Lecture06 - Lecture 6 Accounting Cycle and the Adjusting...

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1 Lecture 6 Accounting Cycle and the Adjusting Entries
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2 Adjusting Entries There are two types of adjusting entries. ACCRUALS Revenues earned or expenses incurred that have not been previously recorded. DEFERRALS Receipts of assets or payments of cash in advance of revenue or expense recognition.
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3 End of accounting period. Cash received or paid. Revenues earned or expense incurred Examples include rent received in advance (an Examples include rent received in advance (an unearned revenue) or insurance paid in unearned revenue) or insurance paid in advance (a prepaid expense). advance (a prepaid expense). Deferrals
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4 Prepaid Expense - Example 1 On January 1, 2003, Tipton, Inc. paid $3,600 for a 3-year fire insurance policy. They are paying in advance for a resource they will use over a 3-year period. The entry on January 1, 2003, to record the policy on Tipton’s books would appear as follows . . . This is an ASSET ASSET account
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5 Prepaid Expense - Example 1 At the end of 2003, we determine how much At the end of 2003, we determine how much of the “prepaid expense” has been used up of the “prepaid expense” has been used up during the period. during the period. Since the policy is for Since the policy is for 3 years 3 years , we can , we can assume that 1/3 of the policy will expire assume that 1/3 of the policy will expire each year. each year. 1/1/03 12/31/03 Year end 12/31/04 Year end 12/31/05 Year end Paid cash for insurance < 3-year insurance policy >
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6 Prepaid Expense - Example 1 On December 31, 2003 , Tipton must adjust the Prepaid Insurance Expense account to reflect that 1 year of the policy has expired. $3,600 × 1/3 = $1,200 per year. In effect, the prepaid asset goes down, while the  expense goes up.
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7 Prepaid Expense - Example 1 After we post the entry to the T-accounts, the account balances look like this: Prepaid Insurance Expense 1/1 3,600 12/31 1,200 Bal. 2,400 Insurance Expense 12/31 1,200 Bal. 1,200
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8 Unearned Revenue - Example 2 On December 1, 2003, Tom’s Rentals received a check for $3,000, for the first four months’ rent of a new tenant. The entry on December 1, 2003, to record the receipt of the prepaid rent payment would be . . . This is a LIABILITY account
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9 Unearned Revenue - Example 2 We must record the amount We must record the amount of rent of rent EARNED EARNED during December. during December. Since the prepayment is for Since the prepayment is for 4 4 months months , we can assume that 1/4 of , we can assume that 1/4 of the rent will be earned each month. the rent will be earned each month. Received cash for rent < 4-month prepayment of rent > 12/1/03 12/31/03 Year end 2/28/04 1/31/04 3/31/04
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10 Unearned Revenue - Example 2 On December 31, 2003 , Tom’s Rentals must adjust the Unearned Rent Revenue account to reflect that 1 month of rent revenue has been earned. $3,000
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Lecture06 - Lecture 6 Accounting Cycle and the Adjusting...

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