BSAD 221Introductory Financial

Accounting

Donna Gunn, CA

Matching Principle

Revenues are recorded when

earned.

Expenses are recorded when

incurred.

Because transactions occur over time, ADJUSTMENTS are required at the end of each fiscal period to get the revenues

and expenses into the “right” period.

Accounting Cycle

During the period:• Analyze transactions.• Record journal entries.• Post amounts to general

ledger

• Prepare financial statements

• Provide statements to users

At the end of the period:• Adjust revenues and

expenses

Close revenues, gains, expenses, and losses to

Retained Earnings.

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 equal total credit account balances.

DUCHARME, INC.Unadjusted Trial Balance

December 31, 2011

Description Debit Credit Cash $3,900  Accounts receivable 4,985  Inventory 3,300  Equipment 4,800  Accumulated amortization - equip. $1,440 Furniture and fixtures 6,600  

Accumulated amortization – furn.&fix. 2,200 Accounts payable 2,985 Notes payable 4,000 Common shares 10,000 Retained earnings 1,760 Sales revenues 35,000 Cost of goods sold 27,500  Operating expenses 6,300  

Totals $57,385 $57,385

Note that total debits = total credits

The Unadjusted Trial BalanceIf 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.

Adjusting Entries

There are two types of adjusting entries.

DEFERRALSReceipts of assets or payments of cash in advance of revenue or expense

recognition.

ACCRUALSRevenues earned

or expenses incurred that have

not been previously recorded.

Examples of Items to Adjust

Accruals

• Interest earned during the period

• Wages earned but not yet paid

Deferred

• Adjustments to unearned revenue

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 . .

.

Deferred Revenue

This is a LIABILITY account

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 $3,000Unearned Rent Revenue

$3,000

Deferred RevenueReceived cash for rent

< 4-month prepayment of rent >

12/1/11 12/31/06Year end

1/31/07 2/28/07 3/31/07

We must record the amountof 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.

Deferred RevenueOn 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 750Rent revenue

750In effect, our obligation to let them occupy the space for a

period of time has decreased because they used the space for one month.

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

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.

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 150Interest Revenue 150

$10,000 x 6% x 3/12 = $150

Chart for Deferred and Accrued Revenues

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 . . .

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 $3,600Cash $3,600

This is an ASSET account

Deferred ExpensesPaid cash forinsurance < 3-year insurance policy >

1/1/06 12/31/06Year end

12/31/07Year end

12/31/07Year 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.

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 $1,200Prepaid Insurance $1,200

$3,600 × 1/3 = $1,200 per year.

In effect, the prepaid asset goes down▼, while the expense goes up▲.

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.

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.

Accrued ExpensesAs 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 $50,000Wage Payable $50,000

Chart for Deferred and Accrued Expenses

Accounting Estimates

• Certain circumstances require adjusting entries to record accounting estimates.

• Examples include . . .– Amortization– Bad debts– Income taxes

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.

Amortization

The accounting concept of amortization involves the systematic and rational allocation 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.

AmortizationThe required journal entry includes a debit to

Amortization expense and a credit to an account called Accumulated amortization.

Date Debit CreditDec 31 Amortization Expense $$$$

Accumulated Amortization $$$$

Description

This is called a Contra-Asset account.

Amortization - ExampleAt 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 $2,400Accumulated Amortization $2,400

Accounting Cycle

During the period:• Analyze transactions.• Record journal entries.• Post amounts to general

ledger

• Prepare financial statements

• Provide statements to users

At the end of the period:• Adjust revenues and

expenses

Close revenues, gains, expenses, and losses to

Retained Earnings.