Tutorial

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1 Learning Objectives 7 Interest Calculation 2 Adjusting Entries 8 Journal Entries for Borrowing, Accruing Interest, Repayment of Note 3 Accrued Expenses 9 Accrued Revenues 4 Accrued Salaries 10 Review Question 1 5 Payment of Accrued Salaries in a Later Period 11 Summary 6 Accrued Interest 12 Key Terms

Learning Objectives
After completing this tutorial you should be able to:

• Explain the meaning of the terms accrued revenues and accrued expenses.
• Prepare adjusting journal entries to record accrued interest, accrued salaries and other expenses.
• Prepare adjusting entries to record accrued revenues.

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Adjusting Entries

Adjusting entries are prepared at the end of a fiscal period. These entries are required for accrual accounting because of timing differences between cash flows and the recognition of revenues or expenses.

For example, the cost of employee services is recognized as expense in the period the services are provided regardless of when cash is paid to employees. Thus salaries earned by employees in April are recorded as expense in April even if the cash is paid in May.

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Accrued Expenses

Accrued expenses occur when expenses are recognized economicsore cash is paid.

Under accrual accounting expenses incurred during a period must be recorded in that period even if the cash is paid later.

Example

Assume that a company advertised during December 2000. The company has not received a bill or paid for the advertisement. The advertising costs incurred during the year 2000 must be recorded as expense for the year 2000, even if the payment is made in a later period. Hence, advertising expense of $450 is accrued on Dec 31, 2000. Since a payment of $450 must be made in the future, a liability (Accounts Payable) is recognized for this amount. When the payment for the advertisement is made, the liability will be reduced.

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Accrued Salaries

Salaries earned by employees in a period to be paid in a later period are called accrued salaries. Assume $1,000 of salaries earned by employees in December 2000 will be paid in January 2001.

The cost of services provided by employees during 2000 must be recorded as expense for 2000, even if the payment is made in a later period. Hence, salaries expense of $1,000 is accrued on Dec 31, 2000. Since salaries of $1,000 must be paid in the future, a liability (Salaries Payable) is recognized for this amount. When the salary is paid, the liability will be reduced.

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Payment of Accrued Salaries in Later Period

Assume that the salaries of $1,000 accrued in the previous example, are paid on Jan. 3, 2001. Salaries Payable was credited for $1,000 when salaries expense for the year 2000 was accrued. Now this liability is reduced since the cash is paid.

DATE	ACCOUNT	DEBIT	CREDIT
2001
Jan. 3	Salaries Payable   Cash	1,000	1,000

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Accrued Interest

Interest is accrued for the use of borrowed money during a period if the cash payment for interest will be made in a future period. This transaction is an example of an accrued expense since the expense is recognized economicsore the cash is paid.

Interest is calculated using the following formula:
i = p * t * r / 100
p is the principal.
r is the annual rate of interest.
t is the time in years for which the interest is being calculated.
i is the interest for this time period.

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Interest Calculation

A company signed a 12%, $10,000 note payable on July 1, 2000. The note and the interest will be paid on June 30, 2001.

Interest on this debt accumulates throughout the fiscal period. Management recognizes this expense during the period in which it is incurred rather than waiting until cash is paid. The interest expense recorded on Dec 31, 2000, is the amount of interest owed to creditors for the use of the borrowed money for six months (from July 1 to December 31).

Interest for July 1 to December 31, 2000
i = p * t * r / 100
= $10,000 * 0.5 year * 12/100
= $600
The total interest on the note from July 1, 2000, to June 30, 2001, ($10,000 * 1 * 12/100= $1,200) will be paid on June 30, 2001.

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Journal Entries for Borrowing, Accruing Interest, Repayment of Note

Journal Entry for Borrowing from Creditor

This screen shows the recording of the note on July 1, 2000. The next two screens discuss the accrual of interest and the payment of the note respectively. The organization has obtained money. Hence, cash increases. Further, the business owes $10,000. Thus a liability (Notes Payable) must be recorded for this amount.

Journal Entry for Accruing Interest

Interest is accrued for July 1 to December 31 as shown above. The interest for this period is recognized as expense. Further, the interest payment must be made in the future. The amount of interest to be paid later is recorded as a payable. When the cash is paid this payable will be reduced.

The following two journal entries are prepared when the note and the interest are paid to the creditor.

Journal Entry for Payment of Principal

The note is repaid on June 30, 2001. The amount borrowed was recorded as a liability (Notes Payable). Now this liability is decreased (debited) by $10,000. Cash is credited by the same amount.

Journal Entry for Payment of Interest

The total interest for one year is $1,200. Further, interest for the use of borrowed funds from Jan 1, 2000, to June 30, 2001, must be recognized as expense for this period. Thus Interest Expense is debited for $600. Finally, Interest Payable was credited for $600 when interest expense for the year 2000 was accrued. Now this liability is reduced since the cash is paid.

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Accrued Revenues

Accrued revenues occur when revenues are recognized economicsore cash is received.

Assume that an organization provided services for $500 during December, 2000. The organization has not billed the customer or recorded the sale of services. Accrual accounting recognizes revenue when goods are provided. Since services were provided in December, revenue must be recognized in December. Thus an adjusting entry is prepared on Dec 31, 2000.

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Review Question 1
Fill in the blanks. Use a term from the list given below.

Terms:

adjusting

after

cash

interest expense

interest payable

salaries payable

Accrued expenses result when cash is paid    an expense is recognized.

The   account is credited to record accrued interest.

The   account is debited to record accrued interest.

To record the payment of salaries accrued in a previous period,  is credited.

To record the payment of salaries accrued in a previous period,  is debited.

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Summary
Adjusting entries are prepared at the end of a fiscal period. These entries are required for accrual accounting because of timing differences between cash flows and the recognition of revenues or expenses. Accrued expenses occur when expenses are recognized economicsore cash is paid. For example, cost of services provided by employees which will be paid in a later period is accrued as salaries expense. Interest is accrued for the use of borrowed money during a period if the cash payment for interest will be made in a future period. Accrued revenues occur when revenues are recognized economicsore cash is received.

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Key Terms

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