Download 4.03 Study Guide

4.03 STUDY GUIDE

The accounting method that records revenues when they are earned and expenses
when they are incurred is called the accrual basis of accounting. Revenue is
reported when cash is earned regardless of when cash is received. Likewise,
expenses are reported when they are incurred, regardless of when they are paid.
This is the accrual basis of accounting which allows a business to match its revenue
and expenses for a fiscal period. Adjusting entries are made to ensure the
transactions are reported in the appropriate accounting period. GAAP requires that
most businesses use the accrual basis of accounting for their financial statements.
Accrual based financial statements give a complete picture of the financial condition
of a business.

Expenses paid in one fiscal period but not reported as expenses until a later fiscal
period are called prepaid expenses. Examples of prepaid expenses would be
items such as supplies, insurance, advertising and income taxes. Only that portion
of cash payment for expenses that have been used in the current fiscal period
should be reported as an expense in that fiscal period. Prepaid expenses may be
recorded initially as assets or as expenses. Prepaid expenses are assets until they
are actually used.

An expense incurred in one fiscal period but not paid until a later fiscal period is
called accrued expense. Some types of accrued expenses:
o Accrued Interest Expense
o Accrued Salary Expense
o Accrued Employer Payroll Taxes Expense
o Accrued Federal Income Tax Expense

Revenue received in one fiscal period but not earned until the next fiscal period is
called deferred revenue or unearned revenue. Deferred revenue may be recorded
initially as a liability or as revenue. Only that part of income actually earned should
be recorded as revenue in a fiscal period. An adjusting entry is recorded to separate
the earned and unearned portions of income.

Revenue earned in one fiscal period but not received until a later fiscal period is
called accrued revenue. At the end of the fiscal period, accrued revenue is
recorded as an adjusting entry. The adjusting entry for accrued revenue increases a
revenue account and increases a receivable account. The Income Statement will
report all revenue earned for the period even though some of the revenue has not
yet been received. The Balance Sheet will report all the assets including the
accrued revenue receivable.

An entry made at the beginning of one fiscal period to reverse an adjusting entry
made in the previous fiscal period is called a reversing entry. A reversing entry is
the exact opposite of the related adjusting entry. Reversing entries are made on the
first day of an accounting period in order to remove certain adjusting entries made in
the previous accounting period. Reversing entries are used to avoid the double
counting of revenues or expenses and to allow for the accurate reporting of financial
statements. Reversing entries are most often used with accrual-type adjusting
entries.

A note payable is a promissory note issued by a business or person in order to:
o Purchase merchandise
o Gain an extension of time to pay an account payable
o Borrow money

A discounted note payable is a note on which the interest is collected in advance.
The bank (or lender) discounts the note by deducting the interest charge when the
note is issued rather than at specified intervals or at maturity.
http://www.financial-accounting.us/fa/7/notes-payable.php
http://www.principlesofaccounting.com/chapter12/chapter12.html#Accounting
UNPACKED CONTENT
I.
Procedures for Calculating and Journalizing Prepaid Expenses
A. Steps for journalizing an asset initially recorded as an asset
1. Adjusting entry
a. Calculate the amount of the asset used.
b. Debit the expense account.
c. Credit the asset account.
2. Requires no reversing entry
B. Steps for journalizing an asset initially recorded as an expense
1. Adjusting entry
a. Calculate the amount of the asset still on hand.
b. Debit the asset account for the amount still on hand.
c. Credit the expense account for the amount still on hand.
2. Reversing entry – occurs after closing entries
a. Debit the expense account for the amount still on hand.
b. Credit the asset account for the amount still on hand.
C. Steps for journalizing prepaid interest expense
1. Adjusting entry
a. Calculate the amount of interest for the current period.
b. Debit Interest Expense.
c. Credit Discount on Notes Payable.
2. Requires no reversing entry
II.
Procedures for Calculating and Journalizing Accrued Expenses
A. Steps for journalizing accrued interest expense
1. Adjusting entry
a. Determine the interest expense for the current period.
b. Debit Interest Expense.
c. Credit Interest Payable.
2. Reversing Entry – occurs after closing entries
a. Debit Interest Payable.
b. Credit Interest Expense.
3. Payment of note at maturity
a. Calculate total interest due at maturity.
b. Debit Notes Payable (principal amount).
c. Debit Interest Expense (total interest due).
d. Credit Cash (principal + total interest due).
e. Determine the Interest Expense for the current period. (The debit to
interest expense less the credit balance created by the reversing entry
equals the interest expense for the current period.)
B. Steps for journalizing accrued salary expense
1. Adjusting entry
a. Determine the amount of salary earned for the fiscal period.
b. Debit Salary Expense.
c. Credit the appropriate liability accounts; e.g., Salaries Payable,
Employee Withholding Payables.
d. Note–Glencoe uses only Salaries Payable–Teach creating all liability
accounts.
2. Reversing Entry – occurs after closing entries
a. Debit the appropriate liability accounts; e.g., Salaries Payable.
b. Credit Salary Expense.
C. Steps for journalizing accrued employer payroll taxes expense
1. Adjusting entry
a. Determine the amount of payroll taxes accrued for the fiscal period.
b. Debit the Payroll Taxes Expense.
c. Credit the liability accounts (Social Security Tax Payable, Medicare Tax
Payable, Unemployment Tax Payable – Federal, Unemployment Tax
Payable – State).
2. Reversing entry – occurs after closing entries
a. Debit the liability accounts (Social Security Tax Payable, Medicare Tax
Payable, Unemployment Tax Payable – Federal, Unemployment Tax
Payable – State).
b. Credit the Payroll Taxes Expense.
D. Steps for journalizing Accrued Federal Income Tax Expense
1. Adjusting entry – (Any unpaid federal income tax is an accrued expense.)
a. Determine the amount of unpaid federal income tax.
b. Debit Federal Income Tax Expense.
c. Credit Federal Income Tax Payable.
2. Reversing entry – During the year, cash will be paid for accrued income tax
expense for the previous year plus periodic payments for the current year’s
income tax expense. To avoid confusing the amount of tax expense
recorded for each of these years and to provide year-to-date income tax
expense information for each year, no reversing entry is necessary.
III.
Procedures for Calculating and Journalizing Deferred Revenue and Accrued
Revenue
A. Steps for journalizing unearned revenue for payments received initially
recorded as revenue (unearned rental income)
1. Adjusting entry
a. Determine the amount of unearned revenue.
b. Debit Rent Income.
c. Credit Unearned Rent.
2. Reversing Entry
a. Debit Unearned Rent.
b. Credit Rent Income.
B.
Steps for journalizing revenue recognized as payments received that
are initially recorded as a liability (unearned rental income)
1. Adjusting entry
a. Debit Unearned Rent.
b. Credit Rental Income.
2. Requires no reversing entry
C. Steps for journalizing accrued interest income
1. Adjusting entry
a. Calculate the amount of accrued interest from the date of the note until
the end of the fiscal period.
b. Debit Interest Receivable.
c. Credit Interest Income.
2. Reversing Entry
a. Debit Interest Income.
b. Credit Interest Receivable