Dr. Mohamed A. Hamada Lecturer of Accounting Information Systems Accounting I BA 104 Chapter 6 Adjusting deferrals and accruals Accounts Dr. Mohamed A. Hamada Lecturer of Accounting Information Systems

Study Objectives Identify the major types of adjusting entries. Prepare adjusting entries for deferrals. Prepare adjusting entries for accruals. Describe the nature and purpose of an adjusted trial balance. 1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements? Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases). Forward-looking Information Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image). Timeliness (no real time financial information)

Main features of Adjustments Adjusting entries are internal transactions—no new source document exists for the adjustment. Adjusting entries are non-cash transactions—the Cash account will never be used in an adjusting entry. Adjusting entries will always involve at least one income statement account and one balance sheet account.

Case 1 , pre-paid expenses Journal Entry Pre-paid expense (debit) Cash (credit) Adjusting Entry Expense (debit) consumed amount in the period Pre-paid expense (credit)

Case 2 “Unearned Revenues” Receipt of cash that is recorded as a liability because the revenue has not been earned. Cash Receipt Revenue Recorded BEFORE Unearned revenues often occur in regard to: rent airline tickets school tuition magazine subscriptions customer deposits

Adjusting Entries for “Unearned Revenues” are items that have been initially recorded as liabilities but are expected to become revenues over time or through the normal operations of the business. These are deposits by customers for work to be done in the future. EX: Unearned rent

Unearned Revenues Example On 1/10/98, the El-Ahram Gazette received $240 for a one-year subscription. The monthly subscription rate is $20. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit Prepare the proper initial journal entry.

Unearned Revenues Example On 1/10/98, the El-Ahram Gazette received $240 for a one-year subscription. The monthly subscription rate is $20. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit 1-Oct Cash 240 Unearned Subscriptions 240 to record receipt of one-year subscription payment

Unearned Revenues Example The El-Ahram Gazette’s fiscal year-end is on 31/12/98 (three months later). Record the adjustment necessary at 31/12/98. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit Prepare the proper adjusting journal entry.

Unearned Revenues Example The El-Ahram Gazette’s fiscal year-end is on 31/12/98 (three months later). Record the adjustment necessary at 31/12/98. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit 31-Dec Unearned Subscriptions 60 Subscription Revenue 60 to record recognition of three months of subscription earned $20 x 3 months = $60

Adjusting entries for Accruals Second Adjusting entries for Accruals

Adjusting Entries for Accruals Made to record: Revenues earned (Accrued Revenues)and OR Expenses incurred (Accrued Expenses) in the current accounting period that have not been recognized through daily entries.

Case 3 : Adjusting Entries for “Accrued Revenues” Revenues earned but not yet received in cash or recorded. Adjusting entry results in: Revenue Recorded Cash Receipt BEFORE Accrued revenues often occur in regard to: rent interest services performed

Adjusting Entries for “Accrued Revenues” An adjusting entry serves two purposes: (1) It shows the receivable that exists, and (2) It records the revenues earned.

Adjusting Entries for “Accrued Revenues” Illustration: In October Pioneer Advertising Agency earned $200 for advertising services that had not been recorded. Oct. 31 Accounts Receivable 200 Service Revenue 200 Illustration 3-14

Accrued Revenues Example On 31/12/97, First Bank owes your company $100 of interest on your account. You will receive the interest on 10/1/98. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit Prepare the proper adjusting journal entry.

Accrued Assets/Revenues Example On 31/12/97, First Bank owes your company $100 of interest on your account. You will receive the interest on 10/1/98. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit 31-Dec Interest Receivable 100 Interest Revenue 100 to record interest earned but not yet received

Adjusting Entries for “Accrued Expenses” Expenses incurred but not yet paid in cash or recorded. Adjusting entry results in: Expense Recorded Cash Payment BEFORE Accrued expenses often occur in regard to: rent interest taxes salaries

Adjusting Entries for “Accrued Expenses” An adjusting entry serves two purposes: (1) It records the obligations, and (2) It recognizes the expenses.

Accrued Liabilities/Expenses Example At 31/12/97, your company owes $400 of interest to Big Corp. You will not actually pay the interest until 10/1/98. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit Prepare the proper adjusting journal entry.

Accrued Liabilities/Expenses Example At 12/31/97, your company owes $400 of interest to Big Corp. You will not actually pay the interest until 1/10/98. GENERAL JOURNAL Page: 1 Date Description PR Debit Credit 31-Dec Interest Expense 400 Interest Payable 400 to recognize interest owed to Big Corporation

Adjusting Entries for “Accrued Expenses” 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%. Oct. 31 Interest expense 50 Interest payable 50 Illustration 3-18

Accounting cycle , The Adjusted Trial Balance After all adjusting entries are journalized and posted the company prepares another trial balance from the ledger accounts (Adjusted Trial Balance). After adjusted trial balance is prepared, this should be Followed by preparing the financial statements .

The Adjusted Trial Balance

Review Question The Adjusted Trial Balance Which of the following statements is incorrect concerning the adjusted trial balance? An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger after all adjustments are made. The adjusted trial balance provides the primary basis for the preparation of financial statements. The adjusted trial balance lists the account balances segregated by assets and liabilities. The adjusted trial balance is prepared after the adjusting entries have been journalized and posted.

Adjusting Journal Entries Question On 10/1/98, BeeBee Inc. pays $3,600 for a 12-month insurance policy. What kind of transaction would this be called? a. Accrued Liability b. Prepaid Expense c. Accounting Estimate d. Unearned Revenue

Adjusting Journal Entries Question On 10/1/98, BeeBee Inc. pays $3,600 for a 12-month insurance policy. What kind of transaction would this be called? a. Accrued Liability b. Prepaid Expense c. Accounting Estimate d. Unearned Revenue

Adjusting Journal Entries Question The last day of 1998 is on a Thursday. CeeCee Inc. will pay its employees on Friday. What kind of adjusting entry is required? a. Accrued Liability b. Accrued Asset c. Accounting Estimate d. Unearned Revenue

Adjusting Journal Entries Question The last day of 1998 is on a Thursday. CeeCee Inc. will pay its employees on Friday. What kind of adjusting entry is required? a. Accrued Liability b. Accrued Asset c. Accounting Estimate d. Unearned Revenue

Preparing Financial Statements Financial Statements are prepared directly from the Adjusted Trial Balance. Balance Sheet Income Statement Owner’s Equity Statement

Preparing Financial Statements Illustration 3-25 Preparation of the income statement and owner’s equity statement from the adjusted trial balance

Preparing Financial Statements Illustration 3-26

Example : The ledger of Ale, Inc Example : The ledger of Ale, Inc. on March 31, 2010, includes the following selected accounts before adjusting entries. An analysis of the accounts shows the following: 1. Insurance expires at the rate of $300 per month. 2. Supplies on hand total $900. 3. The office equipment depreciates $500 per month. 4. 2/5 of the unearned revenue was earned in March. Prepare the adjusting entries for the month of March.

End of this chapter Very thanks