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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.

[BLANK_AUDIO]