Extra Help Notes on Adjusting Entries We are learning about the role of adjusting entries in the accounting cycle specifically deferrals and accruals Many students consider this of the most complicated topics in the course You ll need to make sure that you are analyzing the entries from the company s perspective not the customers or creditor We will assume in the entries below that all payments are made in cash immediately not on credit Deferred Revenues A Deferred revenues arise when a company receives cash in advance from a customer prior to providing the service or goods Common examples include deposits on construction work to be performed and payments made to secure hotel or airline reservations The initial entry to record the receipt of cash is B The entry above is NOT the adjusting entry The adjusting entry is prepared at the end of the period to account for the portion of the Unearned Revenue that has been earned during the period The adjusting entry would appear as follows Cash Asset Unearned Revenue Liability xx Unearned Revenue Revenue xx xx xx C For example assume a lawyer received 2 000 in advance from a client to prepare an estate plan and recorded the following entry Cash Asset Unearned Revenue Liability 2 000 2 000 D At the end of the accounting period the lawyer had finished 75 of the estate plan and had 25 left to complete The adjusting entry would record 1 500 of revenue earned during the period and reduce the balance in the Unearned Revenue account by 1 500 75 such that it now equals 500 25 at the end of the period Unearned Revenue Revenue 1 500 1 500 Deferred Expenses A Deferred expenses occur when a company pays for goods or services in advance of using them to help produce a profit Examples include purchasing supplies or an insurance policy The initial entry to record the prepaid expense is B The entry above is NOT the adjusting entry The adjusting entry is prepared at the end of the period to account for the portion of the Prepaid Asset supplies insurance etc that has been used during the period The adjusting entry would appear as follows Prepaid Expense Asset xx Cash Asset Expense Prepaid Asset xx xx xx C For example assume that a company paid 3 600 for a 12 month insurance policy in October that provided coverage from October 1 until September 30 of the following year The initial entry to record the prepaid expense would be Prepaid Insurance Asset 3 600 Cash Asset 3 600 D At the end of the accounting period assume December 31 the company has used up 3 months of insurance and has 9 months left in coverage The adjusting entry would record 900 of insurance expense 3 12 x 3 600 and reduce the balance of prepaid insurance by 900 such that it now equals 2 700 9 12 x 3 600 Insurance Expense Prepaid Insurance 900 900 Accrued Revenues A An accrued revenue is one that has been earned during the period and not yet recorded An example might include interest earned on a note receivable or consulting revenue a company has earned but not yet billed the client for at the end of the year There is no initial entry in this type of transaction only an adjusting entry prepared at the end of the period to account for the revenue earned not yet recorded The adjusting entry would appear as follows Receivable Asset Revenue xx xx B For example assume the company loaned an employee 50 000 at the beginning of the year at a 10 annual interest rate The interest on the loan is due in 5 years when the loan matures The adjusting entry from the company perspective would be Interest Receivable Interest Revenue 500 500 Accrued Expenses A An accrued expense is when an expense has been incurred during the period and not yet recorded An example might include employee salaries or wages that have not been paid as of the fiscal year end This would commonly occur when employees are paid on a Friday and the fiscal year end falls on a Tuesday There is no initial entry in this type of transaction only an adjusting entry prepared at the end of the period to account for the expense incurred not yet recorded The adjusting entry would appear as follows Expense Payable Liability xx xx B For example assume the company owed employees 75 000 in wages at the end of the accounting period December 31 Wages are scheduled to be paid Friday January 3 in the following year Wage Expense Wages Payable 75 000 75 000 Depreciation A Depreciation expense is similar to deferred expenses above except it relates to a long term asset such as property and equipment Unlike supplies and insurance which are purchased and used over a short period of time property and equipment represent deferred expenses which will be used up over many years Depreciation is the allocation of the cost of the long term asset over its estimated useful life When the asset is acquired the initial entry is as follows Asset Cash xx xx B The entry above is NOT the adjusting entry The adjusting entry is prepared at the end of the period to allocate the cost of the long term asset over its estimated life There are several acceptable ways to calculate this amount which you will learn about in Chapter 8 The adjusting entry would appear as follows Depreciation Expense xx Accumulated Depreciation xx C For example assume that at the beginning of year 1 a company paid 150 000 for a machine which had an estimated useful life of 10 years and no residual value The initial entry to record the machine would be Machine Asset Cash Asset 150 000 150 000 D At the end of the every year for the next 10 years the company would record the following adjusting entry to account for the depreciation expense related to the machine Depreciation Expense Machine Things to Remember 15 000 15 000 Notice that every adjusting entry has several things in common 1 They are always prepared at the end of the accounting period 2 They adjust the balances to reflect the proper amounts as of the end of the period 3 Every adjusting entry affects one balance sheet account Asset or Liability and one Income Statement account Revenue or Expense
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