THEACCOUNTINGCYCLE:ACCRUALSANDDEFERRALSChapter

4Learning

objectivesWhyadjustmententryisneeded?Whatistypeofadjustingentry?Howtoadjusttransaction?MaterialityprincipleAttheendoftheperiod,weneedtomakeadjustingentriestogettheaccountsuptodateforthefinancialstatements.Adjustingentriesareneededwheneverrevenueorexpensesaffectmorethanoneaccountingperiod.Everyadjustingentryinvolvesachangeineitherarevenueorexpense

andanassetorliability.AdjustingEntries

Convertingassetstoexpenses

Accruingunpaidexpenses

Convertingliabilitiestorevenue

AccruinguncollectedrevenuesTypesofAdjustingEntriesPriorPeriodsCurrentPeriodFuturePeriodsTransactionPaidcashinadvanceofincurringexpense(createsanasset).EndofCurrentPeriodAdjustingEntry

Recognizesportion

ofassetconsumed

asexpense,andReducesbalanceof

assetaccount.ConvertingAssetstoExpensesExamplesInclude:DepreciationSuppliesExpiringInsurancePoliciesConvertingAssetstoExpensesJan.1Dec.31$2,400InsurancePolicyCoveragefor12Months$200MonthlyInsuranceExpenseOnJanuary1,WebbCo.purchasedaone-yearinsurancepolicyfor$2,400.ConvertingAssetstoExpensesInitially,coststhatbenefitmorethanoneaccountingperiodarerecordedasassets.

ConvertingAssetstoExpensesThecostsareexpensedastheyareusedtogeneraterevenue.ConvertingAssetstoExpensesIncomeStatementCostofassetsusedthisperiodtogeneraterevenue.BalanceSheetCostofassetsthatbenefitfutureperiods.ConvertingAssetstoExpensesDepreciationisthesystematicallocationofthecostofadepreciableassettoexpense.Depreciableassetsarephysicalobjectsthatretaintheirsizeandshapebutlosetheireconomicusefulnessovertime.TheConceptofDepreciationTheportionofanasset’sutilitythatisusedupmustbeexpensedintheperiodused.Cash(credit)FixedAsset(debit)Ondatewheninitialpaymentismade...Theasset’susefulnessispartiallyconsumedduringtheperiod.Atendofperiod...DepreciationExpense(debit)AccumulatedDepreciation(credit)TheConceptofDepreciationOnMay2,2005,JJ’sLawnCareServicepurchasedalawnmowerwithausefullifeof50monthsfor$2,500cash.Usingthestraight-linemethod,calculatethemonthlydepreciationexpense.$2,50050=$50Depreciationexpense(perperiod)=CostoftheassetEstimatedusefullifeDepreciationIsOnlyanEstimateJJ’sLawnCareServicewouldmakethefollowingadjustingentry.Contra-assetDepreciationIsOnlyanEstimateJJ’s$15,000truckisdepreciatedover60monthsasfollows:$15,00060months=$250permonthDepreciationIsOnlyanEstimateAccumulateddepreciationwouldappearonthebalancesheetasfollows:PriorPeriodsCurrentPeriodFuturePeriodsTransactionCollectcashinadvanceofearningrevenue(createsaliability).EndofCurrentPeriodAdjustingEntryRecognizesportionearnedasrevenue,

andReducesbalanceof

liabilityaccount.ConvertingLiabilitiestoRevenueExamplesInclude:AirlineTicketSalesSportsTeams’SalesofSeasonTicketsConvertingLiabilitiestoRevenueJan.1Dec.31$6,000RentalContractCoveragefor12Months$500MonthlyRentalRevenueOnJanuary1,WebbCo.received$6,000inadvanceforaone-yearrentalcontract.ConvertingLiabilitiestoRevenueInitially,revenuesthatbenefitmorethanoneaccountingperiodarerecordedasliabilities.

ConvertingLiabilitiestoRevenueOvertime,therevenueisrecognizedasitisearned.ConvertingLiabilitiestoRevenueIncomeStatementRevenueearnedthisperiod.BalanceSheetLiabilityforfutureperiods.ConvertingLiabilitiestoRevenuePriorPeriodsCurrentPeriodFuturePeriodsTransactionPaycashinsettlementofliability.EndofCurrentPeriodAdjustingEntryRecognizesexpense

incurred,andRecordsliabilityfor

futurepayment.AccruingUnpaidExpensesExamplesInclude:InterestWagesandSalariesPropertyTaxesHey,whendowegetpaid?AccruingUnpaidExpensesMonday,May29Friday,June2$3,000WagesExpenseOnMay31,WebbCo.oweswagesof$3,000.PaydayisFriday,June2.Wednesday,May31AccruingUnpaidExpensesInitially,anexpenseandaliabilityarerecorded.AccruingUnpaidExpensesIncomeStatementCostincurredthisperiodtogeneraterevenue.BalanceSheetLiabilitytobepaidinafutureperiod.AccruingUnpaidExpensesMonday,May29Friday,June2$5,000WeeklyWagesLet’slookattheentryforJune2.Wednesday,May31$2,000WagesExpense$3,000WagesExpenseAccruingUnpaidExpensesTheliabilityisextinguishedwhenthedebtispaid.AccruingUnpaidExpensesPriorPeriodsCurrentPeriodFuturePeriodsTransactionCollectcashinsettlementofreceivable.EndofCurrentPeriodAdjustingEntryRecognizesrevenueearnedbutnotyetrecorded,andRecordsreceivable.AccruingUncollectedRevenueExamplesInclude:InterestEarnedWorkCompletedButNotYetBilledtoCustomerAccruingUncollectedRevenueSaturday,Jan.15Tuesday,Feb.15$170InterestRevenueOnJan.31,thebankowesWebbCerestof$170.Interestispaidonthe15thdayofeachmonth.Monday,Jan.31AccruingUncollectedRevenueInitially,therevenueisrecognizedandareceivableiscreated.AccruingUncollectedRevenueIncomeStatementRevenueearnedthisperiod.BalanceSheetReceivabletobecollectedinafutureperiod.AccruingUncollectedRevenueSaturday,Jan.15Tuesday,Feb.15$320MonthlyInterest$170InterestRevenueLet’slookattheentryforFebruary15.Monday,Jan.31$150InterestRevenueAccruingUncollectedRevenueThereceivableiscollectedinafutureperiod.AccruingUncollectedRevenueAsacorporationearnstaxableincome,itincursincometaxesexpense,andalsoaliabilitytogovernmentaltaxauthorities.AccruingIncomeTaxesExpense:TheFinalAdjustingEntryCostsarematchedwithrevenueintwoways:

Directassociationofcostswithspecificrevenuetransactions.

Systematicallocationofcostsoverthe“usefullife”oftheexpenditure.AdjustingEntriesandAccountingPrinciplesAnitemis“material”ifknowledgeoftheitemmightreasonablyinfluencethedecisionsofusersoffinancialstatements.SuppliesLightbulbsManycompaniesimmediatelychargethecostofimmaterialitemstoexpense.TheConceptofMaterialityJournalizetransactions.Postentriestotheledgeraccounts.Preparetrialbalance.Makeend-of-yearadjustments.Prepareadjustedtrialbalance.Let’slookatJJ’sLawnCareServices’adjustedtrialbalance.EffectsoftheAdjustingEntriesAllbalancesaretakenfromtheledgeraccountsonMay31afterpreparingthetwodepreciationadjustingentries.AdjustedTrialBalanceCase4.1Shouldthisbeadjusted?

PropertyManagementProfessionalsprovidesbuildingmanagementservicestoownersofofficebuildingsandshoppingcenters.Thecompanyclosesitsaccountsattheendofthecalendaryear.Themannerinwhichthecompanyhasrecordedseveraltransactionsoccurringduring2005isdescribedasfollows:1,onSeptember1,receivedadvancepaymentfromashoppingcenterforpropertymanagementservicestobeperformedoverthethree-monthperiodbeginningSeptember1.Theentireamountreceivedwascrediteddirectlytoarevenueaccount.Case4.12,OnDecember1,receivedadvancepaymentfromthesamecustomerdescribedinpartaforservicestoberenderedoverthethree-monthperiodbeginningDecember1.Thistime,theentireamountreceivedwascreditedtoanunearnedrevenueaccount.3,RenderedmanagementservicesformanycustomersinDecember.Normalprocedureistorecordrevenueonthedatethecustomerisbilled,whichisearlyinth