Chapter 28 Accruals and prepayments other adjustments Learning

Chapter 28 Accruals and prepayments & other adjustments Learning Objectives 1. 2. 3. 4. 5. 6. 7. Adjust expense account for accruals and prepayments Adjust revenue accounts for amounts owing Accruals, prepayments & revenue in the balance sheet Expenses & revenues in the income statement Adjustment for drawings Extended trial balance Prepayment accruals & entries P 3 C 28 - 1

Journal Adjustment entries We are here Income Statement & Balance Sheet Ledger/ Taccounts Trial Balance C 28 - 2

The Adjustment Process • At the end of the period prepare adjusted financial statements • Ensures that: – All revenue that has been earned has been recorded – All expenses that have been incurred are matched to revenues – Asset and liability accounts are up-to-date • Expenses and revenues are not always paid or received on time. C 28 - 3

Categories of Adjusting Entries • Deferrals • Accruals • Depreciation C 28 - 4

Types of adjustments Adjustment entries Prepayments Prepaid Expenses Unearned/ Prepaid Revenues Accruals Accrued Revenues Accrued Expenses C 28 - 5

Types of adjustments, cont. Prepayments (Deferrals) Accruals Cash paid/received before consumption of related expense or revenue (recorded) Cash paid/received after consumption of expenses / revenues earned Expenses Prepaid Expenses • Expenses paid in advance • Recorded as assets before being used. Accrued Expenses • Expenses owed • For expenses incurred but not yet paid Revenues Unearned/Prepaid Revenues • Revenues received in advance • Recorded as liabilities before being earned Accrued Revenues • Revenues outstanding/not yet received • For revenues earned but cash has not been received C 28 - 6

Prepaid Expenses C 28 - 7

Prepaid Expenses • Expenses paid in advance • Eg: prepaid rent • Asset is recorded when purchased • Adjustment needed to record amount used: Debit expense account Credit asset account C 28 - 8

Prepaid Rent Example • Suppose on April 1, 2010 a company paid $12, 000 for one year’s rent in advance JOURNAL Date 1 -Apr Accounts Debit Prepaid rent Credit $12, 000 Cash $12, 000 C 28 - 9

Prepaid Rent Example • On December 31, 2010 i. e. the company’s yearend • The amount of rent that has expired (consumed) must be recorded as rent expense • Prepaid rent (asset) needs to be reduced so it reflects the amount of rent remaining C 28 - 10

Prepaid Rent Example $12, 000 Prepaid Rent $9, 000 April 1, 2010 $3, 000 Dec. 31, 2010 April 1 to December 31 = 9 months 9 out of 12 months of rent has expired 9/12 x $12, 000 = $9, 000 April 1, 2011 Jan 1, 2011 to 30 Marc 2011 3 out of 12 months of rent remains 3/12 x $12, 000 = $3, 000 C 28 - 11

Prepaid Rent Example • Dec 31, 2010 – Adjust Prepaid Rent account for amount expired JOURNAL Date Accounts Debit 31 -Dec Rent Expense Credit $9, 000 Prepaid Rent $9, 000 C 28 - 12

Prepayments • Prepayment will also happen when items other than purchases are bought for use in the business, and they are not fully used up in the period. • For instance, stationery / supplies is normally not entirely used up over the period in which it is bought. C 28 - 13

Unearned/Prepaid Revenues C 28 - 14

Unearned/Prepaid Revenues • Recorded as a liability when company receives payment – Company owes customer product or service • Revenue is not recorded until earned – When company provides product or service • An adjusting entry is made to transfer amount from unearned revenue to revenue C 28 - 15

Unearned Revenue Example • On November 1, 2010 a company receives a customer payment of $18, 000 for services (fees) to be performed during the next three months C 28 - 16

Unearned Revenue Example • Nov 1, 2010 – Record advance payment received by customer JOURNAL Date Nov 1 Accounts Debit Cash Unearned revenue Credit $18, 000 C 28 - 17

Unearned Revenue Example $18, 000 $12, 000 Nov. 1, 2010 $6, 000 Dec 31, 2010 Nov 1, 2010 - Dec 31, 2010 = 2 months 2 out of 3 months of revenue has been earned 2/3 x $18, 000 = $12, 000 Jan 31, 2011 Jan 1, 2011 - Jan 31, 2011 = 1 month 1 out of 3 months remains unearned 1/3 x $18, 000 = $6, 000 C 28 - 18

Unearned Revenue Example • Dec 31 – Record portion of unearned revenue that has been earned JOURNAL Date Dec 1 Accounts Debit Unearned revenue Service fees Credit $12, 000 C 28 - 19

Unearned Revenue Example Unearned Revenue Dec 31 $12, 000 Nov 1 $18, 000 $6, 000 End-of-year balance Represents amount unearned Service Fees Dec 31 $12, 000 Represents amount earned C 28 - 20

Accrued Expenses C 28 - 21

Accrued Expenses • Expense incurred before cash is paid • Results in a liability • Common accrued expenses: – Salaries – Interest – Taxes C 28 - 22

Accrued Salary Expense Example • A company pays its employees a weekly salary each Friday • Salaries for each week total $10, 000 • December 31, 2008 the company’s year-end, falls on a Wednesday C 28 - 23

$10, 000 Salaries $6, 000 Monday, Dec 29, 2008 $4, 000 Wednesday, Dec 31, 2008 Friday, Jan 2, 2009 Monday through Wednesday = 3 days 3 out of 5 days of salaries expense has been incurred 3/5 x $10, 000 = $6, 000 C 28 - 24

Accrued Salary Expense Example • Dec 31 – Record accrued salary expense JOURNAL Date Dec 31 Accounts Debit Salary expense Salary payable/accrued salary Credit $6, 000 C 28 - 25

Accrued Revenues C 28 - 26

Accrued Revenues • Companies often earn revenue before cash is received • Results in an accrued revenue – Receivable recorded • Example: – A company performed services for customers during the last week of the year totaling $5, 000 – The revenue has not yet been recorded because the customers won’t be billed until January C 28 - 27

Accrued Revenue Example • Dec 31 – Record accrued revenue JOURNAL Date Dec 31 Accounts Debit Accounts Receivable Service Fees Credit $5, 000 C 28 - 28

Summary of Adjusting Entries Types of Adjustments Accounts Before Adjustments Adjusting Entries Prepaid Expenses Assets overstated Expenses understated Dr. Expense Cr. Asset Unearned Revenues Liabilities overstated Revenues understated Dr. Liability Cr. Revenue Accrued Revenues Assets understated Revenues understated Dr. Asset Cr. Revenue Accrued Expenses Liabilities understated Expenses understated Dr. Expense Cr. Liability C 28 - 29

Summary of Adjusting Entries • Purpose of adjusting entries – Measure income – Update balance sheet • Each adjusting entry affects – One income statement account • Revenue or Expense – One balance sheet account • Asset or liability C 28 - 30

The adjusted trial balance l An Adjusted Trial Balance is prepared after all adjusting entries have been journalized and posted. l Its purpose is to prove the equality of the total debit and credit balances in the ledger after all adjustments have been made. l Financial statements can be prepared directly from the adjusted trial balance. C 28 - 31

End of Week 7 C 28 - 32