The second category of adjusting entries is accruals. Prior to an accrual adjust- ment, the revenue account (and the related asset account) or the expense account (and the related liability account) are understated. Thus, the adjusting entry for accruals will increase both a statement of fi nancial position and an income statement account.
ACCRUED REVENUES
Revenues for services performed but not yet recorded at the statement date are
accrued revenues. Accrued revenues may accumulate (accrue) with the passingof time, as in the case of interest revenue. These are unrecorded because the earn- ing of interest does not involve daily transactions. Companies do not record inter- est revenue on a daily basis because it is often impractical to do so. Accrued revenues also may result from services that have been performed but not yet billed or collected, as in the case of commissions and fees. These may be unre- corded because only a portion of the total service has been performed and the clients will not be billed until the service has been completed.
An adjusting entry records the receivable that exists at the statement of fi nancial position date and the revenue for the services performed during the period. Prior to adjustment, both assets and revenues are understated. As shown in Illustration 3-13, an adjusting entry for accrued revenues results in an increase (a debit) to an asset account and an increase (a credit) to a reve- nue account.
Learning Objective 6
Prepare adjusting entries for accruals.
Accrued Revenues
Asset Revenue
Debit Adjusting Entry (+)
Credit Adjusting Entry (+)
Illustration 3-13
Adjusting entries for accrued revenues
• HELPFUL HINT For accruals, there may have been no prior entry, and the accounts requiring adjustment may both have zero balances prior to adjustment.
4. Unearned Service Revenue 4,600,000
Service Revenue 4,600,000
(To record revenue for services performed)
✔
The Navigator Related exercise material: BE3-3, BE3-4, BE3-5, BE3-6, and DO IT! 3-2.Action Plan (cont’d)
✔ Don’t forget to make adjusting entries for deferrals. Failure to adjust for deferrals leads to overstatement of the asset or liability and understatement of the related expense or revenue.
1,200
My fee is 200
Cash is received;
receivable is reduced Revenue and receivable
are recorded for unbilled services Nov. 10
Accrued Revenues
In October, Yazici Advertising performed services worth 200 that were not
billed to clients on or before October 31. Because these services are not billed,
they are not recorded. The accrual of unrecorded service revenue increases an
Debit–Credit Analysis
Journal Entry
Posting Basic Analysis
Oct. 31 Adj. 200
Oct. 31 Bal. 200
Accounts Receivable 112
Debits increase assets: debit Accounts Receivable 200.
Credits increase revenues: credit Service Revenue 200.
Oct. 31 Accounts Receivable Service Revenue
(To record revenue for services performed) 200
200 The asset Accounts Receivable is increased 200; the revenue Service Revenue is increased 200.
Assets = Liabilities + Equity Service Revenue
⫹ 200 Accounts
Receivable
⫹ 200 Equation
Analysis
Oct. 3 10,000
31 400
31 Adj. 200 Oct. 31 Bal. 10,600 Service Revenue 400 Illustration 3-14
Adjustment for accrued revenue
Equation analyses summarize the effects of transactions on the three elements of the accounting equation, as well as the effect on cash fl ows.
Illustration 3-15 Accounting for accrued revenues
ACCOUNTING FOR ACCRUED REVENUES
Reason for Accounts Before Adjusting Examples Adjustment Adjustment Entry Interest, rent, Services performed Assets understated. Dr. Assets services performed but not yet Revenues understated. Cr. Revenues but not collected recorded.
ACCRUED EXPENSES
Expenses incurred but not yet paid or recorded at the statement date are called
accrued expenses. Interest, taxes, and salaries are common examples of accruedexpenses.
The asset Accounts Receivable shows that clients owe Yazici 200 at the statement of fi nancial position date. The balance of 10,600 in Service Revenue represents the total revenue for services performed by Yazici during the month ( 10,000
+400
+200). Without the adjusting entry, assets and equity on the statement of fi nancial position and revenues and net income on the income statement are understated.
On November 10, Yazici receives cash of 200 for the services performed in October and makes the following entry.
Nov. 10 Cash 200
Accounts Receivable 200
(To record cash collected on account)
The company records the collection of the receivables by a debit (increase) to Cash and a credit (decrease) to Accounts Receivable.
Illustration 3-15 summarizes the accounting for accrued revenues.
A = L + E
+200
−200 Cash Flows +200
asset account, Accounts Receivable. It also increases equity by increasing a
revenue account, Service Revenue, as shown in Illustration 3-14.
The Basics of Adjusting Entries 115
Illustration 3-16
Adjusting entries for accrued expenses
Accrued Expenses
Expense Liability
Credit Adjusting Entry (+) Debit
Adjusting Entry (+)
As Illustration 3-18 (page 116) shows, the accrual of interest at October 31 increases a liability account, Interest Payable. It also decreases equity by increas- ing an expense account, Interest Expense.
Interest Expense shows the interest charges for the month of October.
Interest Payable shows the amount of interest the company owes at the state- ment date. Yazici will not pay the interest until the note comes due at the end of three months. Companies use the Interest Payable account, instead of cred- iting Notes Payable, to disclose the two different types of obligations—interest and principal—in the accounts and statements. Without this adjusting entry, liabilities and interest expense are understated, and net income and equity are overstated.
A report released by Fannie Mae’s (USA) board of directors stated that improper adjusting entries at the mortgage-fi nance company resulted in delayed recognition of expenses caused by interest-rate changes. The motivation for such accounting apparently was the desire to achieve earnings estimates.
Ethics Note
Illustration 3-17
Formula for computing interest
• HELPFUL HINT
In computing interest, we express the time period as a fraction of a year.
Annual Time in
Face Value
× Interest × Terms of = Interest
of Note Rate One Year
5,000 × 12% × 12—1 = 50
Let’s look in more detail at some specifi c types of accrued expenses, beginning with accrued interest.
ACCRUED INTEREST Yazici Advertising signed a three-month note
payable in the amount of 5,000 on October 1. The note requires Yazici to pay interest at an annual rate of 12%.
The amount of the interest recorded is determined by three factors:
(1) the face value of the note; (2) the interest rate, which is always expressed as an annual rate; and (3) the length of time the note is out- standing. For Yazici, the total interest due on the 5,000 note at its maturity date three months in the future is 150 ( 5,000
×12%
×123), or
50 for one month. Illustration 3-17 shows the formula for computing interest and its application to Yazici for the month of October.
Companies make adjustments for accrued expenses to record the obligations
that exist at the statement of fi nancial position date and to recognize the expenses
that apply to the current accounting period. Prior to adjustment, both liabilities
and expenses are understated. Therefore, as Illustration 3-16 shows, an adjust-
ing entry for accrued expenses results in an increase (a debit) to an expense
account and an increase (a credit) to a liability account.
ACCRUED SALARIES AND WAGES Companies pay for some types of expenses,
such as employee salaries and wages, after the services have been performed.
Yazici paid salaries and wages on October 26 for its employees’ fi rst two weeks of work. The next payment of salaries will not occur until November 9. As Illustra- tion 3-19 shows, three working days remain in October (October 29–31).
At October 31, the salaries and wages for these three days represent an accrued expense and a related liability to Yazici. The employees receive total salaries and wages of 2,000 for a fi ve-day work week, or 400 per day. Thus, accrued salaries and wages at October 31 are 1,200 ( 400
×3). This accrual increases a liability, Salaries and Wages Payable. It also decreases equity by increasing an expense account, Salaries and Wages Expense, as shown in Illustration 3-20.
After this adjustment, the balance in Salaries and Wages Expense of 5,200 (13 days
×400) is the actual salary and wages expense for October. The balance
Debit–CreditAnalysis
Journal Entry
Posting Basic Analysis
Equation Analysis
Oct. 31 Adj. 50 Oct. 31 Bal. 50
Oct. 31 Adj. 50 Oct. 31 Bal. 50
Interest Expense 905 Interest Payable 230
Debits increase expenses: debit Interest Expense 50.
Credits increase liabilities: credit Interest Payable 50.
Oct. 31 Interest Expense Interest Payable
(To record interest on notes payable)
50
50 The expense Interest Expense is increased 50; the liability Interest Payable is increased 50.
Assets
Interest Payable
⫹ 50
= Liabilities + Equity
Interest Expense
⫺ 50
Illustration 3-18
Adjustment for accrued interest
Illustration 3-19
Calendar showing Yazici’s pay
periods October
Adjustment period Start of
pay period
Payday Payday
S M Tu W Th F S
1 2 3 4 5 6
7 8 9 10 11 12 13 14 16 17 18 19 20 21 22 23 24 25 27 28 29 30 31
26 15
November
S M Tu W Th F S
1 2 3
4 5 6 7 8 10
11 13 14 15 16 17 18 19 20 21 22 24 25 26 27 28
23 29 30 12
9
The Basics of Adjusting Entries 117
in Salaries and Wages Payable of 1,200 is the amount of the liability for salaries and wages Yazici owes as of October 31. Without the 1,200 adjustment for salaries and wages, Yazici’s expenses are understated 1,200 and its liabili- ties are understated 1,200.
Yazici pays salaries and wages every two weeks. Consequently, the next payday is November 9, when the company will again pay total salaries and wages of 4,000. The payment consists of 1,200 of salaries and wages payable at October 31 plus 2,800 of salaries and wages expense for November (7 work- ing days, as shown in the November calendar
×400). Therefore, Yazici makes the following entry on November 9.
Nov. 9 Salaries and Wages Payable 1,200
Salaries and Wages Expense 2,800
Cash 4,000
(To record November 9 payroll)
This entry eliminates the liability for Salaries and Wages Payable that Yazici recorded in the October 31 adjusting entry, and it records the proper amount of Salaries and Wages Expense for the period between November 1 and November 9.
Illustration 3-21 summarizes the accounting for accrued expenses.
A = L + E
−1,200
−2,800 Exp
−4,000 Cash Flows
−4,000
Illustration 3-20 Adjustment for accrued salaries and wages
Debit–Credit Analysis
Journal Entry
Posting Basic Analysis
Equation Analysis
Oct. 26 4,000 31 Adj. 1,200 Oct. 31 Bal. 5,200
Oct. 31 Adj. 1,200 Oct. 31 Bal. 1,200 Salaries and Wages Expense 726 Salaries and Wages Payable 212
Debits increase expenses: debit Salaries and Wages Expense 1,200.
Credits increase liabilities: credit Salaries and Wages Payable 1,200.
Oct. 31 Salaries and Wages Expense Salaries and Wages Payable
(To record accrued salaries and wages)
1,200
1,200 The expense Salaries and Wages Expense is increased 1,200; the liability Salaries and Wages Payable is increased 1,200.
Assets
Salaries and WagesPayable
⫹ 1,200
= Liabilities + Equity
Salaries and Wages Expense
⫺ 1,200
Illustration 3-21 Accounting for accrued expenses
ACCOUNTING FOR ACCRUED EXPENSES
Reason for Accounts Before Adjusting Examples Adjustment Adjustment Entry Interest, rent, Expenses have been Expenses understated. Dr. Expenses salaries incurred but not yet paid Liabilities understated. Cr. Liabilities
in cash or recorded.