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Hello I'm Professor Bryan Bucce. [br]Welcome back.

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This is part two of our look at adjusting [br]journal entries.

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Hopefully this sequel will be an Empire [br]Strikes Back type of sequel, rather than

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a Mannequin two type sequel. [br]Anyway, let's go to it.

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Now we're going to do some practice with [br]adjusting journal entries.

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I will have a series of related [br]transactions, some of them will be

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regular journal entries, regular [br]transactions.

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And then we'll be faced with the question [br]of do we need to do an adjusting entry

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based on those, and if so, what would the [br]adjusting entry be?

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As always the pause icon will appear if [br]you want to pause the video and try it

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yourself, or you can just roll through [br]and listen to the answer and try it later

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on the homework's. [br]So, let's get started.

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>>September 30th. [br]BOC loans $100,000 to an employee at a

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12% interest rate. [br]>> This is a regular journal entry,

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that's occurring during the fiscal year. [br]BOC is loaning cash.

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Anytime you loan cash, cash is going [br]down.

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We make cash go down with a credit. [br]The debit here is going to be an asset

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called notes receivable, because our [br]asset is that our employee owes us

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$100,000 cash back. [br]That is an asset because it's going to be

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a future cash inflow, we make the asset [br]increase with a debit.

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>> December 31st, it is the end of the [br]fiscal year.

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No principal or interest payments have [br]been made yet.

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>> Now it's December 31st, so the [br]question is do we need to make an

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adjusting entry? [br]We do in this case because three months

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has gone by and we haven't gotten paid [br]interest, but we our, we have earned

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interest revenue. [br]Because we have provided the service of

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having the money outstanding to the [br]employee over three months.

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We have a contract where we're going to [br]eventually get paid.

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So, it's earned and realize we get to [br]record.

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Interest revenue. [br]Revenue's a credit account so we increase

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interest revenue with a credit. [br]We credit interest revenue for 3,000.

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The debit side is again going to be a [br]receivable.

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The employee owes us $3,000 of cash based [br]on this interest.

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So it's sort of like an accounts [br]receivable, although we only use accounts

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receivable when we deliver goods to [br]customers.

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Here we want to call it interest [br]receivable.

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Debit interest receivable to increase the [br]asset for 3,000.

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>>How did you come up with $3,000 as the [br]amount of interest revenue?

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>>Okay let me show you. [br]We have $100,000 principal, 12% interest

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rate, so $100,000 times .12 is $12,000 of [br]interest per year.

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Anytime you see an interest rate you [br]should assume it's an annual rate, unless

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it says otherwise. [br]It hasn't been a year so we take 12,000

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of interest per year, times 3/12 because [br]it's been three months, and we end up

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with 3,000 of interest, for the three [br]months.

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>> January 6th, the employee sends a [br]check for three months of interest on the

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loan. [br][BLANK_AUDIO].

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>> So now we are back during the fiscal [br]year, the next fiscal year, the employee

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sends us a check, means we are receiving [br]cash.

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Cash is an asset, goes up through a [br]debit, so we're going to debit Cash for

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$3,000. [br]And then we want to get rid of the

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interest receivable asset. [br]The interest has been received, it's no

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longer receivable. [br]So we're going to credit interest

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receivable to reduce this asset 3,000, [br]which just zeros it out because the

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employees fully paid us what they owe in [br]terms of interest.

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>> December 31st it is the end of the [br]fiscal year.

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During December, employees earned [br]$400,000 in salaries, but paychecks do

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not get issued until January 2nd. [br]>> So it is the end of the fiscal year.

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December 31st. [br]We have to ask ourselves whether we need

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an adjusting entry. [br]We do in this case because we've had

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employees work for us, wiithout getting [br]paid.

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Even though they haven't been paid, we [br]still have to recognize an expense for

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the amount of salaries that they earned [br]during December.

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So we debit Salary Expense to increase [br]the expense for $400,000.

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But since it hasn't been paid in cash we [br]credit a liability, salaries payable to

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create or increase this liability for [br]$400,000.

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Which represents the fact that as of [br]December 31st we owe our employees

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$400,000 cash. [br]At some point in the future, based on

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work they've already provided. [br]>> What do you mean by earned salaries?

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I thought earned was one of the revenue [br]recognition criteria.

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This is an expense. [br]>>Yes, earned is one of the revenue

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recognition criteria. [br]And from the perspective of the employee,

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the employee did earn revenue. [br]The employee provided service.

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They have an agreement to get paid. [br]So they have earned salaries revenue.

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The salaries revenue for the employee Is [br]a salary expense for us as the employer.

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>> January second the paychecks are [br]sent.

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>> We've sent the checks which means [br]that we've paid cash.

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Anytime we pay cash, cash goes down, we [br]credit cash to reduce it 400,000, and

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what we are doing is, we are paying off [br]this obligation or liabilities seller's

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payable. [br]We reduce a liability with a debit.

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So, we debit salaries payable 400,000, [br]which now zeros out that liability.

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We don't over employees any more cash [br]based on work they provided so far.

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>> November 20th, BOC pays $10,000 for [br]December's rent.

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>> This one, we've paid cash. [br]So, cash is going down.

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We reduce cash with a credit so there's a [br]credit to cash for 10,000.

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We create an asset called Prepaid Rent, [br]we debit the asset to increase it.

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This is the example where we paid cash in [br]advance of getting the benefit of

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occupying the space. [br]So it's an asset because we'll either get

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to occupy the space or we'll get our [br]$10,000 back at this point.

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>> December 31st, it is the end of the [br]fiscal year.

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Is an adjusting entry needed? [br]If so, what is it?

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>> So we do need an adjusting entry at [br]this point, because what's happened is,

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December has gone by. [br]We occupied the space for December.

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The prepaid rent is no longer prepaid. [br]It's been used up.

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So we're going to debit rent expense. [br]Increase in expense to recognize that

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we've incurred the cost of rent for [br]occupying the space in December.

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We have to credit prepaid rent, reduce [br]the asset because it's no longer prepaid.

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This has to be zeroed out at the end of [br]December because we no longer have any

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future rent prepaid at this point. [br]Credit in the asset by 10,000 Brings its

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balance down to zero. [br]>> June 30, a customer pays BOC $60,000

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for a three-year software license. [br]>> In this example we are selling

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software as BOC. [br]We've received $60,000 cash from a

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customer. [br]Anytime we receive cash, cash goes up.

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We debit cash for $60,000. [br]We haven't delivered any of the software.

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We've, we've got the cash, the license, [br]but, but we not get to recognize the

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revenue until all this three years go by. [br]So this is a liability at this point

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called honor and software revenues ,so we [br]credit the liability to create it,

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because we have an obligation to deliver [br]to the access to the software over the

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next three years [br]>> December 31st.

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It is the end of the fiscal year. [br]Is an adjusting entry needed?

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If so what is it? [br]>> We do need an adjusting entry

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because part of that three years has gone [br]by.

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And as time goes by, we get to recognize [br]revenue for the amount of time that's

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gone by. [br]Because we've earned that part of the

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service of providing software. [br]So six months have gone by.

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We get to recognize software revenue for [br]six months, so we credit software revenue

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to increase the revenue account for [br]10,000.

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We reduce the liability because 10,000 of [br]this has been earned.

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It's no longer unearned. [br]So we debit unearned software revenue to

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reduce the liability. [br]The balance as of December 31st in this

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liability account is $50,000, which is [br]the amount of revenue we are going to

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earn over the remaining 2 1/2 years of [br]the software license.

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>> I know why the answer is $10,000, [br]but maybe you should explain it for the

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other viewers. [br]>> I'm happy to explain it for the

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other viewers. [br]So we're going to earn $60,000 over three

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years. [br]Assuming it's earned on a straight line

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basis, that would be 20,000 per year. [br]It hasn't been a year.

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It's only been six months, or half a [br]year, so half of 20,000 would be 10,000.

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So we get to recognize $10,000 of revenue [br]for these six months.

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>> June 30th, BOC purchases a building [br]for $500,000.

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The expected life of the building is 20 [br]years and its expected salvage value is

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$100,000. [br]>>So, on June 30th all we have to account

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for is purchasing the building. [br]We don't do any depreciation yet cause we

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just bought the building. [br]So, we paid cash 500,000.

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Anytime we pay cash, we credit cash to [br]reduce the cash account.

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We debit Building to create the asset [br]account to represent that we have this

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new asset called, that's a Building, so [br]we debit Building $500,000 and credit

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Cash 500,000. [br][BLANK_AUDIO]

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>> December 31st. [br]It is the end of the fiscal year.

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Is an adjusting entry needed? [br]If so, what is it?

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>> We definitely need an adjusting [br]entry to record the depriciation.

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So the format of the journal entry for [br]depreciation expense always looks like

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this. [br]You debit depreciation expense to create

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the expense for the period. [br]And then you credit the contra-asset

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accumulated depreciation. [br]Remember, that's where we're going to

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keep track of all the reductions in the [br]original cost of the building over time.

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We're going to keep it, track of it not [br]in the building account, but in the

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separate contra-asset account, which has [br]a credit balance.

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So a credit to accumulated depreciation [br]increases this account.

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So this the format you're always going to [br]see for depreciation expense journal

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entries. [br]Now I do have on this slide, so you don't

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have to ask, the calculation for how we [br]got this.

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The original cost of the building was [br]500,000, the salvage value's expected to

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be 100,000, so we're going to depreciate [br]400,000 of value over time.

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The time is going to be 20 years. [br]So based on a straight line basis, we

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have 400,000 divided by 20 is 20,000 per [br]year.

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So that's the annual expense. [br]But notice here only six months have gone

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by. [br]So we take that 20,000 divided by 2 to

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get a $10,000 six month depreciation [br]expense.

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>> What if your salvage value or useful [br]life estimates are wrong?

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How can you possibly know what a building [br]will be worth in 20 years, or even that

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you will use it for 20 years? [br]>> Both the salvage value and the

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useful are manager's best estimate of how [br]long they plan to use it How much it'll

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worth when they're done using it, when [br]they buy, the asset.

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Like all estimates, it'll probably be [br]wrong.

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If at any point in time, managers decide [br]they're going to use the asset longer or

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shorter than they thought, or the salvage [br]value will be higher or less than they

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thought. [br]They can change the assumptions, and

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recalculate the depreciation expense [br]going forward.

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And then if we get the end of the life, [br]and we sell the asset for more or less

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than its salvage value, we'll just book a [br]gain or a loss at that point.

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>> December 31st, BOC still has an [br]outstanding order $300,000 of products

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that will be delivered and billed in [br]January.

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>> So the question here is, do we need [br]an adjusting entry to reflect that we

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still have this outstanding order that [br]has not yet been delivered or billed?

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Well, the answer is no. [br]We do not need an adjusting entry,

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because there has not been any kind of [br]revenue that's been earned at this point.

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We haven't delivered the goods so we [br]can't recognize revenue, we haven't

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earned it. [br]We haven't billed cash, we haven't

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collected cash. [br]So there's no realization yet, there's

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not existing account that needs to be [br]adjusted.

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Basically, this entire transaction will [br]happen some time in the future There's

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nothing we need to adjust at this point. [br]>> Okay.

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So we can't record the revenue yet. [br]But is there any way we can let people

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know this order? [br]>> Yes.

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Companies can always voluntarily disclose [br]information that they're not allowed to

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recognize in the financial statements. [br]So a common disclosure in financial

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statements is called the quarter backlog. [br]Which talks about these orders and lets

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investors know about them, even though [br]they haven't gotten to the point where we

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could recognize revenue for them yet. [br]So to provide a quick overview of

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adjusting entries before we wrap up the [br]video.

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Think about a timeline where you have [br]cash transactions that could either

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happen before or after you recognize [br]that, recognize that revenue or expense

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in the financial statements. [br]In the example of the deferred revenue

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and the deferred expense, what happened [br]was the cash transaction happened before.

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We recognize the revenue or expense. [br]So either we receive cash and create a

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liability. [br]Then when we earn the revenue, we credit

0:15:54.050,0:15:58.840
revenue and reduce the liability. [br]Or we pay cash to recognize a prepaid

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asset. [br]Then as time goes by and we use up

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whatever we prepaid, we debit the expense [br]and reduce that prepaid asset.

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For the accruals, what happens is the [br]revenue or expense comes before the cash

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transaction. [br]So for an accrued expense we recognize an

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expense before we pay the cash. [br]So that we create a payable liability,

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like a wage is payable or a tax is [br]payable.

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Then later on, we pay the cash and reduce [br]the liability.

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Where sometimes we recognize revenue, [br]because we provided some kind of service

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but haven't been paid cash yet. [br]We created asset to represent the

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receivable. [br]Later on we collect the cash and get rid

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of the receivable. [br]So all of the adjusting entries are

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going to fit in to one of these four [br]categories.

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Now that we've done examples of all the [br]possible types of adjusting journal

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entries, I can't think of anything better [br]than to do more practice with them.

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And that's what we'll do next video. [br]In the Relics [UNKNOWN] case.

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I'll see you then. [br]>> See you next video.

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[BLANK_AUDIO]