Hello I'm Professor Bryan Bucce. Welcome back.
This is part two of our look at adjusting journal entries.
Hopefully this sequel will be an Empire Strikes Back type of sequel, rather than
a Mannequin two type sequel. Anyway, let's go to it.
Now we're going to do some practice with adjusting journal entries.
I will have a series of related transactions, some of them will be
regular journal entries, regular transactions.
And then we'll be faced with the question of do we need to do an adjusting entry
based on those, and if so, what would the adjusting entry be?
As always the pause icon will appear if you want to pause the video and try it
yourself, or you can just roll through and listen to the answer and try it later
on the homework's. So, let's get started.
>>September 30th. BOC loans $100,000 to an employee at a
12% interest rate. >> This is a regular journal entry,
that's occurring during the fiscal year. BOC is loaning cash.
Anytime you loan cash, cash is going down.
We make cash go down with a credit. The debit here is going to be an asset
called notes receivable, because our asset is that our employee owes us
$100,000 cash back. That is an asset because it's going to be
a future cash inflow, we make the asset increase with a debit.
>> December 31st, it is the end of the fiscal year.
No principal or interest payments have been made yet.
>> Now it's December 31st, so the question is do we need to make an
adjusting entry? We do in this case because three months
has gone by and we haven't gotten paid interest, but we our, we have earned
interest revenue. Because we have provided the service of
having the money outstanding to the employee over three months.
We have a contract where we're going to eventually get paid.
So, it's earned and realize we get to record.
Interest revenue. Revenue's a credit account so we increase
interest revenue with a credit. We credit interest revenue for 3,000.
The debit side is again going to be a receivable.
The employee owes us $3,000 of cash based on this interest.
So it's sort of like an accounts receivable, although we only use accounts
receivable when we deliver goods to customers.
Here we want to call it interest receivable.
Debit interest receivable to increase the asset for 3,000.
>>How did you come up with $3,000 as the amount of interest revenue?
>>Okay let me show you. We have $100,000 principal, 12% interest
rate, so $100,000 times .12 is $12,000 of interest per year.
Anytime you see an interest rate you should assume it's an annual rate, unless
it says otherwise. It hasn't been a year so we take 12,000
of interest per year, times 3/12 because it's been three months, and we end up
with 3,000 of interest, for the three months.
>> January 6th, the employee sends a check for three months of interest on the
loan. [BLANK_AUDIO].
>> So now we are back during the fiscal year, the next fiscal year, the employee
sends us a check, means we are receiving cash.
Cash is an asset, goes up through a debit, so we're going to debit Cash for
$3,000. And then we want to get rid of the
interest receivable asset. The interest has been received, it's no
longer receivable. So we're going to credit interest
receivable to reduce this asset 3,000, which just zeros it out because the
employees fully paid us what they owe in terms of interest.
>> December 31st it is the end of the fiscal year.
During December, employees earned $400,000 in salaries, but paychecks do
not get issued until January 2nd. >> So it is the end of the fiscal year.
December 31st. We have to ask ourselves whether we need
an adjusting entry. We do in this case because we've had
employees work for us, wiithout getting paid.
Even though they haven't been paid, we still have to recognize an expense for
the amount of salaries that they earned during December.
So we debit Salary Expense to increase the expense for $400,000.
But since it hasn't been paid in cash we credit a liability, salaries payable to
create or increase this liability for $400,000.
Which represents the fact that as of December 31st we owe our employees
$400,000 cash. At some point in the future, based on
work they've already provided. >> What do you mean by earned salaries?
I thought earned was one of the revenue recognition criteria.
This is an expense. >>Yes, earned is one of the revenue
recognition criteria. And from the perspective of the employee,
the employee did earn revenue. The employee provided service.
They have an agreement to get paid. So they have earned salaries revenue.
The salaries revenue for the employee Is a salary expense for us as the employer.
>> January second the paychecks are sent.
>> We've sent the checks which means that we've paid cash.
Anytime we pay cash, cash goes down, we credit cash to reduce it 400,000, and
what we are doing is, we are paying off this obligation or liabilities seller's
payable. We reduce a liability with a debit.
So, we debit salaries payable 400,000, which now zeros out that liability.
We don't over employees any more cash based on work they provided so far.
>> November 20th, BOC pays $10,000 for December's rent.
>> This one, we've paid cash. So, cash is going down.
We reduce cash with a credit so there's a credit to cash for 10,000.
We create an asset called Prepaid Rent, we debit the asset to increase it.
This is the example where we paid cash in advance of getting the benefit of
occupying the space. So it's an asset because we'll either get
to occupy the space or we'll get our $10,000 back at this point.
>> December 31st, it is the end of the fiscal year.
Is an adjusting entry needed? If so, what is it?
>> So we do need an adjusting entry at this point, because what's happened is,
December has gone by. We occupied the space for December.
The prepaid rent is no longer prepaid. It's been used up.
So we're going to debit rent expense. Increase in expense to recognize that
we've incurred the cost of rent for occupying the space in December.
We have to credit prepaid rent, reduce the asset because it's no longer prepaid.
This has to be zeroed out at the end of December because we no longer have any
future rent prepaid at this point. Credit in the asset by 10,000 Brings its
balance down to zero. >> June 30, a customer pays BOC $60,000
for a three-year software license. >> In this example we are selling
software as BOC. We've received $60,000 cash from a
customer. Anytime we receive cash, cash goes up.
We debit cash for $60,000. We haven't delivered any of the software.
We've, we've got the cash, the license, but, but we not get to recognize the
revenue until all this three years go by. So this is a liability at this point
called honor and software revenues ,so we credit the liability to create it,
because we have an obligation to deliver to the access to the software over the
next three years >> December 31st.
It is the end of the fiscal year. Is an adjusting entry needed?
If so what is it? >> We do need an adjusting entry
because part of that three years has gone by.
And as time goes by, we get to recognize revenue for the amount of time that's
gone by. Because we've earned that part of the
service of providing software. So six months have gone by.
We get to recognize software revenue for six months, so we credit software revenue
to increase the revenue account for 10,000.
We reduce the liability because 10,000 of this has been earned.
It's no longer unearned. So we debit unearned software revenue to
reduce the liability. The balance as of December 31st in this
liability account is $50,000, which is the amount of revenue we are going to
earn over the remaining 2 1/2 years of the software license.
>> I know why the answer is $10,000, but maybe you should explain it for the
other viewers. >> I'm happy to explain it for the
other viewers. So we're going to earn $60,000 over three
years. Assuming it's earned on a straight line
basis, that would be 20,000 per year. It hasn't been a year.
It's only been six months, or half a year, so half of 20,000 would be 10,000.
So we get to recognize $10,000 of revenue for these six months.
>> June 30th, BOC purchases a building for $500,000.
The expected life of the building is 20 years and its expected salvage value is
$100,000. >>So, on June 30th all we have to account
for is purchasing the building. We don't do any depreciation yet cause we
just bought the building. So, we paid cash 500,000.
Anytime we pay cash, we credit cash to reduce the cash account.
We debit Building to create the asset account to represent that we have this
new asset called, that's a Building, so we debit Building $500,000 and credit
Cash 500,000. [BLANK_AUDIO]
>> December 31st. It is the end of the fiscal year.
Is an adjusting entry needed? If so, what is it?
>> We definitely need an adjusting entry to record the depriciation.
So the format of the journal entry for depreciation expense always looks like
this. You debit depreciation expense to create
the expense for the period. And then you credit the contra-asset
accumulated depreciation. Remember, that's where we're going to
keep track of all the reductions in the original cost of the building over time.
We're going to keep it, track of it not in the building account, but in the
separate contra-asset account, which has a credit balance.
So a credit to accumulated depreciation increases this account.
So this the format you're always going to see for depreciation expense journal
entries. Now I do have on this slide, so you don't
have to ask, the calculation for how we got this.
The original cost of the building was 500,000, the salvage value's expected to
be 100,000, so we're going to depreciate 400,000 of value over time.
The time is going to be 20 years. So based on a straight line basis, we
have 400,000 divided by 20 is 20,000 per year.
So that's the annual expense. But notice here only six months have gone
by. So we take that 20,000 divided by 2 to
get a $10,000 six month depreciation expense.
>> What if your salvage value or useful life estimates are wrong?
How can you possibly know what a building will be worth in 20 years, or even that
you will use it for 20 years? >> Both the salvage value and the
useful are manager's best estimate of how long they plan to use it How much it'll
worth when they're done using it, when they buy, the asset.
Like all estimates, it'll probably be wrong.
If at any point in time, managers decide they're going to use the asset longer or
shorter than they thought, or the salvage value will be higher or less than they
thought. They can change the assumptions, and
recalculate the depreciation expense going forward.
And then if we get the end of the life, and we sell the asset for more or less
than its salvage value, we'll just book a gain or a loss at that point.
>> December 31st, BOC still has an outstanding order $300,000 of products
that will be delivered and billed in January.
>> So the question here is, do we need an adjusting entry to reflect that we
still have this outstanding order that has not yet been delivered or billed?
Well, the answer is no. We do not need an adjusting entry,
because there has not been any kind of revenue that's been earned at this point.
We haven't delivered the goods so we can't recognize revenue, we haven't
earned it. We haven't billed cash, we haven't
collected cash. So there's no realization yet, there's
not existing account that needs to be adjusted.
Basically, this entire transaction will happen some time in the future There's
nothing we need to adjust at this point. >> Okay.
So we can't record the revenue yet. But is there any way we can let people
know this order? >> Yes.
Companies can always voluntarily disclose information that they're not allowed to
recognize in the financial statements. So a common disclosure in financial
statements is called the quarter backlog. Which talks about these orders and lets
investors know about them, even though they haven't gotten to the point where we
could recognize revenue for them yet. So to provide a quick overview of
adjusting entries before we wrap up the video.
Think about a timeline where you have cash transactions that could either
happen before or after you recognize that, recognize that revenue or expense
in the financial statements. In the example of the deferred revenue
and the deferred expense, what happened was the cash transaction happened before.
We recognize the revenue or expense. So either we receive cash and create a
liability. Then when we earn the revenue, we credit
revenue and reduce the liability. Or we pay cash to recognize a prepaid
asset. Then as time goes by and we use up
whatever we prepaid, we debit the expense and reduce that prepaid asset.
For the accruals, what happens is the revenue or expense comes before the cash
transaction. So for an accrued expense we recognize an
expense before we pay the cash. So that we create a payable liability,
like a wage is payable or a tax is payable.
Then later on, we pay the cash and reduce the liability.
Where sometimes we recognize revenue, because we provided some kind of service
but haven't been paid cash yet. We created asset to represent the
receivable. Later on we collect the cash and get rid
of the receivable. So all of the adjusting entries are
going to fit in to one of these four categories.
Now that we've done examples of all the possible types of adjusting journal
entries, I can't think of anything better than to do more practice with them.
And that's what we'll do next video. In the Relics [UNKNOWN] case.
I'll see you then. >> See you next video.
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