Chapter 3: Adjusting Accounts(Read pages 84-98 NTK Comp. 1 pg 109).
Accrued Interest Expense EX:If a company has a $6,000 loan from a bank at 5% annual interest, then 30 days' accrued interest expense is $25
$6,000 x 0.05 x 30/360. The adjusting entry debits Interest Expense for $25 and credits Interest Payable for $25.
Steps of Accrued Services Revenue in Step 2: At December 31, 20 days of services have already been provided.
-Because the contracted services have not yet been entirely provided, FastForward has earned two-thirds of the 30 day fee, or $1,800 (2,799 x 20/30). -The Revenue Recognition principle requires FastForward to report the $1,800 on the December income statement. The balance sheet reports that the club owes FastForward $1,800
Steps of Accrued Services Revenue in Step 1: In the Second week of December, FastForward agreed to provide 30 days of consulting services to a Fitness club for a fixed fee of $2,700 (or $90/day).
.FastForward will provide services from Dec 12 through Jan 10, or 30 days of services. The club agrees to pay FastForward $2,700 on January 10 when the service is complete.
Cash Basis Accounting
Accounting system that recognizes revenues when cash is received and records expenses when cash is paid. -Cash receipts minus cash payments
Accrual Basis Accounting
Accounting system that recognizes revenues when earned and expenses when incurred; the basis for GAAP. -(Matched with revenues) Most agree that this method better reflects business performance than cash basis accounting. Increases comparability of financial statements from period to period
Explanation of Accrued Services Revenue
Accounts Receivable are reported on the balance sheet at $1,800 and the $7,850 total of consulting revenue is reported on the income statement. Not making the adjustment -Understates consulting revenue by $1,800 in the December income statement -Understates accounts receivable by $1,800 on December 31 balance sheet.
Future Cash Payment of Accrued Expenses
Accrued Expenses at the end of one account period result in cash payment in a future period. Recall that FastForward recorded Accrued Salaries of $210. On January 9th, the first payday of the next period, the following entry settles the accrued liability (salaries payable) and records salaries expense for seven days of work in January. The $210 debit is payment of the liability for the days; salary accrued on December 31st. The $490 debit records the salary for January first seven days (Including New Years Day) as an expense of the new accounting period. $700 credit records the total amount of cash paid to the employee.
Future Cash Receipt of Accrued Revenues and EX: Recall that FastForward made an adjusting entry for $1,800 to record 20 days' accrued revenue earned from its consulting contract. When FastForward receives $2,700 cash on January 10 for the entire contract amount, it makes the following entry to remove the accrued asset (accounts receivable) and record revenue earned in January.
Accrued Revenues at the end of one account period result in cash receipts in a future periods. The $2,700 debit is the cash received. The $1,800 credit is the removal of the receivable, and the $900 credit is revenue earned in January.
Framework of Accrued Revenues
Adjusting entries increase a revenue (income statement) account and increase an asset (balance sheet). Come from services, products, interest, and rent. We use service fees and interest to show how to adjust for accrued revenues.
Explanation of Unearned Revenues adjustment
Adjusting entry transfers $250 from unearned revenue (liability account) to a revenue account. Not making the adjustment -Understates revenue by $250 in the December income statement -Overstates unearned by $250 on the December 31 balance sheet.
Depreciation
Allocation of the costs of these assets over their expected useful lives (Benefit Periods). Recorded with an adjusting entry similar to that for other prepaid expenses.
Unearned Consulting revenue for STEP 2: Fast Forward agreed on December 26 to provide consulting services to a client for 60 days for a fixed fee of $3,000
As time passes, FastForward earns this payment through consulting. By December 31, it has provided 5 days' service and earned 5/60 of the $3,000 unearned revenue. This amounts to $250 ($3,000 x 5/60). The revenue recognition principle requires that $250 of unearned revenue be reported as revenue on the December income statement.
step 2 process in Prepaid insurance
As time passes, the benefits of the insurance gradually expire and a portion of the prepaid insurance asset becomes expense. For instance, one month's insurance coverage expires by December 31st, 2019. This expense is $100, or 1/24 of $2,400, which leaves $2,300.
Time Period Assumption
Assumption that an organization's activities can be divided into specific time periods such as month, three-month quarter, a six month interval, or a year.
Cash Basis Accounting Transaction: Paid 2,400 for 24 months insurance beginning Dec 1, 2019.
Balance sheet never reports a prepaid insurance asset because it is immediately expensed. Cash basis income for 2019-2021 does not match the cost of insurance with the insurance benefits for those years and months.
Unearned Revenue (deferred revenues)
Cash received in advance of providing products and services. When cash is accepted, an obligation to provide products or services is accepted. Liability decreases and the Unearned revenues become earned revenues Adjusting entries for unearned revenue decrease the unearned revenue (balance sheet) account and increase revenue (income statement) account Common in sporting and concert events.
fiscal year
Consecutive 12-month (or 52-week) period chosen as the organization's annual accounting period. -Companies with little seasonal variation in sales often use the calendar year as their fiscal year.
framework for prepaid expenses
Decrease an asset and record an expense (Increasing expense)
four types of adjustments exist for transactions and events that extend over more than one period
Deferral of expense, deferral of revenue, accrued expense, accrued revenue.
annual financial statements
Financial statements covering a one-year period; often based on a calendar year, but any consecutive 12-month (or 52-week) period is acceptable.
interim financial statements
Financial statements covering periods of less than one year; usually based on one-, three-, or six-month periods.
Accrued Interest Revenue
If a company is holding notes receivable that produce interest revenue, we must adjust the accounts to record any earned and yet uncollected interest revenue. The adjusting entry is similar to the one for accruing services revenue. Specifically, debit interest receivable (asset) and credit Interest Revenue.
Summary of adjustments and Financial statement links
Information for some adjustments is not available until after the period-end. This means that some adjusting and closing entries are recorded later than, but dates as of, the last day of the period. EX) Company receives a December utility bill on January 10. When it received the bill, the company records the expense and the payable as of December 31. The Income statement and balance sheet include these adjustments even though amounts were not known at period end.
Step 1 of Accrued Salaries Expense: FastForward employee earns $70 per day, or $350 for a five-day workweek beginning on Monday and ending on Friday.
Its employee is paid every two weeks on Friday. On December 12 and 26, the wages are paid, recorded in the journal, and posted to the ledger.
Accounting Period
Length of time covered by financial statements; also called reporting period.
Explanation of adjustment for supplies
Not making the adjustment on or before December 31 would -Understate expenses by $1,050 for the December income statement -Overstate supplies by $1,050 in the December 31 balance sheet
Explanation of Prepaid Insurance
Not making the adjustment on or before December 31st would -Understate expenses by $100 for the December income statement. -Overstate prepaid insurance (assets) by $100 in the December 31 balance sheet.
Other Prepaid expenses adjustments
Prepaid rent and Prepaid Advertising are accounted for exactly as insurance and supplies are. -Some prepaid expenses are both paid for and fully used up within a single period. -One example is when a company pays monthly rent on the first day of each month. In this case, we record the cash paid with a debit to Rent Expense instead of an asset account.
Accrued Revenues (accrued assets)
Revenues earned in a period that are both unrecorded and not yet received in cash (Or other assets). EX: Technician who bills customers after the job is done. If one third of a job is complete by the end of a period, then the technician must record 1/3 of the expected billing as revenue in that period--even though their no billing or collection.
Explanation of Salaries expense adjustment.
Salaries Expense of $1,610 is reported on the December income statement, and $210 of salaries payable (liability) is reported in the balance sheet. Not making the adjustment -Understates salaries expense by $210 in the December income statement -Understates salaries payable by $210 on the December 31 balance sheet.
Plant assets (Plant & Equipment or Property, Plant & Equipment)
Special category of prepaid expenses which are long term tangible assets used to produce and sell products and services. Provide benefits for more than one period. EX) Buildings, machines, vehicles, and fixtures. They wear out or become less useful. The costs are gradually reported as expenses in the income statement over the assets' useful lives (Benefit Periods).
Adjustments are made using a 3-step process
Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Step 3: Record an adjusting entry to get from step 1 and step 2.
Steps in Depreciation adjustments in Step 1: FastForward Purchased Equipment for $26,000 in early December to use in earning revenue. This Equipment's cost must be depreciated
Step 1: FastForward Purchased Equipment for $26,000 in early December to use in earning revenue. This Equipment's cost must be depreciated
Unearned Consulting revenue for STEP 1: Fast Forward agreed on December 26 to provide consulting services to a client for 60 days for a fixed fee of $3,000
Step 1: On Dec 26, the client paid the 60-day fee in advance, covering the period December 27 to February 25. The entry to record the cash received in advance is. This advance payment increases cash and creates a liability to do consulting work over the next 60 days (5 days this year and 55 days next year)
step 1 process in Prepaid insurance
Step 1: We determine that the current balance of FastForward's prepaid insurance is equal to its $2,400 payment for 24 months of insurance benefits that began on December 1st, 2019.
Explanation of the depreciation adjustments.
The Equipment account ($26,000) - Accumulated Depreciation ($300) = $25,700. The $300 balance in the Depreciation Expense account is reported in the December Income statement. Not making the adjustment at December 31 would -Understate expenses by $300 for the December income statement -Overstate assets by $300 in the December 31 balance sheet.
Step 3 of Accrued Salaries Expense: FastForward employee earns $70 per day, or $350 for a five-day workweek beginning on Monday and ending on Friday.
The adjusting entry for accrued salaries, along with T-account postings, follows.
Steps of Accrued Services Revenue in Step 3:
The adjusting entry for accrued services, along with T-account postings, follows.
Steps in Depreciation adjustments in Step 3:
The adjusting entry to record monthly depreciation expense, along with T-account postings, follows.
STEP 3 of Supplies at period-end and make adjusting entry.
The adjusting entry to record this expense and reduce the Supplies asset account, along with T-account postings, follows
step 3 process in Prepaid insurance
The adjusting entry to record this expense and reduce the asset, along with T-account postings, follows.
Unearned Consulting revenue for STEP 3: Fast Forward agreed on December 26 to provide consulting services to a client for 60 days for a fixed fee of $3,000
The adjusting entry to reduce the liability account and recognize earned revenue, along with T-Account postings, follows.
Step 2 of Accrued Salaries Expense: FastForward employee earns $70 per day, or $350 for a five-day workweek beginning on Monday and ending on Friday.
The calendar shows three working days after the December 26 pay day (29, 30, and 31). This means the employee has earned three days' salary by the close of business on Wed, Dec 31, yet this salary cost has not been paid or recorded. FastForward must report the added expense and liability for unpaid salary from December 29, 30, and 31.
Steps in Depreciation adjustments in Step 2: The equipment is expected to have a useful life (benefit period) of five years and to be worth about $8,000 at the end of five years.
This means the net cost of this equipment over its useful life is $18,000 ($26,000 - $8,000). FastForward depreciates it using straight-line depreciation, which allocates equal amounts of the asset's net cost to depreciation during its useful life. -Dividing the $18,000 net cost by 60 months (5 years) in the asset's life gives a monthly cost of $300.
natural business year
Twelve-month period that ends when a company's sales activities are at their lowest point.
STEP 2 of Supplies at period-end and make adjusting entry.
When FastForward computes (physically counts) its remaining unused supplies at December 31, it finds $8,670 of supplies remaining of the $9,720 total supplies. The $1,050 difference between two amounts is December's supplies expense.
STEP 1 of Supplies at period-end and make adjusting entry: FastForward purchased $9,720 of supplies in December, some of which were used during that same month.
When Financial Statements are prepared at December 41, the cost of supplies used during December is expensed.
Accrued Interest expense
accrued on notes payable (loans) and other long term liabilities at the end of a period. Interest expense is incurred as time passes. Unless interest is paid on the last day of an accounting period, we need to adjust for interest expense incurred but not yet paid. Principal amount Owed x Annual Interest Rate x Fraction of year since last payment
Prepaid expenses (Deferred expenses)
are assets paid for in advance of receiving their benefits. When these assets are used, those advance payments become expenses.
Accrued Expense
are costs that are incurred in a period that are both unpaid and unrecorded. Reported on the income statement for the period when incurred. Adjusting entries for recording accrued expenses increase the expense (income statement) account and increase liability (balance sheet) EX: Salaries, interest, rent, and taxes.
Adjusting Entry
made at the end of an accounting period to reflect a transaction or event that is not yet recorded. Affects one or more income statement accounts and one or more balance sheet accounts (but never the Cash account).
Expense Recognition Principle
requires that expenses be recorded in the same accounting period as the revenues that are recognized as a result of those expenses. Recording expenses early understates current-period income; recording it late overstates current-period income.
Revenue Recognition Principle
requires that revenue be recorded when goods or services are provided to customers and at an amount expected to be received from customers. Adjustments ensure revenue is recognized (reported) in time period when those services and products are provided. Recording revenue early overstates current-period income; recording it late understates current-period income.
Accumulated Depreciation
separate contra account. Cumulative sum of all depreciation expense recorded for an asset.