Source Documents General Journal General Ledger Trial Balance Adjusting Entries Difference between TRANSACTIONS and ADJUSTMENTS Transactions occur through-out the accounting cycle and normally involve arms-length exchanges. Adjustments are made at the end of the accounting period to adjust for changes in account balances that are not the result of an exchange with an outside party. Adjusting Entries will always affect at least one Balance Sheet account and one Income Statement Account (in this class) Adjusting entries are done at the end of a reporting period, such as the Fiscal Year End Revenue Recognition Principle - You must recognize revenues that are Realized and Earned Matching Principle = matching the revenues earned during a period with the expense incurred to produce that revenue. CASH is the Key If the cash has already been exchanged, but you are not impacting the Income Statement, you are DEFERRING. If the Cash has NOT been exchanged but you are impacting the Income Statement, you are ACCRUING Deferred Expenses - Examples include Supplies and Prepaids. Initially recorded as assets but are expected to become expenses over time. Deferred Revenue - Examples include Unearned revenue. Cash received in advance of earning it. Accrued Expenses - Examples include Accrued Wages and Accrued Interest Expense. The expense has been incurred but we have not paid it yet. Accrued Revenue - Examples include Accrued Fees Income and Accrued Interest Income. The revenue has been earned but not yet recorded (received). Classify the following items as (a) prepaid expense, (b) unearned revenue, (c) accrued revenue, or (d) accrued expense: 1. A two-year premium paid on a fire insurance policy. 2. Fees earned but not yet received. 3. Fees received but not yet earned. 4. Salary owed but not yet paid. 5. Subscriptions received in advance by a magazine publisher. 6. Supplies on hand. 7. Taxes owed but payable in the following period. 8. Utilities owed but not yet paid. Page 1
Common Examples: Accounting 1A Supplies - rather than expensing each pencil as you take it out of the cabinet, it is common to take an inventory at the end of the period and expense what was used. The amount of supplies used during the period should be recorded as an expense; the amount of supplies on hand should be recorded as an asset. Fastforward purchased a total of $9,720 of supplies during 2017. As of December 31, 2017, only $8,670 in supplies were on hand. Supplies Supplies Expense 9,720 Debit Credit 1 Dec 31 1 2 2 3 3 4 4 Prepaid Insurance - these expenses (usually insurance, rent or advertising) are paid for in advance but cannot be expensed until they have expired. Fastforward purchased a 24-month insurance policy on December 1, 2017 for $2,400 Prepaid Insurance Insurance Expense 2,400 Debit Credit 1 Dec 31 1 2 2 3 3 4 4 Page 2
Unearned Fees - if money is received from customers before the services are performed, we must wait until the services are performed to record the amount as revenue. When the money is received it is unearned and an adjustment is needed to record any revenue earned by then end of the accounting period. On December 26, 2017, Fastforward received $3,000 from a customer for 60 days of consulting services. Unearned Consulting Revenue Consulting Revenue 3,000 5,800 Debit Credit 1 Dec 31 1 2 2 3 3 4 4 Wages Expense - if expenses are incurred prior to payment, the expense must be recorded in the accounting period in which it was used or incurred. Fastforward s employee is paid $70 per day each Friday for that week. The last pay day of 2017 was Friday, December 26. Salaries Payable Salaries Expense 1,400 Page 3
Debit Credit 1 Dec 31 1 2 2 3 3 4 4 Accrued Revenues - all revenue earned during the accounting period must be recorded as revenue. If any revenues have been earned but not yet recorded, an adjustment is needed. Fastforward agreed to provide $2,700 in consulting services for December 11, 2017, to January 10, 2018. Payment will be received in full upon completion of the contract on January 10, 2018. As of December 31, 2017, 20 days of the contract had been earned. Accounts Receivable Consulting Revenue 6,050 Debit Credit 1 Dec 31 1 2 2 3 3 4 4 Depreciation Expense The assets we buy we use to produce revenue. As we use the assets to produce revenue we must record and expense for the use of the equipment in the same accounting period in which the revenue was earned. So, we spread the cost of the asset over the number of months that we will use the equipment to earn revenue. This process is called Depreciation. The depreciation you are familiar with usually means a decrease in value. Accounting depreciation means using up the usefulness of an asset. Assets that are expected to provide value for a length longer than 1 year are normally tracked as Property, Plant and Equipment. (FIXED ASSETS) Page 4
Historical Cost principle - Asset is recorded at Historical Cost and not changed regardless of market value. Useful Life - period of time the asset is expected to produce revenue Depreciation matches the assets original cost with the revenues produced over its useful life.the balance sheet value of the asset is going to decrease each year as the useful life of the asset is used up and the cost is allocate to the Income Statements that benefited from the asset. Rather than tracking the debits and credits for the asset in one account like the Truck Account, we track the original cost debit in one account and the depreciation credits we have recorded in a separate account. We net the two accounts together to get the remaining value of the asset. Depreciation is tracked in an account called Accumulated Depreciation which is a CONTRA ASSET. The contra asset is used rather than reducing the asset value directly. A Plant Asset Cost less the related accumulated depreciation is erred to as the BOOK VALUE or undepreciated cost Contra - means opposite. Thus a contra asset has the opposite normal balance of an asset. Book Value is determined by deducting the contra-asset from the asset. Straight Line Method of Depreciation: Book Value is not the same as market value. Book Value is not expected to represent a selling price of the asset. Book Value = Cost - Accumulated Depreciation Fastforward purchased equipment in early December 2017 for $26,000. The equipment is expected to have a useful life of 5 years and an estimated residual value of $8,000. Equipment Accumulated Depreciation - Equipment Depreciation Expense GENERAL JOURNAL Debit Credit 1 Dec 31 1 2 2 3 3 4 4 Page Page 5
Adjusted Trial Balance the adjusting journal entries have changed the account balances that are to be reported in the financial statements. An Adjusted Trial Balance must be prepared to update the account balance to include all adjustments. Pablo Management has five part-time employees, each of whom earns $250 per day. They are normally paid on Fridays for work completed Monday through Friday of the same week. Assume that December 28, 2017, was a Friday, and that they were paid in full on that day. The next week, the five employees worked only four days because New Year s Day was an unpaid holiday. a. Assuming that December 31, 2017, was a Monday, prepare the adjusting entry for wages expense that would be recorded at the close of that day. b. Assuming that January 4, 2018, was a Friday, prepare the journal entry that would be made to record payment of the employees wages for that week. GENERAL JOURNAL 1 2 3 4 5 6 7 8 Debit Credit Page 6
The following three separate situations require adjusting journal entries to prepare financial statements as of April 30. For each situation, present both: The April 30 adjusting entry. The subsequent entry during May to record payment of the accrued expenses. a. On April 1, the company retained an attorney for a flat monthly fee of $3,500. Payment for April legal services was made by the company on May 12. b. A $900,000 note payable requires 12% annual interest, or $9,000, to be paid at the 20th day of each month. The interest was last paid on April 20, and the next payment is due on May 20. As of April 30, $3,000 of interest expense has accrued. c. Total weekly salaries expense for all employees is $10,000. This amount is paid at the end of the day on Friday of each five-day workweek. April 30 falls on a Tuesday, which means that the employees had worked two days since the last payday. The next payday is May 3. GENERAL JOURNAL 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Debit Credit Page 7
Prepare adjusting journal entries for the year ended (date of) December 31, 2017, for each of these separate situations. a. Depreciation on the company s equipment for 2017 is computed to be $18,000. b. The Prepaid Insurance account had a $6,000 debit balance at December 31, 2017, before adjusting for the costs of any expired coverage. An analysis of the company s insurance policies showed that $1,100 of unexpired insurance coverage remains. c. The Office Supplies account had a $700 debit balance on December 31, 2016; and $3,480 of office supplies were purchased during the year. The December 31, 2017, physical count showed $300 of supplies available. d. Two-thirds of the work related to $15,000 of cash received in advance was performed this period. e. The Prepaid Insurance account had a $6,800 debit balance at December 31, 2017, before adjusting for the costs of any expired coverage. An analysis of insurance policies showed that $5,800 of coverage had expired. f. Wage expenses of $3,200 have been incurred but are not paid as of December 31, 2017. GENERAL JOURNAL 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Debit Credit Page 8
Natsu Company s annual accounting period ends on October 31, 2017. The following information concerns the adjusting entries that need to be recorded as of that date. a. The Office Supplies account started the fiscal year with a $600 balance. During the fiscal year, the company purchased supplies for $4,570, which was added to the Office Supplies account. The supplies available at October 31, 2017, totaled $800. b. An analysis of the company s insurance policies provided the following facts. Policy Date of Purchase Months of Coverage Cost A April 1, 2016 24 $6,000 B April 1, 2017 36 7,200 C August 1, 2017 12 1,320 c. The total premium for each policy was paid in full (for all months) at the purchase date, and the Prepaid Insurance account was debited for the full cost. (Year-end adjusting entries for Prepaid Insurance were properly recorded in all prior fiscal years.) d. The company has four employees, who earn a total of $1,000 for each workday. They are paid each Monday for their work in the five-day workweek ending on the previous Friday. Assume that October 31, 2017, is a Monday, and all four employees worked the first day of that week. They will be paid salaries for five full days on Monday, November 7, 2017. e. The company purchased a building on November 1, 2014, that cost $175,000 and is expected to have a $40,000 salvage value at the end of its predicted 25-year life. Annual depreciation is $5,400. f. Since the company does not occupy the entire building it owns, it rented space to a tenant at $1,000 per month, starting on September 1, 2017. The rent was paid on time on September 1, and the amount received was credited to the Rent Earned account. However, the October rent has not been paid. The company has worked out an agreement with the tenant, who has promised to pay both October and November rent in full on November 15. The tenant has agreed not to fall behind again. g. On September 1, the company rented space to another tenant for $725 per month. The tenant paid five months rent in advance on that date. The payment was recorded with a credit to the Unearned Rent account. Required 1. Use the information to prepare adjusting entries as of October 31, 2017. 2. Prepare journal entries to record the first subsequent cash transaction in November 2017 for parts c and e. GENERAL JOURNAL 1 2 3 4 5 6 7 8 9 10 Page 9 Debit Credit
11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 Accounting 1A Classified Balance Sheet We are going to categorize, or classify, the accounts on the Balance Sheet based on how soon the accounts will be received (assets) or paid (liabilities). Why? Actually, it makes a big difference. It is important for owners, investors and managers to know when money is due to be received and when money is due to be paid. Current Assets that will be consumed or converted into cash within one year - Cash, Accounts Receivable, Supplies, Prepaid Insurance Property Plant & equipment are LONG TERM ASSETS expected to serve the company for many years Current Liabilities that are due within one year and will be paid with current assets - Accounts Payable, Wages Payable Long Term Liabilities- shown after Current Liabilities - non-current portion of a Mortgage note. (the term Note is usually an indicator that you may have a long term liability) Stockholders Equity - Pull the Ending Retained Earnings Balance from the Statement of Retained Earnings Closing Process The Fiscal Year, which in many cases will be the calendar year, is the accounting period we are using when doing Closing Entries. Nominal or Temporary Accounts Revenue, Expense and Dividends Begin each period with a zero balance Balances are not carried forward year after year, Closed out to Retained Earnings. Page 10
Real or Permanent Accounts All Balance Sheet Accounts Do not get zeroed out at the end of the accounting period. Balance continue from period to period Income Summary Only used in the closing process Temporary accounts used to close out revenue and expense accounts Steps in closing: 1. Close Revenues to the Income Summery 2. Close Expenses to the income Summary 3. Close the Income Summary to Retained Earnings 4. Close Dividends to Retained Earnings (don t use Income Summary) Journalizing Closing Entries Closing entries are only done on the last day of the fiscal year theore the date on your journal is the last day - December 31 After posting the entries, prepare a Post Closing Trial Balance to prove debits equal credits and show that all income statement and drawing accounts are at zero. Use the following adjusted trial balance of Wilson Trucking Company to prepare the (1) income statement, (2) statement of retained earnings, and classified balance sheet for the year ended December 31, 2017. The Retained Earnings account balance is $155,000 at December 31, 2016. Prepare closing entries. Account Title Debit Credit Cash $ 8,000 Accounts receivable 17,500 Office supplies 3,000 Trucks 172,000 Accumulated depreciation Trucks $ 36,000 Land 85,000 Accounts payable 12,000 Interest payable 4,000 Long-term notes payable 53,000 Common stock 20,000 Retained earnings 155,000 Dividends 20,000 Trucking fees earned 130,000 Depreciation expense Trucks 23,500 Salaries expense 61,000 Office supplies expense 8,000 Repairs expense Trucks 12,000 Totals $410,000 $410,000 Page 11
Income Statement Expenses: Total expenses Net income Retained Earnings Statement Retained earnings, Retained earnings, Page 12
Balance Sheet Assets Current assets: Current liabilities: Liabilities Total current liabilities: Total current assets Plant assets: Total liabilities: Stockholders' Equity Total plant assets Total assets Total equity Total liabilities and equity GENERAL JOURNAL 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Debit Credit Page 13
In the blank space beside each numbered balance sheet item, enter the letter of its balance sheet classification. If the item should not appear on the balance sheet, enter a Z in the blank. A. Current assets B. Long-term investments C. Plant assets D. Intangible assets E. Current liabilities F. Long-term liabilities G. Equity 1. Commissions earned 2. Interest receivable 3. Long-term investment in stock 4. Prepaid insurance 5. Machinery 6. Notes payable (due in 15 years) 7. Copyrights 8. Current portion of long-term note payable 9. Accumulated depreciation Trucks 10. Office equipment 11. Rent receivable 12. Salaries payable 13. Income taxes payable 14. Common stock 15. Office supplies 16. Interest payable 17. Rent revenue 18. Notes receivable (due in 120 days) 19. Land (used in operations) 20. Depreciation expense Trucks Page 14