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Adjusting Entries

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Transcript

Hello, and welcome to this lecture today My name is Justin like the numbers. And in this lecture we're going to be talking about adjusting entries for accrual accounting. So adjusting entries are made at the end of a period. And they are made because of the difference between the cash and accrual system. There are certain transactions that need to be adjusted in order to reflect the true profitability at the end of the month and also the true position as well on the balance sheet. So the three main concepts we'll be talking about today are earning costs incurred and assets consumed.

So let's first look at earned. So if something's actually been earned, it needs to be recorded as revenue. Now, if we haven't actually got this already recorded on our books, it's sitting in accounts receivable then We need to factor in these two situations. So if a service has been performed, but it's been previously paid, that's considered to be unearned. However, if there's a situation where that work has actually been completed, and we're aware of that before the end of the month, then we'll need to make an adjustment to actually transfer that from unearned revenue to be earned revenue. Now, the second situation is where you've got amounts that have actually been earned.

So say for example, you've got revenue that's actually been earned. And you've already closed off your books around your cats receivable. But you're aware that there's a large amount that needs to needs to be invoiced. You can actually accrue that on your balance sheet as well as within your p&l. Okay, so normally accruals we think of payables, but there is actually situations where you can actually accrue the revenue And what that actually does is it sits as a current asset as an accrued revenue, and the other side of that transaction will be going into your p&l into a revenue line item. And this is very, very common in practice to be able to actually accrue revenue, usually in things like project work and other kinds of businesses where the invoicing hasn't yet occurred to the customer.

But you want to take up a whole lot of margin and revenue in that period. The second situation is where you've got, for example, interest receivable, where you've got interest invested somewhere, and you're going to receive the interest maybe in the first few days of the next month, but it isn't recorded yet in your books. So what you need to do is actually accrue the revenue that the revenue for interest and it sits in an account on the balance sheet as an asset called interest receivable. And the other side of that will be in your p&l as interest rates. Revenue. The second kind of category where you need to make adjustments, where you've actually got costs that have been incurred.

So let's look at a couple of examples. First example is where you've got a loan, we actually borrowing money, and you've got interest that you need to pay out on the loan. Again, it's simply it's the opposite to where you've got interest that you're earning, here's what your interests were, you've incurred a cost, and actually going to pay that let's say in the first few days or the next month. And so what you need to do in your books, you actually need to record the cost of the interest in your profit and loss. And the other side of that transaction will be sitting as a liability as an interest payable because you actually need to pay that to finance Yeah. And so that will actually we need to take up a reduction in owner's equity for the cost.

And we need to then take a liability for the actual payable amount that will be paid when the cash actually transacts early next period a second century Question of costs incurred could be an example like where you've got wages that need to be accrued. So say for example, you've got a situation where you've had people that have worked in the period, and you've incurred a whole lot of costs. And they may even the week that they actually paid all the period that it paid might might cut over two months. And some of the costs are actually in the second period. And some of the costs are in the first period. And they actually get paid in the second period.

However, at the end of the month, when you're reporting the month, you actually need to record the costs that relate to that period. Not for that, not for the second period, but just for the first period. So let's say for example, you got a week and you got two days in the first period and another three days in a week later the second period, you will need to actually accrue the wages into that first period. So what you would do is you would need to take up a liability for the accrued one wages payable could be another name used in practice. And then you need to put a cost into your profit and loss, which will reduce your owner's equity. And therefore you need to calculate and work out the actual cost.

So you will debit the wages expense, and credit will be going to liability, which is accrued wages. And this could actually apply to any type of cost, not just wages. And there's a lot of other examples in practice of what you could accrue. So it's not just isolated to wages, it could literally be anything. So in practice, there's literally dozens of examples where you might accrue different costs. But I guess the concept is the same as this example with wages.

So the nature of how you trade it would be you increase the cost, and you take up a liability for the crew. The third kind of situation where you need to take a cruise, where assets get consumed. Now what I mean by that is where the actual net book value of that asset has reduced. Now, a couple of examples could be depreciation, or amortization. And remember this is a depreciation is actually not the depreciation expense, but the accumulated depreciation is actually a contra asset, if you recall from previous lectures. And so, when you take up depreciation that actually the accumulated depreciation ends up reducing the cost base of the property, plant and equipment account.

And therefore, it's consuming that asset to reduce its net book value. So, what you actually do to calculate depreciation is you take the cost of that actual asset, what you purchased it for you minus the residual, which residual is what you would sell it for at the end of its useful life, like a scrap value is also another name for it. If you know the scrap value, let's say up front and you mean include that in the actual calculation. And then you divide this by its useful life and its useful life is the number of years that it will actually last you. And again, it's it's an estimate, there are some guidelines under accounting rules of, of how many years you can depreciate certain types of assets. Okay?

So let's say for example, you've got a an asset where you've got a $10,000 vehicle, you believe, by the end of its useful office doesn't have a scrapbook of scrap value. And you believe that the useful life is example, let's say it's five years for example, then the depreciation would actually be $2,000 per year, that you would actually depreciate that. And so the same look, the same rules would apply if you're amortizing an intangible asset as depreciation, it's just a different terminology and altos ation is for intangibles and depreciation is for tangibles. And finally, prepayments. Another example assets are consumed. So in this in this example, you could have, for example, three months of rent or insurance that you've paid up front.

And at the end of the period, you need to make an adjustment because one month has passed, you've actually incurred the cost of that actual, let's say, for example, it's interest. Sorry, it's insurance, in which case that needs to actually be transferred from prepayment to your profit and loss. And so what you're actually going to do is you're going to need to reduce the prepayment that's sitting on the balance sheet. And then you're going to also need to take up an expense for that particular insurance or rent or whatever it is, for that particular period, because you're no longer going to have three months worth of prepayment. At the end of the first month you only gonna have two. So on your balance sheet, you'll have two months.

And that one month needs to be transferred to profit and loss as an expense because you've actually incurred that cost. So this is adjusting entries, we'll be going through some examples in the future to put this into practice. And it's really done at the end of a period to actually, again reflect the true cost and revenues at the end of the period as well as the true position on your balance sheet. And they use for accrual accounting purposes. So we have an accurate result of what our position is. So these this is what the adjusting journals would look like under the as a general journal.

So what you would have is you'd have a usually an adjustments made at the end of the calendar month, so you generally would give a date of the last day of the month, you would then include your the reference of the accounts that you need to actually post the adjustment to. And for example, if you're taking up a depreciation expense, you would be debiting. The depreciation expense once you've capital How much that needs to be for that particular period. And then the different sets on your profit and loss, and then the accumulated depreciation would be what hits your asset as a, it's a contra asset, if you recall, and that's actually going to reduce the book value of your property, plant and equipment, such your depreciation. Second example is where you've got your wages expense. So again, you need to calculate how many days or weeks need to be accrued.

And this could be any expense, not just wages. This is just conceptually showing you how to take up the general journal. So you need to then take up the debit, which reduces your owner's equity, take up the expense for whatever the amount that relates to that particular period. And then the difference sits as a liability under accrued wages. And then finally, if you're reducing your prepaid rent for that particular month, you need to take up an expense On his equity, which is an expense, which reduces your profit. And the prepaid account, which actually was your future benefit is now reducing by that one month that's actually now been incurred as a cost has been transferred across into your rent expense.

Okay, so this is adjusting entries, and we'll see you in the next lecture.

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