Adjusting Entries

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

ACCRUAL

Accrual Basis

Revenues and expenses are recognized when

earned or incurred regardless of when cash is

received or paid.

Consistent with GAAP

CASH BASIS

Cash Basis

Revenues and expenses are recognized when cash

is received or paid.

Not consistent with GAAP.

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

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

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.

ADJUSTMENT TYPES

Prepaid expenses

Depreciation

Unearned revenues

Accrued expenses

Accrued revenues

P R E PA I D E X P E N S E S

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.

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?

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.

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.

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.

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

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

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

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

ADJUSTMENTS

Adjustments are only made when financial

statements are prepared.

Affect both the income statement and the balance

sheet.

Do not affect cash.

HOME WORK

Text page 127-128 Brief Exercises 1-4 & 6