 Hello, and welcome to the session in which we would look at adjusting entries. Adjusting entries are the basic component of accrual accounting. Accrual accounting is the basic for accounting. When you learn accounting, gap, you have to know accrual. Adjusting entries, those are the oxygen of accrual. So if you don't understand and if you don't know how to apply adjusting entries, you will have problems as an accounting students and you will have major problem as a CPA candidate. So in this session, I will go over different type of adjusting entries, explaining those concepts briefly and working this example. Now, most likely, if you are watching this recording, you are either a student taken an accounting course or an accounting major or a CPA candidate. I cannot I cannot emphasize this enough. It's extremely important that you are comfortable with adjusting entries because once you know how to do adjusting entries, you understand the four types, how adjusting entries are affected, which accounts do they affect on the balance sheet, which account do they affect on the income statement, then you will have relatively easier time understanding more advanced topic. But if you don't understand adjusting entries, you're going to carry that weakness throughout your accounting career all the way to getting your CPA exam. Now, if you're a CPA candidate, I strongly suggest you check out my website forhatlectures.com. I can be a useful addition. I don't replace your CPA review course. What I teach you is the basics. What I teach you is something different than your CPA review course. So that's why I consider myself as a supplement because CPA review courses, they assume, you know, adjustments, you may or may not know adjustments. Or if you didn't know it in the past, you may forgot how to do adjustments. Therefore, by explaining the material better, I can add 10 to 15 points to your CPA review score. Your risk with me is one month of subscription. Your potential return is passing your exam. And if not for any, if not for anything, take a look at my website to find out how well your university is doing on the CPA exam. I do have financial accounting courses, material, intermediate accounting, as well as other courses. So in addition to the lecture, I have additional resources like practice exercises, multiple choice through false. I strongly suggest you take a look at my website. Also on LinkedIn, connect with me and take a look at the students that use my system to succeed on the CPA exam. Please like this recording on YouTube, share it, connect with me on Instagram and Facebook. So let's take a look at this exercise. Now, the first thing you want to know about adjusting entries, we have four types. Four types. I'm not sure if we're going to go over all four types in this example. But every time I go through a type, once you understand the type, it's easier to deal with the journal entry. So let's take a look at the first example and see what type is it. And we'll go over them. Now, on farhatlectures.com, I have a detailed explanation about adjusting entries. This is just an exercise, but I will try to explain the concepts as well. Briefly, though, a three year fire insurance policy was purchased on July 1st, 2021 for twelve thousand two hundred and forty. The company debited insurance expense for the entire amount. OK, first, let's journalize the entry, what's what's I call basic a basic journal entry when this event occur. So this event occur. And by the way, we're doing everything as of December 31st. So all the adjusting entries were assuming the year end is December 31st. So on July 1st, this is what happened on July 1st. We bought the policy and we debited insurance expense for the entire amount. And we credited cash for the entire amount, obviously. So this is a basic journal entry. You purchased an insurance policy and you debited for and you debited insurance expense. Now, this is when you when you bought this policy, the assumption here is you're going to consume this policy by the end of the year. Well, that's not really true. OK, so basically this you could consider this an error or you can consider it as a temporary journal entry until we make the adjustment. OK, but this is not the proper way to journalize what happened on July 1st. What happened on July 1st? We purchased a prepaid because the prepaid is for three years. Now, the insurance policy was for six months and our year end is July, August, September, October, November, December. Six months and our year end is December 31st. It would have been OK to debit the expense, but that's not the case. So now we have to fix this error. We have to fix this error or again, rather than an error, let's call it an adjustment. The first thing is you want to know what type of adjustments are you making here? This is called a prepaid prepaid adjustment. Prepaid you are adjusting prepaid. This is a prepaid adjustment. How do you how are we going to fix this adjustment? Well, let's think about it. So let's look from a T account perspective. We have insurance expense and we have in there 12,240. Now we have to find out how much the actual insurance expense should be. So simply put, we have to reduce our insurance expense. We did not use up all the policy. The policy is for three years. Well, let's do this if let's get our calculators ready. So here's our calculator and we purchased. We paid 12,240 and we're going to divide this policy by 36 months. Why? Because it's for three years. So our monthly insurance expense is three hundred and forty dollars. How did I know this? Again, it's three years and the cost. So let me do it again. Twelve thousand. So you know this. OK, divided by 36 months equal to three forty. Now, the only expense that should be here is for July, August, September, October, November and December. So therefore, we're going to take this amount multiplied by six multiplied by six. And that's going to give us two thousand and forty dollars. That's the amount that should be here in insurance expense two thousand and forty. What does that mean? It means we have to back out of expense. We have to credit expense. We have to back out of expense. The amount that's going to give us two thousand and forty. Well, how do we do this? Well, we have 12 we are recording right now. Twelve thousand two forty of expense, which is incorrect. We're going to deduct from it two thousand and forty. And we have to back out ten thousand two hundred. So this is part of the entry. This is the credit for every credit. We have to have a debit. We're going to take it out of insurance expense and we're going to put it into, you guessed it, prepaid insurance, which is an asset. Prepaid insurance, which is an asset. Therefore, I'm going to debit my prepaid insurance expense. Ten thousand two hundred. My prepaid insurance balance is ten thousand two hundred. Therefore, I debit prepaid insurance ten thousand two hundred. And I removed it out of insurance expense. Ten thousand two hundred because the only expense I need to record, I need to record is only two thousand and forty dollars for July for the year. Twenty twenty one from July 1st till December 31st. Now, the way they did this entry, it's a little bit kind of from the beginning. They shouldn't have debit insurance expense. The way they should have done this, let me show you how should they have done this, just this way, you know, you understand, because the information could be given to you in two different ways. OK, let's assume they did it properly. Let's assume they journalize the entry properly. If they did, if they did journalize the entry properly, they would have debited prepaid insurance, twelve thousand two hundred and forty, credited cash, twelve thousand two hundred and forty. So I'm just telling you, if they did it properly, it should have been something like this on July 1st. This should have been July 1st rather than this entry. OK, then by December 31st, what should have they done is credited insurance expense two thousand and forty and credited prepaid insurance. Two thousand and forty. This is this is if they did it right from the beginning, right from the beginning, they should have had a prepaid rather than insurance expense. But at the end of the day, the same thing happened. What do I mean by the same thing? Let me erase this to show you that from a T account perspective, the same thing happened. So from a T account, notice starting with insurance expense, we only have two thousand and forty, two thousand and forty, two thousand and forty, that's the balance. Notice two thousand and forty prepaid insurance, prepaid insurance. We started with twelve thousand two hundred and forty, reduced it by two thousand and forty. We end up with ten thousand two hundred. Same thing, ten thousand two hundred. But this is the proper way. This this is the proper way of recording the prepaid as a prepaid. OK, so this is a prepaid adjustment. Usually if it's recorded properly, we increase an expense and we reduce an asset if it's recorded properly from the beginning. So when you adjust the prepaid, you are bringing the prepaid down and you are increasing the related expense. Now, remember, every adjusting entry will affect a balance sheet account and an income statement account. So notice here, this is the adjusting entry right here. An income statement account went up, a balance sheet went down. An income statement and a balance sheet. OK, let's erase all of this and move on to the next, next adjustment, next adjustment. Depreciation on the equipment, total ten thousand twelve thousand two hundred and fifty, hopefully you should memorize this by heart when you book depreciation. It's depreciation expense, accumulated depreciation. Notice depreciation expense is an income statement. It went up, accumulated depreciation is a balance sheet. It also went up. They both went up. Remember, we affect the balance sheet account and an income statement account. Remember, accumulated depreciation is a contra asset account is a contra asset account that goes on the balance sheet. So make sure you know this by heart. I mean, you get a depreciation entry on your exam, whether it's the CPA or your classroom, make sure you memorize it. Depreciation expense is a debit. It's an expense on the income statement. Accumulated depreciation is a contra asset reduces the asset that is depreciating. Whatever that asset is, make sure you know that. And this is also a prepaid, a form of prepaid, OK, prepaid adjustment. Notice in a prepaid adjustment, you increase an expense and you reduce an asset. I'm sorry, this was not the proper way because it was not done the proper way. But that's what we did. Actually, you increase an expense and usually you reduce an asset. Let's take a look at number three employee salaries of 16,500 for the month of December will be paid in early January 2022. Translation, well, the employee earned the money. But we will not be paying them till January. What does that mean from an accounting perspective? It means we have an expense at that expense is called accrued expense. Accrued expense is another type of adjusting entries and other types. So this is the second type. We said prepaid is one type accrued expense in the other accrued expenses. We always debit an expense and credit the related liability related payable. Here what we're doing is we are accruing. We are we are recording accruing means recording expenses for salaries. So what do we do? We debit salaries expense and we credit salaries payable. Salaries liability. So this is a form of what did we say? This is called accrued expenses, always accrued expenses. You increase an expense and you increase a liability. Notice an income statement account is the expense. A liability is a balance sheet. Notice when we do adjusting entries, we don't touch the cash unless we are adjusting, we are doing adjusting entries for the bank for the bank reconciliation. Then we will involve cash. Otherwise, generally speaking, adjusting entries will not involve cash, will not involve cash. This is another type. This is an accrued expense. Let's take a look at the fourth entry on November 1st. The company borrowed 190,000 from a bank. The note requires principal and interest at 12% to be paid April 30th, 2022. All right. Good. So let's first prepare the journal entry when the transaction took place. The transaction took place November 1st. Therefore, on November 1st, we are going to debit. Let's do this from the beginning. We are going to debit cash 190,000. I'm going to credit notes payable 190,000. Didn't you say we don't involve cash? Yes, this is not the adjusting entry. This is November 1st. The adjusting entry happened on December 31st. Now here's what happened on a timeline. Let me show you on a timeline what's going on here. Let me make this in red. On a timeline, we have the following are the following took place. We borrowed the money. November 1st, which is this is the journal entry for it. Then we're going to have to make an adjusting entry December 31st. Then we are going to pay off the loan. April 30th. OK, so this is what happened first. We did this entry now from November 1st till December 31st. We have all of November and all of December, the loan accrued interest for two months. Well, what we have to do is we have to compute the interest, which is 190,000 times 2 divided by 12 times 12 percent. Let's do this on a calculator here, 2 divided by 12. Let's get the fraction first, times 190,000 times point one, two, 12 percent, and that's 3,800, 3,800. So this is the interest expense that we have to accrue again. What type of adjusting entry accrued expense? What do we do under accrued expense? We are going to debit an expense and credit the related liability. Therefore, we are going to debit interest expense, 3,800 credit accrued credit, the liability, 3,800. So this is the adjusting entry. So this is on December 31st. Now, on April 30th, when we make the payment on April 30th, when we make the payment, let's do the payment anyhow, although it's not it's not required in this exercise, but let's do the payment. So we did November 1st. We took out the loan. We make the adjusting entry. Now we're going to make the payment April 30th on April 30th. Here's what we have to do on April 30th. We are going to so we have six months. So we're going to be six months. It's so first we have to compute how much interest we are going to pay 190,000 times 612 times 12%. It's going to give us the total interest. So 0.5 is 612. Oops, clear this 0.5 times 190,000 for the loan. 190,000 times 0.12. So the total interest we have to pay is 11,400. Let's generalize the entry. So now on April 30th, April 30th, we have to pay cash in total. We have to pay cash in total 190,000 plus 11,400 plus 100 and 90,000. We have to pay in cash 201,400. Well, part of it, it's going to be for the note. We're going to have to debit the note 190,000. Then remember, we have to remove the interest payable. Notice here, we have an interest payable. We said we owe the bank 3,800. Now we pay it. We have to debit interest payable 3,800. Now we still have a dozen balance. Now we have to record the expense that took place from this from January 1st till till April 30th. Well, the difference is 11,400 minus 3,800, because the total interest was 11,400. So let's do it that way. 11,400 minus 3,800. And that's the amount of interest expense. Interest expense, and that's going to be 7,600. OK, now also, if you want to do this, you can take 190,000 times 4 divided by 12 times 12 percent. It should give you 7,600, the amount of interest for this period. But I just took the total interest and back out the interest that we already recorded for this period, which is November and December. Right, so this is again in a crude interest journal entry, that I went further and I paid off the loan. This way I showed you how it all works. OK, let's work another adjusting entry. Five, on December 1st, the company received $6,000 in cash from another company that's renting office and Adams building, the payment representing rent for December, January, February. It was credited to the third rent revenue, at least they did it right. OK, so on December 1st, 12, 1, we received $6,000 in cash. Good, we debit cash, 6,000, and we credit. They said here they credited the third revenue. And this is what they should have done, the third rent revenue. And in your textbook, it might be called unearned revenue. That's fine, 6,000. This is the third type of adjusting entries unearned revenue. OK, this is unearned revenue. It means you received the money, but you haven't earned it yet. And they did it properly as of December 1st. The debited cash credited the third rent revenue. Now, December 31st, 12, 31. From December 1st to December 31st, I earned one month of revenue. Well, they gave me 6,000 for three months. Therefore, I earned 2,000. What I do on December 31st, I debit this account. I start to reduce this account. The third rent revenue, 2,000. And I will credit rent. I'd start to to to count the revenue, 2,000. Therefore, this is the adjusting entry right here. Now, from a T account perspective, my deferred rent revenue, I had 6,000 initially. I reduced it by two. I still have 4,000, and this is for the month of January and February, which I'm going to have to earn later on. When I earn, I do the same journal entry. This is a unearned revenue and unearned revenue. If it's booked properly, debiting cash credited rent revenue, you will reduce the liability and you will increase revenue. OK, this is unearned revenue. And the reason I said if it's booked properly, because what could have done is this, they could have debited cash and credited rent revenue, which would not be correct. And then the adjusting entry will be different. OK, but they did it properly. Let's look at transaction six. On December 1st, the company received $6,000 in cash from another company that's renting office space in Adams building. The payment was credited to rent revenue. Oh, OK, good. So now, we did not book the transaction properly. So here's what happened now. We debited cash 6,000 on December 1st, and we credited rent revenue. Now, you should know what we need to do. We need to take out 4,000 out of rent revenue, make it. So simply put, this happened on December 1st. They did it incorrectly. OK, so what do we have to do now on December 31st? We have to take out of rent revenue 4,000 because we haven't earned it yet. We only earned 2,000 and put it into unearned revenue. Therefore, I'm going to debit rent revenue for 4,000 and I'm going to credit the third rent revenue for another 4,000. Simply put, here's what happened. This is rent revenue. So initially, I had 6,000 in rent revenue. I'm going to debit it for in my rent revenue is only 2,000 for the month of December for rent revenue for the third rent revenue for the third rent revenue. I did not have anything that I need to put in 4,000. And I should have a balance. Just move it up a little bit further. OK, so for the third rent revenue and this is a liability, I had nothing. Then I booked 4,000. Therefore, I still have 4,000 for January and February. Back to what I'm supposed to have 2,000 only of revenue for 2021 and 4,000 of unearned revenue for January and February of 2022. So notice I'm back to exactly what I want to be. So notice number five is the correct proper proper way to do it. OK, now the only the only adjustment we did not work is an adjustment called accrued revenue and accrued revenue. You debit receivable and your credit revenue. This is the adjustment. Anyway, as I mentioned earlier, you can go to my website to to to to to look at more adjusting entries and explain and learn how to do adjusting entries. It's critical. It's extremely important that you understand this topic inside out, whether you are an accounting student or most importantly, a CPA candidate. All what I'm asking you is give me a chance for a month to help you. 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