7. Cheatsheet Topics: Deferral of expense, Deferral of revenue, Accrued Expense, Accrued Revenue

When does deferral of expense occur?

Prepaid expenses, also called prepaid assets. These are assets we have paid for in advance.

Why do we need to defer expense for prepaid assets?

We have to defer the expense because since we prepaid for the assets, we have to expense them over time as we use them.

Give examples of prepaid assets.

Prepaid Insurance, Supplies, Prepaid Rent, etc.

What adjustment is needed on the trial balance for deferral of expense? Use prepaid insurance as an example.

Debit insurance expense, credit prepaid insurance.

Why do we debit insurance expense and credit prepaid insurance?

Debit insurance expense because insurance should be expensed over time so we only count the expense when we use that insurance for that month for example. Credit prepaid insurance because prepaid insurance is an asset and since we used the insurance our prepaid insurance amount goes down.

What adjustment is needed on the trial balance for deferral of expense? Use supplies as an example.

Debit supplies expense, credit supplies.

Why do we debit supplies expense and credit supplies?

Debit supplies expense because we expense the supplies as we use them. Credit supplies since as we use the supplies, the supplies go down.

What does depreciation apply to?

Applies to a specific category of assets called plant assets or fixed assets.

What are plant assets or fixed assets?

Long-term tangible assets used to produce and sell products and services. Examples include buildings, machines, vehicles, and equipment.

How are the cost of plant assets reported?

Gradually reported as expenses in the income statement over the assets' useful lives.

As a plant asset such as a machine ages, we need to…

expense it over time.

What is the adjustment that should be made to account for depreciation of a plant asset?

Debit Depreciation expense, credit Accumulated Depreciation.

Why do we Debit Depreciation expense and credit Accumulated Depreciation.

Debit depreciation expense since the expenses for the plant assets go up as it ages. (Depreciates over time) Credit accumulated depreciation to reduce the book value of an asset over it's useful life.

What is the formula for book value of an asset?

Original asset cost - Accumulated Depreciation

How should the account name be specified for Accumulated Depreciation?

If it was for Equipment the specific account name would be Accumulated Depreciation - Equipment.

When does Deferral of Revenue occur?

When we have been paid by customers but have not yet provided them the service/product.

What is the entry to record the transaction for deferral of revenue (NOT the adjustment)?

debit cash and credit unearned revenue (such as unearned consulting revenue)

What adjustment needs to be made for deferral of revenue?

debit unearned revenue and credit the revenue account (such as consulting revenue)

Why do we debit unearned revenue and credit the revenue account?

We debit unearned revenue since we have now earned that revenue so we reduce the liability. We credit the revenue account to show we have now earned that revenue.

When does Accrued Expense occur?

When we have an expense we need to pay such as wages but we have not paid it yet.

Give an example of when Accrued Expenses would occur.

This can occur for example if the employee is paid on Mondays for the week prior but the accounting period ends on a Thursday so the wages expense for Monday, Tuesday, Wednesday, and Thursday must be recorded for the current accounting period. The expense for Friday would be recorded in the next accounting period.

What adjustment needs to be made for Accrued Expense? Use wages as an example.

Debit wages expense, Credit wages payable.

What is the formula for computing accrued interest?

Principle amount owed x Annual interest rate x Fraction of year since last payment.

fraction of year: number of days / 360

Review future cash payment of accrued expense.

When would Accrued Revenue occur?

When we have provided a service for a customer but have not been paid yet.

What adjustment needs to be made for Accrued Revenue?

Debit accounts receivable, credit revenue for the specific account.

Why do we Debit accounts receivable, credit revenue for the specific account?

We debit accounts receivable since we are expected to receive payment from the customer later.

We credit revenue for the specific account (such as Services revenue) since we record the revenue in this accounting period.

Review future cash receipt of Accrued Revenues

Before adjusting for deferral of expense what is overstated/understated?

asset is overstated, expense is understated

Before adjusting for deferral of revenues what is overstated/understated?

liability is overstated and revenue is understated

Before adjusting for accrued expense what is overstated/understated?

liability is understated and expense is understated

Before adjusting for accrued revenues what is overstated/understated?

asset is understated and revenue is understated