Adjusting the Accounts
Supplies
Bal.
Pur.
100
400
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
1
“Cash” vs. “Accrual”
Cash
Revenue
Expenses
Accrual
received
paid
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
2
“Cash” vs. “Accrual”
Cash
Revenue
Expenses
received
paid
Accrual
earned
incurred
GAAP requires using the ACCRUAL basis
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
3
Why make
Adjusting Journal Entries?
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
4
Why make
Adjusting Journal Entries?
Better Financial Statements
(every adjusting entry will have
one Balance Sheet and
one Income Statement effect)
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
5
Matching Concept
Revenue
Expenses
Time (period)
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
6
I. Identifying accounts to be adjusted:
Accruals and Deferrals
A. Timing of cash changing hands:
accruals
deferrals
$
cash AFTER event cash BEFORE event
Deferrals have been recorded;
accruals have not.
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
7
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
8
I. Identifying accounts to be adjusted:
Accruals and Deferrals
B. Definitions
An ACCRUAL is an expense that has NOT
been paid or a revenue that has NOT
been received.
Examples of accruals:
Expense: salaries, interest, taxes
Revenue: services
(performed on account)
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
9
I. Identifying accounts to be adjusted:
Accruals and Deferrals
B. Definitions
A deferral is a delay of the recognition
of an expense already paid or of a
revenue already received.
Examples of deferrals:
Expense: supplies, insurance, rent
(tenant)
Revenue: subscriptions, rent (landlord)
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
10
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
11
II. Accruals
A. EXPENSES
1. Example
Salaries increase as employees work each
day, yet, for convenience, salaries are
recorded when PAID. Since the cash is paid
after the event, salaries are an example of
accrued expense.
The adjusting entry necessary when payday
and the end of the fiscal period are on
different days would be:
Salaries Expense
Salaries Payable
incurred
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
incurred
12
II. Accruals
2. Decision tree conclusion
Accrued Expense
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
13
II. Accruals
A. REVENUE
1. Example
11/15
12/31
2/28
A CPA firm is auditing a client’s records; the
engagement begins in mid-November and lasts
through the end of February. As work is being
performed each day, revenue is earned. Since the
cash will not be collected until completion of the
engagement (after the event), this is an example of
accrued revenue.
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:
Accounts Receivable
Service Revenue
earned
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
earned
14
II. Accruals
2. Decision tree conclusion
Accrued Revenue
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
15
II. Accruals
C. Reversing Entries -- Appendix to Chap 4
What?
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
16
II. Accruals
C. Reversing Entries -- Appendix to Chap 4
What?
Which?
accruals
cash AFTER event
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
$
17
II. Accruals
C. Reversing Entries -- Appendix to Chap 4
What?
Which?
When?
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
18
II. Accruals
C. Reversing Entries -- Appendix to Chap 4
What?
Which?
When?
Why?
helps next year
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
19
II. Accruals
C. Reversing Entries -- Appendix to Chap 4
What?
Which?
When?
Why?
What else?
More Soon
All ACCRUALS need to be reversed.
Watch for new rule and apply it here,too.
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
20
II. Accruals
C. Reversing Entries
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
21
III. Deferrals
A. (Prepaid) EXPENSES
1. Examples from chapters 1 and 2:
supplies, insurance, rent
2. Two methods of accounting for deferred
(prepaid) expenses
a. ASSET METHOD
(Chapter 3 and homework)
b. EXPENSE METHOD
(Appendix and in class)
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
22
III. Deferrals
A. 3. Identifying method for deferred EXPENSES
a. Where was initial transaction recorded?
b. Where is the balance of the account
before adjustment?
Which method would we be using . . .
Prepayment
Asset
Expense
for insurance
_______
________
for supplies
_______
________
for rent
_______
________
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
23
III. Deferrals
A. 4. Consider this example:
Supplies
Bal.
Pur.
Supplies Expense
100
400
Ending Inventory = $50
a. ASSET Method
Supplies Expense
Supplies
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
450
450
24
III. Deferrals
A. 4. Consider this example:
Supplies
Bal.
Pur.
Supplies Expense
100
400
450
a. ASSET Method
Supplies Expense
Supplies
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
450
450
25
III. Deferrals
A. 4. Consider this example:
Supplies
Bal.
Pur.
100
400
Supplies Expense
450
450
a. ASSET Method
Supplies Expense
Supplies
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
450
450
26
III. Deferrals
A. 4. Consider this example:
Supplies
Bal. 100
Pur. 400
Bal. = 50
450
Supplies Expense
Used
450
a. ASSET Method
Supplies Expense
Supplies
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
450
450
27
III. Deferrals
A. 4. b. Decision tree conclusion
Asset
Method
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
28
III. Deferrals
A. 5. Re-consider the example:
Supplies
Supplies Expense
Bal.
Pur.
100
400
Ending Inventory = $50
a. EXPENSE Method
Supplies
Supplies Expense
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
50
50
29
III. Deferrals
A. 5. Re-consider the example:
Supplies
Supplies Expense
Bal.
Pur.
50
100
400
50
Ending Inventory = $50
a. EXPENSE Method
Supplies
Supplies Expense
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
50
50
30
III. Deferrals
A. 5. Re-consider the example:
Supplies
Supplies Expense
Unused
Bal. 100
Pur. 400
50
50
Ending Inventory = $50
a. EXPENSE Method
Supplies
Supplies Expense
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
50
50
31
III. Deferrals
A. 4. b. Decision tree conclusion
Expense
Method
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
32
Comparison of Methods
ASSET METHOD
Supplies
Supplies Expense
Bal.
Pur.
100
400
450
exactly the
same
results
EXPENSE METHOD
Supplies
50
450
Supplies Expense
Bal.
Pur.
100
400
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
50
33
Comparison of Methods
Key to administering methods is
CONSISTENCY
JFMAMJJASOND
20x1
20x2
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
34
Comparison of Methods
Key to administering methods is
CONSISTENCY
20x1
20x2
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
35
Reversing entries necessary?
“Rule” becomes “old rule” -won’t work.
These are DEFERRALS -- not
accruals.
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
36
III. A. 6. Reversing Entries
New Rule: One rule -- two ways to say it.
a. If an ADJUSTING entry creates
(first entry in the account) the
balance in a BALANCE SHEET
account, a reversing entry would be
advantageous.
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
37
III. A. 6. Reversing Entries
New Rule: One rule -- two ways to say it.
b. If the direction of a deferral
ADJUSTING entry is BALANCE
SHEET to INCOME STATEMENT, it
should NOT be reversed.
If the direction of a deferral
ADJUSTING entry is INCOME
STATEMENT to BALANCE SHEET, it
should be reversed.
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
38
III. A. 6. Reversing Entries
Consider the SUPPLIES example...
ASSET METHOD
Supplies
Supplies Expense
Bal.
Pur.
100 AJE 450
400
NO
AJE 450 C2 450
EXPENSE METHOD
Supplies
AJE 50
YES!!
Supplies Expense
Bal. 100 AJE 50
Pur. 400 C2 450
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
39
III. A. 6. Reversing Entries
Consider the SUPPLIES example...
EXPENSE METHOD
Supplies
AJE 50
R 50
Supplies Expense
Bal. 100 AJE 50
Pur. 400 C2 450
R
50
Nature = Asset
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
40
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
41
???????????????
You should try one …
… about Prepaid Insurance
… on your own time.
Solution on class web page.
Now turn to middle of page 6
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
42
III. Deferrals
B. REVENUE
1. Examples
landlords, magazine companies, lawyers
Assume that attorneys Jones, Fraud, and
Swindle, whose year ends December 31,
received $1,200 on September 1 for one year’s
service in advance.
$1,200
1/1
9/1
12/31
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
12/31
43
III. Deferrals
B. REVENUE
1. Examples
landlords, magazine companies, lawyers
Assume that attorneys Jones, Fraud, and
Swindle, whose year ends December 31,
received $1,200 on September 1 for one year’s
service in advance.
2. Two methods of accounting for deferred
revenue
When CASH was debited, what was credited?
a. LIABILITY METHOD
b. REVENUE METHOD
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
44
III. Deferrals
B. 3. Identifying method for deferred REVENUE
a. Where was initial transaction recorded?
b. Where is the balance of the account
before adjustment?
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
45
III. Deferrals
B. 4. Consider the example of the lawyers:
Unearned Fees
Fees Earned
9/1 1,200
$1,200
4 mo
$400
earned
a. REVENUE Method
8 mo
$800
unearned
Fees Earned
Unearned Fees
800
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
800
46
III. Deferrals
B. 4. Consider the example of the lawyers:
Unearned Fees
Fees Earned
800
800
9/1 1,200
B = $400
$1,200
4 mo
$400
8 mo
$800
a. REVENUE Method
Fees Earned
Unearned Fees
800
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
800
47
III. Deferrals
B. 4. Consider the example of the lawyers:
Unearned Fees
800
Fees Earned
unearned 800
9/1 1,200
B = $400
$1,200
4 mo
$400
8 mo
$800
a. REVENUE Method
Fees Earned
Unearned Fees
800
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
800
48
III. Deferrals
B. 4. b. Decision tree conclusion
Revenue
Method
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
49
III. Deferrals
B. 5. Re-consider the example of the lawyers:
Unearned Fees
Fees Earned
9/1 1,200
$1,200
4 mo
$400
8 mo
$800
a. LIABILITY Method
Unearned Fees
Fees Earned
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
400
400
50
III. Deferrals
B. 5. Re-consider the example of the lawyers:
Unearned Fees
400
Fees Earned
9/1 1,200
$1,200
4 mo
$400
400
8 mo
$800
a. LIABILITY Method
Unearned Fees
Fees Earned
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
400
400
51
III. Deferrals
B. 5. Re-consider the example of the lawyers:
Unearned Fees
400
Fees Earned
earned
9/1 1,200
400
B=800
unearned
$1,200
4 mo
$400
8 mo
$800
a. LIABILITY Method
Unearned Fees
Fees Earned
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
400
400
52
III. Deferrals
B. 4. b. Decision tree conclusion
Liability
Method
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
53
Comparison of Methods
Liability Method
Unearned Fees
AJE 400
Fees Earned
9/1 1,200
AJE 400
exactly the
sameMethod
results
Revenue
Unearned Fees
Fees Earned
AJE 800
AJE 800
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
9/1 1,200
54
Comparison of Methods
Liability Method
Unearned Fees
AJE 400
9/1 1,200
NO
Fees Earned
C2 400
AJE 400
Revenue Method
Unearned Fees
Fees Earned
AJE 800
AJE 800 9/1 1,200
C2 400
YES!!
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
55
III. Deferrals
B. 6. Reversing Entries Necessary?
Revenue
Method
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
56
Reversing Entry
Revenue Method
Unearned Fees
Fees Earned
R 800 AJE 800
AJE 800 9/1 1,200
C2 400
R
800
Nature = Liability
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
57
???????????????
You should try one …
… about Unearned Tuition
… on your own time.
Solution on class web page.
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
58
Plant Assets
Plant Assets (long-lived assets)
are also forms of deferrals.
The remainder of the notes in the
handout are on the class web
page. Check it out.
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
59
Hopefully, you learned a great
deal today.
Use the decision tree as a
learning tool this week!
Have a great week!
Copyright © 1999 by M. Ray Gregg.
All Rights Reserved.
60