 Hello and welcome to the session in which we would look at bootcamp part 2 for the FAR CPA exam. In this session we will review adjusting entries. This is a series of my bootcamp FAR exam starting with how to analyze transaction using t-accounts, using the accounting equation, how to journalize and post the ledger, and how to prepare a trial balance. So in the prior session, basically part one of five, we looked at these steps and as a result we end up with this trial balance as of October 31st, 2024. Now these numbers are giving to you, but each of these numbers we build step by step until we got to this trial balance. So if you'd like to look at how we came up with this trial balance, please look at the prior section. Now in this session I'm going to be referring, this is what we did in the prior session, but the numbers are giving to us here. In this session we're going to be going over the adjusting entries, how to prepare adjusting entries. It's extremely important to know how to prepare adjusting entries. There are four types of adjusting entries, whether you are a CPA candidate or an intermediate accounting student you will need to be aware of, need to be comfortable with, need to know how these adjusting entries will affect the financial statements. I will help you whether you are an accounting student or a CPA candidate understand those adjusting entries. Whether you are an accounting student or a CPA candidate, I encourage you to take a look at my website, farhatlectures.com. I don't replace your CPA review course, you keep it. My material is a useful addition to your CPA review course. I explain the material differently. I help you and explain the material in a different way than your CPA review course, so it might click. As a result, your CPA review course will make more sense. As a result you will pass the exam. Your risk is one month of subscription, your potential gain is passing the exam. If not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. I do have courses for other, I have resources for other courses as well and my supplemental courses are aligned with your course, whether you are taking back a Roger, Wiley or Glyme, they are aligned to go with your course. If you haven't connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, connect with me on Instagram, Facebook, Twitter and Reddit. So we're going to be working with the adjusting entries as of October 31st, 2024. As I mentioned earlier, we have four types of adjusting entries. I'm going to break them down into two main groups. We have the deferrals and we have the accruals. Under the deferrals we have prepaid expenses. Sometime we can call it in your textbook or in your review course might be called rather than prepaid, it might be called deferred, same thing. We have unearned revenue, same exact thing. In your book it might be called deferred, same exact thing. Under accrual we have accrued revenues and accrued expenses. In total we have four. And if you know anything about me, once we have a list of items, I'm going to go over each item separately starting with prepaid expenses. And I'm going to be working with this trial balance to adjust the prepaid accounts. Remember, we are working as of October 31st, 2024, starting with prepaid expenses, one of four adjusting entries. First thing is what are prepaid expenses? Well, prepaid expenses are any time you pay cash in advance of the expense. So before the expense was incurred, you prepaid for the expense. And prepaid will benefit future period. What could be some examples of prepaid? Well, you can prepay your insurance. You can prepay your rent. Supplies is a form of prepaid. Any prepaid account is a prepaid. Building an equipment is a form of a prepaid. Why? Because you would, you will buy those building and equipment and you will use them in the future where the expense takes place in the future. You can prepay for your advertising. Simply put, any expense can be prepaid. Now for our purposes, first you need to identify, you need to know which account needs adjustments in form of prepaid. I would say for our purposes, we purchase some supplies, we purchase prepaid rent, and we have equipment. So simply put, in the real world, or this is how it works, we need to ask ourselves, it seems we have 3,000 of supplies. Ask the employees, do we still have 3,000 worth of supplies? And if they say, yes, we still have 3,000 worth of supplies. No adjustment is needed. If we have 3,000 of supplies, our trial balance showing 3,000, then we have 3,000. There is a good chance, we don't have 3,000 of supplies, because this amount is when we, at the beginning of the period, or when we purchase the supplies. At the end of the period, we might have lost some supplies, not lost, use them, or lost for that matter. So if that supplies is consumed, then we have to reduce our supplies. Therefore, a typical prepaid will take the following journal entry. When we adjust prepaid, assuming it was recorded as a prepaid initially, again, assuming it was recorded as a prepaid initially, which is the normal way in quote, we reduce the prepaid, and we increase the, the related expense. And the best way to do it is to work an example. Right now, we have a prepaid called supplies, and we have 3,000 in that prepaid. Let's see what happened after our employee counted the supplies. After the employee counted the supplies, at month end count, they show we still have 500. So right now, we have 3,000. That number is incorrect. That number should be 500. This is the correct balance. What does that mean? It means I have to make an adjusting entry. I have to reduce my supplies by 2,500. I would reduce my supplies. As a result, I have to expense my supplies. I will debit supplies expense. So the entry will take place, will take, increase my expense, reduce my asset supplies. Notice by 2,500. As a result, I have the proper balance of 500. What happened if I did not book this entry? If I did not book this entry, my assets will be overstated. I will have more assets. I will show 3,000. Well, in fact, I only have 500. My expenses will always be understated by 2,500. As a result, my profit will be overstated by 2,500 because I reported less expenses. So notice how this adjusting entry affect the balance sheet and affect the income statement as well. So we're done with this supplies. Basically, the supplies it's going to go to 2,500. Now, we said prepaid rent is another form of prepaid and we need to ask ourselves, do we still have this much of prepaid? And the answer is most likely not. Okay, most likely not. We have 12,000 of prepaid rent. We purchased this prepaid rent on October 15th. Guess what? And we purchased it for one year. Therefore, if we take 12,000 divided by 12, our prepaid are consumed at $1,000 per month. However, since we bought it on October 15th, we're going to have to reduce it. We have to split this $1,500 because since October the 15th, we consumed $500. What does that mean? It means we have to credit our prepaid $500. Now, the prepaid balance is $11,500 and we have to debit our rent expense $500. So simply put, our expenses are increased, our prepaid are reduced. Now, the new prepaid balance minus $500 is $11,500 and the supplies was minus $2,500 and the remaining is $500. So this is how we adjusted our prepaid rent. So we're done with supplies, done with prepaid, and we'll do the same thing whether we have more prepaid or not. Equipment, as I told you, property, plant, and equipment are a form of prepaid. But remember, property, plant, and equipment, how do we consume them? Well, we really don't consume them, we use them up. They benefit our business. Property, plant, and equipment, they get depreciated. So what's going to happen, part of this $9,000, it's going to be turned into a depreciation expense. For the purpose of this session, since I'm teaching you how to prepare adjustments, I'm going to be giving you the depreciation amount. But you're going to have to learn eventually how we come up with this number. So I'm going to say estimated depreciation happens to be $250. What does that mean? It means now you have to record an expense called depreciation expense for $250. Therefore, you debit depreciation expense $250. What do you credit? Well, for property, plant, and equipment, you don't credit the account itself. We're going to create a sub-account called accumulated depreciation equipment. This account is a contra asset. It serves to serve the equipment account. Therefore, you're going to still have the equipment reported at $9,000. On the balance sheet, you're going to deduct accumulated depreciation. It's going to reduce it by $250. And that's going to give us $87.50. And this is called the book value of the equipment. Same concept. If you did not book this entry, your expenses will be understated. You will have less expenses. As a result, your profit will be higher and your asset will be shown at $9,000, while your asset should be shown at book value $87.50. Your assets are overstated. So it's very important to understand how prepaid expenses work. It doesn't matter now which prepaid expense are you dealing with. When you adjust the prepaid, assuming it was recorded initially as a prepaid, you reduce the prepaid and you increase the expense. Now, why am I saying initially recorded as a prepaid? Because some prepaid, what some companies do, they first initially, they record everything in expenses. Then they make an adjustment, take it out of expenses, whatever is not used and put it into prepaid. Well, that's a story for a different lecture. Okay, but this is what we have here. We have to, in the session, since we're learning the basics, you have to know the basics. And eventually, when you are faced with that exception, which is the alternative method, you'll be able to do it. Now, let me show you from a trial balance perspective what happened to each account. These are the unadjusted balances. This is the adjusted column. And these are the adjusted balances. Again, we dealt with three account supplies, prepaid and equipment supplies was $3,000. We credited supplies, the adjusted balance $500. Prepaid equipment was $12,000. We reduced it by $500. The adjusted balance is $11,500. Equipment, we did not have accumulated depreciation. We credited accumulated depreciation. Now the balance is $250. And for every credit, we have a debit. We debited supplies expense. We debited rent expense. We debited depreciation expense. And those are their balances because they did not have any existing prior balance. The next adjustment is unearned revenue. This is adjustment two or four. What is unearned revenue? Unearned revenue is when you are receiving the cash in advance of performing the service. So you receive the cash in advance of the revenue. That's how it works. Somebody pay you, but you did not do the work yet. You're going to have to do the work in the future. In the real world, when you subscribe for a magazine, when you buy your airline ticket, when you pay for your hotel, these are all unearned revenue for the seller. And what happened is until they perform the service, they cannot look it as revenue. So let's take a look at our trial balance and see if we have an unearned revenue. It looks here that we have 4,000 unearned revenue. Somebody paid us 4,000 in advance. How do we adjust unearned revenue? Unearned revenue, it's always going to go down once we adjust it because we already have the unearned revenue. So we have 4,000 and unearned revenue. Unearned revenue will go down and as a result, revenue will go up. So as a result, we're going to earn this revenue. So what Adam did, this is Adam Company earned one fourth of the 4,000. One fourth means earned a thousand. One fourth of 2,000 is a thousand. So what does that mean? It means I'm going to debit unearned revenue a thousand. I'm going to credit my revenue a thousand. So this is the journal entry. Now how much unearned revenue do I have left? The balance is 3,000. The 3,000 is the balance, just as a result of reducing the unearned revenue from four to three. So simply put, it's going to go from four minus 1,000. The unearned revenue will be three. Notice what happened if we did not book this entry. If we did not book this entry, we will have less revenues, $1,000 less, and we will have more liabilities of $1,000 because our liabilities went down. We would have more liabilities. So we really want to make sure we book our unearned revenue. If we have unearned revenue, we want to record it as revenue. If we want to look good, right? And that's what we want to do. From the trial balance, notice we had 4,000 of unearned revenue. We're going to debit unearned revenue a thousand. The remaining balance, the adjusted balance is straight. And what's going to happen, I had only 10,000 of revenue. I'm going to add a thousand to it from the unearned revenue. Now my revenue is 11,000. The third type of adjusting entries are called accrued revenues. This is three or four. First, we need to know what are accrued revenues. Well, accrued revenues are revenues performed but not recorded. So we did the work, but we did not record the work. Well, guess what? If we did the work, it's revenue. Therefore, we have to report it as revenue. So other example could be any work done but not yet recorded. You did the work for someone. You did not record as revenue. It's time to record the revenue. So how do you record accrued revenue? Very simple. You're going to record the revenue. You're going to increase the revenue, but obviously you did not get paid. You're going to increase an account receivable. So every time you adjust revenues, I'm sorry, every time you adjust accrued revenues and accrued means record. This is the accrual. What do you do? You're going to debit receivable credit revenue. Well, let's take a look at this. Adam Inc. performed $4,000 of work not yet billed. So we did the work. We were busy. We did not bill the client. It's the end of October. We told our accountant, look, we did the work. We did not bill the client, record $4,000 of revenue and obviously bill them as well for that matter. So what we do is we debit account receivable and we credit consulting revenues. So simply put, we're going to add another $4,000 to account receivable and we're going to add another $4,000 to our revenue. Otherwise, our revenues are understated in our assets. Account receivable are understated. So from a trial balance perspective, the account receivable here was $4,000. We're going to add to it $4,000 and we're going to end up with $8,000. Okay, we're going to end up with $8,000 of account receivable. Revenues was $10,000. We added $1,000. Then we added $4,000. Now account receipt revenue is $15,000. The adjusted balance. The fourth type of adjusting entries are called accrued expenses. Accrued expenses sounds like accrued revenues, but rather than revenues, they are expenses. What are they? Expenses incurred, but not yet recorded. Just like we have revenues that we did not record, we might have expenses that we did not record. Examples could be salaries, interest expense, any expense that you know you have to account for, but you have not yet. It's the end of the period. If it's related to that period, you book that accrued expense. So simply put, you're going to increase an expense when you book accrued expense, but since you're not paying it now, you're going to increase a liability. So if you debit rent expense, you credit rent payable. If you debit salaries expense, you credit salaries payable. If you debit XYZ expense, you credit XYZ payable. So this is basically you have to find out what expenses that you accrued. So for example, the assistant earned $1,000 worth of salaries, but not yet paid at the end of October. So the assistant that worked with Adam at his consulting company earned $1,000, but Adam did not pay this individual by the end of the month. Well, if not, we have to debit salaries expense $1,000, credit salaries payable $1,000. Why? Because we have to accrue this expense. We have to accrue. Otherwise, our expenses are understated and our liabilities are understated. Simply put, we are responsible for $1,000 for that assistant. I hope this makes sense. Another example will be interest incurred as of October on the notes payable. You remember we borrowed money on the notes payable is $100. What does that mean? It means because we had a loan at the bank by the end of the month. The loan accrued interest. Interest is an expense. We did not pay the interest yet, but we have to record the interest expense. Remember, it's a matching principle. We have to match the expense to that period. Therefore, same concept. We're going to debit interest expense credit the related payable interest payable. So accrued expenses, you would always increase an expense and increase a payable the related table to that expense. Why? Because you are recording an expense not yet paid. Eventually, you will pay it. Once you pay it, you would reduce the payable and you would reduce the cash once you pay that expense. Let's take a look at this at the trial balance. Now we debited interest expense $100. We credited interest payable. We did not have interest payable. Now we have 100 of interest payable. We did not have interest expense. Now we have 100 of interest expense. And also we accrued, what else did we accrue? We accrued wages. We accrued $1,000 worth of wages. We debited wages and we credited salaries and wages payable. Now wages expense total is $6,000. Let's take a look at the complete adjusted trial balance. Now we move everything to the end. Now we are ready to complete the adjusted balance. $68,000. We did not adjust cash. Eventually, we'll get to that. Account receivable went from $4,000 to $8,000 because we added another $4,000. Supplies went from $3,000 to $500. Prepaid went from $12,000 to $11,500. Equipment stayed the same. Not really. But we reduced it by accumulated depreciation. The notes are still the same. Accounts payable the same. Unearned service revenue was $4,000. We reduced it to $3,000 by debiting it $1,000, so on and so forth. For example, our salaries expense were $5,000. We added $1,000. Now it's $6,000. Service revenue were $10,000. We added $5,000. Now it's $15,000. The few things I want to, hopefully you notice as we are going through this, adjusting entries would always affect an income statement account and a balance sheet account. So if you look at any of these entries, for example, if we take the $4,000, we debited account receivable, credited revenue account receivable. It's a balance sheet account. Revenue is an income statement. So you're always affecting either a balance sheet or an income statement, and always you are increasing either a revenue or an expense. So you're affecting a revenue or an expense. Usually, if it's the proper entries, they're both going up. Okay, if we're going through, we're not using the alternative method. Now this is the adjusted trial balance as of October 31st. In the next session, I'm going to say this is the adjusted trial balance that we prepared in this session. And based on this adjusted trial balance, we are ready to prepare our financial statements. So in the next session, what I'm going to do, I'm going to start to prepare financial statements based on this adjusted trial balance. Now you know how to prepare this. At the end of this recording, I'm going to remind you whether you are an accounting student or a CPA candidate, farhatlectures.com can help supplement your CPA exam preparation. I am in addition, I don't replace your CPA review course. My material is aligned to go with your CPA review course will help you with that CPA review course. Also, I have the AI CPA previously released questions. Invest in your career, invest in yourself. Your CPA exam is a lifetime investment. Good luck, study hard, and of course, stay safe.