Bob's Notes ... Read these first!
Chapters 1, 2, 3 and 4 are laying the foundation for ALL other chapters of this course (as well as all other accounting courses in your future).
As usual check over your chapter 3 "Tips & Hints" AND the "Chapter Outline". Again pay attention to the terms and definitions at the end of the chapter since this can be a "challenging" chapter. Introduced in this chapter is the difference between the Cash Basis of accounting and the Accrual Basis of accounting.
Just in case your short term memory has atrophied due to hard-core partying or having children of your own we are doing the ACCRUAL BASIS of accounting and NOT the Cash Basis. The ACCRUAL BASIS is based on THREE major accounting precepts. These are:
The Revenue Principle:
The bulk of chapter 3 deals with the adjusting process. Adjusting entries are usually made at the end of an accounting period to allocate income and expenses to the period in which they actually occurred. Adjusting entries can be categorized as either ACCRUALS or DEFERRALS.
Accrual of Expenses
An accountant might say, "We need to accrue the interest expense on the bank loan." (Accrue means to "periodically accumulate over time")
Assume that on JAN 1 your company borrowed $1,000,000 at 6% interest for 2 years. Each month your company incurs (Calculation = $5,000 per month interest ($1,000,000 x 6% = $60,000 per year divided by 12 months = $5,000 per month). The interest expense is not due to be paid until the loan itself is to be repaid. An adjusting entry is needed because nothing had been recorded in the accounts for interest expense, but the company did incur (means to "become liable for") interest expense during the accounting period. Further, the company has a liability or obligation for the unpaid interest up to the end of the accounting period. What the accountant is saying is that an accrual-type adjusting journal entry needs to be recorded.
Another situation requiring an adjusting entry is when a payroll period falls between 2 accounting periods. For example assume you are paid every two weeks. You earn $500 per week ($1,000 per two week payroll-payday). Assume that one of the weeks was in JAN while the second week is in FEB. The accountant might also say, "We need to accrue for the wages earned by the employees on Mon JAN26 thru Fri JAN30." The adjusting entry would be ... DEBIT Salary Expense, $500 and CREDIT Salary Payable, $500. (When the salary is actually paid to employees in FEB, Salary Payable will be debited (decreased) and Cash will be credited (also decreased). The salary expense for JAN will be subtracted from JAN revenues to determine Net Income (Profit or Loss).
Accrual of Revenue
Accountants might also state that they must "accrue" revenues that have been earned but not yet received. For example, assume that your company has provided services to customer SmithCorp in FEB. On FEB 28 you send a bill to SmithCorp requesting payment. SmithCorp will send the payment within 30 days which is typical for an Account Receivable.
In another situation, on MAR 01, your company invested $60,000 in a one-year CD (Certificate of Deposit at a bank) which pays you 10% annual interest. On MAR 31, you need to ACCRUE the interest you've earned, but not yet received. The adjusting entry will be ... DEBIT: Interest Receivable, $500 and CREDIT: Interest Revenue, $500 . (Calculation is $60,000 x 10% = $6,000 for one year, divided by 12 = $500 p[er month). This entry would be made each month until the Cash payment for the interest is received from the bank CD. Then you would debit "Cash" and credit "Interest Receivable".
Deferral of Expenses
Assume that, On Jan 01 you paid GEICO insurance (the annoying little lizard SOB on TV) $1,800 to provide insurance for your company for the following six months (Jan, Feb, Mar, Apr, May, June) at a rate of $300 per month.
At the end of JAN, you have "Used Up or Consumed" one month of the GEICO insurance coverage. An adjusting entry is needed to allocate an Insurance Expense (using-up) to JAN and reflect that your asset PREPAID INSURANCE has been reduced by 1/6 (one of the six months of insurance coverage).
Another related situation relates to buying supplies to be used in your business operation (office supplies, copy papers etc). Assume that, on MAR 01 you bought 10 cases of copy paper paying, in cash, $100 per case. The entry would be ... DEBIT Supplies, $1,000 and CREDIT Cash, $1,000. At the end of MAR you determine that you only have 4 cases of copy paper remaining. Therefore, during MAR you must have "used-up" the other 6 cases (in the amount of 6 cases x $100 per case).
Deferral of Revenues
Deferrals can also involve revenues. Assume that you are the owner of the infamous magazine BOB (as in "hunka-hunka" ... but I digress). A subscriber pays (obviously a highly intelligent, damn near-perfect individual - but I digress again), IN ADVANCE, for a one-year subscription (12 monthly issues) to BOB magazine. The cost for the one-year subscription is $600 (and worth every cent). You (BOB magazine) receives the $600 on JUNE 01 2008 in payment through MAY 31, 2009.
At the end of JUNE, you (BOB magazine) send the June issue to your subscriber (did I mention that he or she has exceptional taste). In effect you have reduced your liability to deliver 12 issues by 1/12 (the issue you just sent). An adjusting entry is needed to reflect your "earning" of one months worth (1/12th) of the original $600 (one-year) payment.
This situation (above) routinely occurs in the construction industry. For example, when a swimming pool builder receives 100% of the Cash payment before the pool is built, the pool builder has both an Asset (debit (increase) CASH) ... AND ... a LIABILITY (credit (increase) UNEARNED REVENUE) ... THE pool builder OWES the customer either the a swimming pool OR the Cash back. When the swimming pool is 18% completed (or 6% or 72%), the pool builder has earned the right to keep 18% of Cash and owes 18% less that he did.
|Links to Online Resources → USE them!|
|Accrued Revenues||Accrued Expenses||Unearned Revenues|
|Prepaid Expenses||Depreciation||Adjustment Process Illustrated|
Homework Assignment ... (from the textbook - at the end of the chapter)
Use the "Working Papers" (link below) to complete this assignment. Type in, and save, your
answers. Submit it (upload by the due date) ... using the ANGEL "Assignment Drop Box".
|S3 - 3 (pg 155)||S3 - 4 (pg 155)||S3 - 8 (pg 156)|
|S3 - 9 (pg 156)||S3 - 10 (pg 156)||E3 - 14 (pg 157)|
|E3 - 17 (pg 158)||E3 - 18 (pg 158)||E3 - 24 (pg 160)|
|P3 - 32 A (pg 163)||P3 - 34 A (pg 165)||P3 - 35 A (pg 163)|
Link To the "Working Papers" - use these for homework !
Do the homework. Use these answers to help you over any "bumps" ... they'll save you time and reduce frustrations (a little). Check your work and fix the mistakes - it's not cheating - it's learning - remember I don't "grade" these ... but I do deduct (a lot) for incomplete assignments.
Link To The Answers For The Assignment Above ... Click Here !