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Hult International Business School - London

International Accounting

Handout 3 Adjusting Entries for Deferrals


Module A - 2015 / 2016

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Adjusting Entries Overview


At the end of the accounting period, adjustments need to
be made to several trial balance accounts.

Adjustments are needed because events would have taken place


during the accounting period (which DID have an impact on account
balances) but were never recorded;

Examples:

either because it was impossible to do or inconvenient to do.


Office supplies account balance was not adjusted every time a printer cartridge
was changed;
Prepaid insurance account balance was not adjusted every day the policy was
in force;
Unearned revenue account balance was not adjusted every day work was
done for a client who prepaid for services;

At the end of the accounting period therefore, these entries must be


made, otherwise these account balances (and therefore financial
statements) will not reflect the economic reality.
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Transactions (V) in T Accounts


15. Halfway through the year WW takes out a business insurance coverage and
(pre)pays $1,000 cash for it. Its will cover WW for the next twelve months.
PrepaidInsurance
Debit
+
1,000

Cash

Credit

Debit
+

Credit

1,000

Deferred Expense under rules of accrual accounting:


Property, Equipment, Supplies are all recorded as assets (as they are
resources that will benefit the business going forward).
These assets will get used up at some point, the benefit will cease to exist.
Consequently, these assets will become a business expense.
This leads to a deferred expense adjusting entry.

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Transactions (V) in T Accounts


16. On October 1st, WW receives $1,200 advance payment from a customer for
consulting work to be performed (equally) over the next 12 months.
Cash
Debit
+
1,200

Credit

UnearnedRevenue
Debit

Credit
+
1,200

Deferred Revenue under rules of accrual accounting:


Revenue can only be recorded when it has been earned, i.e. service has been
performed.
Cash received as a prepayment gives rise to a liability (Unearned Revenue).
As work is later completed Revenue is (progressively) recognized and the
liability account is (progressively) eliminated.
This leads to a deferred revenue adjusting entry.
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Trial Balance Revisited


A trial balance for
transactions 1
through 16 is shown
below.

There were no errors made


in recording the transactions
during the accounting
period, however some
accounts (highlighted) are
not correct.
Adjustments need to be
made.

WinstonWolfeServicesInc.
TrialBalanceSheet($s)
December31,20X5
Debit
Cash
A/R
OfficeSupplies
ComputerWorkstation
PrepaidInsurance
A/P
Debt
UnearnedRevenue
CommonStock
Dividends
Revenue(s)
Expense(s)
Total
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Credit

19,450
200
2,000
4,000
1,000
2,000
3,000
1,200
23,000
3,000
1,200
750
30,400

30,400

Deferred Expenses & Revenues (I)


Deferred means ... delayed until later.

Recording (expensible) items as assets means ... delaying


(deferring) the recording of an expense until later;

Since the economic benefit (from these assets) will eventually expire;
these asset accounts will have to be reduced causing an expense to be
recorded.

Recording (revenueble) items as liabilities means ... delaying


(deferring) the recording of a revenue until later;

Since the economic benefit (from these liabilities) will eventually arise;
these liability accounts will have to be reduced causing a revenue to be
recorded.

DeferredExpense

First

Later

CashPaid

ExpenseRecognized

DeferredRevenue CashReceived
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RevenueRecognized

Deferred Expenses
Recording (expensible) items as assets means ... delaying
(deferring) the recording of an expense until later;

Since the economic benefit (from these assets) will eventually


expire;
these asset accounts will have to be reduced causing an expense
to be recorded.
First
AssetAccout
Cash,A/P,etc.
Credi t

Debi t

Later
$XYZ
$XYZ

ExpenseAccount
AssetAccout
Credi t

Debi t

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$XYZ
$XYZ

Deferred Expenses (I)


First

Later

AssetAccout
Cash,A/P,etc.
Credi t

Debi t

$XYZ
$XYZ

ExpenseAccount
AssetAccout
Credi t

Debi t

$ABC
$ABC

15. (A) Halfway through the year WW takes out a business insurance coverage
and (pre)pays $1,000 cash for it. Its will cover WW for the next twelve months.
PrepaidInsurance
Debit
+
1,000

Credit

Cash

=
Debit
+

Credit

1,000

15. (B) By the end of the year, half the insurance policy would have expired. An
adjusting entry for $500 must be made in order to adjust the asset account.
InsuranceExpense

Insurance Expense (not originally


on the trial balance), will now appear
there.

Debit
+
500

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Credit

PrepaidInsurance
Debit
+

Credit

500

Deferred Expenses (II)


First
AssetAccout
Cash,A/P,etc.
Credi t

Debi t

Later
$XYZ
$XYZ

ExpenseAccount
AssetAccout
Credi t

Debi t

$ABC
$ABC

(A) The Office Supplies account on the trial balance indicates a balance of $2,000.
(B) Inventory taken at the end of the year indicates that the cost of the Office
Supplies account still in possession is $1,500.

$500 worth of Office Supplies have therefore been used up and have become a
period expense. Adjusting entry is required.
SuppliesExpense
Debit
+
500

Credit

OfficeSupplies
Debit
+

Credit

500

Supplies Expense (not originally on the trial balance), will now appear there.

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Deferred Expenses Depreciation


Equipment, PE&E Fixed Assets accounts also need to be
adjusted.

Deterioration of fixed assets causes them to be progressively


depreciated (periodic wear and tear reduction in benefit from the
equipment);
At some point it will be worn out and no benefit will be left in it.

As opposed to supplies, Equipment, PP&E conforms to


the Cost Concept.

Original cost of PP&E must be kept in the account.


As opposed to reducing the PP&E account directly, it must be reduced
indirectly.

Credit will be recorded not directly to the PP&E account, but to the separate
(though related) account called Accumulated Depreciation.
I.e. there will be two accounts for PP&E in the ledger.

Net of which will give us the ending balance of the PP&E account.
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Accumulated Depr. & Depr. Expense


Depreciation Expense associated with the PP&E account
can only be estimated.

Unlike Office Supplies (where inventory count will tell exactly what is
left in the account);
Unlike Prepaid Insurance (where contract will tell exactly what period of
coverage is left);
For PP&E estimates must be made for:

Useful life of the equipment;


Salvage (re-sale) value at the end of the useful life;

There are several methods to calculate the Depreciation Expense,


simplest of which is the straight line, i.e. in proportion.
Adjusting entry to record the estimated Depreciation is shown below on
the right:
First
PP&EAccout
Cash,A/P,etc.
Credi t

Debi t

Later
$XYZ
$XYZ

Depr.Expense
Credi t Acc.Depreciation

Debi t

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$ABC
$ABC

Accumulated Depr. Account (I)


A contra account ... whose balance is netted off the PP&E
account on the B/S.
First
PP&EAccout
Cash,A/P,etc.
Credi t

Debi t

Later
$XYZ
$XYZ

Depr.Expense
Credi t Acc.Depreciation

Debi t

$ABC
$ABC

(A) The Equipment (Computer Workstation) account on the trial balance indicates
a balance of $4,000.
(B) Assuming the purchase was made at the beginning of the year, useful life of 5
years, no salvage value and straight line depreciation, Depreciation Expense of
$4,000 / 5 = $800 must be recorded.
Depreciation
Expense
Debit
+
800

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Credit

Accumulated
Depreciation
Debit

Credit
+
800

Accumulated Depr. Account (II)


The un-depreciated portion of PP&E cost (i.e. the
remaining amount) is the Book Value and is listed as an
Asset on the B/S.
WinstonWolfeServicesInc.
BalanceSheet($s)
December31,20X5
Assets
Cash
A/R
OfficeSupplies
ComputerWorkstation
AccumulatedDepreciation
PrepaidInsurance
TotalAssets

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19,450
200
1,500
4,000
800

3,200
500
24,850

Deferred Revenues (I)


Recording (revenueble) items as liabilities means ...
delaying (deferring) the recording of a revenue until later;

Since the economic benefit (from these liabilities) will eventually


arise;
these liability accounts will have to be reduced causing a revenue
to be recorded.
First
Cash
UnearnedRev.
Credi t

Debi t

Later
$XYZ
$XYZ

UnearnedRev.
Credi t RevenueAccount

Debi t

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$ABC
$ABC

Deferred Revenues (II)


First

Later

Cash
UnearnedRev.
Credi t

Debi t

$XYZ
$XYZ

UnearnedRev.
Credi t RevenueAccount

Debi t

$ABC
$ABC

16. (A) On October 1st, WW receives $1,200 advance payment from a customer for
consulting work to be performed (equally) over the next 12 months.
Cash
Debit
+
1,200

Credit

UnearnedRevenue
Debit

Credit
+
1,200

16. (B) By the end of the year, one quarter of the Unearned Revenue would
become earned. An adjusting entry for $300 must be made in order to adjust
UnearnedRevenue
Revenue(s)
=
the liability account.

Revenues account will now increase.

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Debit

300

Credit
+

Debit

Credit
+
300

Adjusted Trial Balance


Majority of accounts have changed.
WinstonWolfeServicesInc.
TrialBalance($s)
December31,20X5
Debit
Cash
A/R
OfficeSupplies
ComputerWorkstation
PrepaidInsurance
A/P
Debt
UnearnedRevenue
CommonStock
Dividends
Revenue(s)
Expense(s)
Total

Cash
A/R
OfficeSupplies
ComputerWorkstation
AccumulatedDepreciation
PrepaidInsurance
A/P
Debt
UnearnedRevenue
CommonStock
Dividends
Revenue(s)
Expense(s)
DepreciationExpense
InsuranceExpense
SuppliesExpense
Total

Credit

19,450
200
2,000
4,000
1,000
2,000
3,000
1,200
23,000
3,000
1,200
750
30,400

WinstonWolfeServicesInc.
AdjustedTrialBalance($s)
December31,20X5
Debit

30,400

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Credit

19,450
200
1,500
4,000
800
500
2,000
3,000
900
23,000
3,000
1,500
750
800
500
500
31,200

31,200

Summary Deferred Items

Items first recorded as Assets are transferred into an Expense


account.
Items first recorded as Liabilities are transferred into a Revenue
account.

Image source: http://www.expertsmind.com/questions/example-of-adjusting-entries30185459.aspx

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