BSAD 221 Introductory Financial Accounting Donna Gunn, CA

1. BSAD 221Introductory Financial AccountingDonna Gunn, CA

2. Matching Principle Revenues are recorded when earned. Expenses are recorded when incurred. Because transactions occur over time, ADJUSTMENTSare required at the end of each fiscal period to get the revenues and expenses into the “right” period.

3. Accounting Cycle • During the period: • Analyze transactions. • Record journal entries. • Post amounts to general ledger • Close revenues, gains, expenses, and losses to Retained Earnings. • Prepare financial statements • Provide statements to users • At the end of the period: • Adjust revenues and expenses

4. The Unadjusted Trial Balance • A listing of individual accounts, usually in financial statement order. • Ending debit or credit balances are listed in two separate columns. • Total debit account balances should equaltotal credit account balances.

5. Note that total debits = total credits

6. The Unadjusted Trial Balance If total debits do not equal total credits on the trial balance, errors have occurred . . . • in preparing balanced journal entries, • in posting the correct dollar effects of a transaction, • in computing ending balances in accounts, • in copying ending balances from the ledger to the trial balance.

7. ACCRUALS DEFERRALS Receipts of assets or payments ofcash in advance of revenue or expense recognition. Revenues earned or expensesincurred that have not been previously recorded. Adjusting Entries There are two types of adjusting entries.

8. Examples of Items to Adjust Accruals • Interest earned during the period • Wages earned but not yet paid Deferred • Adjustments to unearned revenue

9. Deferred Revenue • On December 1, 2011, Tom’s Rentals received a cheque for $3,000, for the first four months’ rent from a new tenant. • The entry on December 1, 2011, to record the receipt of the prepaid rent payment would be . . .

10. Deferred Revenue • On December 1, 2011, Tom’s Rentals received a cheque for $3,000, for the first four months’ rent from a new tenant. • The entry on December 1, 2011, to record the receipt of the prepaid rent payment would be . . . • Cash $3,000 • Unearned Rent Revenue $3,000 This is a LIABILITY account

11. 12/1/11 12/31/06 Year end 1/31/07 2/28/07 3/31/07 Deferred Revenue Received cash for rent < 4-month prepayment of rent > We must record the amount of rent EARNED during December. Since the prepayment is for 4 months, we can assume that 1/4 of the rent will be earned each month.

12. Deferred Revenue On December 31, 2011, Tom’s Rentals must adjust the Unearned Rent Revenue account to reflect that one month of rent revenue has been earned. $3,000 × 1/4 = $750 per month. Unearned rent revenue 750 Rent revenue 750 In effect, our obligation to let them occupy the space for a period of time has decreased because they used the space for one month.

13. Accrued Revenues When revenues are earned but not yet recorded at the end of the accounting period because cash changes hands after the service is performed or goods delivered

14. Accrued Revenues On October 1, 2011, Webb, Inc. invests $10,000 for 6 months in abondthat pays 6% interest per year. Webb will not receive the interest until thebond matures on March 31, 2012. On December 31, 2011, Webb, Inc. must make an entry for the interest earned so far.

15. Accrued Revenues On October 1, 2011, Webb, Inc. invests $10,000 for 6 months in a bond that pays 6% interest per year. Webb will not receive the interest until the bond matures on March 31, 2012. On December 31, 2011, Webb, Inc. must make an entry for the interest earned so far. Interest Receivable 150 Interest Revenue 150 $10,000 x 6% x 3/12 = $150

16. Chart for Deferred and Accrued Revenues

17. Deferred Expenses On January 1, 2011, Matrix, Inc. paid $3,600 for a 3-year fire insurance policy. They are paying in advance for a resource they will use over a 3-year period.The entry on January 1, 2011, to record the policy on Matrix’s books would appear as follows . . .

18. Deferred Expenses On January 1, 2011, Matrix, Inc. paid $3,600 for a 3-year fire insurance policy. They are paying in advance for a resource they will use over a 3-year period.The entry on January 1, 2011, to record the policy on Matrix’s books would appear as follows . . . Prepaid insurance $3,600 Cash $3,600 This is an ASSET account

19. Deferred Expenses Paid cash for insurance < 3-year insurance policy > 1/1/06 12/31/06 Year end 12/31/07 Year end 12/31/07 Year end At the end of 2011, we determine how much of the “prepaid expense” has been used up during the period. Since the policy is for 3 years, we can assume that 1/3 of the policy will expire each year.

20. Deferred Expenses On December 31, 2011, Tipton must adjust the Prepaid Insurance account to reflect that 1 year of the policy has expired. Insurance Expense $1,200 Prepaid Insurance $1,200 $3,600 × 1/3 = $1,200 per year. In effect, the prepaid asset goes down▼, while the expense goes up▲.

21. Accrued Expenses Recall that accrued expenses are expenses incurred in the current period but not billed or paid until the next accounting period. Common examples are interest expense incurred on debt, wages expense owed to employees, and utilities expense.

22. Accrued Expenses As of 12/27/11, Denton, Inc. had already paid $1,900,000 in wages for the year. Denton pays its employees every Friday. Year-end, 12/31/11, falls on a Wednesday. The employees have earned total wages of $50,000 for Monday through Wednesday of the week ending 1/02/12.

23. Accrued Expenses As of 12/27/11, Denton, Inc. had already paid $1,900,000 in wages for the year. Denton pays its employees every Friday. Year-end, 12/31/11, falls on a Wednesday. The employees have earned total wages of $50,000 for Monday through Wednesday of the week ending 1/02/12. Wage Expense $50,000 Wage Payable $50,000

24. Chart for Deferred and Accrued Expenses

25. Accounting Estimates • Certain circumstances require adjusting entries to record accounting estimates. • Examples include . . . • Amortization • Bad debts • Income taxes

26. Accounting Estimates • Certain circumstances require adjusting entries to record accounting estimates. • Examples include . . . • Amortization • Bad debts • Income taxes Let’s look at the adjustment for amortization expense.

27. Amortization The accounting concept of amortizationinvolves the systematic and rationalallocation of the cost of a long-term asset to the multiple accounting periods during which it is used to generate revenue. This is a “cost allocation” concept, not a “valuation” concept.

28. Amortization The required journal entry includes a debit to Amortization expense and a credit to an account called Accumulated amortization. This is called a Contra-Asset account.

29. Amortization - Example At April 30, 2011, Van Houtte’s trial balance showed Property and equipment of $313,900 (all numbers in thousands) and Accumulated amortization of $195,100. For the period, Van Houtte needs to record an additional $2,400 in amortization. Amortization Expense $2,400 Accumulated Amortization $2,400

30. Accounting Cycle • During the period: • Analyze transactions. • Record journal entries. • Post amounts to general ledger • Close revenues, gains, expenses, and losses to Retained Earnings. • Prepare financial statements • Provide statements to users • At the end of the period: • Adjust revenues and expenses