CHAPTER 7 – Adjusting journal entries Bellringer: Have you ever paid for something in advance? What was it? You buy a car worth $36,000 and you drive the car off the lot. You change your mind and try to give the car back. Is it still worth $36,000? Have you ever borrowed money from anyone? Did they loan the money for free? Have you ever loaned someone money? Was it for free? Has anyone paid you in advance for something? What you already know: Source Documents - evidence of accounting events. Record in the general journal in chronological order. Post the effect of these events in the General Ledger Accounts. What you will know: Enduring Understanding: Not all accounting events arise from source documents. Essential questions: What are adjusting journal entries and how do they impact the financial statements? Objectives – SWBAT: Compare and contrast general journal entries from adjusting journal entries. Identify four types of adjusting journal entries and describe their impact on the accounting equation. Demonstrate how to make and post adjusting journal entries. What you already know: Source Documents - evidence of accounting events. Record in the general journal in chronological order. Post the effect of these events in the General Ledger Accounts. This process continues throughout accounting cycle (time between financial statements). BUT…. Are all accounting events supported by source documents???? NO! What are adjusting journal entries? An internal entry made to adjust accounts for internal accounting events. Prior to preparing Financial Statements Before these are done – prepare a trial balance. No source documents available Purpose? Proper Expense and Revenue recognition in period incurred. #1 – Expense Deferrals Have you ever paid for something in advance? What was it? ◦ 1/1/10 - You paid for Rent for the entire year in the amount of $24,000. Lease 1/1/10 – 12/31/10. ◦ 7/1/10 - You paid for Car Insurance for 1 year $1,200. Policy 7/1/10 – 6/30/11. #1 – Expense Deferrals 6/1/10 - You buy a car worth $36,000 with a 5 year useful life and you drive the car off the lot. What is the car’s value after 1 month? 7 months? 2 years? Depreciation – allocation of cost of the long-term asset over its useful life. Accumulated Depreciation – Account accumulates depreciation expense taken over life of asset – contra account (opposite debit/ credit rules). Depreciation = Cost Useful Life $36,000= $7,200 per year 5 years ◦ Depreciation Expense – debit ◦ Accumulated Depreciation - Credit #1 – Expense Deferrals Occurs when a company uses previously purchased assets in an attempt to generate revenue in future periods. Expense recognition has been deferred. Increase expense, decrease asset Rent Expense, debit Prepaid rent, credit Depreciation Expense, debit Accumulated Depreciation (contra asset) #2 – Expense Accruals Have you ever borrowed money from anyone? Did they loan the money for free? ◦ 5/1/10 - You borrowed cash and signed a 3 year note 8% $40,000 (loan due 4/30/13). How much is owed the bank as of 12/31/10? ◦ At the end of they year 12/31/10, the company owes more than just $40,000…….. They also owe interest: $40,000 x 8% x 8/12 = $2,133.33 #2 – Expense Accruals Recorded when expenses are incurred in one accounting period and payment is made in a later period. Increase expense, increase liability Interest Expense, Debit Interest Payable, Credit #3 – Revenue Accruals Have you ever loaned someone money? Was it for free? 11/1/10 – Company loaned a supplier $10,000 cash for 90 days at 6 % interest. How much is owed the company at 12/31/10? This note earns interest each day but the company only needs to record the interest before financial statement preparation. The customer also owes interest: $10,000 x 6% x 60/365 = $98.63 #3 – Revenue Accruals Recorded when revenues are earned in one accounting period and payment is received in a later period. Increase revenue, increase asset Interest Receivable, Debit Interest Earned (revenue), Credit #4 – Revenue Deferrals Has anyone paid you in advance for something? 12/1/10 – A customer pays you $9,000 for services to be performed during December and January. Two-thirds of the services were completed by 12/31/10. How much revenue did you earn as of 12/31/10? Original General Journal Entry – Cash $9,000 Debit Unearned Revenue $9,000 (Liability) The company earned only 2/3 x 9,000 = 6,000. The company still owes 1/3 of services to the customer to be completed. If they do not complete the services, they must give 1/3 of the money back. Therefore, this is a liability. #4 – Revenue Deferrals Occurs when a company has been paid in advance by a client for services to be performed in the future. Revenue Recognition has been deferred. Increase revenue, decrease liability Unearned Revenue, Debit Service Fees Earned (revenue), Credit Exit ticket: ◦ “Go Around” – Tell me one thing you learned from today. ◦ Ready…… Set……. Go!