1. Adjusting Entries

2. TWO METHODS  Some companies will employ different methods of accounting based on the nature of their operations.  These methods change the time in which revenue and expenses are recorded and ultimately, it will result in different net profits/losses

3. ACCRUAL Accrual Basis  Revenues and expenses are recognized when earned or incurred regardless of when cash is received or paid.  Consistent with GAAP

4. CASH BASIS Cash Basis  Revenues and expenses are recognized when cash is received or paid.  Not consistent with GAAP.

5. EXAMPLE  On Jan 1 2014, customers owed Murray Co. $30 000 for services provided in 2013. During 2014 Murray Co. received $125 000 cash from customers. On December 31, 2014 customers owed Murray Co. $19 500 for services provided in 2014. Calculate revenue for 2014 using:  Cash basis  Accrual Basis

6. SOLUTION  Revenue for 2014 - $125,000 (Using Cash Basis, Revenue is recorded as cash is received)  Cash received from Customers 2014 - $125 000 Deduct: Collection of 2013 A/R - (30 000) Add: A/R at Dec 31/2014 19 500 Revenue for 2014 using accrual - $114 500

7. ADJUSTING ACCOUNTS  Accounts are adjusted at the end of each accounting period to bring an asset or liability account to its proper amount.  Adjusting entries also update the related expense or revenue accounts.  These adjustments are necessary for the preparation of financial statements.

8. ADJUSTMENT TYPES  Prepaid expenses  Depreciation  Unearned revenues  Accrued expenses  Accrued revenues

9. PREPAID EXPENSES  Costs paid in advance of receiving their benefits.  They are recorded as assets.  As these assets are used, their costs become expenses.  These costs expire with the passage of time or through use and consumption, e.g., insurance, supplies.

10. EXAMPLE On January 1, a company purchases an insurance policy that covers three months and costs $1,800. What will the transaction look like using T-accounts?

11. DEPRECIATION  Companies acquire assets such as equipment, buildings, vehicles, and patents to generate revenues.  These assets are expected to provide benefits for more than one accounting period.  Depreciation is the process of allocating the costs of assets over their expected useful lives.

12. UNEARNED REVENUES  Cash received in advance of providing products and services.  The company has an obligation to provide goods or services.  Unearned revenues are liabilities.  As products and services are provided, the amount of unearned revenues becomes earned revenues.

13. EXAMPLE On March 1, a company received a $12,000 payment from a customer for maintenance services to be provided over the next two months.

14. ACCRUED EXPENSES  Costs incurred in a period that are both unpaid and unrecorded.  Adjusting entries must be made to record the expense for the period and the related liability at the balance sheet date.  Examples: interest, wages, rent, taxes

15. EXAMPLE  On December 31, $1,200 of interest has accrued on a company’s bank loan. The payment of the interest is not due until January 1. The December 31 entry to record the accrued interest would be: Interest Expense 1,200 Interest Payable 1,200

16. ACCRUED REVENUES  Revenues earned in a period that are both unrecorded and not yet received in cash.  Adjusting entries must be made to record the revenue for the period and the related asset at the balance sheet date.  Examples: fees earned, interest earned, rent earned

17. EXAMPLE  On December 31, $16,500 of consulting fees have been earned but have not been recorded or billed to the client. The entry to record the accrued consulting fees earned would be:  Accounts Receivable 16,500 Consulting Fees Earned 16,50

18. ADJUSTMENTS  Adjustments are only made when financial statements are prepared.  Affect both the income statement and the balance sheet.  Do not affect cash.

19. HOME WORK  Text page 127-128 Brief Exercises 1-4 & 6