Chapter 3 – Accruals and Adjustments

Accrual Basis of Accounting vs. Cash Basis of Accounting Accrual- Transactions that changes a companies financial statements are recorded in the period it occurs. Cash- Revenue is recorded when cash is received and expenses are recorded when they are paid Cash Basis is not in accordance with GAAP’s

Accrual vs. Cash Example Year One Year Two Activity Purchased paint, painted building, paid employees Received payment for work done in year one. Accrual Basis Revenue: $80,000 Expense: 50,000 Net Income: 30,000 Revenue: $0 Expense: 0 Net Income: 0 Cash Basis Revenue: $ 0 Expense: 50,000 Net Loss: (30,000) Revenue: $80,000 Expense: 0 Net Income: 80,000

Types of Adjusting Entries Prepaid Expenses – Expenses paid in cash and recorded as an asset before they are consumed (Rent and Insurance). Unearned Revenue – Revenue received in cash and recorded as a liability before they are earned. Accrued Expenses – Expenses incurred but not paid in cash or recorded. (Salaries and Interest) Accrued Revenue – Revenue earned but not yet received or recorded. Amortization – Allocation of costs of capital assets to expense over their useful lives.

Prepaid Expenses Sept 1, 09 – Paid $7,500 to the landlord for rent for the next 3 months. DR CR Sept 1 Prepaid Rent $7500 Cash $7500 Sept 30 Rent Expense $2500 Prepaid Rent $2500

Supplies Adjustments Sept 5, we purchased $1000 worth of Supplies Sept 25 used $250 worth of supplies cleaning the Johnson Home DR CR Sept 5 Supplies $1000 Cash $1000 Sept 25 Supplies Expense $250 Supplies $250

Unearned Revenue Oct 1 Received cash ($100) from D. Smith for cleaning scheduled for Oct 30 DR CR Oct 1 Cash $100 Unearned Revenue $100 Oct 30 Unearned Revenue $100 Revenue $100

Accrued Revenues Performed Service on Oct 31, but will not bill until Nov 10 ($3000) Revenue Collected Nov 30 DR CR Oct 31 Accounts Receivable $200 Service Revenue $200 -To accrue revenue earned, but not billed or collected Nov 10 Accounts Receivable $2800 Service Revenue $2800 Nov 30 Cash $3000 Accounts Receivable $3000

Accrued Expenses Interest, Rent, Property Taxes, and Salaries Eg. Accrued Interest – Signed a three month $5000 Note Payable on October 1 that will be due January 1. The annual interest rate is 6% $5000 X 6% X = $25 Time in terms one year Face Value of Loan Annual Interest Rate X = Interest X

Accrued Expenses DR CR Oct 31 Interest Expenses $250 Interest Payable $250 Nov 30 Interest Expenses $250 Dec 31 Interest Expenses $250

Accrued Salaries The pay period at ABC Corp is from October 15 to October 26. The final 3 work days of October (29,30,31) will be paid out on November 9th. DR CR Oct 31 Salaries Expense $1250 Salaries Payable $1250 To record accrued salaries for October

Amortization We have to record the Historical Cost of an item in the books of the company when we purchase an item. (Cost Principle) But how do we record the value of an item that degrades over time? Answer: Amortization Amortization is an estimation of the loss of value of an item during a given time period.

Amortization Example A forklift has a useful life of 1 year (12 Months) and it was originally worth $1000. DR CR Oct 31 Amortization Expense $83 Accumulated Amortization - Forklift $83 To record amortization of forklift for Oct Historical Cost: 1000 Accumulated Amortization 83 Net Book Value: 917