Unearned revenue (also known as deferred revenue or deferred income)

represents revenue already collected but not yet earned.

Hence, they are also called "advances from customers".
Following the accrual concept of accounting, unearned revenues are considered
as are liabilities.
It is to be noted that under the accrual concept, income is recognized when
earned regardless of when collected.
And so, unearned revenue should not be included as income yet; rather, it is
recorded as a liability. This liability represents an obligation of the company to
render services or deliver goods in the future. It will be recognized as income
only when the goods or services have been delivered or rendered.
At the end of the period, unearned revenues must be checked and adjusted if
necessary. The adjusting entry for unearned revenue depends upon the journal
entry made when it was initially recorded.
There are two ways of recording unearned revenue: (1) the liability method, and
(2) the income method.
Liability Method of Recording Unearned Revenue
Under the liability method, a liability account is recorded when the amount is
collected. The common accounts used are: Unearned Revenue, Deferred Income,
Advances from Customers, etc. For this illustration, let us use Unearned
Revenue.
Suppose on January 10, 2016, ABC Company made $30,000 advanced collections
from its customers. If the liability method is used, the entry would be:
Jan 10 Cash 30,000.00  
    Unearned Revenue   30,000.00
Take note that the amount has not yet been earned, thus it is proper to record it
as a liability. Now, what if at the end of the month, 20% of the unearned
revenue has been rendered? This will require an adjusting entry.
The adjusting entry will include: (1) recognition of $6,000 income, i.e. 20% of
$30,000, and (2) decrease in liability (unearned revenue) since some of it has
already been rendered. The adjusting entry would be:
Jan 31 Unearned Revenue 6,000.00  
    Service Income   6,000.00

We are simply separating the earned part from the unearned portion. Of the
$30,000 unearned revenue, $6,000 is recognized as income. In the entry above,
we removed $6,000 from the $30,000 liability. The balance of unearned revenue
is now at $24,000.
Income Method of Recording Unearned Revenue
Under the income method, the accountant records the entire collection under
an incomeaccount. Using the same transaction above, the initial entry for the
collection would be:
Jan 10 Cash 30,000.00  
    Service Income   30,000.00
If at the end of the year the company earned 20% of the entire $30,000, then
the adjusting entry would be:
Jan 31 Service Income 24,000.00  
    Unearned Income   24,000.00
By debiting Service Income for $24,000, we are decreasing the income initially
recorded. The balance of Service Income is now $6,000 ($30,000 - 24,000),
which is actually the 20% portion already earned. By crediting Unearned Income,
we are recording a liability for $24,000.
Notice that the resulting balances of the accounts under the two methods are
the same (Cash: $30,000; Service Income: $6,000; and Unearned Income:
$24,000).
Another Example
On December 1, 2016, DRG Company collected from TRM Corp. a total of
$60,000 as rental fee for three months starting December 1.
Under the liability method, the initial entry would be:
Dec 1 Cash 60,000.00  
    Unearned Rent Income   60,000.00
On December 31, 2016, the end of the accounting period, 1/3 of the rent
received has already been earned (prorated over 3 months).

We should then record the income through this adjusting entry:

Dec 31 Unearned Rent Income 20,000.00  
    Rent Income   20,000.00
In effect, we are transferring $20,000, one-third of $60,000, from the Unearned
Rent Income (a liability) to Rent Income (an income account) since that portion
has already been earned.
If the company made use of the income method, the initial entry would be:
Dec 1 Cash 60,000.00  
    Rent Income   60,000.00
In this case, we must decrease Rent Income by $40,000 because that part has
not yet been earned. The income account shall have a balance of $20,000. The
amount removed from income shall be transferred to liability (Unearned Rent
Income). The adjusting entry would be:
Dec 31 Rent Income 40,000.00  
    Unearned Rent Income   40,000.00
Conclusion
If you have noticed, what we are actually doing here is making sure that the
earned part is included in income and the unearned part into liability. The
adjusting entry will always depend upon the method used when the initial entry
was made.
If you are having a hard time understanding this topic, I suggest you go over
and study the lesson again. Sometimes, it really takes a while to get the concept.
Preparing adjusting entries is one of the most challenging (but important) topics
for beginners.

Lesson5

Prepaid expenses (a.k.a. prepayments) represent payments made for expenses

which have not yet been incurred.
In other words, these are "advanced payments" by a company for supplies, rent,
utilities and others that are still to be consumed. Hence, they are included in the
company's assets.
Expenses are recognized when they are incurred regardless of when paid.
Expenses are considered incurred when they are used, consumed, utilized or has
expired.
Because prepayments they are not yet incurred, they are not recorded as
expenses. Rather, they are classified as current assets since they are readily
available for use.
Prepaid expenses may need to be adjusted at the end of the accounting period.
The adjusting entry for prepaid expense depends upon the journal entry made
when it was initially recorded.
There are two ways of recording prepayments: (1) the asset method, and (2) the
expense method.
Asset Method
Under the asset method, a prepaid expense account (an asset) is recorded when
the amount is paid. Prepaid expense accounts include: Office Supplies, Prepaid
Rent, Prepaid Insurance, and others.
In one of our previous illustrations (if you have been following our
comprehensive illustration for Gray Electronic Repair Services), we made this
entry to record the purchase of service supplies:
Dec 7 Service Supplies 1,500.00  
    Cash   1,500.00
Take note that the amount has not yet been incurred, thus it is proper to record
it as an asset.
Suppose at the end of the month, 60% of the supplies have been used. Thus,
out of the $1,500, $900 worth of supplies have been used and $600 remain
unused. The $900 must then be recognized as expense since it has already been
used.

In preparing the adjusting entry, our goal is to transfer the used part from the
asset initially recorded into expense – for us to arrive at the proper balances
shown in the illustration above.
The adjusting entry will include: (1) recognition of expense and (2) decrease in
the asset initially recorded (since some of it has already been used). The
adjusting entry would be:
Dec 31 Service Supplies Expense 900.00  
    Service Supplies   900.00
The "Service Supplies Expense" is an expense account while "Service Supplies" is
an asset. After making the entry, the balance of the unused Service Supplies is
now at $600 ($1,500 debit and $900 credit). Service Supplies Expense now has a
balance of $900. Now, we've achieved our goal.
Expense Method
Under the expense method, the accountant initially records the entire payment
as expense. If the expense method was used, the entry would have been:
Dec 7 Service Supplies Expense 1,500.00  
    Cash   1,500.00
Take note that the entire amount was initially expensed. If 60% was used, then
the adjusting entry at the end of the month would be:
Dec 31 Service Supplies 600.00  
    Service Supplies Expense   600.00
This time, Service Supplies is debited for $600 (the unused portion). And then,
Service Supplies Expense is credited thus decreasing its balance. Service Supplies
Expense is now at $900 ($1,500 debit and $600 credit).
Notice that the resulting balances of the accounts under the two methods are
the same (Cash paid: $1,500; Service Supplies Expense: $900; and Service
Supplies: $600).
Another Example
GVG Company acquired a six-month insurance coverage for its properties on
September 1, 2016 for a total of $6,000.
Under the asset method, the initial entry would be:
Sep 1 Prepaid Insurance 6,000.00  
     Cash   6,000.00
On December 31, 2016, the end of the accounting period, part of the prepaid
insurance already has expired (hence, expense is incurred). The expired part is
the insurance from September to December. Thus, we should make the following
adjusting entry:
Dec 31 Insurance Expense 4,000.00  
    Prepaid Insurance   4,000.00
Of the total six-month insurance amounting to $6,000 ($1,000 per month), the
insurance for 4 months has already expired. In the entry above, we are actually
transferring $4,000 from the asset to the expense account (i.e., from Prepaid
Insurance to Insurance Expense).

If the company made use of the expense method, the initial entry would be:
Sep 1 Insurance Expense 6,000.00  
    Cash   6,000.00
In this case, we must decrease Insurance Expense by $2,000 because that part
has not yet been incurred (not used/not expired). Insurance Expense shall then
have a balance of $4,000. The amount removed from the expense shall be
transferred to Prepaid Insurance. The adjusting entry would be:
Dec 31 Prepaid Insurance 2,000.00  
    Insurance Expense   2,000.00

Conclusion
What we are actually doing here is making sure that the incurred (used/expired)
portion is included in expense and the unused part into asset. The adjusting
entry will always depend upon the method used when the initial entry was made.
If you are having a hard time understanding this topic, I suggest you go over
and study the lesson again. Sometimes, it really takes a while to get the concept.
Preparing adjusting entries is one of the challenging (but important) topics for
beginners.

Lesson6

When a fixed asset is acquired by a company, it is recorded at cost (generally,

cost is equal to the purchase price of the asset). This cost is recognized as an
asset and not expense.
The cost is to be allocated as expense to the periods in which the asset is
used.This is done by recording depreciation expense.
There are two types of depreciation – physical and functional depreciation.
Physical depreciation results from wear and tear due to frequent use and/or
exposure to elements like rain, sun and wind.
Functional or economic depreciation happens when an asset becomes
inadequate for its purpose or becomes obsolete. In this case, the asset
decreases in value even without any physical deterioration.
Understanding the Concept of Depreciation
There are several methods in depreciating fixed assets. The most common and
simplest is the straight-line depreciation method.
Under the straight line method, the cost of the fixed asset is
distributed evenly over the life of the asset.
For example, ABC Company acquired a delivery van for $40,000 at the beginning
of 2012. Assume that the van can be used for 5 years. The entire amount of
$40,000 shall be distributed over five years, hence a depreciation expense of
$8,000 each year.

Straight-line depreciation expense is computed using this formula:

Depreciable Cost – Residual Value 
Estimated Useful Life
Depreciable Cost: Historical or un-depreciated cost of the fixed asset
Residual Value or Scrap Value: Estimated value of the fixed asset at the end
of its useful life
Useful Life: Amount of time the fixed asset can be used (in months or years)
In the above example, there is no residual value. Depreciation expense is
computed as:
= $40,000 – $0 
5 years
= $8,000 / year
With Residual Value
What if the delivery van has an estimated residual value of $10,000? The
depreciation expense then would be computed as:
= $40,000 – $10,000 
5 years
= $30,000 
5 years
= $6,000 / year
How to Record Depreciation Expense
Depreciation is recorded by debiting Depreciation Expense and crediting
Accumulated Depreciation. This is recorded at the end of the period (usually, at
the end of every month, quarter, or year).
The entry to record the $6,000 depreciation every year would be:
Dec 31 Depreciation Expense 6,000.00  

    Accumulated Depreciation   6,000.00

Depreciation Expense: An expense account; hence, it is presented in the

income statement. It is measured from period to period. In the illustration above,
the depreciation expense is $6,000 for 2012, $6,000 for 2013, $6,000 for 2014,
etc.
Accumulated Depreciation: A balance sheet account that represents the
accumulated balance of depreciation. It is continually measured; hence the
accumulated depreciation balance is $6,000 at the end of 2012, $12,000 in 2013,
$18,000 in 2014, $24,000 in 2015, and $30,000 in 2016.
Accumulated depreciation is a contra-asset account. It is presented in the
balance sheet as a deduction to the related fixed asset. Here's a table illustrating
the computation of the carrying value of the delivery van.
  2012 2013 2014 2015 2016

Delivery Van - Historical Cost $40,000 $40,000 $40,000 $40,000 $40,000

Less: Accumulated Depreciation 6,000 12,000 18,000 24,000 30,000

 Delivery Van - Carrying Value $34,000 $28,000 $22,000 $16,000 $10,000

Notice that at the end of the useful life of the asset, the carrying value is equal
to the residual value.
Depreciation for Acquisitions Made Within the Period
The delivery van in the example above has been acquired at the beginning of
2012, i.e. January. Therefore, it is easy to calculate for the annual straight-line
depreciation. But what if the delivery van was acquired on April 1, 2012?
In this case we cannot apply the entire annual depreciation in the year 2012
because the van has been used only for 9 months (April to December). We need
to prorate.
For 2012, the depreciation expense would be: $6,000 x 9/12 = $4,500.
Years 2013 to 2016 will have $6,000 annual depreciation expense.
In 2017, the van will be used for 3 months only (January to March) since it has a
useful life of 5 years (i.e. April 1, 2012 to March 31, 2017).
The depreciation expense for 2017 would be: $6,000 x 3/12 = $1,500, and thus
completing the accumulated depreciation of $30,000.
2012 (April to December) $ 4,500

2013 (entire year) 6,000

2014 (entire year) 6,000

2015 (entire year) 6,000

2016 (entire year) 6,000

2017 (January to March) 1,500

Total for 5 years $ 30,000

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Lesson7
Companies provide services or sell goods for cash or on credit. Allowing credit
tends to encourage more sales.
However, businesses that allow credit are faced with the risk that their
receivables may not be collected.
Accounts receivable should be presented in the balance sheet at net realizable
value, i.e. the most probable amount that the company will be able to collect.
Net realizable value for accounts receivable is computed like this:
Accounts Receivable - Gross Amount $ 100,000
Less: Allowance for Bad Debts 3,000
Accounts Receivable - Net Realizable Value $ 97,000

Allowance for Bad Debts (also often called Allowance for Doubtful Accounts)
represents the estimated portion of the Accounts Receivable that the company
will not be able to collect.
Take note that this amount is an estimate. There are several methods in
estimating doubtful accounts.The estimates are often based on the company's
past experiences.
To recognize doubtful accounts or bad debts, an adjusting entry must be made
at the end of the period. The adjusting entry for bad debts looks like this:
Dec 31 Bad Debts Expense xxx.xx  
    Allowance for Bad Debts   xxx.xx
Bad Debts Expense a.k.a. Doubtful Accounts Expense: An expense account;
hence, it is presented in the income statement. It represents the estimated
uncollectible amount for credit sales/revenues made during the period.
Allowance for Bad Debts a.k.a. Allowance for Doubtful Accounts: A balance
sheet account that represents the total estimated amount that the company will
not be able to collect from its total Accounts Receivable.
What is the difference between Bad Debts Expense and Allowance for Bad
Debts?
Bad Debts Expense is an income statement account while the latter is a balance
sheet account. Bad Debts Expense represents the uncollectible amount for credit
sales made during the period. Allowance for Bad Debts, on the other hand, is the
uncollectible portion of the entire Accounts Receivable.
You can also use Doubtful Accounts Expense and Allowance for Doubtful
Accounts in lieu of Bad Debts Expense and Allowance for Bad Debts. However, it
is a good practice to use a uniform pair. Some say that Bad Debts have a higher
degree of uncollectibility that Doubtful Accounts. In actual practice, however, the
distinction is not really significant.
Here's an Example
Gray Electronic Repair Services estimates that $100.00 of its credit revenue for
the period will not be collected. The entry at the end of the period would be:
Dec 31 Bad Debts Expense 100.00  
    Allowance for Bad Debts   100.00
Again, you may use Doubtful Accounts. Just be sure to use a logical (and
uniform) pair every time. For example:
Dec 31 Doubtful Accounts Expense 100.00  
Allowance for Doubtful
      100.00
Accounts
If the company's Accounts Receivable amounts to $3,400 and its Allowance for
Bad Debts is $100, then the Accounts Receivable shall be presented in the
balance sheet at $3,300 – the net realizable value.
Accounts Receivable (Gross Amount) $ 3,400
Less: Allowance for Bad Debts 100
Accounts Receivable - Net Realizable Value $ 3,300
Lesson8

An adjusted trial balance is prepared after adjusting entries are made and posted
to the ledger.
This is the second trial balance prepared in the accounting cycle. Its purpose is
to test the equality between debits and credits after adjusting entries are entered
into the books of the company.
To illustrate how it works, here is a sample unadjusted trial balance:
Gray Electronic Repair Services

Unadjusted Trial Balance

December 31, 2016

         

Account Title   Debit   Credit

Cash   $    7,480.00    

Accounts Receivable   3,400.00    

Service Supplies   1,500.00    

Furniture and Fixtures   3,000.00    

Service Equipment   16,000.00    

Accounts Payable       $    9,000.00

Loans Payable       12,000.00

Mr. Gray, Capital       13,200.00

Mr. Gray, Drawing   7,000.00    

Service Revenue       9,550.00

Rent Expense   1,500.00    

Salaries Expense   3,500.00    

Taxes and Licenses   370.00    

Totals   $  43,750.00   $  43,750.00

At the end of the period, the following adjusting entries were made:
Dec 31 Accounts Receivable 300.00  

    Service Revenue   300.00

         

  31 Utilities Expense 1,800.00  

    Utilities Payable   1,800.00

         

  31 Service Supplies Expense 900.00  

    Service Supplies   900.00

         

  31 Depreciation Expense 720.00  

    Accumulated Depreciation   720.00

         

After posting the above entries, the values of some of the items in
the unadjusted trial balance will change. Take the first adjusting entry. Accounts
Receivable is debited hence is increased by $300. Service Revenue is credited for
$300.
The balance of Accounts Receivable is increased to $3,700, i.e. $3,400
unadjusted balance plus $300 adjustment. Service Revenue will now be $9,850
from the unadjusted balance of $9,550.
Next entry. Utilities Expense and Utilities Payable did not have any balance in the
unadjusted trial balance. After posting the above entries, they will now appear in
the adjusted trial balance.
Third. Service Supplies Expense is debited for $900. Service Supplies is credited
for $900. The Service Supplies account had a debit balance of $1,500. After
incorporating the $900 credit adjustment, the balance will now be $600 (debit).
And fourth. There were no Depreciation Expense and Accumulated Depreciation
in the unadjusted trial balance. Because of the adjusting entry, they will now
have a balance of $720 in the adjusted trial balance.
Adjusted Trial Balance Example
After incorporating the adjustments above, the adjusted trial balance would look
like this. Just like in the unadjusted trial balance, total debits and total credits
should be equal.
Gray Electronic Repair Services

Adjusted Trial Balance

December 31, 2016

         

Account Title   Debit   Credit

Cash   $    7,480.00    

Accounts Receivable   3,700.00    

Service Supplies   600.00    

Furniture and Fixtures   3,000.00    

Service Equipment   16,000.00    

Accumulated Depreciation       $      720.00

Accounts Payable       9,000.00

Utilities Payable       1,800.00

Loans Payable       12,000.00

Mr. Gray, Capital       13,200.00

Mr. Gray, Drawing   7,000.00    

Service Revenue       9,850.00

Rent Expense   1,500.00    

Salaries Expense   3,500.00    

Taxes and Licenses   370.00    

Utilities Expense   1,800.00    

Service Supplies Expense   900.00    

Depreciation Expense   720.00    

Totals   $  46,570.00   $  46,570.00

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