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Adjusting Entries
❖ Ensure that the revenue recognition and expense recognition principles are followed.
❖ Necessary because the trial balance may not contain up-to-date and complete data.
❖ Required every time a company prepares financial statements so that they are UpToDate
❖ Cash account is not involved
❖ Will include one income statement account and one balance sheet account
Deferrals Accruals
1. Prepaid Expenses. 1. Accrued Revenues.
Expenses paid in cash Revenues for services
before they are used or performed but not yet received
consumed. in cash or recorded.
2. Unearned Revenues. 2. Accrued Expenses.
Cash received before Expenses incurred but not
services are performed. yet paid in cash or recorded.
PREPAID EXPENSES
Payment of cash, that is recorded as an asset because service or benefit will
be received in the future.
Cash Payment BEFORE Expense Recorded
Prepayments often occur regarding:
◆ insurance ◆ rent ◆ intangible assets
◆ supplies ◆ equipment
◆ advertising ◆ buildings
◆Expire either with the passage of time or through use.
◆Adjusting entry:
►Increase (debit) to an expense account and
►Decrease (credit) to an asset account
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Illustration: Pioneer Advertising Agency purchased supplies costing $2,500 on October 5.
Pioneer recorded the payment by increasing (debiting) the asset Supplies. This account shows
a balance of $2,500 in the October 31 trial balance. An inventory count at the close of business
on October 31 reveals that $1,000 of supplies are still on hand.
LO 4 Prepare adjusting entries for deferrals.
Illustration: On October 4, Pioneer Advertising Agency paid $600 for a one-year fire insurance
policy. Coverage began on October 1. Pioneer recorded the payment by increasing (debiting)
Prepaid Insurance. This account shows a balance of $600 in the October 31 trial balance.
LO 4 Prepare adjusting entries for deferrals.
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DEPRECIATION
◆ Buildings, equipment, and motor vehicles (assets that provide service for many
years) are recorded as assets, rather than an expense, in the year acquired.
◆ Acquiring long-lived assets is essentially a long-term prepayment for services
◆ Depreciation is the process of allocating the cost of an asset to expense over
its useful life
◆ Depreciation does not attempt to report the actual change in the value of the
asset.
◆ It is a non-cash expense
◆ The assets’ residual values and useful lives are reviewed at each financial year
end and adjusted, if its impact on depreciation is significant
LO 4 Prepare adjusting entries for deferrals.
HISTORICAL COST PRINCIPLE
Assets are recorded at their actual cost.
The cost remains on the books as long as the business owns the asset.
No adjustments are made for changes in the market value of the asset.
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USEFUL LIFE
The period of time that an asset is expected to help produce revenues.
Useful life expires as a result of wear and tear or because it no longer satisfies
the needs of the business.
As this happens, depreciation expense should be recognized and the value of the
asset should be reduced.
SALVAGE VALUE
The expected market value or selling price of an asset at the end of its useful life
Also called scrap or residual value
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STRAIGHT-LINE DEPRECIATION EXAMPLE
Jessie has motor scooters with an estimated useful live of 3 years, no salvage
value, and an original cost of $3,600.
1st step: Calculate the depreciable cost.
FORMULA: Original Cost – Salvage = Depreciable Cost
Value
$3,600 – $0 = $3,600
2nd step: Determine depreciation expense for this accounting period.
Depreciable Cost $3,600
FORMULA: = = $100 per month
Estimated Useful Life 36 months
Illustration: For Pioneer Advertising, assume that depreciation on the
equipment is $480 a year, or $40 per month.
LO 4 Prepare adjusting entries for deferrals.
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Statement Presentation
◆ Accumulated Depreciation is a contra asset account (credit).
◆ Appears just after the account it offsets (Equipment) on the balance sheet.
◆ Book value is the difference between the cost of any depreciable asset and its accumulated
depreciation. Book Value is also known as carrying or unexpired cost.
LO 4 Prepare adjusting entries for deferrals.
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LO 4 Prepare adjusting entries for deferrals.
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UNEARNED REVENUES
Receipt of cash that is recorded as a liability because the service has not been
performed.
Cash Receipt BEFORE Revenue Recorded
Unearned revenues often occur regarding:
◆ Rent ◆ Magazine subscriptions
◆ Airline tickets ◆ Gift Cards
◆ Adjusting entry is made to record the revenue for services performed during the
period and to show the liability that remains at the end of the period.
◆ Results in a decrease (debit) to a liability account and an increase (credit) to a
revenue account. LO 4 Prepare adjusting entries for deferrals.
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Illustration: Pioneer Advertising Agency received $1,200 on October 2 from R. Knox for
advertising services expected to be completed by December 31. Unearned Service
Revenue shows a balance of $1,200 in the October 31 trial balance. Analysis reveals that the
company performed $400 of services in October.
LO 4 Prepare adjusting entries for deferrals.
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LO 4 Prepare adjusting entries for deferrals.
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ACCRUED REVENUES
Revenues for services performed but not yet received in cash or recorded.
Revenue Recorded BEFORE Cash Receipt
Accrued revenues often occur regarding:
◆ Rent ◆ Services performed
◆ Interest
◆ Adjusting entry shows the receivable that exists and records the revenues for
services performed.
◆ Adjusting entry:
► Increases (debits) an asset account and
► Increases (credits) a revenue account.
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Illustration: In October Pioneer Advertising Agency earned $200 for
advertising services that had not been recorded.
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LO 5 Prepare adjusting entries for accruals.
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ACCRUED EXPENSES
Expenses incurred but not yet paid in cash or recorded.
Expense Recorded BEFORE Cash Payment
Accrued expenses often occur in regard to:
◆ Rent ◆ Taxes
◆ Interest ◆ Salaries
◆Adjusting entry records the obligation and recognizes the expense.
◆Adjusting entry:
►Increase (debit) an expense account and
►Increase (credit) a liability account.
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Illustration: Pioneer Advertising Agency signed a three-month note payable in the
amount of $5,000 on October 1. The note requires Pioneer to pay interest at an
annual rate of 12%.
LO 5 Prepare adjusting entries for accruals.
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Illustration: Pioneer Advertising Agency last paid salaries on October 26; the next
payment of salaries will not occur until November 9. The employees receive total
salaries of $2,000 for a five-day work week
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LO 5 Prepare adjusting entries for accruals.
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