1. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 1 Adjusting the Accounts Supplies Bal. 100 Pur. 400

2. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 2 “Cash” vs. “Accrual” CashAccrual Revenuereceived Expenses paid

3. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 3 “Cash” vs. “Accrual” CashAccrual Revenuereceivedearned Expenses paidincurred GAAP requires using the ACCRUAL basis

4. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 4 Why make Adjusting Journal Entries?

5. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 5 Why make Adjusting Journal Entries? Better Financial Statements ( every adjusting entry will have one Balance Sheet and one Income Statement effect)

6. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 6 Matching Concept Revenue Expenses Time (period)

7. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 7 I. Identifying accounts to be adjusted: Accruals and Deferrals accrualsdeferrals cash AFTER eventcash BEFORE event Deferrals have been recorded; accruals have not. A. Timing of cash changing hands: $

8. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 8

9. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 9 B. Definitions An ACCRUAL is an expense that has NOT been paid or a revenue that has NOT been received. I. Identifying accounts to be adjusted: Accruals and Deferrals Examples of accruals: Expense: salaries, interest, taxes Revenue: services (performed on account)

10. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 10 I. Identifying accounts to be adjusted: Accruals and Deferrals B. Definitions A deferral is a delay of the recognition of an expense already paid or of a revenue already received. Examples of deferrals: Expense: supplies, insurance, rent (tenant) Revenue: subscriptions, rent (landlord)

11. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 11

12. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 12 II. Accruals A. EXPENSES 1. Example Salaries increase as employees work each day, yet, for convenience, salaries are recorded when PAID. Since the cash is paid after the event, salaries are an example of accrued expense. Salaries Expenseincurred Salaries Payable incurred The adjusting entry necessary when payday and the end of the fiscal period are on different days would be:

13. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 13 II. Accruals 2. Decision tree conclusion Accrued Expense

14. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 14 II. Accruals A. REVENUE 1. Example A CPA firm is auditing a client’s records; the engagement begins in mid-November and lasts through the end of February. As work is being performed each day, revenue is earned. Since the cash will not be collected until completion of the engagement (after the event), this is an example of accrued revenue. The adjusting entry necessary on the CPA’s records at the end of the year when financial statements are about to be prepared would be: Accounts Receivableearned Service Revenue earned 11/152/2812/31

15. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 15 II. Accruals 2. Decision tree conclusion Accrued Revenue

16. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 16 II. Accruals C. Reversing Entries -- Appendix to Chap 4 What?

17. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 17 II. Accruals C. Reversing Entries -- Appendix to Chap 4 What? Which? accruals cash AFTER event $

18. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 18 II. Accruals C. Reversing Entries -- Appendix to Chap 4 What? Which? When?

19. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 19 II. Accruals C. Reversing Entries -- Appendix to Chap 4 What? Which? When? Why? helps next year

20. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 20 II. Accruals C. Reversing Entries -- Appendix to Chap 4 All ACCRUALS need to be reversed. Watch for new rule and apply it here,too. What? Which? When? Why? What else? More Soon

21. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 21 II. Accruals C. Reversing Entries Accruals

22. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 22 III. Deferrals A. (Prepaid) EXPENSES 1. Examples from chapters 1 and 2: supplies, insurance, rent 2. Two methods of accounting for deferred (prepaid) expenses a. ASSET METHOD (Chapter 3 and homework) b. EXPENSE METHOD (Appendix and in class)

23. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 23 III. Deferrals A. 3. Identifying method for deferred EXPENSES a. Where was initial transaction recorded? b. Where is the balance of the account before adjustment? Which method would we be using... PrepaymentAssetExpense for insurance_______________ for supplies_______________ for rent_______________

24. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 24 III. Deferrals A. 4. Consider this example: SuppliesSupplies Expense Bal. 100 Pur. 400 Ending Inventory = $50 a. ASSET Method Supplies Expense 450 Supplies450

25. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 25 III. Deferrals A. 4. Consider this example: SuppliesSupplies Expense Bal. 100 Pur. 400 a. ASSET Method Supplies Expense 450 Supplies450 450

26. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 26 III. Deferrals A. 4. Consider this example: SuppliesSupplies Expense Bal. 100 Pur. 400 a. ASSET Method Supplies Expense 450 Supplies450 450

27. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 27 III. Deferrals A. 4. Consider this example: SuppliesSupplies Expense Bal. 100 Pur. 400 a. ASSET Method Supplies Expense 450 Supplies450 450 Bal. = 50 Used

28. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 28 III. Deferrals A. 4. b. Decision tree conclusion Asset Method

29. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 29 III. Deferrals A. 5. Re-consider the example: SuppliesSupplies Expense Bal. 100 Pur. 400 Ending Inventory = $50 a. EXPENSE Method Supplies 50 Supplies Expense 50

30. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 30 III. Deferrals A. 5. Re-consider the example: SuppliesSupplies Expense Bal. 100 Pur. 400 Ending Inventory = $50 a. EXPENSE Method Supplies 50 Supplies Expense 50 50

31. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 31 III. Deferrals A. 5. Re-consider the example: SuppliesSupplies Expense Bal. 100 Pur. 400 Ending Inventory = $50 a. EXPENSE Method Supplies 50 Supplies Expense 50 50 Unused

32. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 32 III. Deferrals A. 4. b. Decision tree conclusion Expense Method

33. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 33 Comparison of Methods SuppliesSupplies Expense Bal. 100 Pur. 400 450 ASSET METHOD SuppliesSupplies Expense Bal. 100 Pur. 400 EXPENSE METHOD 50 exactly the same results

34. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 34 Comparison of Methods Key to administering methods is CONSISTENCY J F M A M J J A S O N D 20x120x2

35. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 35 Comparison of Methods Key to administering methods is CONSISTENCY 20x120x2

36. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 36 Reversing entries necessary? “Rule” becomes “old rule” -- won’t work. These are DEFERRALS -- not accruals.

37. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 37 III. A. 6. Reversing Entries New Rule: One rule -- two ways to say it. a. If an ADJUSTING entry creates (first entry in the account) the balance in a BALANCE SHEET account, a reversing entry would be advantageous.

38. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 38 III. A. 6. Reversing Entries New Rule: One rule -- two ways to say it. b. If the direction of a deferral ADJUSTING entry is BALANCE SHEET to INCOME STATEMENT, it should NOT be reversed. If the direction of a deferral ADJUSTING entry is INCOME STATEMENT to BALANCE SHEET, it should be reversed.

39. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 39 III. A. 6. Reversing Entries Consider the SUPPLIES example... SuppliesSupplies Expense Bal. 100 Pur. 400 AJE 450 ASSET METHOD SuppliesSupplies Expense Bal. 100 Pur. 400 EXPENSE METHOD AJE 50 C2 450 NO YES!!

40. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 40 AJE 50 C2 450 Supplies Expense III. A. 6. Reversing Entries Consider the SUPPLIES example... Supplies Bal. 100 Pur. 400 EXPENSE METHOD AJE 50 Nature = Asset R 50

41. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 41 Expense Method

42. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 42 ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? You should try one … … about Prepaid Insurance … on your own time. Solution on class web page. Now turn to middle of page 6

43. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 43 III. Deferrals B. REVENUE 1. Examples landlords, magazine companies, lawyers Assume that attorneys Jones, Fraud, and Swindle, whose year ends December 31, received $1,200 on September 1 for one year’s service in advance. 1/112/31 $1,200 9/1

44. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 44 III. Deferrals B. REVENUE 1. Examples landlords, magazine companies, lawyers Assume that attorneys Jones, Fraud, and Swindle, whose year ends December 31, received $1,200 on September 1 for one year’s service in advance. 2. Two methods of accounting for deferred revenue When CASH was debited, what was credited? a. LIABILITY METHOD b. REVENUE METHOD

45. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 45 III. Deferrals B. 3. Identifying method for deferred REVENUE a. Where was initial transaction recorded? b. Where is the balance of the account before adjustment?

46. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 46 III. Deferrals B. 4. Consider the example of the lawyers: Unearned FeesFees Earned 9/1 1,200 a. REVENUE Method Fees Earned 800 Unearned Fees800 $1,200 4 mo8 mo $400$800 earnedunearned

47. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 47 III. Deferrals B. 4. Consider the example of the lawyers: Unearned FeesFees Earned 9/1 1,200 a. REVENUE Method Fees Earned 800 Unearned Fees800 $1,200 4 mo8 mo $400$800 800 B = $400

48. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 48 III. Deferrals B. 4. Consider the example of the lawyers: Unearned FeesFees Earned 9/1 1,200 a. REVENUE Method Fees Earned 800 Unearned Fees800 $1,200 4 mo8 mo $400$800 800 B = $400 unearned

49. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 49 III. Deferrals B. 4. b. Decision tree conclusion Revenue Method

50. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 50 III. Deferrals B. 5. Re-consider the example of the lawyers: Unearned FeesFees Earned 9/1 1,200 a. LIABILITY Method Unearned Fees 400 Fees Earned 400 $1,200 4 mo8 mo $400$800

51. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 51 III. Deferrals B. 5. Re-consider the example of the lawyers: Unearned FeesFees Earned 9/1 1,200 a. LIABILITY Method Unearned Fees 400 Fees Earned 400 $1,200 4 mo8 mo $400$800 400

52. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 52 III. Deferrals B. 5. Re-consider the example of the lawyers: Unearned FeesFees Earned 9/1 1,200 a. LIABILITY Method Unearned Fees 400 Fees Earned 400 $1,200 4 mo8 mo $400$800 400 earned B=800 unearned

53. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 53 III. Deferrals B. 4. b. Decision tree conclusion Liability Method

54. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 54 Comparison of Methods Unearned FeesFees Earned 9/1 1,200AJE 400 Liability Method Revenue Method Unearned FeesFees Earned 9/1 1,200AJE 800 exactly the same results

55. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 55 Comparison of Methods Liability Method Revenue Method Unearned FeesFees Earned 9/1 1,200AJE 400 C2 400 Unearned FeesFees Earned 9/1 1,200AJE 800 C2 400 NO YES!!

56. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 56 III. Deferrals B. 6. Reversing Entries Necessary? Revenue Method

57. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 57 Reversing Entry Revenue Method Unearned FeesFees Earned 9/1 1,200AJE 800 C2 400 R 800 Nature = Liability

58. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 58 ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? You should try one … … about Unearned Tuition … on your own time. Solution on class web page.

59. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 59 Plant Assets Plant Assets (long-lived assets) are also forms of deferrals. The remainder of the notes in the handout are on the class web page. Check it out.

60. Copyright © 1999 by M. Ray Gregg. All Rights Reserved. 60 Hopefully, you learned a great deal today. Use the decision tree as a learning tool this week! Have a great week!