Introduction to Accounting Preparing for a User’s Perspective Accrued Expenses: Cash is paid AFTER expense is recognized Debits and Credits Trainer By Kevin C. Kimball, CPA with support from www.canvas.net Free Jan. 2014 Available on the Google Play Store

Matching Principle Rent Revenues Sales Revenues Interest Income Recognize expenses in the same accounting period as the revenues that they helped generate. Rent Revenues Sales Revenues Interest Income Insurance Premiums Consulting Revenues Cash Out = Create Assets Cash Out = Pay off Liabilities Cost of Goods Sold Salary Expense Maintenance Fees Wages Expense Depreciation Expense Travel Expense Interest Expense Utilities Expense Claims incurred Advertising Expense Meals & Entertainment Expense

Three Common Matching Principle Situations 12/31/X1 12/31/X2 12/31/X3 Easy NO adjustments needed. 1) Cash is paid at the SAME time as the benefit received. 2) Cash is paid BEFORE the benefit is received Yes, adjustments needed. Deferred expenses and the expense is recognized. Yes, adjustments needed. 3) Cash is paid AFTER the benefit is received Accrued expenses and the expense is recognized. Matching principle: AMOUNT $ and TIMING of EXPENSES

Deferred Expenses vs Accrued Expenses DEFERRED EXPENSES: To “defer” means to put off until later; therefore, “deferred” expenses are expenses whose recognition is put off into the future even though payment has been made now. Pay cash NOW Deferred expenses Recognize expense LATER ACCRUED EXPENSES: To “accrue” means to grow or to accumulate over time. In accrual accounting, if the matching principle criteria are met in the current period, expenses will need to be “accrued” into the current accounting period even if cash will not be paid out until a later accounting period. Recognize expense NOW Accrued expenses Pay cash Later

2) Cash is paid AFTER the expense is recognized. Example: On 5/1/X1 Borrower borrowed $10,000 from Lender Co. for 12 months at 12% simple interest. All interest and the principal are to be paid on 4/30/X2. Per accrual accounting, record all required entries for Borrower Co. on 5/1/X1, 12/31/X1 and 4/30/X2. Principal $10,000 * Rate = 12% * Time = 12/12 = $1,200 per year FTYE 12/31/X1 FTYE 12/31/X2 $1,200 per year / 12 months = $100 per month 5/1 4/30 Per the matching principle WHEN should the interest expense be recognized? 8 months P =$10,000 * r = 12% * t = (8/12) $800 4 months P =$10,000 * r = 12% * t = (4/12) $400 = $1,200

2) Cash is paid AFTER the expense is recognized. FTYE 12/31/X1 FTYE 12/31/X2 5/1/X1 4/30/X2 Cash $10,000 Interest Expense $400 Note Payable $10,000 Interest Payable $800 12/31/X1 Notes Payable $10,000 Interest Expense $ 800 Cash $11,200 Interest Payable $800 Interest Payable 800 12/31/X1 800 12/31/X1 4/30/X2 800 $0 12/31/X2

2) Cash is paid AFTER the expense is recognized. FTYE 12/31/X1 FTYE 12/31/X2 Interest Expense $800 Interest Expense $400 5/1 4/30 8 months $800 4 months $400 = $1,200 Do our recognized expenses comply with the matching principle? YES

2) Cash is paid AFTER the expense is recognized. Example: On 12/1/X5 New Co. signed a contract to receive $9,000 of consulting services from Consultant A over the three month period ending 2/28/X6. Assuming the services were provided evenly and New Co. paid for them on 2/28/X6, record all of New Co.’s required entries AND adjusting entries for 20X5 and 20X6 to comply with the matching principle. FTYE 12/31/X5 FTYE 12/31/X6 $9,000/3 months = $3,000 per month 12/1 2/28 $3,000 of Consulting Expense Recognized BUT NO Cash Paid $6,000 of Consulting Expense Recognized AND $9,000 of Cash Paid Per the matching principle, WHEN should New Co. recognize the consulting expense?

2) Cash is paid AFTER the expense is recognized. FTYE 12/31/X5 FTYE 12/31/X6 12/1/X5 2/28/X6 No entry needed. Consulting Expense $6,000 Accrued Expense $3,000 12/31/X5 Cash $9,000 Consulting Expense $3,000 Accrued Expenses $3,000 Accrued Expenses 3,000 12/31/X5 3,000 12/31/X5 2/28/X6 3,000 12/31/X6

YES 2) Cash is paid AFTER the expense is recognized. FTYE 12/31/X5 12/1 2/28 $3,000 of Consulting Expense Recognized BUT NO Cash Paid $6,000 of Consulting Expense Recognized AND $9,000 of Cash Paid Did New Co. properly comply with the matching principle and accrue the expenses into the correct periods? YES

Accrued Expenses: Expense recognition key points 1) Only recognize expenses in the accounting period in which the benefit is received, which should match the related revenue. 2) If you receive and use up a service that you haven’t yet paid for, you will need to accrue and recognize the expense now and pay the liability off later. Accrued expenses Balance Sheet Assets: Liabilities: Unearned Revenue Equity At year end, review all accrued expense account balances to determine if they are properly stated and adjust accordingly. Income Statement Revenues Expenses Net Income 4) At year end, review your expense accounts to ensure you have accrued all appropriate expenses whether cash has been paid or not.

Introduction to Accounting Preparing for a User’s Perspective Accrued Expenses: Cash is paid AFTER expense is recognized Debits and Credits Trainer By Kevin C. Kimball, CPA with support from www.canvas.net Free Jan. 2014 Available on the Google Play Store