Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. Adjusting entries are made so the revenue recognition and matching principles are followed. The depreciation formula (straight-line) to compute straight-line depreciation for a one-year period is: This video will explain the depreciation process and entries: To illustrate the use of the straight line depreciation formula, let’s return to the MicroTrain Company. Adjusting entries involve the transactions referring to accrual and deferral. expensing a part of the cost of a building. When a business passes an adjusting entry of accrual, it leads to cash receipt and expenditure. The three factors involved in computing depreciation expense are as follows: Accountants use different methods for recording depreciation. The journal entry was: The estimated residual value for each truck was $ 1,000, so MicroTrain estimated the total residual value for all four trucks at $4,000 (1,000 x 4 trucks). The supplies expense for the period will be $7,000 ($500 beginning balance + $8,000 in supplies purchased – $1,500 remaining) and the adjusting entry will be: Before this adjusting entry was made, the supplies asset account had a balance of $8,500. At month-end after the adjusting entry, unearned revenue will decrease on the balance sheet, and revenue will increase on the income statement. You must make an adjusting entry to decrease (debit) your deferred revenue account and increase (credit) your revenue account. For this illustration, let us use Unearned Revenue.Suppose on January 10, 2017, ABC Company made $30,000 advanced collections from its customers. A deferral-type adjusting entry is … probably. Copyright © 2020 AccountingCoach, LLC. The first interest payment is to be made on June 30, 2018, and the company is preparing its financial statements for the year ending December 31, 2017. At the end of the period, we need to make adjusting entries to get the accounts up to date for the financial statements. A depreciable asset is a manufactured asset such as a building, machine, vehicle, or piece of equipment that provides service to a business. The company estimated the useful life of each truck to be four years. Enjoy the videos and music you love, upload original content, and share it all with friends, family, and the world on YouTube. When we record depreciation, we will debit depreciation expense and credit a new account called Accumulated Depreciation. Accruals and Deferrals Journal Entries. Using the straight-line depreciation formula, MicroTrain calculated the annual depreciation on the trucks as follows: annual depreciation = (asset cost $40,000 – estimated residual value $4,000)/ 4 year estimated useful life. Example. In order to create accurate financial statements, you must create adjusting entries for your expense, revenue, and depreciation accounts. In a deferral adjustment for revenues collected in advance that are now earned: 1) a liability is decreasing because cash is being paid for an expense incurred at the time of the adjustment 2) the liability recorded when cash was received is increased by the adjustment for the revenue being earned Accrual vs Deferral – Meaning. It reports the remaining amount of the prepaid expense,  $ 2,200, as an asset on the balance sheet. The journal entry is simple. We will move a liability to revenue or an asset to an expense. We can use the following formula for supplies expense: Beginning supplies + supplies purchases during the period  – physical count of supplies remaining. Each month, one-twelfth of the deferred revenue will become earned revenue. We discuss other depreciation methods later in the course. Deferrals require adjusting entries at the end of each fiscal period to align revenues and expenses to the correct period. A third example is the accrual of utilities expense. The adjusting entry is between a revenue and an asset account. Remember to rate your confidence to check your answer, maybe? The following sections explain a few typical accounting adjustments. Accounting Principles: A Business Perspective. In deferral accounting, there is a part of the payment that is left due to being paid in the future period by a company.Now when you make a purchase, then at that time, you make an entry, but when you make the payment later then, you need to adjust that entry, which is known as the deferral adjusting entry. This is called the matching principle in accounting. This procedure is known as postponement or deferral of expenses. MicroTrain has a beginning supplies balance of $ 500 and purchased $8,000 in supplies during the period. What is the resulting impact on the financial statements? And it reports accumulated depreciation in the balance sheet as a deduction from the related asset. The  $ 2,200 prepaid expense represents 11 months of insurance protection that remains as a future benefit. When subscribers to a magazine pay in advance for a year, the cash receipt is recorded as unearned subscription revenue, which is … Adjusting journal entry ensures that one does not overstate or understate both the income statement and the balance sheet. To learn more, see Explanation of Adjusting Entries. To record the adjusting entry, debit Deferred Compensation Expense for $914 and credit Deferred Compensation Liability for $914. The journal entry made on December 1, to record the purchase of the policy is illustrated in the following table (remember, when we pay for expenses in advance we record them as an asset): On December 31, an adjusting journal entry is made because it is the end of an accounting period and MicroTrain has not used all of the insurance they paid for. The firm recorded the following journal entry: The balance in the Unearned Service Revenues liability account established when MicroTrain received the cash will be converted into revenue as the company performs the training services. Thus, depreciation expense for December is $9,000 ÷ 12 = $750. Generally, adjusting journal entries are made for accruals and deferrals, as well as estimates. 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