paid the event, salaries are an example of. The adjusting entry necessary when payday and the end of the fiscal period are on different days would be: 2. Decision tree conclusion If this is the entry required for this follow a similar format:, other accrued expense items must B. Revenue 1. Example Your CPA firm is auditing a client's records; the engagement begins in mid-november and lasts through the end of February. Each day as work is being performed, revenue is earned. Since the cash will not be collected until completion of the engagement (after the event), this is an example of. The adjusting entry necessary on the CPA's records at the end of the year when financial statements are about to be prepared would be: 2. Decision tree conclusion If this is the entry required for this accrued revenue items would follow a similar format: item, other Copyright 1999 by M. Ray Gregg. All Rights reserved. (5th edition) page 2
3 C. "Reversing Entries" are presented in the appendix to Chapter 3. What? Which? When? Why? What Else? opposite of AJEs all accruals first day of new year helps next year go better will learn more later All need to be reversed. Watch for new rule and apply it here, too. III. DEFERRALS A. (Prepaid) Expenses 1. Examples already encountered in chapters 1 and 2 2. Two methods of accounting for deferred (prepaid) expenses a. b. (emphasized in Chapter 3) (covered in Appendix) 3. In order to identify the method used for deferred EXPENSES, consider a. where the initial transaction was recorded b. where the balance of the account is before adjustment Which method would we be using if... Prepayment Asset Expense for insurance for supplies for rent Copyright 1999 by M. Ray Gregg. All Rights reserved. (5th edition) page 3
4 III. A. 4. Consider example of Supplies and Supplies Expense... Supplies Supplies Expense Bal. 100 Pur. 400 Ending Inventory = $50 a. Using the method the AJE for supplies is: b. Decision tree conclusion 5. Re-consider example of Supplies and Supplies Expense... (Appendix) Supplies Supplies Expense * Bal. 100 * * Pur. 400 * Ending Inventory = $50 a. Using the method the AJE for supplies is: b. Decision tree conclusion Upon comparing the results, the asset method and the expense method accomplish The KEY to administering the methods is. means during an accounting period, and... from one period to the next Copyright 1999 by M. Ray Gregg. All Rights reserved. (5th edition) page 4
5 What about reversing entries for deferred expenses under these methods? Are they necessary? "Rule" becomes "old rule"--won't work. These are, not accruals. 6. Reversing entries New rule: one rule--two ways to say it a. When an ADJUSTING entry (first entry in the account), a reversing entry would be advantageous. b. When the direction of a deferral ADJUSTING entry is to, it should NOT be reversed. When the direction of a deferral ADJUSTING entry is to, it should be reversed. For the SUPPLIES example... Reversing entry for ASSET METHOD? Reversing entry for EXPENSE METHOD?????????????????????????? Now you try this one...on your own time... and check your answers by referring to the solution available on the class web site. Prepaid Insurance Insurance Expense Bal. 1,000 Make the adjusting entry necessary: $600 of premiums have expired Which method is being used? Reversed? Why or why not? Copyright 1999 by M. Ray Gregg. All Rights reserved. (5th edition) page 5
6 ????????????????????????? Prepaid Insurance Insurance Expense * Bal. 1,000 * Again, you make the adjusting entry: $600 of premiums have expired Which method is being used? Reversed? Why or why not? III. DEFERRALS B. Revenue 1. Examples Assume the attorneys Jones, Fraud, and Swindle, whose year ends December 31, received $1,200 on September 1 for one year's service in advance. When CASH was debited, what was credited? 2. Two methods of accounting for deferred REVENUE a. b. 3. In order to identify the method used for deferred REVENUE, consider a. where the initial transaction was recorded b. where the balance of the account is before adjustment Copyright 1999 by M. Ray Gregg. All Rights reserved. (5th edition) page 6
7 III. B. 4. Consider the example of the lawyers... Unearned Fees Fees Earned 9/1 1,200 a. Using the method the adjusting entry is: b. Decision tree conclusion 5. Re-consider the example of the lawyers... Unearned Fees Fees Earned * 9/1 1,200 * a. Using the method the adjusting entry is: b. Decision tree conclusion Upon comparing results, the liability method and the revenue method accomplish What about reversing entries for deferred revenue under these methods? Are they necessary? 6. Reversing entries for LIABILITY METHOD? for REVENUE METHOD? Copyright 1999 by M. Ray Gregg. All Rights reserved. (5th edition) page 7
8 Now you try a couple on your own time... and be sure to check you answers on the class web site. Assume a prominent midwestern university collected $4,000 in tuition on September 1. When cash was debited, the university credited...????????????????????????? Unearned Tuition Tuition Earned * 4,000 * Make the adjusting entry necessary at November 30: Which method is being used? Reversed? Why or why not?????????????????????????? Unearned Tuition Tuition Earned 4,000 Again, you make the adjusting entry necessary at November 30: Which method is being used? Reversed? Why or why not? Copyright 1999 by M. Ray Gregg. All Rights reserved. (5th edition) page 8
9 IV. Plant Assets (a form of deferrals) A. Desire to maintain "cost" of account B. "Decline in Usefulness" = C. "Nature" of Accumulated Depreciation is. Represents TOTAL depreciation taken since asset acquired. D. Result of "main" account and "contra" account worth naming: Equipment ) Accumulated Depreciation = Use the decision tree as a study tool this week! Copyright 1999 by M. Ray Gregg. All Rights reserved. (5th edition) page 9
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