16 terms

Accrual basis of accounting

Accrual basis of accounting
uses the adjusting process to recognize revenues when earned and expenses when incurred (matched with revenue)
Prepaid expenses
• Referred to items paid for in advance of receiving their benefits. Prepaid expenses are assets.

When these assets are use,
there cost become expenses.
Adjusting entries for prepaid expenses
increase expenses and decrease assets.
• Example of prepaid expenses are prepaid insurance, supplies and depreciation
• You Have to figure out the insurance expense, and prepaid insurance
• Supplies are prepared expenses requiring adjustment
• You have to figure out the supply expense and supplies (you have to reduce the asset)

Prepaid rent is another prepaid expense, and are counted for exactly as insurance and supplies.
Is a special category of prepared expenses
• You have to figure out the depreciation expenses and accumulated depreciation
Unearned revenue
• Refers to cash received in advance of providing product and service
• Unearned revenue are liabilities. When cash is accepted an obligation to provide product or service is attempted. As product or service are provided, the unearned revenue becomes earned revenue. Adjusting entry for unearned revenue involves increasing revenue and decreasing unearned revenue
o First, you have to record the journal entry.
o Then you have to record what is earned
o You have to reduce the liability and recognize earned revenue
Accrued expenses
• Refers to costs that are incurred in a period but are both unpaid and unrecorded. Accrued expense must be reported on the income statement of the period When incurred adjusting entries for recording accrued expense involved increasing expense and increasing liability. This adjustment recognizes expenses incurred in a period but not yet paid. Common examples of accrued expenses are salaries, interest, rent, and taxes. When you use salaries and interest to show how to adjust account for accrued expenses
o Step one
o Record how much was earned
o Record salary expense and salary, payable

Accrued expenses
• Companies, we have accrued interest expenses on notes payable and other long-term liabilities at the end of the period
• Interest expense is incurred with passage of time. Unless interest is paid on the last day of the accountant period, we need to adjust for interest expense incurred but not yet paid. This means we must accrued interest costs from the most recent payment date up to the end of the period.
• You have to figure out the salary, payable, and the salary expense, and cash

also intrestpayable and intrest expense
Accrued revenue
• Accrued revenue refers to revenue earned in aperiod that are both unrecorded and not get received in cash example is a technician who bills customer only when the job is done. If one third of the job is complete by the end of the period then the technician must record one third of the expected billing as revenue in that period even though there is no building or collection. The adjusting entry for accrued revenue increases assets and increase revenue. Accrued revenue commonly arise from services, products, interests, and rent. We use service fees and interest to show how to adjust for accrued revenue
o Accrued service revenue
o Are not recored until adjusting entries are made at the end of the accounting period. These accrued revenues are earned but unrecorded because either the buyer has not yet paid for them or the seller has not yet billed for them.
o You have to figure out the account receivable and the consulting revenue
Accrued interest revenue
• In addition to the accrued interest expense. We described earlier interest can yield an accrued revenue when a debtor owes money ( or other assets) to accompany. If a company is holding a note or account recievable that produce interest revenue, we must adjust the account to record any earned and yet uncollected interest revenue. The adjusting entry is similar to the one for accrued service revenue. Specifically, we debit interest receivable which is an asset and credit interest revenue.
Under accrual accounting, cash transactions are recorded as well as noncash transactions such as:
Purchases of inventory on account
Sales on account
Depreciation expense
Accrual of expenses incurred but not yet paid
Usage of prepaid rent, insurance, and supplies
The Adjustment Process

Examine the trial balance for accounts that may need to be adjusted.
Basic categories of adjusting entries:

Paid Cash in Advance for resource that will be used up in the future
Supplies, Insurance, Rent, Plant assets, etc.
Received Cash BEFORE performing Service
Collected subscription revenue, paid for class

Special type of Deferral for Plant Assets
Provided Service or sold product before receiving Cash
"on account"
An Expense has occurred before paying Cash
Prepaid Expense
A prepaid expense is an expense paid for in advance.
Because they provide future economic benefit, prepaid expenses are classified as assets.
Insurance, Rent, etc.
Before financial statements are prepared, prepaid expenses are adjusted to reflect the amount of the asset used up during the period of the statements.
Deferred Asset Adjustment
Adjustment records the effect of using up an Asset
"Using Up" an Asset
the Asset value has been reduced
We need to Credit the Asset
Debits must Equal Credits
If Assets create economic benefits,
Using them up leads to a Cost/Expense
We need to Debit an Expense Account
Deferred Asset Rule
Debit Expense and Credit Asset
Deferred Revenue
Unearned revenue exists when customers have paid in advance for services that have not yet been provided.
The organization "owes" the customer the service in the future
Thus, Unearned Revenue is a liability (an obligation)
Liability Increases, thus Credit Unearned Revenue
Received Cash, thus Debit Cash
Revenue is recognized when the services are provided.
Reduces the organizations obligation
Thus Liability is reduced, Debit Unearned Revenue
Revenue is increased, Credit Service Revenue
Adjusting Accrued Expenses
Accrued Expense
An expense of an Organization that hasn't been paid for by Cash
Matching Principle requires that we determine all Costs associated with Revenue, even if cash hasn't been paid
Taxes owed, Salaries owed, Interest owed, etc.
Before financial statements are prepared, expenses are adjusted to reflect the cost to the organization for the period of the statements.

Accrued expense refers to a liability that arises from an expense that has not yet been paid.
An Expense that has not been paid
The Expense value has increased
We need to Debit the Expense account
Leads to a liability that the organization owes
Liability value has increased
We need to Credit the Liability
Accrued Expense Rule:
Debit Expense, Credit Liability
Accrued Revenues
Accrued revenue is revenue that has been earned but cash has not been collected.
"On Account"
Closing the Books
Temporary accounts are closed
Revenues (are Debited)
Retained Earnings is Credited
Expenses (are Credited)
Retained Earnings is Debited
Dividends (are Credited)
Retained Earnings are Debited
Permanent accounts are not closed
Stockholders' Equ