1. Chapter 10: accruals and prepayment
Learning outcomes:
prepare accounting entries for accruals and prepayment
Understand the reasons behind the adjusting entries.
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2. definition
When the accrual basis of accounting is used, an entity recognises items as assets, liabilities, equity, income and expenses (the elements of financial statements) when they satisfy the definitions and recognition criteria for those elements in the conceptual framework for financial reporting 2010.
Accruals are expenses incurred by the business during the accounting period but not yet paid for, ie expenses which are paid in arrears.
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3. Framework for Adjustments
An adjusting entry is recorded to bring an asset or liability account balance to its proper amount.
Adjustments are necessary for transactions and events that extend over more than one period. It is helpful to group adjustments by the timing of cash receipts or cash payments in relation to the recognition of the related revenues or expenses. Here is a framework for adjusting the books of the company.
There are two broad categories of adjustments. The first is when we pay or receive cash before the expense or revenue is recognized. This category includes prepaid or deferred expenses (including depreciation) and unearned or deferred revenues.
The second major category of adjustments is when cash is paid or received after the expense or revenue is recognized. These are some very common adjustments. The category includes accrued expenses and accrued revenues.

4. Prepaid (Deferred) Expenses
Here is the check
for my 24-month insurance policy.
Resources paid for prior to receiving the actual benefits.
Let’s start with the first type of adjusting entries that we showed you on the previous screen, the payment or receipt of cash before the expense or revenue is recognized.
We will start with a prepaid expense. For all adjustments involving prepaid expenses, we increase, or debit, an expense account and reduce, or credit, an asset account. Now, let’s look at an example.

5. What adjustment is required?
Prepaid Insurance
(a) On 12/1/13, FastForward paid $2,400 for insurance for 2-years (24-months, December 2013 through November 2015). FastForward recorded the expenditure as Prepaid Insurance on 12/1/13.
What adjustment is required?
On December 1, 2013, FastForward paid $2,400 to cover its insurance for 24-months, December 2013 through November When FastForward made the payment, it debited prepaid insurance and credited cash. Let’s look at the adjusting entry we would make on December 31, 2013.
We would debit, or increase, the insurance expense account for $100 (1/24th of $2,400) and credit, or reduce, the asset “prepaid insurance.” Now we have recorded the insurance expense for December, Let’s post the adjusting entry and see what the ledger account looks like on December 31, 2013.
The prepaid insurance account is reduced to $2,300, representing $100 per month for the remaining 23 months of the policy. The insurance expense account now has a $100 balance, the amount of the insurance for December 2013.
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6. Unearned (Deferred) Revenues
We will apply this cash
you gave us towards your total consulting fees.
Cash received in advance of providing products or services.
The term unearned revenues refers to cash received in advance of providing products and services. Unearned revenues, also called deferred revenues, are liabilities.
When accounting for deferred revenues, we are faced with a transaction where cash is received in advance of providing a product or service. In other words, we have received the cash, but have done nothing to earn it. In our example, we will examine accounting for the receipt of cash prior to our company rendering any services.
When we render consulting services, we will prepare an adjustment for deferred revenues (a liability). We always debit, or reduce, a liability account and credit, or increase, a revenue account. Let’s move on to our consulting example.

7. Unearned (Deferred) Revenues
P 1
On December 26, 2013, FastForward agrees to provide consulting services to a client for a fixed fee of $3,000 for 60 days. On this date, the client pays the entire consulting fee in advance. FastForward makes the following entry:
On December 26, 2013, FastForward agrees to provide consulting services to a client for a fixed fee of $3,000 for 60 days. On this date, FastForward makes an entry to debit, or increase, to the cash account and a credit, or increase, to a liability account called unearned revenue. We know the use of the word unearned revenue may be a little confusing for now, but remember that the key word is unearned. The company has done nothing to earn the consulting fees. Let’s post the entry to the ledger account, unearned revenue.
Remember, the unearned revenue account is a liability account and will remain a liability until the consulting services are rendered. Now, let’s look at the adjusting entry FastForward will make on December 31, 2013, the end of the accounting period.

8. Unearned (Deferred) Revenues
P 1
(d) On December 31, FastForward earns 5-days of consulting fees. Each day that passes results in consulting fees of $50 ($3,000 ÷ 60), so FastForward earned ($50 × 5 days) $250.
As of December 31, 2013, FastForward has earned $250 of consulting fees as a result of the passage of time. Five days have gone by since the company entered into the 60-day contract. Let’s make the adjusting entry.
The adjusting entry is to debit, or decrease, the liability account, unearned revenue and credit, or increase, the revenue account, consulting revenue for $250 (five days at the rate of $50 per day). Let’s post the adjusting entry so we can look at the balances in the ledger account.
The unearned revenue account has a credit balance of $2,750. This balance will be recognized as revenue as more time passes. The consulting revenue account has a credit balance of $250. The revenue account will appear on the income statement and be closed at the end of the accounting period. The liability account, unearned revenue, will appear on the balance sheet on December 31, 2013.
Now let’s change the subject and look at adjustments for accrued expenses.

9. want to be paid for our work!
Accrued Expenses
P 1
Costs incurred in a period that are
both unpaid and unrecorded.
We’re about one-half
done with this job and
want to be paid for our work!
An accrued expense is defined as a cost incurred in the current period that is both unpaid and unrecorded. When you use your credit card, often you do not record the transaction until you pay your monthly invoice; even though you have incurred the cost. Accrued expenses must be reported on the income statement of the period when incurred.
For all accrued expense adjusting entries, we debit, or increase an expense account, and credit, or increase, a liability account. Let’s look at a specific example of an accrued expense.

10. Accrued Salaries Expenses
FastForward’s employee earns $70 per day and is paid every two weeks on Friday. Year-end, 12/31/13, falls on a Wednesday. The last payday of 2013 is Friday, 12/26/13. From 12/26 until year-end is three working days. The employee has earned $210 for Monday through Wednesday. He will not be paid until Friday 1/9/14.
FastForward’s employee earns $70 per day and is paid every two weeks on Friday. Year-end, 12/31/13, falls on a Wednesday. The last payday of 2013 is Friday, 12/26/13. From 12/26 until year-end is three working days. The employee has earned $210 for Monday through Wednesday. He will not be paid until Friday January 9, 2014.
Look at the schematic of the dates. We need to record an adjusting entry on December 31, 2013 to recognize the salary earned by the employee but not paid. Let’s look at the adjusting entry.

11. Accrued Salaries Expenses
(e) FastForward’s employee has earned but not been paid on December 31, 2013, $210.
In our adjusting journal entry we will debit, or increase, salaries expense and credit, or increase, salaries payable for $210. After the adjustment, salaries expense for 2013 is stated properly. Let’s look at the posting to the ledger accounts.
Salaries expense recorded during the year amounted to $1,400. After posting our adjusting entry, the new balance at the end of the year is $1,610. The salaries payable account will be eliminated when the employee is paid on January 9, Now let’s look at the entry to record the salaries expense on the next payday.

12. Future Payment of Accrued Expenses
On January 9, 2014, FastForward will pay the payroll for the two weeks from December 26, 2013 through January 9, Here is the journal entry for the payroll:
On January 9, 2014, FastForward will pay the payroll for the two weeks from December 26, 2013 through January 9, The journal entry for this payroll involves a debit to the liability account, Salaries Payable, for $210, the amount we accrued at December 31, 2013, a debit to Salaries Expense for $490 (7 work days times $70 per day), and a credit to Cash for $700. We must be careful to remove the accrued payable (liability) when we actually pay the employee for all amounts previously owed.

13. Accrued Interest Expenses
FastForward borrowed $6,000 from First National Bank on December 1, The note bears interest at the annual rate of 6% and is due to be repaid in one year. Let’s accrue interest for the month ended December 31, 2013.
FastForward borrowed $6,000 from First National Bank on December 1, The note bears interest at the annual rate of 6% and is due to be repaid in one year. Let’s accrue interest for the month ended December 31, 2013.
In our adjusting journal entry, we will debit, or increase, interest expense and credit, or increase, interest payable for $30 ($6,000 times 6% for one month or 30/360). After the adjustment, interest expense for 2013 is accurately reported. Let’s look at the posting to the ledger accounts.
Interest Expense accrued at the end of the year is $30. The interest payable account will be eliminated when the bank is repaid the principal of $6,000 and the annual interest of $360 on December 1, Now let’s move on and look at accrued revenue.

14. Yes, I’ve completed your consulting job, but have not
Accrued Revenues
P 1
Revenues earned in a period that
are both unrecorded and not yet received.
Yes, I’ve completed your consulting job, but have not
had time to bill you.
The adjusting entry to accrue revenues is needed because many firms have delivered a product or provided a service but have not recorded the revenue in the current period. In our example, FastForward completes a consulting engagement but did not have time to prepare the statement and mail it to the client. The company has earned the revenue, but has not recorded it at year-end.
The adjusting entries to record accrued revenue will always debit, or increase, an asset account and credit, or increase, a revenue account. Let’s look at a specific example.

15. Accrued Service Revenue
P 1
(f) On December 12, 2013, FastForward agrees to render consulting services under a 30-day fixed fee contract for $2,700 ($90 per day). All services are to be completed by January 10, 2014, when the client will pay in full.
On December 12, 2013, FastForward agrees to render consulting services under a 30-day fixed fee contract for $2,700 ($90 per day). All services are to be completed by January 10, 2014, when the client will pay in full. Let’s look at the necessary adjusting entry.
The company will debit, or increase, the asset, accounts receivable, and credit, or increase, the revenue account, Consulting Revenue for $1,800. Twenty days have passed since the contract was signed and no payment is due or received from the client. So, FastForward will recognize $1,800 in revenue ($90 per day times 20-days). Let’s look at the adjusted account balances.
Notice that the accounts receivable and service revenue accounts have been updated to include the earned but unbilled amount of services provided. Let’s look at the subsequent completion of the consulting job and collection of cash.

16. Future Receipt of Service Revenues
On January 10, 2014, FastForward completed its obligation under the consulting contract. The client was billed $2,700 and FastForward received $2,700 in cash.
On January 10, 2014, FastForward completed its obligation under the consulting contract. The client was billed $2,700 and FastForward received $2,700 in cash. FastForward will debit the Cash account for $2,700, eliminate the Account Receivable of $1,800, and recognize the revenue earned in January of $900. On the next slide, we have prepared a summary of the adjusting process.
Revenue in January
10 $90 = $900