Chapter 3 Accruals and Adjustments Accrual Basis of

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. n 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 n

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

Types of Adjusting Entries n n n 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 DR CR Sept 30 Rent Expense $2500 Prepaid Rent $2500 n

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

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 n Oct 30 Unearned Revenue DR $100 CR $100

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

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

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

Accrued Salaries n 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 9 th. Oct 31 Salaries Expense Salaries Payable To record accrued salaries for October DR $1250 CR $1250

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

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