Hello everyone, welcome to course 3, week 1. This week we're going to be talking about the adjusting entries and adjusted trial balance. Let's take a look at our learning objectives. First, we will recognize the need for adjusting entries and when they are required. Next, we'll understand the methodology and procedure of recording adjusting journal entries, and then finally, we will learn how to prepare the adjusted trial balance. Let's take a look at the accounting cycle. Look at that, we are on step 5, record and post adjusting entries. Let's take a look at why adjusting entries are required. They are required to follow the revenue and expense recognition principles, where we recognize revenue when it is earned and expenses when they are incurred. They're needed because the first trial balance may not contain updated information regarding revenues and expenses at the end of each accounting period. Adjusting entries will include one income statement account and one balance sheet account. There are two categories of adjusting entries, deferral entries, which include prepaid expenses and unearned revenue and accrual entries, which include accrued revenue and accrued expenses. We will go through each one of these. Let's start with prepaid expenses. Prepaid expense is an asset, it is a payment of an expense before it is used or consumed by the organization. For example, prepaid insurance, prepaid rent, and supplies. An adjusting entry is required due to the asset expiring through time or through use. We debit or increase an expense and credit or decrease an asset account or a contra asset account. Let's take a look at our first example. Example a, prepaid insurance, on October 30th, 2022, Kiki company paid $5,200 for insurance for the next three months, November 2022, December 2022, and January 2023. What would the original entry have been made on 10-30-2022? We would have debited prepaid insurance for 5,200 and credited cash for 5,200. What is the monthly insurance used? We'll have to do a simple calculation. We'll take that $5,200, divide it by 3, and get $1,400 per month. What is the monthly insurance used for November? Fourteen hundred dollars. So what would the entry be? We would debit insurance expense for $1,400 and credit prepaid insurance. We will increase an expense and decrease the asset. Let's take a look at our second example regarding supplies. On October 31st, 2022, Kiki company paid $7,500 for supplies. At the end of November, employees did a physical count and valued the supplies on hand to be 4,250. The original entry on 10-31-2022 would have been a debit to supplies and a credit to cash. What is the amount of supplies used during the month? What we need to do is subtract that 4,250 from 7,500. We get the amount of supplies used during the month to be 3,250. What is the adjusting entry on 11/30? We will debit supplies expense for that 3,250 and credit supplies. Notice we increased an expense and decreased an asset. Now, let's talk about depreciation. Depreciation is for fixed assets, for example, equipment and furniture and the cost is recorded at the original cost. The cost of that fixed asset is charged over the life of the asset. The cost is called depreciation. It is called depreciation expense. Versus the previous two examples, prepaid expense and supplies, the asset is not credited because per generally accepted accounting principles, the cost of that fixed asset must be kept at cost on the balance sheet. We have a brand new account called accumulated depreciation. This is a contra asset. It behaves the opposite of an asset. It's normal balance is a credit. Also, a very new definition is book value. Book value of a fixed asset is the original cost of that fixed asset minus its accumulated depreciation. There are several ways to calculate depreciation. We will be using straight line depreciation in this course. There are other accelerated methods of depreciation that a company can use for tax purposes which benefits them to decrease the amount of tax that they have to pay. Let's take a look at straight-line depreciation. Salvage value is what the fixed asset can be sold for at the end of its useful life. Our calculation for monthly depreciation is the asset's cost minus salvage value divided by the estimated useful life in months. The estimated useful life tends to be per various tax schedules of fixed asset class useful lives. Let's take a look at our third example. Example c, office equipment. On October 30th, 2022, Kiki company paid $17,000 for office equipment. The office equipment has a useful life of three years or 36 months and the salvage value of the office equipment is $2,600. What would the original entry have been during the purchase of the office equipment? We would have debited office equipment for 17,000 and credited cash for 17,000, assuming we paid with cash. What is the monthly depreciation? We'll take the cost, which is the 17,000, subtract out the salvage value of 2,600 and divide it by the 36 months, which gives us a monthly depreciation of $400 per month. What is the adjusting entry on 11-30-2022? We will debit depreciation expense, dash office equipment for $400 and credit that contra asset account called accumulated depreciation dash office equipment. Each type of fixed asset has its own depreciation expense account and definitely its own accumulated depreciation account. That's why we have dash office equipment so that we can calculate the book value of each fixed asset. Let's take a look at that book value. We have the original cost of the office equipment 17,000, subtract out that one month of accumulated depreciation, so the book value of that office equipment is $16,600.
