Chapter 17 Accounting for Accruals and Deferrals

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1 Chapter 17 Accounting for Accruals and Deferrals o Understand Accrual and Deferrals o Accrued Expense o Accrued Revenue o Deferred Expense o Deferred Revenue 1

2 Accruals and Deferrals Accruals Expenses incurred and revenue earned in the current accounting period but not recorded as of the end of the period Accrual Basis Applies the matching principles of accounting Record revenue in the period earned (regardless of when cash changes hands) Record expenses in the same period that generated the revenue Deferrals Expenses and revenue that have been recorded in the current accounting period but are not incurred or earned until a future period 2

3 Accrued Expenses Expenses that build up or accumulate during the current period but will not be paid until the next period; AKA accrued liabilities Recorded in the current period Debit to an expense account Credit to a liability account Assume that Bluff City Supply Company pays its employees every Friday for a normal five-day workweek and that the weekly payroll is $20,000. Dec. 31,, is a Wednesday. The week s salaries will be paid on Friday, Jan. 2, 20X2. Daily salaries are $20,000 5 days = $4,000. Employees are owed for Monday, Tuesday and Wednesday, the last 3 days of the accounting period. The following entry is prepared on Dec. 31, : 3 Dec. 31 Salaries Expense 12,000 Salaries Payable 12,000

4 Paying Accrued Salaries Expense-No Reversing Entry Assume that Bluff City Supply Company pays its employees every Friday for a normal five-day workweek and that the weekly payroll is $20,000. Dec. 31,, is a Wednesday. The following entry was prepared on Dec. 31, : Dec. 31 Salaries Expense 12,000 Salaries Payable 12,000 On Friday, Jan. 2, 20X2, Bluff City paid the payroll for the week and prepared the following journal entry: 4 20X2 Jan. 2 Salaries Expense 8,000 Salaries Payable 12,000 Cash 20,000

5 Paying Accrued Salaries Expense-Reversing Entry Used Assume that Bluff City Supply Company pays its employees every Friday for a normal five-day workweek and that the weekly payroll is $20,000. Dec. 31,, is a Wednesday. The following entry was prepared on Dec. 31, : 5 Dec. 31 Salaries Expense 12,000 Salaries Payable 12,000 On Thursday, Jan. 1, 20X2, Bluff City made the following reversing entry (an exact opposite of the adjusting entry): 20X2 Jan. 1 Salaries Payable 12,000 Salaries Expense 12,000 On Jan. 2, 20X2, makes the following entry to payment of salaries: 20X2 Jan. 2 Salaries Expense 20,000 Cash 20,000

6 Adjusting for Accrued Interest Expense Assume that on Nov. 1,, Bluff City Supply Company borrowed $12,000 on a 90-day, 14% note. The due date of the note is Jan. 30, 20X2. An adjusting entry must be made on Dec. 31,, to record the accrued interest. The accrued interest is calculated for the period of Nov. 1 to Dec. 31,. Interest = $12, days 360 days = $280 The following adjusting entry is prepared: Dec. 31 Interest Expense 280 Interest Payable 280 6

7 Paying Accrued Interest Expense-No Reversing Entry On Jan. 30, 20X2, Bluff City Supply Company must repay the note and the total amount of interest. We need to compute the interest for the current period; the 30 days in January. Interest = $12, days 360 days = $140 The following entry is prepared on January 30, 20X2, to repay the note and the total amount of interest: 7 20X2 Jan. 30 Notes Payable 12,000 Interest Expense 140 Interest Payable 280 Cash 12,420

8 Paying Accrued Interest Expense-Reversing Entry Used Assume on Jan. 1, 20X2, Bluff City made the following reversing entry: 20X2 Jan. 1 Interest Payable 280 Interest Expense 280 On Jan. 2, 20X2, makes the following entry to pay the note and total amount of interest: 20X2 Jan. 2 Notes Payable 12,000 Interest Expense 420 Cash 12,420 8

9 Accrued Revenue Revenue that has been earned but will not be received until the next accounting period. Must be recorded in the current period to properly match revenue and expenses. Assume that on Nov. 1,, Burroughs Company entered into a threemonth lease agreement with White Company. Terms of the lease require that full payment of $1,800 for all three months be made by White on Jan. 31, 2X02. On Dec. 31,, Burroughs will have earned two months of interest (November and December). An adjusting entry must be prepared for the accrued revenue as of Dec.31,. $1,800 3 months = $600/month; $600/month 2 months = $1,200 20X2 Dec. 31 Rent Receivable 1,200 Rent Income 1,200 9

10 Recording the Receipts of Accrued Revenue-No Reversing Entry On Jan. 31, 20X2, Burroughs will receive the full $1,800 due from White. Burroughs must record the receipt of $1,800, record one month s rent income earned in 20X2, and remove the receivable from the books. The following entry is prepared on Jan. 31, 20X2, to record the cash receipt and the current period s revenue: 20X2 Jan. 31 Cash 1,800 Rent Receivable 1,200 Rent Income

11 Recording the Receipts of Accrued Revenue-Reversing Entry Used Assume that on Nov. 1,, Burroughs Company entered into a three-month lease agreement with White Company. Terms of the lease require that full payment of $1,800 for all three months be made by White on Jan. 31, 2X02. On Dec. 31,, Burroughs recorded the following adjusting entry for 2 months of accrued interest: 11 Dec. 31 Rent Receivable 1,200 Rent Income 1,200 Assume on Jan. 1, 20X2, Burroughs made the following reversing entry: 20X2 1 Rent Income 1,200 Jan. Rent Receivable 1,200 On Jan. 31, 20X2, makes the following entry to record receipt of the total amount of rent: 20X2 Jan. 31 Cash 1,800 Rent Income 1,800

12 Summary of Accruals An accrual always adds to the expense or the revenue. The adjusting entry for an accrual always creates a balance sheet account-either a payable or a receivable. An accrual adjustment can always be reversed. 12

13 Deferred Expenses An advance payment for goods or services that benefit more than one accounting period The prepayment can be initially recorded in two different ways: As an asset As an expense The end-of-period adjustment depends on the way in which the deferred expense was initially recorded. Both methods result in the same amount of expense being allocated to the two accounting periods involved. 13

14 Deferred Expenses Recorded as Assets On Oct. 1,, Bluff City Supply Company purchased casualty and theft insurance for a period of one year at a cost of $3,600. Bluff prepared the following entry to record the purchase of the insurance: 14 Oct. 1 Prepaid Insurance 3,600 Cash 3,600 The amount of insurance that expires each month is $3, months = $300. On Dec. 31,, Bluff records the following entry to transfer 3 months of insurance (Oct. to Dec.) from the asset account to an expense account: Dec. 3 1 Insurance Expense 900 Prepaid Insurance 900

15 Deferred Expenses Recorded as Expenses On October 1,, Bluff City Supply Company purchased casualty and theft insurance for a period of one year at a cost of $3,600. Bluff prepared the following entry to record the purchase of the insurance: Oct. 1 Insurance Expense 3,600 Cash 3,600 Dec. 3 1 Prepaid Insurance 2,700 Insurance Expense 2,700 15

16 Reversing Entries for Deferred Expenses Recorded Initially as Expenses If the initial entry for a deferred expense was recorded as an expense, the adjusting entry will create an asset. The fact that this asset account was created as part of the adjusting process allows you to reverse the adjustment. On Dec. 31,, Bluff records the following entry to transfer 9 months of insurance (Jan. to Sep. of 20X2) from the expense account to the asset account: 16 Dec. 3 1 Prepaid Insurance 2,700 Insurance Expense 2,700 The following entry is prepared on January 1, 20X2, to reverse the adjustment: 20X2 Jan. 1 Insurance Expense 2,700 Prepaid Insurance 2,700

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19 Deferred Revenue Revenue that has been received in the current period but will not be fully earned until the future. Must be pushed off to future periods to match revenue and expenses properly. Can be initially recorded in two different ways 19 As a liability As revenue The end-of-period adjustment depends on the way in which the deferred revenue was initially recorded. Both methods result in the same amount of revenue being allocated to the two accounting periods involved.

20 Deferred Revenue How would the New York Yankees organization record money collected in advance from season ticket sales? Money collected in advance is unearned revenue because no goods or services have been delivered or provided. Unearned revenue is a liability, and is recognized as revenue only as the goods or services are provided. 20

21 Deferred Revenue Recorded as a Liability On Apr. 1,, Laurel Publishers receives in advance annual subscriptions that total $120,000. Laurel records the cash receipt as a liability and records the following entry: Apr. 1 Cash 120,000 Unearned Subscriptions Income 120,000 The Unearned Subscriptions Income account is a liability account with a normal credit balance. Per month Laurel earns $120, months = $10,000. On Dec. 31,, Laurel records the following entry to transfer 9 months of subscriptions received (Apr. to Dec.) from the liability account to a revenue account: 21 Dec. 31 Unearned Subscriptions Income 90,000 Subscriptions Income 90,000

22 Deferred Revenue Recorded as Revenue On Apr. 1,, Laurel Publishers receives in advance annual subscriptions that total $120,000. Laurel records the cash receipt as revenue and records the following entry: Apr. 1 Cash 120,000 Subscriptions Income 120,000 Per month, Laurel earns $120, months = $10,000. On Dec. 31,, Laurel records the following entry to transfer 3 months of subscriptions not yet earned (Jan. to Mar. of 20X2) from the revenue account to a liability account: Dec. 31 Subscriptions Income 30,000 Unearned Subscriptions Income 30,000 22

23 Reversing Entries for Deferred Revenue Recorded Initially as Revenue If the initial entry for deferred revenue was recorded as revenue, the adjusting entry will create a liability. The fact that this liability account was created as part of the adjusting process allows you to reverse the adjustment. Laurel recorded the following entry to receive $120,000 of subscriptions on April 1, : Apr. 1 Cash 120,000 Subscriptions Income 120,000 Laurel prepared the following adjusting entry on Dec. 31, : Dec. 31 Subscriptions Income 30,000 Unearned Subscriptions Income 30,000 The following entry is prepared on January 1, 20X2, to reverse the adjustment: 23 20X2 Jan. 1 Unearned Subscriptions Income 30,000 Subscriptions Income 30,000

24 Summary of Reversing Entries All accruals Deferred expenses initially recorded as expenses Deferred revenue initially recorded as revenue Deferred expenses initially recorded as assets Deferred revenue initially recorded as a liability Reverse Do Not Reverse 24

25 Comparison of Methods for Recording Deferred Revenue Received advance subscriptions of $120,000 for 12 issues of a magazine. 25

26 Comparison of Methods for Recording Deferred Revenue Received advance subscriptions of $120,000 for 12 issues of a magazine. 26

27 Joining the Pieces Accruals and Deferrals 27