Now, it's your turn. I'd like to give you some practice with these adjusting entries. I'm going to present you with a transaction, give you a few moments to take a look at it and work through it, and then come back and see how you do. As you're going through these, keep in mind that you're thinking about deferred revenues, deferred expenses, accrued revenues or accrued expenses. And that might help you think about how to record each of these. And of course while you doing this, I'll be right there with you. I know there's a lot of vegetables to be eaten. I'll go to the beets now. Okay, first one. On January 1, a publisher receives $30 in cash from an individual for a 3 year magazine subscription. What entries is that publisher going to record? Let's think about two different things. The entry that gets recorded when the subscription is purchased on January 1st. And then the entry that gets recorded on December 31st as an adjusting entry. Take a few minutes, give it a shot. Then come back and we'll see how it went. How did it go? I bet you are to tackle this one. Let's take a look. When the subscription is purchased on January 1, the company receives cash from the individual for the magazine subscription. The simple receipt of the cash means the transaction has occurred and something needs to be recorded in the book. Recall from my tutorial that we will record an increasing cash which is an asset. So it would be a left side entry, in the journal entry for $30, because that's how much cash was received. But the company can't yet record that as revenue, because it hasn't yet earned the revenue. It won't earn the revenue until it's actually provided the magazines to the individual customer. Now, it has a liability or an obligation to provide those magazines because a customer has given cash to the publisher. So we'll record that liability as a deferred revenue for the entire $30. Then as the company provides magazines to the customer, the company will be able to record the revenue because it will have been earned. So on December 31st at the end of the first year, we'll record an adjusting entry. Now remember at the end of the first year, the company will have provided some magazines to the customer and will be entitled to record the earned portion of the revenue as revenue. And since we have a $30 subscription that was 3 years, the simple math tells us that each sheet here is about $10. So the companies entitled to record that $10 in revenue at the end of the first year. So it would record the revenue as the right hand side to retained earning and then the left hand side would be a reduction in the deferred revenue liability. Okay, let's go to the next one. On November 30, XYZ company pays its landlord $4,000 for December rent. What entries does XYZ company record in its books? Let's think about them in terms of two entries when the payment is made on November 30th. And second on December 31st the adjusting entry that would be recorded. Take a few minutes give it a try, then come on back, and we'll see how it went. How did it do? Let's take a look. When the payment is made on November 30th, the company has an outflow of cash. So certainly something would need to be reported at that point in time. So we're going to see the reduction in cash on the right hand side of the entry. And the company is essentially purchased an asset, its paid it's rent in advance. And so we're going to record this asset account as a left hand side entry or a debit in the journal entry. And we'll call it prepaid rent, we might call it rent paid in advance, or rent paid to the landlord before we've used the building. But importantly, it's an asset and it's related to rent. On December 31st, the XYZ company has made use of the building and at that point in time, it would need to record an expense. So it would record its left hand side entry to retained earnings for its rent expense. And a right hand side entry to reduce the asset account, and we're recording the expense to reflect the usage of that asset. Now, remember the matching principle, This is key in this particular instance. The matching principle again tells us that any time we record revenues, for this year in particular. Any time we record revenues, we need to find all the costs that the company has incurred to generate those revenues. And they have to be recorded as an expense at the same time we're recording the revenues. So that we have our expenses matched to the revenues they helped us to generate. That's the fundamental nature of accrual accounting and that is indeed why we're having to record this adjusting entry. So you might recognize thi, not as a deferred revenue which we just previously saw in the first practice transaction. But this one is a deferred expense or a prepaid expense. Okay, let's move to the next one. On, January 1st, STR Company buy some equipment that cost a $1,000. They think they're going to be able to use it for 5 years at which point in time it's not going to be worth anything at that point. What entries does the company need to record? Let's think about these again in two entries when the equipment is purchased on January 1. And then second on December 31 the adjusting entry. Take a few minutes. Give it a try, and then come back and we will see how it went. Okay, let's take a look. When the equipment is purchased on January first, very similar to the prior transaction. We see an outflow of cash, and so we have a reduction to cash on the right hand side of the journal entry for the entire $100,000 cost. And we have an increase in the asset account that we'll call equipment or property plant and equipment, something of that nature. But importantly, it's an asset account and that increases. Now as we use that asset to help us generate revenues. Remember the matching principle is going to tell us that we need to record the cost of using that asset as an expense. So that we would be matching the expense associated with the asset to the revenues it's helping us generate. So as an adjusting entry on December 31st, we would need to record a reduction in the asset account to reflect that we've been using the asset. And we'll record a left hand side to retained earnings for an expense. And this expense we'll call depreciation expense. It's a fancy name that accountants, That accountants give this expense. But it is essentially the result of matching the cost of using the asset to the revenues that asset has helped us generate. And here we've got a left hand and a right hand for $20,000. How did we get that $20,000? I'm curious to know if that's the number that you came up with. And it'd be interesting to know the logic behind this $20,000. We have $100,000 that we've spent on this asset. The company estimates that it will use that equipment for five years. So the cost of that equipment will be allocated over all five of those years. Because it will be helping to generate revenues in each of those years. There are many different ways that companies can use to allocate that cost. I've just simply taken the $100,000 and divide it by the 5 years and just have suggested that we allocate an equal portion to each of those 5 years. And so the current year would be allocated $20,000. There are other more sophisticated ways to do that that we won't worry about at the moment. The important point is knowing that we need to record the expense. Now one other thing I'm going to put out here is that we had talked previously about with deferred revenues and deferred expenses. The cash effect happens first, and the adjusting entry is recorded later. And so what we're seeing here is that when the equipment was purchased, the cash affect the card. And then the expense that's recorded at later dates is a result of a cruel accounting in a matching principle. Let's try another one. On December 31st, JK Company determines that it owes income tax of $10,000 for the fiscal year. It's going to pay that bill the following April 15th. But the $10,000 is related to the year that ends December 31st. What entry is JKL Company going to record? Again two parts, the adjusting entry on December 31st, and when the payment is made on April 15th. Take a few minutes. Give it a try and then come back and let's see how you did. And I'm realizing that this is a lot like vegetables and I haven't been eating mine. So while you're gone to work on this one. I'll take another bite of this beet. So how did it go? My beet was very good. I hope you enjoyed yours as well. Let's take a look and see how it went. Okay, on December 31st, we're going to record an adjusting entry. We're going to record an expense, so we'd have a left hand side to retained earnings with a notation of income tax expense. And since we haven't yet paid the bill in cash, we have an obligation to pay it but haven't yet paid it. We're recording a right hand side or a credit to a liability account. We can call that income taxes that we have to pay in the future for this year's income tax. Or we can call it income tax payable or income tax that we owe to the government, but importantly it's a liability. Right hand side to a liability, so we're increasing that by $10,000. Now remember, the matching principle again. Tells us that we have to take the expenses we've incurred the current year when we've been generating the current year's revenues. And record them this year, to match them to this years revenues. That's exactly what we're doing here itwh this entry. When April 15th arrives, the company makes payment. At that point in time, the liability has been satisfied by the payment of cash. So we reduce the liability, the left hand side or debit, and we reduce the cash balance by $10,000. Now notice, this is a bit different than the three transactions we've recorded previously. You might notice that in this example, we've recorded the adjusting entry first. And we've recorded the entry where the cash effect occurs later. Recall that with deferred revenues and expenses, the cash effect occurs first, and then the adjusting entry occurs. But with accrued revenues and accrued expenses, the revenue and the expense of recorded first and the cash of that occurs in the future. So her we have the cash of that occurring in the future. So this would be an accrued expense. We are accruing the expense by recording it here with a corresponding liability associated with it. I think we're on a roll here. Let's try another one. Okay, GHI Company leases a building to JKL Company for $3,000 per month. GHI receives the rent payment the $3,000 for each month at the beginning of the following month. What entries does GHI company record related to the rent for the month of December? We're going to see an adjusting entry on December 31st of the current year. And then we'll see another entry when payment is made in January of the following year. Take a few minutes. Give it a try, then come back and we'll see how you did. Okay, how did it go? I think you might be getting the hang of this. On December 31st, there's an adjusting entry. GHI company has provided the use of the building to another company for the month of December. Now remember we can record revenue or recognize revenue when we have completed the transaction or provided the service, and that collectability of the cash is reasonably assured. Well in this case, GHI has provided use of the building to the other company for the month of December. So it's completed providing the service for that month and collectability is reasonably assured, we're assuming probably. Because they have an ongoing relationship and JKL routinely pays its bills. So in this case the company, GHI Company can go ahead and record revenue for the month of December and the amount of $3,000. But notice that it hasn't received any cash. So recall in this situation when we're recording revenues, but we haven't received any cash, we'll record an asset called the receivable. And I've called that rent receivable but we could call it rent that we expect to receive from the tenant in the future. But importantly its an asset and we're expecting to receive payment. And then when the payment is received in January, GHI company will record the receipt of the cash by making left hand side entry or debit to cash. And they would reduce the rent receivable asset account. Because they no longer need that on the books because they have received the cash. Notice again they were looking at accrued revenues similarly to looking at accrued expenses in the prior transaction. The cash effect is occurring at some point in the future, but the revenue is being recorded as an adjusting entry in the current accounting period.
