1. Types of Adjusting Entries
Deferred
expense
Accrued
liability
ALL RECOGNIZE REVENUE OR EXPENSES
BEFORE OR AFTER CASH IS EXCHANGED
Adjusting entries are made at the end of the accounting period in an accrual-based company.
Adjusting entries are internal transactions that never involve an increase/decrease to Cash.
At least one Balance Sheet and one Income Statement account is involved.
When we talk about a deferred expense or revenue, the event has not taken place but cash has flowed.
When we talk about an accrued asset or liability, the event has taken place but cash has not flowed.
Accrued
asset
Deferred
revenue
LO5

2. Accruals (deferred expenses) Cash paid before expense is incurred
Examples:
Prepaid rent
Prepaid insurance
Office supplies
Property and equipment
Costs are initially recorded as assets and allocated to expenses in future periods
Accruals (Deferred Expense): cash paid before the expense is incurred.
These are some common examples.
Deferred expense = prepaid expense = prepaid asset

3. Accrual Example Initial journal entry: 9/1 Prepaid Rent 2,400
Prepay rent on office space for one year on September 1
Initial journal entry:
9/1 Prepaid Rent 2,400
Cash 2,400
Monthly adjusting journal entry:
9/30 Rent Expense
Prepaid Rent
($2,400 annual × 1/12 = $200 per month for months)
An asset is created.
as asset expires it becomes an expense, via adjusting entry
prepaid rent becomes rent expense, a month at a time

4. Unearned (Deferred) Revenue Cash received before revenue is earned
Examples:
Insurance collected in advance
Subscriptions collected in advance
Gift certificates
Receipts are initially recorded as liabilities (unearned or refundable receipts) and recorded as revenues in future periods when earned
Deferred revenue: cash received before revenue is earned
liability created because goods or services are still owed
Deferred revenue = unearned revenue

5. Deferred Revenue Example
Received $2,400 for an insurance policy in advance on September 1
Initial journal entry:
9/1 Cash ,400
Insurance Collected in Advance ,400
Monthly adjusting journal entry:
9/30 Insurance Collected in Advance
Insurance Revenue
($2,400 annual × 1/12 = $200 per month for 12 months)
"the other company" from the deferred expense entries: for example, the landlord who received the prepaid rent has a deferred revenue
as the revenue is earned, liability is reduced, revenue increased, via adjusting entry
magazine subscriptions received by a publisher in advance, earned as magazines are mailed

6. Accrued Liability Expense incurred before cash is paid
Examples:
Payroll
Taxes
Interest
Record expense (and corresponding liability) in period incurred; pay for it in a future period
No cash flow on recording, only when paid
Accrued liability: expense incurred before cash is paid
opposite of deferred expense
no cash has changed hands but the transaction has been completed

7. Accrued Liability Example #1
Pay biweekly wages of $28,000
At end of month, between pay periods:
Wages Expense ,000
Wages Payable 4,000
Next payday:
Wages Payable 4,000
Wages Expense ,000
Cash 28,000
taxes, payroll, utilities, interest

8. Accrued Liability Example #2
On March 1, assume a 9%, 90-day, $20,000 loan is taken out with a bank
Initial journal entry:
3/1 Cash ,000
Note Payable ,000
Monthly adjusting journal entry:
3/31 Interest Expense
Interest Payable
($20,000 principal × 9% × 3/12 = $450 for 3 months or $450/3 = $150 per month)
adjusting entry records expense even though no payment was made
interest for short-term loan often paid at maturity with principal
I = P  R  T is formula to calculate interest liability at any point in time
Interest, Principal, Rate, Time

9. Accrued Asset Revenue earned before cash is received
Examples:
Rent
Interest
Record revenue (and corresponding receivable) in period earned; receive payment in a future period
Accrued asset: revenue is earned before cash is received

10. Accrued Asset Example First day of the month: Rent Receivable 2,500
Rent payment of $2,500 due within first 10 days of month
First day of the month:
Rent Receivable ,500
Rent Revenue ,500
Upon receipt of cash:
Cash ,500
Rent Receivable ,500
both rent and interest are earned as time goes by, regardless of when cash is received
need adjusting entry if payment is not received

11. Steps in the Accounting Cycle
1. Collect and
analyze info
7. Close the
accounts
2. Journalize
transactions
6. Record and
post adjusting
entries
3. Post
transactions to
general ledger
5. Prepare
financial
statements
4. Prepare
work sheet
LO6