Chapter 3! The Adjusting Entry

1. Chapter 3! The Adjusting Entry Unit 1 Test (cover chapter 1 to 4) will occur on Friday September 26!

2. Adjusting Entry • There are many different types of adjusting entries accountants make at the end of the fiscal period: • Prepaid Expense - Amortization • Prepaid Insurance • Accrued Revenue • Supplies adjustment (Accrued Expense) • Unearned Revenue • Late-Arriving Purchase Invoice (Accrued Expenses)

3. Adjusting for Depreciation The Nature of Depreciation • There are two categories for assets: • Short Term Assets: These assets last only short term: E.g. Cash and AR • Long Term Assets : These assets last long term: E.g. Land, Building, Equipment, Computer, Car, Truck etc • Long Term assets are also called “Fixed Assets” or “Capital Assets”

4. Depreciation • The long term assets (like car, truck, computer and equipment) help the business’ producing income over many assets. • Therefore, the cost of purchasing these assets must be spread out over the length of time that they help produce revenue. • By doing depreciation adjusting entry, we are honoring matching principle.

5. Depreciation • Accountants must estimate the useful life of the long term assets. • The two most common methods of calculating depreciation are the straight line method and declining balance method.

6. Straight Line Method • SLMD for one year = Cost – Salvage Value Periods • Cost = original cost of the long term asset • Salvage value = how much you will receive when you sell it at the end of the useful life or selling priceafter you used it for many years. • Periods = How long you will use it before selling it or throwing away

7. Adjusting for Depreciation • Let’s say I own Pizza restaurant and I use my car to deliever pizza. • How long does my car last? In other words, how many years will my car help my business to generate income? • It lasts 15 years. After 15 years, my car will die. Its useful life is 15 years. • We recorded $15000, the original cost in Balance Sheet. (I paid $15000 2 year old, used Honda Civic on January 1 2013)

8. Amortization • The car example we used: • SLMD = 15000 - 0 = 1000 per year 15 years • This means that my car’s value will decrease by $1000 every year. • (Assuming that we bought the car on January 1, 2013) Adjusting Entry we should make on December 31 is: Amortization Expense $1000 Accumulated Amortization – Auto $1000 To record annual depreciation

9. Amortization • What if Mr. Park purchased this car on November 1, 2013? How much should he depreciate on December 31, 2013? • 1000 /12 months * 2 months = 166 December 31 Amortization Expense $166 Accumulated Amortization – Auto $166 To record amortization of auto

10. Amortization • The balance in the Accumulated Amortization account will increase by $83 every month or $1000 every year. • Statement Presentation on Dec 31 2013: Auto $15000 Less: Accumulated amort – auto ($166) Net Book Value $14834 • The difference between the cost and its accumulated amortization is called the net book value of that asset.

11. Accrued Salaries (Accrued Expense category) • Sometimes salaries and commissions are paid after the work has been performed. • For example Pioneer Adverstising employees began work on December 13. They were last paid on December 24. Their next payment will occur on January 7. • At December 31, the salaries for the last 5 working days in December represent an accrued expense and a liability to Pioneer Advertising.

12. Accrued Salaries (Accrued Expense category) • At December 31, they must make an adjusting entry: (4 employees * 5 days *$100 per day = 2000) Dec 31 Salaries Expense 2000 Salaries Payable 2000 To record accrued salaries

13. Accrued Salaries (Accrued Expense category) • Pioneer Advertising pays salaries every two weeks. • On January 7, 2014 as they pay their salaries, they will make the following journal entry: Jan 7 Salaries Payable $2000 Salaries Expense $2000 Cash $4000 To record January 7 payroll

14. Accrued Revenue • Some Revenues are earned but not yetreceived in cash or recorded at the statement date. • Accrued revenues may accumulate (or accrue) with the passage of time, as happens with interest revenue and rent revenue. • An adjusting entry is required for two purposes: to record the accurate revenue and to record increase in AR or NR.

15. Accrued Revenue • BMO’s perspective: Park Accounting borrowed $50,000 at 5% interest on September 1, 2014 which is due August 31, 2015. What kind of JE is made on September 1, 2014? Sept 1 Loan Receivable $50,000 Bank $50,000

16. Accrued Revenue • Adjusting Entry that BMO has to make on December 31, 2014? • (5% * 50000 * 4 months / 12 months = 833) Dec 31, 2014 Interest Receivable $833 Interest Revenue $833 Adjusting Entry for accrued interest Revenue : Loan #5987

17. Accrued Revenue • JE on August 31 2015? Aug 31 Cash $52500 Loan Receivable $50000 Interest Receivable $833 Interest Revenue $1667

18. The Adjusted Trial Balance and FS • Adjusted Trial Balance: After all adjusting entries are posted, another (or updated) trial balance is prepared from the general ledger accounts. • Basic procedure of making ATB is same as Trial Balance. • An adjusted trial balance proves that total debit balances and the total credit balances in the ledger are equal after all adjustments have been made. • Show Page 125 : We can make BS, IS, SOE from Adjusted Trial Balance.

19. Classwork / Homework P138 E3-5, E3-8 P142 P3-6A