ACCT 210 Lecture, Fall 2004

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-1 The Accounting Cycle Accruals and Deferrals Chapter 4 © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-2 Learning Objective Learning Objective LO1 To explain the purpose of adjusting entries. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-3 At the end of the period, we need to make adjusting entries to get the accounts up to date for the financial statements. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-4 Adjusting entries are needed whenever revenue or expenses affect more than one accounting period. Every adjusting entry involves a change in either a revenue or expense and an asset or liability. Adjusting Entries Adjusting Entries © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-5 Learning Objective Learning Objective LO2 To describe and prepare the four basic types of adjusting entries. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-6  Converting assets to expenses  Converting assets to expenses  Accruing unpaid expenses  Accruing unpaid expenses  Converting liabilities to revenue  Converting liabilities to revenue  Accruing uncollected revenue  Accruing uncollected revenue Types of Adjusting Entries Types of Adjusting Entries © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-7 Learning Objective Learning Objective LO3 To prepare adjusting entries to convert assets to expenses. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-8 Prior Periods Current Period Future Periods Transaction Paid cash in advance of incurring expense (creates an asset). Transaction Paid cash in advance of incurring expense (creates an asset). End of Current Period Adjusting Entry  Recognizes portion of asset consumed as expense, and  Reduces balance of asset account. Adjusting Entry  Recognizes portion of asset consumed as expense, and  Reduces balance of asset account. Converting Assets to Expenses Converting Assets to Expenses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-9 Examples Include: Depreciation Supplies Expiring Insurance Policies Converting Assets to Expenses Converting Assets to Expenses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-10 Jan. 1 Dec. 31 $2,400 Insurance Policy Coverage for 12 Months $200 Monthly Insurance Expense On January 1, Webb Co. purchased a one- year insurance policy for $2,400. On January 1, Webb Co. purchased a one- year insurance policy for $2,400. Converting Assets to Expenses Converting Assets to Expenses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-11 GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Jan. 1 Unexpired Insurance 2,400 Cash 2,400 Purchase a one-year insurance policy. Initially, costs that benefit more than one accounting period are recorded as assets. Initially, costs that benefit more than one accounting period are recorded as assets. Converting Assets to Expenses Converting Assets to Expenses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-12 The costs are expensed as they are used to generate revenue. The costs are expensed as they are used to generate revenue. GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Monthly Adjusting Entry for Insurance Jan. 31 Insurance Expense 200 Unexpired Insurance 200 Insurance expense for January. Converting Assets to Expenses Converting Assets to Expenses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-13 Insurance Expense 1/31 200 Unexpired Insurance 1/1 2,400 1/31 200 Bal. 2,200 Income Statement Cost of assets used this period to generate revenue. Income Statement Cost of assets used this period to generate revenue. Balance Sheet Cost of assets that benefit future periods. Balance Sheet Cost of assets that benefit future periods. Converting Assets to Expenses Converting Assets to Expenses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-14 Depreciation is the systematic allocation of the cost of a depreciable asset to expense. Depreciation is the systematic allocation of the cost of a depreciable asset to expense. Depreciable assets are physical objects that retain their size and shape but lose their economic usefulness over time. Depreciable assets are physical objects that retain their size and shape but lose their economic usefulness over time. The Concept of Depreciation The Concept of Depreciation © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-15 The portion of an asset’s utility that is used up must be expensed in the period used. The portion of an asset’s utility that is used up must be expensed in the period used. Cash (credit) Cash (credit) Fixed Asset (debit) Fixed Asset (debit) On date when initial payment is made . . . The asset’s usefulness is partially consumed during the period. At end of period . . . Depreciation Expense (debit) Depreciation Expense (debit) Accumulated Depreciation (credit) Accumulated Depreciation (credit) The Concept of Depreciation The Concept of Depreciation © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-16 On May 2, 2007, JJ’s Lawn Care Service purchased a lawn mower with a useful life of 50 months for $2,500 cash. Using the straight-line method, calculate the monthly depreciation expense. $2,500 50 $50 = $50 Depreciation expense (per period) = Cost of the asset Estimated useful life Depreciation Is Only an Estimate Depreciation Is Only an Estimate © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-17 JJ’s Lawn Care Service would make the following adjusting entry. JJ’s Lawn Care Service would make the following adjusting entry. GENERAL JOURNAL Date Account Titles and Explanation P RDebit Credit May 31 Depreciation Expense: Equipment 50 Accumulated Depreciation: Equipment 50 To record one month's depreciation. Contra-asset Contra-asset Depreciation Is Only an Estimate Depreciation Is Only an Estimate © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-18 JJ’s $15,000 truck is depreciated over 60 months as follows: JJ’s $15,000 truck is depreciated over 60 months as follows: GENERAL JOURNAL Date Account Titles and Explanation P RDebit Credit May 31 Depreciation Expense: Truck 250 Accumulated Depreciation: Truck 250 To record one month's depreciation. $15,00060 months = $250 per month $15,00060 months = $250 per month Depreciation Is Only an Estimate Depreciation Is Only an Estimate © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-19 Accumulated depreciation would appear on the balance sheet as follows: Accumulated depreciation would appear on the balance sheet as follows: © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-20 Learning Objective Learning Objective LO4 To prepare adjusting entries to convert liabilities to revenue. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-21 Prior Periods Current Period Future Periods Transaction Collect cash in advance of earning revenue (creates a liability). Transaction Collect cash in advance of earning revenue (creates a liability). End of Current Period Adjusting Entry  Recognizes portion earned as revenue, and  Reduces balance of liability account. Adjusting Entry  Recognizes portion earned as revenue, and  Reduces balance of liability account. Converting Liabilities to Revenue Converting Liabilities to Revenue © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-22 Examples Include: Airline Ticket Sales Sports Teams’ Sales of Season Tickets Converting Liabilities to Revenue Converting Liabilities to Revenue © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-23 Jan. 1 Dec. 31 $6,000 Rental Contract Coverage for 12 Months $500 Monthly Rental Revenue On January 1, Webb Co. received $6,000 in advance for a one-year rental contract. On January 1, Webb Co. received $6,000 in advance for a one-year rental contract. Converting Liabilities to Revenue Converting Liabilities to Revenue © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-24 GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Jan. 1 Cash 6,000 Unearned Rental Revenue 6,000 Collected $6,000 in advance for rent. Initially, revenues that benefit more than one accounting period are recorded as liabilities. Initially, revenues that benefit more than one accounting period are recorded as liabilities. Converting Liabilities to Revenue Converting Liabilities to Revenue © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-25 Over time, the revenue is recognized as it is earned. Over time, the revenue is recognized as it is earned. GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Monthly Adjusting Entry for Rent Revenue Jan. 31 Unearned Rental Revenue 500 Rental Revenue 500 Rental revenue for January. Converting Liabilities to Revenue Converting Liabilities to Revenue © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-26 Rental Revenue 1/31 500 Unearned Rental Revenue 1/31 500 1/1 6,000 Bal. 5,500 Income Statement Revenue earned this period. Income Statement Revenue earned this period. Balance Sheet Liability for future periods. Balance Sheet Liability for future periods. Converting Liabilities to Revenue Converting Liabilities to Revenue © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-27 Learning Objective Learning Objective LO5 To prepare adjusting entries to accrue unpaid expenses. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-28 Prior Periods Current Period Future Periods Transaction Pay cash in settlement of liability. Transaction Pay cash in settlement of liability. End of Current Period Adjusting Entry  Recognizes expense incurred, and  Records liability for future payment. Adjusting Entry  Recognizes expense incurred, and  Records liability for future payment. Accruing Unpaid Expenses Accruing Unpaid Expenses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-29 Examples Include: Interest Wages and Salaries Property Taxes Hey, when do we get paid? Accruing Unpaid Expenses Accruing Unpaid Expenses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-30 Monday, May 29 Friday, June 2 $3,000 Wages Expense On May 31, Webb Co. owes wages of $3,000. Payday is Friday, June 2. On May 31, Webb Co. owes wages of $3,000. Payday is Friday, June 2. Wednesday, May 31 Accruing Unpaid Expenses Accruing Unpaid Expenses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-31 GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit May 31 Wages Expense 3,000 Wages Payable 3,000 To accrue wages owed to employees. Initially, an expense and a liability are recorded. Initially, an expense and a liability are recorded. Accruing Unpaid Expenses Accruing Unpaid Expenses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-32 Wages Expense 5/31 3,000 Wages Payable 5/31 3,000 Income Statement Cost incurred this period to generate revenue. Income Statement Cost incurred this period to generate revenue. Balance Sheet Liability to be paid in a future period. Balance Sheet Liability to be paid in a future period. Accruing Unpaid Expenses Accruing Unpaid Expenses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-33 Monday, May 29 Friday, June 2 $5,000 Weekly Wages Let’s look at the entry for June 2. Let’s look at the entry for June 2. Wednesday, May 31 $2,000 Wages Expense $3,000 Wages Expense Accruing Unpaid Expenses Accruing Unpaid Expenses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-34 The liability is extinguished when the debt is paid. The liability is extinguished when the debt is paid. GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit June 2 Wages Expense (for June) 2,000 Wages Payable (accrued in May) 3,000 Cash 5,000 Weekly payroll for May 29-June 2. Accruing Unpaid Expenses Accruing Unpaid Expenses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-35 Learning Objective Learning Objective LO6 To prepare adjusting entries to accrue uncollected revenue. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-36 Prior Periods Current Period Future Periods Transaction Collect cash in settlement of receivable. Transaction Collect cash in settlement of receivable. End of Current Period Adjusting Entry Recognizes revenue earned but not yet recorded, and Records receivable. Adjusting Entry Recognizes revenue earned but not yet recorded, and Records receivable. Accruing Uncollected Revenue Accruing Uncollected Revenue © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-37 Examples Include: Interest Earned Work Completed But Not Yet Billed to Customer Accruing Uncollected Revenue Accruing Uncollected Revenue © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-38 Saturday, Jan. 15 Tuesday, Feb. 15 $170 Interest Revenue On Jan. 31, the bank owes Webb Co. interest of $170. Interest is paid on the 15th day of each month. On Jan. 31, the bank owes Webb Co. interest of $170. Interest is paid on the 15th day of each month. Monday, Jan. 31 Accruing Uncollected Revenue Accruing Uncollected Revenue © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-39 GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Jan. 31 Interest Receivable 170 Interest Revenue 170 To recognize interest revenue. Initially, the revenue is recognized and a receivable is created. Initially, the revenue is recognized and a receivable is created. Accruing Uncollected Revenue Accruing Uncollected Revenue © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-40 Interest Revenue 1/31 170 Interest Receivable 1/31 170 Income Statement Revenue earned this period. Income Statement Revenue earned this period. Balance Sheet Receivable to be collected in a future period. Balance Sheet Receivable to be collected in a future period. Accruing Uncollected Revenue Accruing Uncollected Revenue © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-41 Saturday, Jan. 15 Tuesday, Feb. 15 $320 Monthly Interest $170 Interest Revenue Let’s look at the entry for February 15. Let’s look at the entry for February 15. Monday, Jan. 31 $150 Interest Revenue Accruing Uncollected Revenue Accruing Uncollected Revenue © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-42 The receivable is collected in a future period. The receivable is collected in a future period. GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Feb. 15 Cash 320 Interest Revenue (for February) 150 Interest Receivable (accrued Jan. 31) 170 To record interest received. Accruing Uncollected Revenue Accruing Uncollected Revenue © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-43 As a corporation earns taxable income, it incurs income taxes expense, and also a liability to governmental tax authorities. As a corporation earns taxable income, it incurs income taxes expense, and also a liability to governmental tax authorities. GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Dec. 31 Income Taxes Expense 780 Income Taxes Payable 780 Estimated income taxes applicable to taxable income earned in December. Accruing Income Taxes Expense: The Final Adjusting Entry Accruing Income Taxes Expense: The Final Adjusting Entry © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-44 Learning Objective Learning Objective LO7 To explain how the principles of realization and matching relate to adjusting entries. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-45 Costs are matched with revenue in two ways: Costs are matched with revenue in two ways:  Direct association of costs with specific revenue transactions.  Direct association of costs with specific revenue transactions.  Systematic allocation of costs over the “useful life” of the expenditure.  Systematic allocation of costs over the “useful life” of the expenditure. Adjusting Entries and Accounting Principles Adjusting Entries and Accounting Principles © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-46 Learning Objective Learning Objective LO8 To explain the concept of materiality. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-47 An item is “material” if knowledge of the item might reasonably influence the decisions of users of financial statements. An item is “material” if knowledge of the item might reasonably influence the decisions of users of financial statements. Supplies Lightbulbs Many companies immediately charge the cost of immaterial items to expense. The Concept of Materiality The Concept of Materiality © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-48 Learning Objective Learning Objective LO9 To prepare an adjusted trial balance and describe its purpose. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-49 Journalize transactions. Post entries to the ledger accounts. Prepare trial balance. Make end-of- year adjustments. Prepare adjusted trial balance. Let’s look at JJ’s Lawn Care Services’ adjusted trial balance. Let’s look at JJ’s Lawn Care Services’ adjusted trial balance. Effects of the Adjusting Entries © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-50 JJ's Lawn Care Service Adjusted Trial Balance May 31, 2007 Cash 3,925 $ Accounts receivable 75 Tools & equipment 2,650 Accum. depreciation: tools & eq. 50 $ Truck 15,000 Accum. depreciation: truck 250 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.: truck 250 Total 22,200 $ 22,200 $ All balances are taken from the ledger accounts on May 31 after preparing the two depreciation adjusting entries. Adjusted Trial Balance Adjusted Trial Balance © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 4-51 End of Chapter 4 End of Chapter 4