Chapter 3 Adjusting the Accounts

The Year Calendar Year is January 1 through December 31 Fiscal year is any 12-month period – I.E. ATA’s year is July 1 through June 30

Cash Basis vs. Accrual Cash Basis is when a company only records when cash has been received or paid out. Accrual Basis records events as they happen **Cash accounting is not in accordance with GAAP***

Revenue Recognition Revenue is recognized only when the services have been performed. However, if we receive money ahead of time, we increase the liability account—”Unearned Revenue”

Matching Principle We always need to match the expenses that were needed to produce the revenue

Adjusting Entries Certain accounts are not the same at the end of an accounting period. – Deferrals, accounts recorded as assets and have been used up. Pre-Paid Insurance Supplies Large assets that have depreciated (or lost some of their value)

Pre-Paid Insurance We paid insurance for a period of time and recorded the entire amount as the asset, Pre- Paid Insurance. If we paid for insurance for $600 for 12 months, then we use up $50 each month At the end of the month we record the used up part like this: – Insurance Expense $50.00 (Debit) Pre-Paid Insurance$50.00 (Credit)

You Try Leo Jewelers purchased Insurance on January 1 for $1500/yr. On April 1, he is adjusting his account. How many months have been used ___?____ Figure the amount used up_____?________ What is the entry ______?__________ How much insurance is left ______?____

Supplies When you buy supplies for your business, you add it to the asset account, supplies. However, as you go through the year, your supplies as used, so you don’t have as many at the end of a month, year or quarter.

So What Now You take an inventory of your supplies You determine that you have $100 of pencils left. You bought $ of supplies in the beginning. How many pencils did you use? The adjusting entry is: – Supplies Expense ? (Debit) Supplies? (Credit)

This poor computer isn’t worth what it used to be!!! Many large assets lose their value Examples are: Furniture, Cars, Technology These assets have depreciated in value First, we need to know two things: A contra asset account is an account that offsets an asset but is still noted on the balance sheet. Accumulated Depreciation is a contra-asset account.

Second The book value of any depreciable asset is calculated by taking the original value – depreciation. If you bought office equipment for $5,000 and it has depreciated $1,000, then the book value is $4,000 (5,000-1,000).

Adjusting Entry On the previous example, Smith Bros bought office equipment for $5,000 and it has depreciated $1,000 in the past year. We do adjusting entries at the end of the year (important note) Entry – Depreciation Expense-Office Equip $1,000 (Dr) Accumulated Depreciation-Office Equipment $1,000(Cr)

Do It Page (1-3) only Do this in your notebook (15 minutes)

Unearned Revenue Examples: Magazine Subscriptions, Airline Tickets, Consulting Projects, Architectural contracts. Unearned Revenue is a liability account. It is adjusted when the service is performed or completed. The adjusting entry can be for the entire amount of a partial part.

Pioneer Advertising Agency Pioneer Advertising Agency received $1,200 on October 2 from R. Knox for advertising services expected to be completed by December 31. The first entry: – Cash $1,200 (Dr) Unearned Revenue $1,200 (Cr).

Adjusting Entry At the end of March Pioneer completed one month’s worth of the services. We want to take one-month of the liability away so… – Unearned Revenue $400 (Dr) Service Revenue$400(cr) – ? How much is in Unearned Revenue Now?

You do it! Buhl Company has Unearned Revenue of $10,000. At the end of the month, Buhl has performed 2/5 of the services. What is the amount of revenue earned? What is the entry? How much is still unearned?

Accruals To account for revenue and expenses that should be put into an accounting period but because of timing they have not been recorded.

Revenue not yet recorded Might have happened on the day the financial statements are being prepared so we record it with an adjusting entry Accounts Receivable (Dr.) – Service Revenue (Cr)

Accrued Expenses Examples are interest that has accrued but doesn’t need to be paid yet. Salaries that have been earned but do not need to be paid yet.

Accrued Interest Let’s say we went to the back to get money for our business and we signed a note for $5,000 at 12% annual interest. How did we record this money when received?

At the End of the Month We have accrued 1 month of interest of 1/12. We would then take $5,000 x 12% x 1/12. We should come out with ? The adjusting entry is – Interest Expense ? (Dr.) Interest Payable ?(Cr)

You Do It! Calvin and Hobbes borrowed $30,000 from a local bank on a 15 year note. The annual interest rate is 10%. What is the interest for a year? What is the interest for ½ year? What is entry to record the interest for 6 months?

Accrued Salaries Many companies pay every other week. The accounting period may end in between pay periods. We must account for the days that were performed but not yet paid.

Example Carter just paid everyone on October 26 and the next payday is November 9. They are preparing statements at the end of October. Therefore 3 days of work were performed after October 26. If their total payroll for 5 days of work is $2,000, how much was performed in 3 days?

Next, the Adjusting Entry Salaries Expense1,200 (Dr) Salaries Payable1,200 (Cr) Then when the entire amount is paid on Nov 9 Salaries Payable$1,200 (Dr) Salaries Expense $ 800 (Dr) Cash 2,000 (Cr.)

Finally!!! The adjusted trial balance Take each account in the ledger Write their balance Debits in total should equal credits in total.

Examples Page 112 Page 113 E3-6 Page 128 E3-9 Page 129

Assignments P3-1A P3-2A P3-5A

Test Review Define – Accrual – Book Value – Depreciation – Contra-Asset – Deferrals – Fiscal Year – Prepaid Expenses – Unearned Revenue – Adjusting Entries

Analyze Amount of adjusting entries. Accounts to enter adjusting entries. Problem similar to P3-1A