1. Chapter 3 – Accruals and Adjustments

2. 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

3. 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:
Net Income:
Cash Basis
Revenue: $
Expense: 50,000
Net Loss: (30,000)
Revenue: $80,000
Expense: Net Income: ,000

4. 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.

5. 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

6. 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

7. 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

8. 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

9. 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%
$ X 6% X = $25
Time in terms one year
Face Value of Loan
Annual Interest Rate X =
Interest X

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

11. 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

12. 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.

13. 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:
Accumulated Amortization
Net Book Value: