ch4 - Chapter 4 Adjusting entries and closing process (c)...

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(c) Mikhail B. Pevzner and George Mason University Chapter 4 Adjusting entries and closing process (c) Mikhail B. Pevzner and George Mason University Previously on Acct 301… Balance sheet transactions; Income statement transactions; Outcome: prepaid assets/deferred liabilities; (c) Mikhail B. Pevzner and George Mason University Example On November 1, 2007, Papa Jones bought a three year insurance policy expiring on October 31, 2010 for $1,000,000. On February 1, 2007, Papa Jones bought a machine for $1 million. The machine will be used for 10 years, and will have a salvage value of $100,000. On the same date, Papa Jones also received $100,000 in franchise fees from its franchise fees for year 2007. PJ's franchise obligations are fulfilled over three years.
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(c) Mikhail B. Pevzner and George Mason University Question: How should these transactions be accounted for? More basically, are there any other journal entries we need to make, in addition to the ones made on the transaction dates? Answer: Yes. Prepaid assets expire over time. The value of these assets must be amortized into expenses to reflect assets’ expiration; (c) Mikhail B. Pevzner and George Mason University Amortization of revenues and expenses; The word amortization implies gradual allocation of an asset/liability value into either revenue or expense. When prepaid asset expires, the expired portion of that asset represents an expense to the company. Similarly, when a company completes earning its revenues, it must recognize the part of deferred liability it previously booked as revenue. (c) Mikhail B. Pevzner and George Mason University Principle of systematic and rational allocation One of the key principles in GAAP is that of systematic and rational allocation. You already learned it: that principle says that as assets are being used over time, the proportion of value of those assets must be recognized as an expense against the revenues assets generate. This is just an addition to the matching principle.
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(c) Mikhail B. Pevzner and George Mason University Let’s go back to our example: • On November 1, 2007, Papa Jones bought a three year insurance policy expiring on October 31, 2008 for $1,000,000. • On February 1, 2007, Papa Jones bought a machine for $1 million. The machine will be used for 10 years, and will have a salvage value of $100,000. • On the same date, Papa Jones also received $100,000 in franchise fees from its franchise fees for year 2007. PJ's franchise obligations are fulfilled over three years. (c) Mikhail B. Pevzner and George Mason University Initial Journal Entries February 1, 2007 Cash $1,000,000 to record a purchase of the machine January 1, 2007 Cash $100,000 Deferred franchise revenue $100,000 to record receipt of franchise fees not yet earned. November 1, 2007
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ch4 - Chapter 4 Adjusting entries and closing process (c)...

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