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Journal Entries Only
- Depreciation adjusting entries vary mainly in the specifics of the Accumulated Depreciation account you're dealing with. While the journal entry structure remains consistent—Debiting Depreciation Expense and Crediting Accumulated Depreciation—the Accumulated Depreciation account may specify the type of asset.
- For example, ‘Accumulated Depreciation - Building' or 'Accumulated Depreciation - Equipment’, etc.
- Thankfully, this is not nearly as complicated as the variations seen before in Prepaids! However, it’s still a good thing to know to ensure you get all the points on your exam.
- This is simply a hypothetical scenario.
- Depending on your exam, you may have only one revenue account to close (e.g. Fees Earned), or multiple revenue accounts needing closing (Fees Earned, Consulting Revenue, Rent Revenue, Sales, etc.).
- In essence, the point I’m trying to illustrate is that, whatever revenues you see on the income statement — they will ALL need to be closed!
- This is simply a hypothetical scenario.
- Depending on your exam, you may have only one expense account to close (e.g. Cost of Goods Sold), or multiple expense accounts needing closing (Depreciation Expense, Wages Expense, Rent Expense, Advertising Expense, etc.).
- In essence, the point I’m trying to illustrate is that, whatever expenses you see on the income statement — they will ALL need to be closed!
- Remembering the closing entry for Income Summary, in a Net Income scenario, becomes way easier when we focus on why Retained Earnings, an equity account (-/+), is credited.
- Recall that crediting an equity account (-/+), like Retained Earnings, will INCREASE that account.
- If we have Net Income, why should we increase Retained Earnings when closing Income Summary?
- Because Net Income for the period does exactly that—it gets added to the Retained Earnings account!
- To illustrate this, reflect on the Statement of Retained Earnings formula from previous chapters:
- Seeing it?
- Notice that when closing the Income Summary account under a Net Income scenario — we need to increase Retained Earnings by crediting it, since we know that Net Income is added to Retained Earnings!
- If you remember this, you'll automatically know that the opposite side, the debit, goes to Income Summary.
Beginning R/E
*PLUS NET INCOME*
Minus Dividends
Equals Ending R/E
- Remembering the closing entry for Income Summary, in a Net Loss scenario, becomes way easier when we focus on why Retained Earnings, an equity account (-/+), is debited.
- Recall that debiting an equity account (-/+), like Retained Earnings, will DECREASE that account.
- If we have a Net Loss, why should we decrease Retained Earnings when closing Income Summary?
- Because Net Loss for the period does exactly that—it gets subtracted from the Retained Earnings account!
- To illustrate this, reflect on the Statement of Retained Earnings formula from previous chapters:
- Seeing it?
- Notice that when closing the Income Summary account under a Net Income scenario — we need to decrease Retained Earnings by debiting it, since we know that Net Income is added to Retained Earnings!
- If you remember this, you'll automatically know that the opposite side, the credit, goes to Income Summary!
Beginning R/E
*MINUS NET LOSS*
Minus Dividends
Equals Ending R/E
- Recall that debiting an equity account (-/+), like Retained Earnings, will DECREASE that account.
- If we’ve paid Dividends, why does this decrease Retained Earnings?
- Because Dividends for the period do exactly that—they gets subtracted from the Retained Earnings account!
- To illustrate this, reflect on the Statement of Retained Earnings formula from previous chapters:
- Seeing it?
- Connecting the closing of Dividends to the idea that Dividends are subtracted in the Statement of Retained Earnings can be a super useful memorization tool.
- If you remember that Dividends decrease Retained Earnings — it will help you recall that Retained Earnings must be debited when closing out Dividends!
Beginning R/E
Plus Net Income
*Minus Dividends*
Equals Ending R/E
Journal Entries with Explanations
- "Supplies Remaining" is Given: When the problem states the amount of "supplies remaining," you have to calculate the supplies that have been used up. To do this, subtract the "remaining" supplies from the initial amount purchased. The result is the amount you will use to Debit Supplies Expense and Credit Supplies.
- Example: If you started with supplies worth $5,000 and the problem states that $1,000 worth of supplies remain, then $4,000 ($5,000 - $1,000) worth of supplies have been used up. Your entry would be a Debit to Supplies Expense for $4,000 and a Credit to Supplies for $4,000.
- "Supplies Used" is Given: In this case, the problem tells you outright the amount of supplies used. You directly use this amount for your adjusting entry. There's no need for any additional calculations.
- Example: If the problem tells you that supplies worth $3,000 have been used, you Debit Supplies Expense for $3,000 and Credit Supplies for $3,000.
Regardless of the scenario, the journal entry's structure stays the same: Debit Supplies Expense and Credit Supplies. However, the amount to be debited or credited changes based on whether the problem states "remaining" or "used" supplies.
Word to the Wise: Some professors might try to confuse you by changing the phrasing between questions. A single word can flip your calculation approach. Always read the questions carefully to understand what's being asked and adjust your calculations accordingly.
- In the original entry on November 1st, Survive Company pays $2,500 in cash for supplies. This transaction is recorded as a debit to Supplies, an asset account (+/-), to reflect the increase in the value of supplies owned by the company.
- Simultaneously, Cash, another asset account (+/-), is credited for the same amount. The credit to Cash serves to decrease the cash balance.
- This aligns with your Cash Cheat Code; whenever cash is paid, it is always recorded as a credit because cash is an asset that needs to be decreased.
The $2,800 Supplies Expense that was debited is calculated as follows:
- The company started the year with $1,000 in supplies and bought an additional $2,500, totaling $3,500 in available supplies.
- A year-end inventory count showed that only $700 remains in Supplies.
- The used portion is $3,500 - $700, which equals $2,800 in Supplies Expense.
- We debit Supplies Expense to increase it, as it’s an expense account (+/-).
The $2,800 Supplies that was credited is calculated as follows:
- The total Supplies before the adjusting entry would show as $3,500.
- After counting, only $700 remains, so the used portion of $2,800 needs to be removed from the Supplies account.
- We credit Supplies, an asset account (+/-), to decrease its balance down to the correct year-end amount of $700.
- Refer to the T Account below for reference.
By recording both these entries, we can see that A = L + E remains in balance.
Original Entry on Nov 1: Assets = Liabilities + Equity ↓ 2.5k ↑ 2.5k
- In the original entry on November 1, Survive Company pays $2,500 for supplies. The debit to the Supplies account increases assets by $2,500.
- Simultaneously, the company credits the Cash account, decreasing its assets by $2,500. This way, the transaction effectively trades one asset (Cash) for another (Supplies).
- The accounting equation A = L + E remains in balance because assets go up by $2,500 and down by $2,500, maintaining equilibrium.
Adjusting Entry on Dec 31: Assets = Liabilities + Equity ↓ 2.8k ↓ 2.8k
- On December 31, an adjusting entry is required. Supplies worth $2,800 were consumed and therefore are moved to Supplies Expense.
- The debit to Supplies Expense for $2,800 increases the expense, which decreases Equity by the same amount (since expenses reduce equity).
- On the other side of the transaction, the Supplies asset account is credited by $2,800, effectively reducing the Assets.
- As a result, the equation stays in balance: The decrease in Assets (Supplies) of $2,800 is offset by a corresponding decrease in Equity (through Supplies Expense), maintaining the A = L + E equation.
⚠️ Be extremely careful not to debit Supplies Expense when simply purchasing Supplies!
❌ Incorrect Example
On January 1st, Survive Company purchases $1000 worth of supplies on credit.
Supplies Expense 1,000
Cash 1,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Purchasing supplies does not mean we should debit an expense account. Why not? Well, simply purchasing supplies doesn't mean we've used any of them!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On January 1st, Survive Company purchases $1000 worth of supplies on credit. Supplies 1,000 Cash 1,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
- It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
- So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $2,500 listed in the debit column of the Supplies T Account is a direct reflection of the $2,500 debit to Supplies in the original entry!
- In the original entry on October 1st, Survive Company pays $4,000 in cash for supplies. The transaction is recorded with a debit to Supplies, which is an asset account. This debit entry increases the value of supplies owned by the company.
- Simultaneously, the company credits Cash, another asset account, for the same amount. This credit serves to decrease the company's cash balance, which is consistent with the Cash Cheat Code; whenever cash is paid, it is always recorded as a credit to show the reduction in the asset.
The $1,200 Supplies Expense that was debited is accounted for as follows:
- At the beginning of the year, Survive Company started with $3,000 in supplies and added $4,000 more on Oct 1, making for a total of $7,000 in available supplies.
- The year-end review indicated that $1,200 worth of supplies were used during the year.
- In this example, there is no need to calculate the used portion as it's directly given. We directly take the $1,200 in Supplies Expense.
- We debit Supplies Expense to increase it, as it’s an expense account (+/-).
The $1,200 Supplies that was credited is accounted for as follows:
- Before the adjusting entry, the total Supplies would show as $7,000 ($3,000 initially + $4,000 added).
- The year-end review showed that $1,200 in Supplies were used.
- The used portion of $1,200 needs to be removed from the Supplies account to reflect the actual supplies used.
- We credit Supplies, an asset account, to decrease its balance by $1,200. This aligns the balance with the actual amount used during the year.
- Refer to the T Account below for reference.
By recording both these entries, we can see that A = L + E remains in balance.
Original Entry on Oct 1:
Assets = Liabilities + Equity
↓ 4k
↑ 4k
- In the original entry on Oct 1, Survive Company pays $4,000 for supplies. The debit to the Supplies account increases assets by $4,000.
- At the same time, the company credits the Cash account, reducing its assets by $4,000. Essentially, the transaction swaps one form of asset (Cash) for another (Supplies).
- Therefore, the accounting equation A = L + E remains in balance. Assets go up by $4,000 due to the debit to Supplies and go down by $4,000 due to the credit to Cash. Both sides of the equation remain in equilibrium.
Adjusting Entry on Dec 31: Assets = Liabilities + Equity ↓ 1.2k ↓ 1.2k
- On Dec 31, an adjusting entry is made. Supplies worth $1,200 were consumed and hence are transferred to Supplies Expense.
- The debit to Supplies Expense for $1,200 increases the expense account, which consequently reduces Equity by the same amount (expenses are deducted from equity).
- Concurrently, a credit is made to the Supplies asset account for $1,2k, effectively reducing the Assets.
- Therefore, the equation A = L + E remains in balance. Assets (Supplies) decrease by $1,200, and this is balanced by a corresponding decrease in Equity (through Supplies Expense) by $1,200.
⚠️ Be extremely careful not to debit Supplies Expense when simply purchasing Supplies!
❌ Incorrect Example
On January 1st, Survive Company purchases $1000 worth of supplies on credit.
Supplies Expense 1,000
Cash 1,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Purchasing supplies does not mean we should debit an expense account. Why not? Well, simply purchasing supplies doesn't mean we've used any of them!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On January 1st, Survive Company purchases $1000 worth of supplies on credit. Supplies 1,000 Cash 1,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
- It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
- So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $4,000 listed in the debit column of the Supplies T Account is a direct reflection of the $4,000 debit to Supplies in the original entry!
- When dealing with insurance journal entries in your accounting exams, it's crucial to pay attention to how the information is presented. The problem could specify the "Unexpired" insurance, the "Expired" insurance, the "Coverage length in months," the "Coverage length in years," or the "% Expired." Each variation requires a different approach to calculations. However, if you understand the underlying concept — you’ll face no trouble getting answers correct!
- "Unexpired" Insurance Given: When the question provides the amount of insurance that is still "unexpired," you need to subtract this from the original purchase to find out what has "expired" and should be expensed.
- "Expired" Insurance Given: Here, the question directly gives you the amount that has expired and should be accounted for as an expense. No further calculations are needed to figure this out.
- "% Expired" is Given: When given the percentage of the total prepaid insurance that has expired, multiply this percentage by the total amount of Prepaid Insurance to find the "expired" amount to be expensed.
- "Coverage Length in Months" Given: In this case, you'll likely have to calculate the monthly rate of expiration (total cost divided by the number of months) and then multiply it by the relevant time frame to determine the "expired" amount.
- "Coverage Length in Years" Given: Similar to the monthly scenario, but you'll need to convert the years into months to calculate the monthly expiration rate. Once you have that, multiply by the relevant months to find the "expired" amount.
Regardless of these variations, the format of the journal entry remains constant: Debit Insurance Expense and Credit Prepaid Insurance. However, the amount to debit or credit can change based on these different problem framings.
Word to the Wise: Some professors might try to confuse you by changing the phrasing between questions. A single word can flip your calculation approach. Always read the questions carefully to understand what's being asked and adjust your calculations accordingly.
- Prepaid Insurance
- Survive Company pays $25,000 in cash for additional insurance coverage on September 1st. The company records this transaction with a debit to Prepaid Insurance, an asset account (+/-), to increase its value.
- Cash
- Cash, another asset account (+/-), is credited for the same amount of $25,000.
- This credit to Cash serves to decrease the cash balance.
- This aligns with your Cash Cheat Code; whenever cash is paid, it's always recorded as a credit because cash is an asset that needs to be decreased.
The $20,000 Insurance Expense that was debited is calculated as follows:
- The company started the year with $10,000 in Prepaid Insurance and bought an additional $25,000, totaling $35,000 in available insurance coverage.
- A year-end analysis showed that $15,000 remains unexpired.
- The used portion is $35,000 - $15,000, which equals $20,000 in Insurance Expense.
- We debit Insurance Expense to increase it, as it's an expense account (+/-).
The $20,000 Prepaid Insurance that was credited is calculated as follows:
- The total Prepaid Insurance before the adjusting entry would show as $35,000.
- After the year-end analysis, only $15,000 remains unexpired, so the used portion of $20,000 needs to be removed from the Prepaid Insurance account.
- We credit Prepaid Insurance, an asset account (+/-), to decrease its balance down to the correct year-end amount of $15,000.
- Refer to the T Account below for reference.
By recording both these entries, we can see that A = L + E remains in balance.
Original Entry on Sept 1: Assets = Liabilities + Equity ↓ 25k ↑ 25k
- In the original entry on September 1, Survive Company pays $25,000 for additional insurance coverage. The debit to the Prepaid Insurance account increases assets by $25,000.
- At the same time, the company credits the Cash account, decreasing its assets by $25,000. Essentially, the firm is exchanging one asset (Cash) for another asset (Prepaid Insurance).
- The accounting equation A = L + E remains in balance because assets increase by $25,000 (Prepaid Insurance) and decrease by $25,000 (Cash), maintaining an equilibrium.
Adjusting Entry on Dec 31: Assets = Liabilities + Equity ↓ 20k ↓ 20k
- On December 31, an adjusting entry is required. Insurance coverage worth $20,000 has been consumed and, as a result, needs to be moved to Insurance Expense.
- The debit to Insurance Expense for $20,000 increases the expense, which in turn decreases Equity by the same amount (since expenses reduce equity).
- Simultaneously, the credit to the Prepaid Insurance account for $20,000 reduces the asset balance, effectively decreasing the Assets.
- As a result, the equation remains in balance: The decrease in Assets (Prepaid Insurance) of $20,000 is offset by a corresponding decrease in Equity (through Insurance Expense), keeping the A = L + E equation intact.
⚠️ Be extremely careful not to debit Insurance Expense when prepaying for insurance!
❌ Incorrect Example
On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy.
Insurance Expense 12,000
Cash 12,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Prepaying for insurance does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid insurance doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy. Prepaid Insurance 12,000 Cash 12,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $25,000 listed in the debit column of the Prepaid Insurance T Account is a direct reflection of the $25,000 debit to Prepaid Insurance in the original entry!
- On September 1st, Survive Company pays $25,000 in cash for additional insurance coverage. The transaction is recorded with a debit to Prepaid Insurance, an asset account, to reflect the addition of insurance coverage worth $25,000.
- Simultaneously, Cash is credited for the same amount. This credit serves to decrease the company's cash balance. This is consistent with what I often refer to as the Cash Cheat Code; whenever cash is paid, it's recorded as a credit to show the reduction in the asset.
The $15,000 Insurance Expense that was debited is accounted for as follows:
- At the beginning of the year, Survive Company had $10,000 in Prepaid Insurance and added $25,000 more on Sept 1, making a total of $35,000 in available coverage.
- A year-end analysis indicated that $15,000 worth of coverage has expired during the year.
- In this example, notice the phrase "coverage has expired," which is different from "coverage remains unexpired." It subtly changes our calculation and the corresponding adjusting entry.
- We debit Insurance Expense by $15,000 to increase it since it's an expense account (+/-).
The $15,000 Prepaid Insurance that was credited is accounted for as follows:
- Before the adjusting entry, the total Prepaid Insurance would show as $35,000 ($10,000 initially + $25,000 added).
- The year-end review showed that $15,000 of the coverage has expired.
- This expired portion of $15,000 needs to be moved from the Prepaid Insurance account to reflect the actual coverage used.
- We credit Prepaid Insurance, an asset account, to decrease its balance by $15,000. This aligns the balance with the actual amount used during the year.
- Refer to the T Account below for reference.
By recording both these entries, we can see that A = L + E remains in balance.
Original Entry on Sept 1: Assets = Liabilities + Equity ↓ 25k ↑ 25k
- In the original entry on September 1, Survive Company pays $25,000 for additional insurance coverage. The debit to the Prepaid Insurance account increases assets by $25,000.
- At the same time, the company credits the Cash account, decreasing its assets by $25,000. Essentially, the firm is exchanging one asset (Cash) for another asset (Prepaid Insurance).
- The accounting equation A = L + E remains in balance because assets increase by $25,000 (Prepaid Insurance) and decrease by $25,000 (Cash), maintaining an equilibrium.
Adjusting Entry on Dec 31: Assets = Liabilities + Equity ↓ 15k ↓ 15k
- On December 31, an adjusting entry is needed. It's discovered that $15,000 of the insurance coverage has expired over the year. This expired amount must be moved to Insurance Expense.
- By debiting Insurance Expense for $15,000, this expense account is increased, which consequently decreases Equity by the same amount (remember, expenses reduce equity).
- On the other side, Prepaid Insurance, an asset account, is credited by $15,000, effectively decreasing the Assets.
- Therefore, the equation stays in balance: The Assets (Prepaid Insurance) decrease by $15,000 and are offset by a corresponding $15,000 decrease in Equity (through the Insurance Expense), keeping the A = L + E equation balanced.
⚠️ Be extremely careful not to debit Insurance Expense when prepaying for insurance!
❌ Incorrect Example
On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy.
Insurance Expense 12,000
Cash 12,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Prepaying for insurance does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid insurance doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy. Prepaid Insurance 12,000 Cash 12,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $25,000 listed in the debit column of the Prepaid Insurance T Account is a direct reflection of the $25,000 debit to Prepaid Insurance in the original entry!
- On September 1st, Survive Company pays $30,000 in cash for additional insurance coverage. The transaction is recorded with a debit to Prepaid Insurance, an asset account, to reflect the addition of insurance coverage worth $30,000.
- Simultaneously, Cash is credited for the same amount. This credit serves to decrease the company's cash balance. This is consistent with what I often refer to as the Cash Cheat Code; whenever cash is paid, it's recorded as a credit to show the reduction in the asset.
Calculating the Insurance Expense
- Survive Company started the year with $10,000 in Prepaid Insurance and added $30,000 on Sept 1, totaling $40,000 in Prepaid Insurance.
- At year-end, the company discovers that 10% of the total prepaid insurance has expired.
- To find the expired amount: 10% of $40,000 = $4,000.
The $4,000 Insurance Expense that was debited is accounted for as follows:
- The debit to Insurance Expense for $4,000 represents the portion of the prepaid insurance that has expired during the year.
The $4,000 Prepaid Insurance that was credited is accounted for as follows:
- Before the adjusting entry, the Prepaid Insurance balance would have been $40,000 ($10,000 initial + $30,000 added).
- The adjusting entry credits Prepaid Insurance by $4,000, which reduces its balance to $36,000. This aligns the balance with the actual, unexpired amount of coverage left.
- Refer to the T Account below for reference.
By recording both these entries, we can see that A = L + E remains in balance.
Original Entry on Sept 1: Assets = Liabilities + Equity ↓ 25k ↑ 25k
- In the original entry on September 1, Survive Company pays $25,000 for additional insurance coverage. The debit to the Prepaid Insurance account increases assets by $25,000.
- At the same time, the company credits the Cash account, decreasing its assets by $25,000. Essentially, the firm is exchanging one asset (Cash) for another asset (Prepaid Insurance).
- The accounting equation A = L + E remains in balance because assets increase by $25,000 (Prepaid Insurance) and decrease by $25,000 (Cash), maintaining an equilibrium.
Adjusting Entry on Dec 31: Assets = Liabilities + Equity ↓ 15k ↓ 15k
- On December 31, an adjusting entry is needed. It's discovered that $15,000 of the insurance coverage has expired over the year. This expired amount must be moved to Insurance Expense.
- By debiting Insurance Expense for $15,000, this expense account is increased, which consequently decreases Equity by the same amount (remember, expenses reduce equity).
- On the other side, Prepaid Insurance, an asset account, is credited by $15,000, effectively decreasing the Assets.
- Therefore, the equation stays in balance: The Assets (Prepaid Insurance) decrease by $15,000 and are offset by a corresponding $15,000 decrease in Equity (through the Insurance Expense), keeping the A = L + E equation balanced.
⚠️ Be extremely careful not to debit Insurance Expense when prepaying for insurance!
❌ Incorrect Example
On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy.
Insurance Expense 12,000
Cash 12,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Prepaying for insurance does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid insurance doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy. Prepaid Insurance 12,000 Cash 12,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $25,000 listed in the debit column of the Prepaid Insurance T Account is a direct reflection of the $25,000 debit to Prepaid Insurance in the original entry!
- On March 1st, Survive Company pays $24,000 in cash for a 12-month insurance policy. The transaction is recorded with a debit to Prepaid Insurance, an asset account, to indicate that the company has paid for insurance coverage worth $24,000.
- Concurrently, a credit is made to the Cash account for the same amount of $24,000. This credit serves to reduce the company's cash balance. Keep in mind the Cash Cheat Code: whenever cash is paid, it's recorded as a credit to indicate a reduction in the asset.
Step 1: Determine Monthly Insurance Cost
- First, let's understand the concept of an "expired cost." When Survive Company pays $24,000 for a 12-month insurance policy, not all of it is an "expense" right away. Some of it is considered a "prepaid" asset.
- However, as time goes by, this prepayment "expires" and becomes an expense. To find out how much expires each month, we divide the total cost by the length of the policy in months:
- $24,000 / 12 months = $2,000 expires each month
Step 2: Calculate Coverage Expired Over Specific Time Frame
- From March 1st to December 31st, 10 months have passed. We need to figure out how much of the insurance coverage has expired over these 10 months.
- We already know that $2,000 expires each month. So, for 10 months, it would be:
- $2000 per month x 10 months = $20,000 expired
- You might think counting months is a basic skill you've long mastered, but when it comes to accounting, small errors can lead to significant discrepancies.
- To ensure you're accurate, I strongly recommend counting the months on your fingers instead of doing it in your head.
- Why Count on Fingers?
- It gives you a physical action to coordinate with your mental calculation, reducing the chance of skipping a month.
- How to Count:
- Start with March, because the insurance policy kicks in on March 1st and that month is fully included in the coverage period.
- Continue finger-counting through April, May, June, July, August, September, October, November, and finally, December.
- The Result:
- If you've counted correctly, you'll end up with 10 fingers raised, confirming that you're looking at a 10-month period from March 1st to December 31st.
By physically counting out the months, you eliminate the room for error, ensuring that your calculations for adjusting entries are spot on.
Incorporating Into the Adjusting Entry on Dec 31
- Adjusting Entry on Dec 31:
- The year-end analysis indicates that $20,000 worth of this insurance coverage has expired from March 1st to December 31st.
- As we've calculated, this $20,000 has expired and needs to be recognized as an expense.
- We debit Insurance Expense by $20,000 to reflect this.
- Before the adjusting entry, the Prepaid Insurance account would show a balance of $24,000.
- We've identified that $20,000 of this has expired, so it needs to be moved out of the asset account.
- We credit Prepaid Insurance by $20,000 to align the account with the true value of the coverage that remains, which is $4,000 ($24,000 - $20,000).
- Refer to the T Account below for reference.
The $20,000 Insurance Expense that was debited is accounted for as follows:
The $20,000 Prepaid Insurance that was credited is accounted for as follows:
By recording both these entries, we can see that A = L + E remains in balance.
Original Entry on Mar 1: Assets = Liabilities + Equity ↓ 24k ↑ 24k
- In the original entry on March 1st, Survive Company pays $24,000 for a 12-month insurance policy. The debit to the Prepaid Insurance account increases assets by $24,000.
- At the same time, the company credits the Cash account, decreasing its assets by $24,000. Essentially, the company is exchanging one asset (Cash) for another asset (Prepaid Insurance).
- The accounting equation A = L + E remains in balance because assets increase by $24,000 (Prepaid Insurance) and decrease by $24,000 (Cash), maintaining an equilibrium.
Adjusting Entry on Dec 31: Assets = Liabilities + Equity ↓ 20k ↓ 20k
- On December 31st, an adjusting entry is needed. After calculating the monthly cost of the insurance policy, it's determined that $20,000 of insurance coverage has expired (been used) over 10 months.
- By debiting Insurance Expense for $20,000, the expense account is increased, which consequently decreases Equity by the same amount (remember, expenses reduce equity).
- On the other side, Prepaid Insurance, an asset account, is credited by $20,000, effectively decreasing the Assets.
- Therefore, the equation stays in balance: The Assets (Prepaid Insurance) decrease by $20,000 and are offset by a corresponding $20,000 decrease in Equity (through the Insurance Expense), keeping the A = L + E equation balanced.
⚠️ Be extremely careful not to debit Insurance Expense when prepaying for insurance!
❌ Incorrect Example
On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy.
Insurance Expense 12,000
Cash 12,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Prepaying for insurance does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid insurance doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy. Prepaid Insurance 12,000 Cash 12,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $24,000 listed in the debit column of the Prepaid Insurance T Account is a direct reflection of the $24,000 debit to Prepaid Insurance in the original entry!
- On May 31st, Survive Company pays $180,000 in cash for a 2 year insurance policy. The transaction is recorded with a debit to Prepaid Insurance, an asset account, to indicate that the company has paid for insurance coverage worth $180,000.
- Concurrently, a credit is made to the Cash account for the same amount of $180,000. This credit serves to reduce the company's cash balance. Keep in mind the Cash Cheat Code: whenever cash is paid, it's recorded as a credit to indicate a reduction in the asset.
Step 1: Determine Monthly Insurance Cost
- Survive Company starts off by paying $180,000 for a 2-year insurance policy, recording it under "Prepaid Insurance."
- We first determine how much the insurance "expires" each month:
- 180,000 / 24 months = 7,500
- This means that 7,500 expires each month.
Adjusting Entry on Dec 31, 2023:
Step 2: Calculate Coverage Expired for 2023
- The policy starts on May 31 and we're adjusting on Dec 31. That's 7 months. (Don’t include May, since we started the policy at the end of the month!)
- Monthly expense of $7,500 x 7 months = $52,500 expired
Counting the Months
- You'll need to account for the insurance from June 1 going forward the three years of the policy (or, 36 months).
- Why Skip May?
- Since the policy is effective at the end of May, the coverage starts in June. This means May is not included in the calculation for the year 2023.
- How to Count?
- Start with June, as that's the first full month of coverage. Then proceed to count: July, August, September, October, November, and December.
- You should have 7 months in total.
- Monthly Expiration
- As we calculated earlier, $7,500 of the insurance policy expires each month.+
- Final Calculation
- Multiply the monthly expired cost by the number of months:
- $7,500 x 7 = $52,500 expired from June 1 to Dec, 31 2023.
By physically counting out the months on your fingers, you eliminate the room for error, ensuring that your calculations for adjusting entries are spot on.
Step 3: Making the Adjusting Entry for 2023
- Debit Insurance Expense $52,500
- The debit reflects that $52,500 of the insurance policy has "expired" and has to be recognized as an expense.
- Credit Prepaid Insurance $52,500
- The credit adjusts the Prepaid Insurance account to match the unused amount of $127,500 ($180,000 - $52,500).
- Refer to the T Account below for reference.
Step 1: Revisiting the Monthly Insurance Cost
- As a refresher, Survive Company paid $180,000 for a 2-year insurance policy. This was initially recorded as "Prepaid Insurance."
- From our earlier calculations, we know that $7,500 "expires" each month.
Step 2: Calculate Coverage Expired for 2024
Understand the Time Frame
- For the year 2024, we have to consider the coverage from January to December. This constitutes 12 full months.
- Monthly Expiration
- Our previous calculation determined that $7,500 of the insurance policy expires each month.
Final Calculation
- Multiply the monthly expiration cost by the number of months:
- $7,500 per month x 12 months = $90,000 expired for 2024.
Step 3: Making the Adjusting Entry for 2024
- Debit Insurance Expense $90,000
- The debit entry shows that $90,000 of the insurance policy has "expired" and should now be recorded as an expense for the year 2024.
- Credit Prepaid Insurance $90,000
- The credit entry serves to reduce the Prepaid Insurance account, which, after last year's adjustment, had a balance of $127,500. The new balance in Prepaid Insurance would be $37,500 ($127,500 - $90,000).
- By following this step-by-step process, you can accurately determine the adjusting entry needed for the insurance policy in 2024.
- Refer to the T Account below for reference.
Step 1: Revisiting the Monthly Insurance Cost
- As a quick refresher, Survive Company paid $180,000 for a 2-year insurance policy. The monthly "expiration" of the insurance cost is $7,500 as we calculated before.
Step 2: Calculate Coverage Expired for 2025
Understand the Time Frame
- For 2025, we are considering the period from January 1 to May 31, which gives us 5 months.
Counting the Months
- For this period, we'll be focusing on January, February, March, April, and May.
- How to Count?
- Start with January and proceed to count: February, March, April, and finally, May.
- You should end up with 5 months in total.
- Monthly Expiration
- As a reminder, $7,500 expires from the policy each month.
Final Calculation
- The monthly expiration cost multiplied by the number of months for the period in 2025 is:
- $7,500 per month x 5 months = $37,500 expired.
Step 3: Making the Adjusting Entry for 2025
- Debit Insurance Expense $37,500
- The debit entry acknowledges that $37,500 of the insurance policy has "expired" and should be recognized as an expense up to May 31, 2025.
- Credit Prepaid Insurance $37,500
- The credit entry lowers the Prepaid Insurance account, which had a balance of $37,500 after the adjustment at the end of 2024. After this adjustment, the balance would be zero, meaning the policy is now fully utilized.
- Refer to the T Account below for reference.
- For additional clarity on this concept, review the T Accounts that detail the changes in the Prepaid Insurance and over the two-year policy period from May 31, 2023, to May 31, 2025.
By recording both these entries, we can see that A = L + E remains in balance.
Original Entry on Mar 1: Assets = Liabilities + Equity ↓ 24k ↑ 24k
- In the original entry on March 1st, Survive Company pays $24,000 for a 12-month insurance policy. The debit to the Prepaid Insurance account increases assets by $24,000.
- At the same time, the company credits the Cash account, decreasing its assets by $24,000. Essentially, the company is exchanging one asset (Cash) for another asset (Prepaid Insurance).
- The accounting equation A = L + E remains in balance because assets increase by $24,000 (Prepaid Insurance) and decrease by $24,000 (Cash), maintaining an equilibrium.
Adjusting Entry on Dec 31: Assets = Liabilities + Equity ↓ 20k ↓ 20k
- On December 31st, an adjusting entry is needed. After calculating the monthly cost of the insurance policy, it's determined that $20,000 of insurance coverage has expired (been used) over 10 months.
- By debiting Insurance Expense for $20,000, the expense account is increased, which consequently decreases Equity by the same amount (remember, expenses reduce equity).
- On the other side, Prepaid Insurance, an asset account, is credited by $20,000, effectively decreasing the Assets.
- Therefore, the equation stays in balance: The Assets (Prepaid Insurance) decrease by $20,000 and are offset by a corresponding $20,000 decrease in Equity (through the Insurance Expense), keeping the A = L + E equation balanced.
⚠️ Be extremely careful not to debit Insurance Expense when prepaying for insurance!
❌ Incorrect Example
On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy.
Insurance Expense 12,000
Cash 12,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Prepaying for insurance does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid insurance doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy. Prepaid Insurance 12,000 Cash 12,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $180,000 listed in the debit column of the Prepaid Insurance T Account is a direct reflection of the $180,000 debit to Prepaid Insurance in the original entry!
- Dealing with prepaid rent journal entries in your accounting exams requires careful attention to the details provided. Whether the problem presents you with the "Rent remaining," the "Rent used," the "Lease Term in months," or the "Lease Term in years," each scenario requires a distinct approach for calculation.
- "Rent Remaining" Given: When the question provides the amount of rent that is still "remaining," subtract this from the original prepaid amount to find out what has been "used" and needs to be expensed.
- "Rent Used" Given: In this situation, the question directly states the amount that has been "used" and should be recognized as an expense. No additional calculations are required.
- "Lease Term in Months" Given: In such cases, calculate the monthly rate of rent use (total prepaid rent divided by the lease term in months). Multiply this by the relevant months to ascertain the amount of rent "used."
- "Lease Term in Years" Given: Similar to the "Lease Term in Months," but you'll first need to convert the years into months to calculate the monthly rate. Then, multiply by the relevant months to find the "used" rent.
No matter what variation you encounter, the structure of the journal entry remains the same: Debit Rent Expense and Credit Prepaid Rent. However, the amount to be debited or credited may change based on the problem's specifics.
Word to the Wise: Professors may try to trick you by altering the phrasing between questions. One single word can drastically change the method you use for your calculations. Make sure to read questions carefully to understand the specific requirement, and tailor your calculations accordingly.
- Prepaid Rent
- Survive Company pays $18,000 in cash for a 12-month lease on July 1st. The company records this with a debit to Prepaid Rent, an asset account (+/-), to increase its value.
- Cash
- Cash, another asset account (+/-), is credited for the same amount of $18,000.
- This credit to Cash serves to decrease the cash balance.
- This aligns with your Cash Cheat Code; whenever cash is paid, it's always recorded as a credit because cash is an asset that needs to be decreased.
- The $14,000 Rent Expense that was debited is calculated as follows:
- The company began the year with $8,000 in Prepaid Rent and added another $18,000 in July, totaling $26,000 in available prepaid rent.
- A year-end analysis shows that $12,000 remains for the next year.
- The used portion is $26,000 - $12,000, which equals $14,000 in Rent Expense.
- We debit Rent Expense to increase it, as it's an expense account (+/-).
- The $14,000 Prepaid Rent that was credited is calculated as follows:
- The total Prepaid Rent before the adjusting entry is $26,000.
- After the year-end calculation, only $12,000 remains, so the used portion of $14,000 needs to be removed from the Prepaid Rent account.
- We credit Prepaid Rent, an asset account (+/-), to decrease its balance down to the correct year-end amount of $12,000.
- Refer to the T Account below for reference.
By recording both these entries, we can see that A = L + E remains in balance.
Original Entry on July 1: Assets = Liabilities + Equity ↓ 18k ↑ 18k
- In the original entry on July 1, Survive Company pays $18,000 for a 12-month lease. The debit to the Prepaid Rent account increases assets by $18,000.
- At the same time, the company credits the Cash account, which decreases assets by $18,000. Essentially, the firm is exchanging one asset (Cash) for another (Prepaid Rent).
- The accounting equation A=L+E remains in balance because assets increase by $18,000 (Prepaid Rent) and decrease by $18,000 (Cash), therefore maintaining equilibrium.
Adjusting Entry on Dec 31: Assets = Liabilities + Equity ↓ 14k ↓ 14k
- On December 31, an adjusting entry is required. Rent coverage worth $14,000 has been used and, as a result, needs to be moved to Rent Expense.
- The debit to Rent Expense for $14,000 increases the expense, which in turn decreases Equity by the same amount (since expenses reduce equity).
- Simultaneously, the credit to the Prepaid Rent account for $14,000 reduces the asset balance, effectively decreasing the Assets.
- As a result, the equation remains in balance: The decrease in Assets (Prepaid Rent) of $14,000 is offset by a corresponding decrease in Equity (through Rent Expense), keeping the A=L+E equation intact.
⚠️ Be extremely careful NOT to debit Rent Expense when prepaying for rent! ❌ Incorrect Example: On August 31st, 2023, Survive Company pays $24,000 in cash for a 12-month lease on a building.
Rent Expense 24,000
Cash 24,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Prepaying for rent does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid rent doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On August 31st, 2023, Survive Company pays $24,000 in cash for a 12-month lease on a building. The journal entry is: Prepaid Rent 24,000 Cash 24,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $18,000 listed in the debit column of the Prepaid Rent T Account is a direct reflection of the $18,000 debit to Prepaid Rent in the original entry!
On July 1st, Survive Company pays $24,000 cash for a 12-month lease starting from July.
At year-end, Survive Company reviews its lease agreement and finds that $15,000 of rent has been used. Record the original entry on July 1st, as well as the required adjusting entry on December 31st. Original Entry on July 1: Prepaid Rent 24,000 Cash 24,000 Adjusting Entry on Dec 31: Rent Expense 15,000 Prepaid Rent 15,000
- Prepaid Rent
- Survive Company pays $24,000 in cash for a new 12-month lease. This is recorded with a debit to Prepaid Rent, an asset account, to increase its value.
- Cash
- The Cash account is credited for the same amount of $24,000, decreasing the asset balance.
- The $15,000 Rent Expense that was debited is calculated as follows:
- The company started the year with $12,000 in Prepaid Rent and added another $24,000, totaling $36,000 in available rent coverage.
- A year-end review showed that $15,000 has been used.
- The used portion is exactly $15,000, which is debited as Rent Expense.
- The total Prepaid Rent before the adjusting entry is $36,000.
- After the year-end review, $15,000 has been used, so this amount is removed from the Prepaid Rent account.
- We credit Prepaid Rent to decrease its balance down to the correct year-end amount of $21,000.
The $15,000 Prepaid Rent that was credited is calculated as follows:
- Refer to the T Account below for reference.
By recording both these entries, we can see that A = L + E remains in balance.
Original Entry on July 1: Assets = Liabilities + Equity ↓ 24k ↑ 24k
- In the original entry on July 1, Survive Company pays $24,000 for a new 12-month lease. The debit to Prepaid Rent increases the asset account by $24,000.
- Simultaneously, the company credits the Cash account, which decreases its assets by $24,000. The firm is effectively swapping one asset (Cash) for another asset (Prepaid Rent).
- The accounting equation A=L+E remains balanced as assets increase by $24,000 (Prepaid Rent) while decreasing by $24,000 (Cash). This keeps the equation in equilibrium.
Adjusting Entry on Dec 31: Assets = Liabilities + Equity ↓ 15k ↓ 15k
- On December 31, an adjusting entry is necessary. Rent coverage amounting to $15,000 has been used, and thus needs to be shifted to Rent Expense.
- Debiting Rent Expense for $15,000 increases the expense account, which subsequently decreases Equity by the same amount (since expenses reduce equity).
- At the same time, crediting Prepaid Rent for $15,000 lowers the asset balance, effectively reducing Assets.
- Therefore, the accounting equation remains in balance: The decrease in Assets (Prepaid Rent) of $15,000 is matched by a corresponding decrease in Equity (through Rent Expense), ensuring that A=L+E stays intact.
⚠️ Be extremely careful NOT to debit Rent Expense when prepaying for rent! ❌ Incorrect Example: On August 31st, 2023, Survive Company pays $24,000 in cash for a 12-month lease on a building.
Rent Expense 24,000
Cash 24,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Prepaying for rent does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid rent doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On August 31st, 2023, Survive Company pays $24,000 in cash for a 12-month lease on a building. The journal entry is: Prepaid Rent 24,000 Cash 24,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $24,000 listed in the debit column of the Prepaid Rent T Account is a direct reflection of the $24,000 debit to Prepaid Rent in the original entry!
On July 1st, Survive Company pays $36,000 cash for a new 12-month lease. Record the original entry on July 1st, as well as the required adjusting entry on December 31st. Original Entry on July 1: Prepaid Rent 36,000 Cash 36,000 Adjusting Entry on Dec 31: Rent Expense 18,000 Prepaid Rent 18,000
- Prepaid Rent
- Survive Company pays $36,000 in cash for a new 12-month lease. This is recorded with a debit to Prepaid Rent to increase its value.
- Cash
- The cash account is credited for $36,000, decreasing the asset account.
The $18,000 Rent Expense that was debited is calculated as follows:
- The initial lease is for 12 months at a cost of $36,000, which equates to $3,000 per month.
- $36,000 / 12 = $3,000 per month.
- By December 31st, 6 months of the lease term have passed, making the cost of the used rent 6 months * $3,000/month = $18,000.
The $18,000 Prepaid Rent that was credited is calculated as follows:
- The original Prepaid Rent balance shows $36,000.
- The adjusting entry reduces this by $18,000 to reflect the used portion of the rent, making the new Prepaid Rent balance $18,000.
- Refer to the T Account below for reference.
By recording both these entries, we can see that A = L + E remains in balance.
Original Entry on Mar 1: Assets = Liabilities + Equity ↓ 36k ↑ 36k
- In the original entry on July 1, Survive Company pays $36,000 for a 12-month lease. The debit to the Prepaid Rent account increases assets by $36,000.
- At the same time, the company credits the Cash account, decreasing its assets by $36,000. In essence, the firm exchanges one asset (Cash) for another (Prepaid Rent).
- The equation A=L+E remains in balance because assets increase by $36,000 (Prepaid Rent) and decrease by $36,000 (Cash), keeping everything balanced.
Adjusting Entry on Dec 31: Assets = Liabilities + Equity ↓ 18k ↓ 18k
- In the adjusting entry on December 31, $18,000 worth of rent has been utilized and needs to be moved to Rent Expense.
- The debit to Rent Expense for $18,000 increases the expense, which in turn decreases Equity by the same amount (since expenses reduce equity).
- Concurrently, the credit to the Prepaid Rent account for $18,000 reduces the asset balance, effectively decreasing Assets.
- As a result, the equation remains in balance: The decrease in Assets (Prepaid Rent) of $18,000 is matched by a corresponding decrease in Equity (through Rent Expense), maintaining the A=L+E equation in equilibrium.
⚠️ Be extremely careful NOT to debit Rent Expense when prepaying for rent! ❌ Incorrect Example: On August 31st, 2023, Survive Company pays $24,000 in cash for a 12-month lease on a building.
Rent Expense 24,000
Cash 24,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Prepaying for rent does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid rent doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On August 31st, 2023, Survive Company pays $24,000 in cash for a 12-month lease on a building. The journal entry is: Prepaid Rent 24,000 Cash 24,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
On June 1st, 2023 Survive Company pays $48,000 cash for a new 2-year lease.
Record the original entry on 6/1/2023, as well as the required adjusting entries on 12/31/23, 12/31/24, and 6/1/25. Original Entry on June 1, 2023: Prepaid Rent 48,000 Cash 48,000 Adjusting Entry on Dec 31, 2023: Rent Expense 14,000 Prepaid Rent 14,000 Adjusting Entry on Dec 31, 2024: Rent Expense 24,000 Prepaid Rent 24,000 Final Adjusting Entry on June 1, 2025: Rent Expense 10,000 Prepaid Rent 10,000
- Prepaid Rent: Survive Company pays $48,000 for a new 2-year lease starting from June 1, 2023. This debit to Prepaid Rent increases the asset account by $48,000.
- Cash: A credit to the Cash account for the same $48,000 decreases the Cash asset. The company is essentially exchanging one asset (Cash) for another (Prepaid Rent).
- A = L + E remains in balance: Both assets increase and decrease by $48,000, maintaining equilibrium in the accounting equation.
Step 1: Determine Monthly Rent Cost
- Survive Company starts by paying $48,000 for a 24-month lease, which they record under "Prepaid Rent."
- First, we determine how much of the rent "expires" each month:
- $48,000 / 24 months= $2,000
- This means that $2,000 expires each month.
Step 2: Calculate Rent Expired for 2023
- The lease starts on June 1, 2023, and we're adjusting on December 31, 2023. That's 7 months.
- Monthly expense of $2,000 x 7 months = $14,000 expired
- 👉 Pro Tip: Count the Months on Your Fingers!
- Start with June as it's the first full month of the lease and proceed to count: July, August, September, October, November, and December.
- You should have 7 months in total.
- Monthly Expiration: $2,000 expires each month.
- Final Calculation: $2,000 x 7 = $14,000 expired from June 1 to Dec 31, 2023.
Counting the Months
Step 3: Making the Adjusting Entry for 2023
- Debit Rent Expense $14,000
- The debit reflects that $14,000 of the prepaid rent has "expired" and should be recognized as an expense.
- Credit Prepaid Rent $14,000
- The credit adjusts the Prepaid Rent account to match the unused amount, which is now $48,000 - $14,000 = $34,000.
- Refer to the T Account below for reference.
Step 1: Revisit Monthly Rent Cost
- The monthly rent cost, as determined before, is $2,000.
- The remaining balance in Prepaid Rent at the end of 2023 was $34,000.
Step 2: Calculate Rent Expired for 2024
- The lease has been ongoing, and we're adjusting on December 31, 2024. This time it's for a full year, meaning 12 months.
- Monthly expense of $2,000 x 12 months = $24,000 expired
- 👉 Pro Tip: Count the Months on Your Fingers!
- For this year, we don't need to skip any months because it's for a full year: January through December.
- You should have 12 months in total.
- Monthly Expiration: $2,000 expires each month.
- Final Calculation: $2,000 x 12 = $24,000 expired from January 1 to Dec 31, 2024.
Counting the Months
Step 3: Making the Adjusting Entry for 2024
- Debit Rent Expense $24,000
- This debit entry shows that $24,000 of the prepaid rent has "expired" over the year and should be recognized as an expense.
- Credit Prepaid Rent $24,000
- This credit entry adjusts the Prepaid Rent account to match the unused amount, which now stands at $34,000 - $24,000 = $10,000.
- Refer to the T Account below for reference.
Step 1: Revisit Monthly Rent Cost
- We already know the monthly rent cost is $2,000.
- The remaining balance in Prepaid Rent at the end of 2024 was $10,000.
Adjusting Entry on Jun 1, 2025:
Step 2: Calculate Rent Expired for the Remaining Lease Term
- Now, the lease is coming to an end on Jun 1, 2025. The period we need to consider is from January 1, 2025, to Jun 1, 2025, which is 5 months.
- Monthly expense of $2,000 x 5 months = $10,000 expired
- 👉 Pro Tip: Count the Months on Your Fingers!
- For this final entry, count from January through May.
- You should have 5 months in total.
- Monthly Expiration: $2,000 expires each month.
- Final Calculation: $2,000 x 5 = $10,000 expired from January 1 to May 31, 2025.
Counting the Months
Step 3: Making the Adjusting Entry for 2025
- Debit Rent Expense $10,000
- This debit reflects that the remaining $10,000 of the prepaid rent has "expired" and must be recognized as an expense.
- Credit Prepaid Rent $10,000
- This credit adjusts the Prepaid Rent account to zero, showing that all the prepaid rent has been used up.
By executing this final adjusting entry, we've accounted for all the prepaid rent, ensuring that the account balances to zero as the lease ends. The accounting equation also remains in balance.
- Refer to the T Account below for reference.
- For additional clarity on this concept, review the T Accounts that detail the changes in the Prepaid Insurance and over the two-year policy period from Jun 1, 2023, to Jun 1, 2025.
⚠️ Be extremely careful not to debit Insurance Expense when prepaying for insurance!
❌ Incorrect Example
On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy.
Insurance Expense 12,000
Cash 12,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Prepaying for insurance does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid insurance doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy. Prepaid Insurance 12,000 Cash 12,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $180,000 listed in the debit column of the Prepaid Insurance T Account is a direct reflection of the $180,000 debit to Prepaid Insurance in the original entry!
Prepaid Rent
- Definition: This is rent that you've paid in advance for a lease. When you are the tenant, and you pay for several months upfront, that payment is considered prepaid until you "use" it by occupying the space.
- Journal Entry at Time of Payment:
Prepaid Rent 18,000 Cash 18,000
- Adjusting Journal Entry as Rent is Used:
Rent Expense 14,000 Prepaid Rent 14,000
- Context: You're the tenant, and you've paid for a service you haven't fully used yet.
- Trick Alert: Professors may present you with a situation where you've paid for several months of rent in advance, making you the tenant. However, the way they phrase the question or present the information may be designed to mislead you into thinking you're the landlord who has received advance rent payments.
- It's crucial to identify the cues that clarify your role in the scenario. Are you the one receiving the advance rent payment (landlord), creating "Unearned Rent Revenue"? Or are you the one making the advance payment (tenant), making it a case of "Prepaid Rent"?
Unearned Rent Revenue
- Definition: This is cash you've received in advance but haven't earned yet. When you're the landlord, and you've collected rent for months in advance, that money is considered unearned until the time period passes.
- Journal Entry at Time of Payment:
Cash $$$ Unearned Rent Rev. $$$
- Adjusting Journal Entry as Rent is Used:
Unearned Rent Rev. $$$ Rent Revenue $$$
- Context: You're the landlord, and you've collected rent upfront but haven't provided the full service yet (i.e. the time period of the lease hasn’t passed!)
- Trick Alert: Professors may design a question where you've received advance rent payments, putting you in the landlord's shoes. However, the phrasing of the question or the context could be misleading, making it seem like you're actually the tenant who has paid for rent in advance.
- It's crucial to identify the cues that clarify your role in the scenario. Are you the one receiving the advance rent payment (landlord), creating "Unearned Rent Revenue"? Or are you the one making the advance payment (tenant), making it a case of "Prepaid Rent"?
- Navigating prepaid advertising journal entries in your accounting exams demands keen attention to detail. The problem may specify different aspects of the advertising contract, such as "Contract Remaining," "Advertising Used," "% Used," "Contract in Months," or "Contract in Years.” Each presents its unique set of calculations.
- "Advertising Contract Remaining" Given: When the question mentions the amount of the advertising contract that is still "remaining," you'll need to subtract this from the original prepaid amount. This gives you the portion that has been "used" and should now be recognized as an expense.
- "Advertising Contract in Months" Given: This type of question will tell you the total length of the contract in months and often, how many months have passed. Divide the total prepaid amount by the total months to find the monthly rate, then multiply by the months passed to find the expense.
- "Advertising Contract in Years" Given: Similar to the "in Months" variation, but now you're dealing with years. You'll need to determine the annual rate by dividing the prepaid amount by the total years. If partial years are involved, you may need to pro-rate the annual expense.
Regardless of the variation you encounter, the core structure of the journal entry remains consistent: Debit Advertising Expense and Credit Prepaid Advertising. What changes is the amount that needs to be debited or credited based on the problem's specifics.
Word to the Wise: Watch out for trick questions where professors alter the phrasing or present ambiguous situations. A single word can entirely change your calculation strategy. Always read the questions with utmost care to understand what is specifically being asked, and adjust your calculations as needed.
At year-end, Survive Company analyzes its advertising contracts and determines that $5,000 in unused services remain for the next year in prepaid advertising.
Record the original entry on October 1st, as well as the required adjusting entry on December 31st. Original Entry on Oct 1: Prepaid Advertising 9,000 Cash 9,000 Adjusting Entry on Dec 31: Advertising Expense 8,000 Prepaid Advertising 8,000
- Prepaid Advertising
- Survive Company pays $9,000 in cash for a 6-month advertising contract on October 1st. This amount is debited to Prepaid Advertising, an asset account (+/-), to increase its value.
- Cash
- Cash is credited for the same amount of $9,000.
- This serves to decrease the cash balance.
- This aligns with your Cash Cheat Code; whenever cash is paid, it's always recorded as a credit because cash is an asset that needs to be decreased.
- The $8,000 Advertising Expense that was debited is calculated as follows:
- The company started the year with $4,000 in Prepaid Advertising and added another $9,000 in October, making a total of $13,000 in available prepaid advertising.
- A year-end calculation shows that $5,000 remains for the next year.
- The used portion is $13,000 - $5,000, which equals $8,000 in Advertising Expense.
- We debit Advertising Expense to increase it, as it's an expense account (+/-).
- The $8,000 Prepaid Advertising that was credited is calculated as follows:
- The total Prepaid Advertising before the adjusting entry was $13,000.
- After year-end, only $5,000 remains, so the used portion of $8,000 needs to be removed from the Prepaid Advertising account.
- We credit Prepaid Advertising, an asset account (+/-), to decrease its balance down to the correct year-end amount of $5,000.
- Refer to the T Account below for reference.
⚠️ Be extremely careful NOT to debit Advertising Expense when prepaying for advertising! ❌ Incorrect Example On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month.
Advert. Expense 180,000
Cash 180,000
Your exam will attempt to trick you into doing this, especially on multiple choice. It is incorrect!
- Prepaying for advertising does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid advertising doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
Remember, the correct entry is: ✅ Correct Example On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month. Prepaid Advertising 180,000 Cash 180,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $18,000 listed in the debit column of the Prepaid Rent T Account is a direct reflection of the $18,000 debit to Prepaid Rent in the original entry!
At year-end, Survive Company analyzes its advertising contracts and determines that $4,000 in advertising services have been used up during the year.
Record the original entry on September 1st, as well as the required adjusting entry on December 31st.
Original Entry on Sept 1: Prepaid Advertising 7,000 Cash 7,000 Adjusting Entry on Dec 31: Advertising Expense 4,000 Prepaid Advertising 4,000
- Prepaid Advertising
- Survive Company pays $7,000 in cash for a 6-month advertising contract on September 1st. This amount is debited to Prepaid Advertising, an asset account (+/-), to increase its value.
- Cash
- Cash is credited for the same amount of $7,000.
- This serves to decrease the cash balance.
- This aligns with your Cash Cheat Code; whenever cash is paid, it's always recorded as a credit because cash is an asset that needs to be decreased.
- The $4,000 Advertising Expense that was debited is directly given in the problem:
- The company started the year with $3,000 in Prepaid Advertising and added another $7,000 in September, totaling $10,000 in available prepaid advertising.
- A year-end calculation directly indicates that $4,000 was used up during the year.
- This is recognized as $4,000 in Advertising Expense.
- We debit Advertising Expense to increase it, as it's an expense account (+/-).
- The $4,000 Prepaid Advertising that was credited is calculated as follows:
- The total Prepaid Advertising before the adjusting entry was $10,000.
- After year-end, the used portion of $4,000 needs to be removed from the Prepaid Advertising account.
- We credit Prepaid Advertising, an asset account (+/-), to decrease its balance by the $4,000 used, bringing it down to a remaining balance of $6,000.
- Refer to the T Account below for reference.
⚠️ Be extremely careful NOT to debit Advertising Expense when prepaying for advertising! ❌ Incorrect Example On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month.
Advert. Expense 180,000
Cash 180,000
Your exam will attempt to trick you into doing this, especially on multiple choice. It is incorrect!
- Prepaying for advertising does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid advertising doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
Remember, the correct entry is: ✅ Correct Example On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month. Prepaid Advertising 180,000 Cash 180,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $18,000 listed in the debit column of the Prepaid Rent T Account is a direct reflection of the $18,000 debit to Prepaid Rent in the original entry!
At year-end, Survive Company analyzes its advertising contracts and determines that 60% of its total prepaid advertising contracts have been used up during the year.
Record the original entry on May 1st, as well as the required adjusting entry on December 31st.
Original Entry on May 1: Prepaid Advertising 6,000 Cash 6,000 Adjusting Entry on Dec 31: Advertising Expense 5,100 Prepaid Advertising 5,100
- Prepaid Advertising
- Survive Company pays $6,000 in cash for a 12-month advertising contract on May 1st. The company records this with a debit to Prepaid Advertising, an asset account (+/-), to increase its value.
- Cash
- Cash is credited for the same amount of $6,000.
- This credit serves to decrease the cash balance.
- This aligns with your Cash Cheat Code; whenever cash is paid, it's always recorded as a credit because cash is an asset that needs to be decreased.
- The $5,100 Advertising Expense that was debited is calculated as follows:
- The company started the year with $2,500 in Prepaid Advertising and added another $6,000 in May, making a total of $8,500 in available prepaid advertising.
- A year-end calculation indicates that 60% of the total advertising services have been used up.
- The used portion is 60% of $8,500, which is $5,100 in Advertising Expense.
- We debit Advertising Expense to increase it, as it's an expense account (+/-).
- The $5,100 Prepaid Advertising that was credited is calculated as follows:
- The total Prepaid Advertising before the adjusting entry was $8,500.
- After year-end, the used portion of $5,100 needs to be removed from the Prepaid Advertising account.
- We credit Prepaid Advertising, an asset account (+/-), to decrease its balance down to the correct year-end amount of $3,400.
- Refer to the T Account below for reference.
⚠️ Be extremely careful NOT to debit Advertising Expense when prepaying for advertising! ❌ Incorrect Example On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month.
Advert. Expense 180,000
Cash 180,000
Your exam will attempt to trick you into doing this, especially on multiple choice. It is incorrect!
- Prepaying for advertising does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid advertising doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
Remember, the correct entry is: ✅ Correct Example On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month. Prepaid Advertising 180,000 Cash 180,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $18,000 listed in the debit column of the Prepaid Rent T Account is a direct reflection of the $18,000 debit to Prepaid Rent in the original entry!
On June 1st, Survive Company pays $12,000 cash for a 12-month advertising contract. It will receive the benefits of the contract evenly each month.
Record the original entry on June 1st, as well as the required adjusting entry on December 31st.
Original Entry on June 1: Prepaid Advertising 12,000 Cash 12,000 Adjusting Entry on Dec 31: Advertising Expense 7,000 Prepaid Advertising 7,000
- Prepaid Advertising
- Survive Company pays $12,000 in cash for a 12-month advertising contract on June 1st. This is debited to Prepaid Advertising, an asset account (+/-), to increase its value.
- Cash
- Cash is credited for the same amount of $12,000.
- This serves to decrease the cash balance.
- This aligns with your Cash Cheat Code; whenever cash is paid, it's always recorded as a credit because cash is an asset that needs to be decreased.
- The $7,000 Advertising Expense that was debited is calculated as follows:
- The contract started on June 1st and it's now December 31st, which means 7 months have passed.
- The cost per month is $12,000 / 12 months = $1,000 per month.
- Therefore, the used portion is 7 months x $1,000/month = $7,000 in Advertising Expense.
- We debit Advertising Expense to increase it, as it's an expense account (+/-).
- The $7,000 Prepaid Advertising that was credited is calculated as follows:
- The total Prepaid Advertising before the adjusting entry was $12,000.
- The used portion of $7,000 needs to be removed from the Prepaid Advertising account.
- We credit Prepaid Advertising, an asset account (+/-), to decrease its balance down to the correct year-end amount of $5,000.
- Refer to the T Account below for reference.
⚠️ Be extremely careful NOT to debit Advertising Expense when prepaying for advertising! ❌ Incorrect Example On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month.
Advert. Expense 180,000
Cash 180,000
Your exam will attempt to trick you into doing this, especially on multiple choice. It is incorrect!
- Prepaying for advertising does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid advertising doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
Remember, the correct entry is: ✅ Correct Example On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month. Prepaid Advertising 180,000 Cash 180,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $18,000 listed in the debit column of the Prepaid Rent T Account is a direct reflection of the $18,000 debit to Prepaid Rent in the original entry!
Record the original entry on 6/1/2023, as well as the required adjusting entries on 12/31/2023, 12/31/2024, and 6/1/2025. Original Entry on June 1, 2023: Prepaid Advertising 48,000 Cash 48,000 Adjusting Entry on Dec 31, 2023: Advertising Expense 14,000 Prepaid Advertising 14,000 Adjusting Entry on Dec 31, 2024: Advertising Expense 24,000 Prepaid Advertising 24,000 Adjusting Entry on June 1, 2025: Advertising Expense 10,000 Prepaid Advertising 10,000
- Prepaid Advertising: Survive Company pays $48,000 for a 2-year advertising contract, increasing the Prepaid Advertising asset account by $48,000.
- Cash: This credit decreases the cash asset account by $48,000.
- A = L + E remains in balance: Both assets increase and decrease by $48,000, maintaining equilibrium in the accounting equation.
Step 1: Determine Monthly Rent Cost
- Survive Company starts by paying $48,000 for a 24-month advertising contract, which they record under "Prepaid Advertising."
- First, we determine how much of the advertising "expires" each month:
- $48,000 / 24 months= $2,000
- This means that $2,000 expires each month.
Step 2: Calculate Advertising Expired for 2023
- The contract starts on June 1, 2023, and we're adjusting on December 31, 2023. That's 7 months.
- Monthly expense of $2,000 x 7 months = $14,000 expired
- 👉 Pro Tip: Count the Months on Your Fingers!
- Start with June as it's the first full month of the lease and proceed to count: July, August, September, October, November, and December.
- You should have 7 months in total.
- Monthly Expiration: $2,000 expires each month.
- Final Calculation: $2,000 x 7 = $14,000 expired from June 1 to Dec 31, 2023.
Counting the Months
Step 3: Making the Adjusting Entry for 2023
- Debit Advertising Expense $14,000
- The debit reflects that $14,000 of the prepaid advertising has "expired."
- Credit Prepaid Advertising $14,000
- The Prepaid Advertising account now stands at $34,000.
- Refer to the T Account below for reference.
Step 1: Revisit Monthly Advertising Cost
- The monthly advertising cost, as determined before, is $2,000.
- The remaining balance in Prepaid Advertising at the end of 2023 was $34,000.
Step 2: Calculate Advertising Expired for 2024
- The contract has been ongoing, and we're adjusting on December 31, 2024. This time it's for a full year, meaning 12 months.
- Monthly expense of $2,000 x 12 months = $24,000 expired
- 👉 Pro Tip: Count the Months on Your Fingers!
- For this year, we don't need to skip any months because it's for a full year: January through December.
- You should have 12 months in total.
- Monthly Expiration: $2,000 expires each month.
- Final Calculation: $2,000 x 12 = $24,000 expired from January 1 to Dec 31, 2024.
Counting the Months
Step 3: Making the Adjusting Entry for 2024
- Debit Advertising Expense $24,000
- This debit entry shows that $24,000 of the prepaid advertising has "expired" over the year and should be recognized as an expense.
- Credit Prepaid Advertising $24,000
- This credit entry adjusts the Prepaid Advertising account to match the unused amount, which now stands at $34,000 - $24,000 = $10,000.
- Refer to the T Account below for reference.
Step 1: Revisit Monthly Advertising Cost
- We already know the monthly advertising cost is $2,000.
- The remaining balance in Prepaid Advertising at the end of 2024 was $10,000.
Adjusting Entry on Jun 1, 2025:
Step 2: Calculate Advertising Expired for the Remaining Contract
- Now, the contract is coming to an end on Jun 1, 2025. The period we need to consider is from January 1, 2025, to Jun 1, 2025, which is 5 months.
- Monthly expense of $2,000 x 5 months = $10,000 expired
- 👉 Pro Tip: Count the Months on Your Fingers!
- For this final entry, count from January through May.
- You should have 5 months in total.
- Monthly Expiration: $2,000 expires each month.
- Final Calculation: $2,000 x 5 = $10,000 expired from January 1 to May 31, 2025.
Counting the Months
Step 3: Making the Adjusting Entry for 2025
- Debit Advertising Expense $10,000
- This debit reflects that the remaining $10,000 of the prepaid advertising has "expired" and must be recognized as an expense.
- Credit Prepaid Advertising $10,000
- This credit adjusts the Prepaid Advertising account to zero, showing that all the prepaid advertising has been used up.
By executing this final adjusting entry, we've accounted for all the prepaid advertising, ensuring that the account balances to zero as the contract ends. The accounting equation also remains in balance.
- Refer to the T Account below for reference.
- For additional clarity on this concept, review the T Accounts that detail the changes in the Prepaid Advertising and over the two-year contract period from Jun 1, 2023, to Jun 1, 2025.
⚠️ Be extremely careful not to debit Insurance Expense when prepaying for insurance!
❌ Incorrect Example
On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy.
Insurance Expense 12,000
Cash 12,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Prepaying for insurance does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid insurance doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy. Prepaid Insurance 12,000 Cash 12,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
For example, the $180,000 listed in the debit column of the Prepaid Insurance T Account is a direct reflection of the $180,000 debit to Prepaid Insurance in the original entry!
- Depreciation adjusting entries vary mainly in the specifics of the Accumulated Depreciation account you're dealing with. While the journal entry structure remains consistent—Debiting Depreciation Expense and Crediting Accumulated Depreciation—the Accumulated Depreciation account may specify the type of asset.
- For example, ‘Accumulated Depreciation - Building' or 'Accumulated Depreciation - Equipment’, etc.
- Thankfully, this is not nearly as complicated as the variations seen before in Prepaids! However, it’s still a good thing to know to ensure you get all the points on your exam.
Record the original entry on January 1st, as well as the required adjusting entry on December 31st. Original Entry on Jan 1: Equipment 50,000 Cash 50,000 Adjusting Entry on Dec 31: Depreciation Expense 9,000 Acc. Depr. - Equipment 9,000
- Equipment
- Survive Company pays $50,000 in cash to purchase equipment on January 1st. This amount is debited to the Equipment account, an asset account (+/-), to increase its value.
- Cash
- Cash is credited for the same amount of $50,000.
- This serves to decrease the cash balance.
- This aligns with your Cash Cheat Code; whenever cash is paid, it's always recorded as a credit because cash is an asset that needs to be decreased.
- Depreciation Expense:
- The depreciation expense of $9,000 is already calculated and provided in the problem. We debit Depreciation Expense to increase it, as it's an expense account (+/-).
- Accumulated Depreciation:
- The same amount of $9,000 is credited to Accumulated Depreciation, a contra-asset account (+/-), to increase its balance. This reflects the depreciation of the equipment over time.
- How the Depreciation Was Calculated (For informational purposes only, we’ll dive deeper in Chapte 8!)
- Original Cost: $50,000
- Estimated Useful Life: 5 years
- Salvage Value: $5,000
- Depreciation per Year = (Original Cost - Salvage Value) / Estimated Useful Life
- Depreciation per Year = ($50,000 - $5,000) / 5 = $9,000
- Refer to the Balance Sheet presentation below for reference.
- Historical Cost Principle: Notice that the Equipment account stays at $50,000 between Jan 1 and Dec 31. This aligns with the historical cost principle, which states that an asset should be recorded at its original purchase price and not adjusted for market value changes or depreciation recorded.
- Accumulated Depreciation: This contra-asset account accumulates the total depreciation of the equipment over its useful life. When this account increases (from $0 to $9,000 in this example), it effectively lowers the book value of the Equipment. That's why it's subtracted in the balance sheet.
- Equipment Book Value: This represents the net value of the equipment after accounting for depreciation. It's calculated as the Equipment's original cost ($50,000) minus its Accumulated Depreciation ($9,000), resulting in a book value of $41,000.
- Again, no worries about these concepts until we reach Chapter 8 in Exam 3!
Record the original entry on January 1st, as well as the required adjusting entry on December 31st. Original Entry on Jan 1: Machine 80,000 Cash 80,000 Adjusting Entry on Dec 31: Depreciation Expense 9,000 Acc. Depr. - Machine 9,000
- Machinery
- Survive Company pays $80,000 in cash to purchase machinery on January 1st. This amount is debited to the Machinery account, an asset account (+/-), to increase its value.
- Cash
- Cash is credited for the same amount of $80,000.
- This serves to decrease the cash balance.
- This aligns with your Cash Cheat Code; whenever cash is paid, it's always recorded as a credit because cash is an asset that needs to be decreased.
- Depreciation Expense
- The depreciation expense of $9,000 is already calculated and provided. We debit Depreciation Expense to increase it, as it's an expense account (+/-).
- Accumulated Depreciation - Machinery
- The same amount of $9,000 is credited to Accumulated Depreciation - Machinery, a contra-asset account (+/-), to increase its balance. This reflects the depreciation of the machinery over time.
- How the Depreciation Was Calculated (For informational purposes only)
- Original Cost: $80,000
- Estimated Useful Life: 8 years
- Salvage Value: $8,000
- Depreciation per Year = (Original Cost - Salvage Value) / Estimated Useful Life
- Depreciation per Year = ($80,000 - $8,000) / 8 = $9,000
- Refer to the Balance Sheet presentation below for reference.
- Historical Cost Principle: Note that the Machinery account remains at its original value of $80,000 throughout the year. This aligns with the historical cost principle, which requires assets to be recorded at their original purchase price without adjustments for market value changes or recorded depreciation.
- Accumulated Depreciation: This contra-asset account keeps track of the total depreciation of the machinery over its useful life. As the account's balance increases (from $0 to $9,000), it reduces the book value of the Machinery, evident in the balance sheet presentation.
- Machinery Book Value: This is the net value of the machinery after accounting for its depreciation. Calculated as the original cost ($80,000) minus the Accumulated Depreciation ($9,000), the book value stands at $71,000.
- Again, no worries about these concepts until we reach Chapter 8 in Exam 3!
Record the original entry on January 1st, as well as the required adjusting entry on December 31st. Original Entry on Jan 1: Building 200,000 Cash 200,000 Adjusting Entry on Dec 31: Depreciation Expense 4,500 Acc. Depr. - Building 4,500
- Building
- Survive Company pays $200,000 in cash to purchase a building on January 1st. The Building account, an asset account (+/-), is debited to increase its value.
- Cash
- Cash is credited for the same amount of $200,000.
- This serves to decrease the cash balance.
- This aligns with your Cash Cheat Code; whenever cash is paid, it's always recorded as a credit to decrease the asset account.
- Depreciation Expense
- The depreciation expense of $4,500 is calculated and provided. A debit is made to Depreciation Expense to increase it, as it's an expense account (+/-).
- Accumulated Depreciation - Building
- The same amount of $4,500 is credited to Accumulated Depreciation - Building, a contra-asset account (+/-), to increase its balance. This reflects the depreciation of the building over time.
- How the Depreciation Was Calculated (For informational purposes only)
- Original Cost: $200,000
- Estimated Useful Life: 40 years
- Salvage Value: $20,000
- Depreciation per Year = (Original Cost - Salvage Value) / Estimated Useful Life
- Depreciation per Year = ($200,000 - $20,000) / 40 = $4,500
- Refer to the Balance Sheet presentation below for reference.
- Historical Cost Principle: The Building account remains at $200,000 throughout the year, aligning with the historical cost principle. Assets are recorded at their original purchase price without adjustment for market value changes or recorded depreciation.
- Accumulated Depreciation: This contra-asset account accumulates the total depreciation of the building over its useful life. The account's balance increases (from $0 to $4,500), effectively reducing the book value of the Building on the balance sheet.
- Building Book Value: This is the net value of the building after accounting for depreciation. Calculated as the original cost ($200,000) minus Accumulated Depreciation ($4,500), the book value stands at $195,500.
- Again, no worries about these concepts until we reach Chapter 8 in Exam 3!
Record the original entry on January 1st, as well as the required adjusting entry on December 31st. Original Entry on Jan 1: Truck 30,000 Cash 30,000 Adjusting Entry on Dec 31: Depreciation Expense 2,800 Acc. Depr. - Truck 2,800
- Truck
- Survive Company pays $30,000 in cash to purchase a truck on January 1st. The Truck account, an asset account (+/-), is debited to increase its value.
- Cash
- Cash is credited for the same amount of $30,000.
- This serves to decrease the cash balance.
- This aligns with your Cash Cheat Code; whenever cash is paid, it's always recorded as a credit to decrease the asset account.
- Depreciation Expense
- The depreciation expense of $2,800 is calculated and provided. Depreciation Expense is debited to increase it, as it's an expense account (+/-).
- Accumulated Depreciation - Truck
- The same amount of $2,800 is credited to Accumulated Depreciation - Truck, a contra-asset account (+/-), to increase its balance. This reflects the depreciation of the truck over the year.
- How the Depreciation Was Calculated (For informational purposes only)
- Original Cost: $30,000
- Estimated Useful Life: 10 years
- Salvage Value: $2,000
- Depreciation per Year = (Original Cost - Salvage Value) / Estimated Useful Life
- Depreciation per Year = ($30,000 - $2,000) / 10 = $2,800
- Refer to the Balance Sheet presentation below for reference.
- Historical Cost Principle: The Truck account stays at $30,000 throughout the year, adhering to the historical cost principle. This principle dictates that assets are recorded at their original purchase price and are not adjusted for market changes or recorded depreciation.
- Accumulated Depreciation: This contra-asset account records the depreciation of the truck over time. As the account balance increases from $0 to $2,800, it effectively reduces the book value of the Truck.
- Truck Book Value: This is the net value of the truck after accounting for depreciation. Calculated as the original cost ($30,000) minus the Accumulated Depreciation ($2,800), the book value becomes $27,200.
- Again, no worries about these concepts until we reach Chapter 8 in Exam 3!
- Adjusting entries for Unearned Revenue can differ based on the nature and conditions of the unearned revenue transaction in question. While the journal entry structure remains the same—Debiting 'Unearned Revenue' and Crediting 'Revenue Earned'—the calculation of transaction amounts varies.
- The key goal in handling unearned revenue is to pinpoint how much of that "unearned" portion has actually been "earned" as of December 31st. (This is crucial because that's the amount you'll need to include in your year-end adjusting entry — the amount that was earned!)
- See examples below for clarity:
- In this scenario, the revenue is recognized evenly over the months during which the service will be provided. The journal entry remains the same (Debit Unearned Consulting Revenue, Credit Consulting Revenue), but the amounts change based on the time elapsed.
- Example: You received $12,000 on March 1st for a 12-month consulting project.
- Revenue Recognized Each Month: $12,000 / 12 = $1,000 per month
- Revenue to Recognize at Year End: $1,000/month x 10 months (from March 1 to December 31) = $10,000 to recognize in the year-end adjusting entry.
- The remaining $2,000 in unearned revenue will carry over to the next period's balance sheet until it is earned in the following period. At this point, we’ll record the adjusting entry again for the $2,000.
- Pro Tip: When dealing with word problems about months, years, or other time periods, — always count on your fingers. You’ll feel like a kindergartner, but it will help you avoid errors that can occur when calculating in your head!
- Here, the journal entry is adjusted based on the percentage of the contract that has been completed. It's crucial to know the completion percentage to make an accurate adjusting entry.
- Example: You received $20,000 on January 1st for a consulting project that is expected to be completed within the year.
- Completion as of Year End: Assume that as of December 31st, 70% of the project is completed. (This figure will be given to you in a problem.)
- Revenue to Recognize at Year End: $20,000 x 0.70 = $14,000 to recognize in the year-end adjusting entry.
- The remaining $6,000 in unearned revenue will carry over to the next period's balance sheet until it is earned in the following period. At that time, another adjusting entry will be made for the remaining amount based on the final completion percentage.
- Certain types of service revenue don't align well with the "evenly distributed over time" method highlighted in the previous example (e.g. construction contracts).
- This percentage completion approach allows for revenue recognition that better matches the actual work completed, as opposed to merely accounting for the passage of time.
- The revenue is recognized in the periods the property is actually rented out. This may require prorating the total rent revenue over the rental term.
- Example: You received $24,000 cash on June 1st for a 12-month rent contract of a commercial property.
- Months Rented by Year End: Assume by December 31st, the property has been rented for 7 months (June 1 to December 31st.
- Revenue to Recognize at Year End: $24,000 / 12 months = $2,000 per month. So, $2,000/month x 7 months = $14,000 to recognize in the year-end adjusting entry.
- Remaining Unearned Revenue: The remaining $10,000 will remain in the balance sheet until it's fully earned.
- Note: It's important to match the revenue with the periods the property is actually rented out, instead of simply dividing the total rent over 12 months. As of December 31st, only 7 months of rent has been given!
- In this case, revenue is recognized only once the event has actually taken place. Until then, the revenue remains 'unearned.'
- Example: You sold 200 tickets for a concert at $50 each, totaling $10,000, two months before the event.
- Revenue to Recognize: Since the event occurs after the balance sheet date, you recognize the full $10,000 once the event takes place.
- Unearned Revenue: The entire $10,000 stays as unearned until the concert occurs.
- Note: When it comes to revenue recognition for ticket sales, it’s an all-or-nothing deal — only recognize revenue once the event occurs.
- Revenue is recognized as each magazine is shipped out to subscribers. This could be monthly, quarterly, etc., depending on the subscription terms.
- Example: You received $1,200 on February 1st for a year's subscription of a monthly magazine.
- Issues Sent by Year End: Assume 10 issues are sent by December 31st.
- Revenue to Recognize at Year End: $1,200 / 12 issues = $100 per issue. So, $100/issue x 10 issues = $1,000 to recognize in the year-end adjusting entry.
- Remaining Unearned Revenue: The remaining $200 will carry over to the next period's balance sheet until further magazine issues are sent.
- Note: Revenue is recognized as and when the magazines are shipped.
- This involves recognizing revenue over the period the membership is active. It's essential to know the membership's time frame to calculate the appropriate amount to be recognized.
- Example: You received $480 on April 1st for a year-long gym membership.
- Months Active by Year End: The membership is active for 9 months by December 31st. (April 1 to December 31)
- Revenue to Recognize at Year End: $480 / 12 months = $40 per month. So, $40/month x 9 months = $360 to recognize in the year-end adjusting entry.
- Remaining Unearned Revenue: The remaining $120 will be recognized in the next period's balance sheet as the membership continues.
- Note: It's essential to prorate the membership fees over the active period to recognize the revenue accurately.
Record the original entry on February 1st, as well as the required adjusting entry on December 31st. Original Entry on Feb 1: Cash 24,000 Unearned Revenue 24,000 Adjusting Entry on Dec 31: Unearned Revenue 19,200 Consulting Revenue 19,200
- Cash
- Survive Company receives $24,000 cash for the new consulting contract. Cash is an asset account and is debited by $24,000 to increase its value. Debiting an asset account (+/-) like Cash increases its value.
- Unearned Revenue
- Unearned Revenue, a liability account, is credited for $24,000. Crediting a liability account (-/+) like Unearned Revenue increases its value, signaling an obligation to provide future services.
- Unearned Revenue
- The account is debited by $18,000 to reduce its balance. Debiting a liability account (-/+) like Unearned Revenue decreases its value, signaling that a part of the service has been rendered.
- Consulting Revenue
- Consulting Revenue is credited for $18,000. This is an income account, and crediting it increases its value. Revenue accounts have a natural credit balance (+/-).
- Calculating the Adjusting Entry
- Initial Contract Terms: The contract spans 10 months and totals $24,000, which results in a monthly rate of $2,400.
- Monthly Rate: $24,000 / 10 months = $2,400 per month
- Earned Revenue: By December 31st, 8 months of the contract have elapsed (from May 1 to Dec 31). The earned revenue over this period is $19,200.
- Earned Revenue: 8 months * $2,400/month = $19,200
- Adjustment to Unearned Revenue: The original Unearned Revenue balance was $24,000. The adjusting entry reduces this balance by $19,200, leaving $4,800. This remaining balance corresponds to the 2 remaining months of the contract.
- Remaining Unearned Revenue: 2 months * $2,400 = $4,800
- Refer to the T Account below for reference.
Original Entry on July 1, 2023: Cash 72,000 Unearned Revenue 72,000 Adjusting Entry on Dec 31, 2023: Unearned Revenue 18,000 Consulting Revenue 18,000
Adjusting Entry on Dec 31, 2024: Unearned Revenue 36,000 Consulting Revenue 36,000 Adjusting Entry on Dec 31, 2024: Unearned Revenue 18,000 Consulting Revenue 18,000
- Cash: Survive Company receives $72,000 cash for the new 2-year consulting contract. Cash is debited by $72,000 to increase its balance.
- Unearned Revenue: A liability account, credited for $72,000 to show the obligation to provide services over the next 2 years.
Step 1: Determine Monthly Consulting Revenue
- The initial contract is for 24 months and totals $72,000, resulting in a monthly rate of $3,000.
- $72,000 / 24 months = $3,000 per month
Step 2: Calculate Revenue Earned for 2023
- From July 1 to December 31, 2023, 6 months of service are provided.
- Monthly revenue of $3,000 x 6 months = $18,000 earned
- 👉 Pro Tip: Count the Months on Your Fingers!
- July, August, September, October, November, December.
- That's 6 months in total.
Counting the Months
Step 3: Making the Adjusting Entry for 2023
- Debit Unearned Revenue $18,000: This reduces the Unearned Revenue account, signaling services have been rendered.
- Credit Consulting Revenue $18,000: Recognizes the earned revenue for the period.
- Refer to the T Account below for reference.
Step 4: Calculate Revenue Earned for 2024
- For 2024, it's a full year: 12 months.
- $3,000 x 12 = $36,000 earned
Step 5: Making the Adjusting Entry for 2024
- Debit Unearned Revenue $36,000
- Credit Consulting Revenue $36,000
- Refer to the T Account below for reference.
Step 6: Making the Final Adjusting Entry on July 1, 2025
- The remaining 6 months from January to June 2025 would account for the final $18,000.
- Debit Unearned Revenue $18,000
- Credit Consulting Revenue $18,000
- Refer to the T Account below for reference.
- For additional clarity on this concept, review the T Accounts that detail the changes in the Unearned Revenue account over the two-year contract initiated on July 1, 2023 until July 1, 2025.
Original Entry on July 1 Cash 8,000 Unearned Revenue 8,000 Adjusting Entry on Dec 31 Unearned Revenue 9,000 Consulting Revenue 9,000
- Unearned Consulting Revenue
- Survive Company receives $8,000 in cash for a 6-month consulting project on July 1st. This inflow is recorded with a credit to Unearned Consulting Revenue, a liability account, to increase its value.
- Cash
- Cash is debited for the same amount of $8,000.
- This debit serves to increase the cash balance.
- The $7,200 Consulting Revenue that was credited is calculated as follows:
- Initial Unearned Consulting Revenue for the year was $4,000.
- An additional $8,000 was received in July, making the total Unearned Consulting Revenue $12,000.
- At year-end, the company determines that 75% of the total is earned, resulting in $9,000 (75% of $12,000) in Consulting Revenue.
- Out of this, $1,800 was unearned at the start of the year, making the year-end recognized Consulting Revenue $7,200.
- A credit to Consulting Revenue records this amount.
- The $7,200 Earned Consulting Revenue that was debited is calculated as follows:
- The account had a balance of $12,000 before the adjusting entry.
- The $7,200 earned portion is moved from Unearned Consulting Revenue to Consulting Revenue, decreasing its balance to $4,800.
- A debit to Earned Consulting Revenue records this amount.
- Refer to the T Account below for reference.
Record the original entry on September 1st, as well as the required adjusting entry on December 31st.
Original Entry on Sept 1 Cash 18,000 Unearned Rent Revenue 18,000 Adjusting Entry on Dec 31 Unearned Rent Revenue 12,000 Rent Revenue 12,000
- Cash
- Survive Company received $18,000 in cash for a 6-month lease, which starts in September and ends in February. The debit to Cash serves to increase the asset account.
- Unearned Rent Revenue
- This credit entry acknowledges the liability the company has for services (in this case, the use of property) yet to be provided.
- Per Month Rent Earned:
- The total lease agreement is for $18,000 over 6 months, so the rent is $18,000 / 6 = $3,000 earned per month.
- The $12,000 Rent Revenue that was credited is calculated as follows:
- 4 months (September, October, November, December) have elapsed by the year-end
- So, the rent earned is 4 × $3,000 = $12,000.
- We credit Rent Revenue to recognize this earned portion.
- The $12,000 Unearned Rent Revenue that was debited is calculated as follows:
- Initially, the total Unearned Rent Revenue was $18,000.
- With the year-end adjusting entry, the earned portion of $12,000 needs to be deducted from the Unearned Rent Revenue account.
- We debit Unearned Rent Revenue by $12,000, leaving 18,000 − 12,000 = 6,000 remaining as the balance that is still 'unearned' and will be recognized in the following two months.
- Refer to the T Account below for reference.
Assume 7 out of the 10 concerts have been held by December 31st.
Record the original entry on May 1st, as well as the required adjusting entry on December 31st.
Original Entry on May 1 Cash 20,000 Unearned Ticket Revenue 20,000 Adjusting Entry on Dec 31 Unearned Ticket Revenue 14,000 Ticket Revenue 14,000
- Cash
- Survive Company receives $20,000 in cash for the concert tickets. This amount is debited to Cash to increase the asset account.
- Unearned Concert Ticket Revenue
- The company records a credit to Unearned Concert Ticket Revenue, acknowledging that this amount has not been 'earned' yet, as the concerts have not taken place.
- Per Concert Revenue:
- The total revenue is $20,000 for 10 concerts, making it $20,000 / 10 = $2,000 per concert.
- The $14,000 Concert Ticket Revenue that was credited is calculated as follows:
- 7 concerts have been held by year-end, making the earned revenue 7 × $2,000= $14,000 earned.
- We credit Concert Ticket Revenue to recognize the portion of the ticket sales that has been 'earned.'
- The $14,000 Unearned Concert Ticket Revenue that was debited is calculated as follows:
- Initially, the total Unearned Concert Ticket Revenue was $20,000.
- At year-end, the 'earned' portion is $14,000, which we need to remove from the Unearned Concert Ticket Revenue account.
- A debit of $14,000 leaves $6,000 (20,000 − 14,000) as the balance that will be 'earned' in the next three concerts.
- Refer to the T Account below for reference.
Original Entry on Mar 1 Cash 200 Unearned Subscr. Revenue 200 Adjusting Entry on Dec 31 Unearned Subscr. Revenue 150 Subscription Revenue 150
- Cash
- Survive Publishing Company receives $200 in cash for a 1-year subscription that will deliver issues every quarter. A debit is made to the Cash account to increase its value.
- Unearned Magazine Subscription Revenue
- The entire $200 is credited to the Unearned Magazine Subscription Revenue account to reflect that the service has not yet been provided. This is a liability account, signifying the company's obligation to deliver the magazines.
- Per Quarter Revenue:
- The subscription price is $200 for 4 quarters, making it 4 x $200 = $50 per quarter.
- The $150 Magazine Subscription Revenue that was credited is calculated as follows:
- 3 quarters have been serviced by the year-end, which equals 3 ×$50 = $150 in earned revenue.
- The remaining unearned portion is $200 − $150 = $50 — equivalent to the remaining 1 quarter to service.
- The $150 Unearned Magazine Subscription Revenue that was debited is calculated as follows:
- The total Unearned Magazine Subscription Revenue was initially $200.
- By the end of the year, the remaining unearned amount is $50. We need to debit the Unearned Magazine Subscription Revenue account by $150 to show the correct year-end balance.
- Refer to the T Account below for reference.
- Cash
- On Feb 1st, Survive Fitness Center receives $1,200 in cash for a 1-year gym membership. A debit to Cash increases its balance, reflecting the inflow of money.
- Unearned Gym Revenue
- An equal credit of $1,200 is made to Unearned Gym Revenue, which is a liability account. This shows that the service has not yet been provided and the center is obligated to offer the gym services.
- Per Month Revenue:
- The total membership fee is $1,200 for 12 months, which breaks down to $1,200 / 12 = $100 per month.
- 11-Month Earned Revenue:
- The membership started on Feb 1st, so by Dec 31st, 11 months of service have been provided. The earned revenue for this period is 11 × $100 = $1,100.
- Unearned Gym Revenue Debit:
- The original Unearned Gym Revenue was $1,200. After providing 11 months of service, the unearned portion remaining is 1,200 − 1,100= $100.
- The Adjusting Entry debits Unearned Gym Revenue by $1,100, to decrease this liability account and reflect the earned revenue.
- Gym Revenue Credit:
- An equal credit of $1,100 is made to Gym Revenue, which is an income account, to recognize the earned portion of the original payment.
- Refer to the T Account below for reference.
- Adjusting entries for accruing wages expense can differ based on the nature of the pay period, such as whether the fiscal year-end falls in the middle of the workweek or if there is an unpaid holiday.
- In both cases, the journal entry structure remains the same—Debiting 'Wages Expense' and Crediting 'Wages Payable'—but the calculation of amounts varies. The aim here is to accurately account for the wages that have been incurred but not yet paid by the year-end.
- Monday through Friday Workweek, End of Year Falls in the Middle
- This scenario assumes that the year-end date falls in the middle of a standard Monday through Friday workweek. Wages have to be prorated accordingly.
- Example: Let's assume you have an employee with a daily wage of $200.
- Daily Wage: $200
- Year-End Day: Wednesday
- Wages to Recognize at Year End: $200/day x 3 days (Mon-Wed) = $600
- Journal Entry: Debit Wages Expense $600, Credit Wages Payable $600
- Pro Tip: Always double-check your calendar dates when prorating. This ensures that you don't accidentally overlook a day and miscalculate your payable wages.
- Monday through Friday Workweek with an Unpaid Holiday
- This variation assumes that there is an unpaid holiday during the workweek. This will affect the overall wages that need to be accrued.
- Example: Assume you have an employee with a daily wage of $200 and an unpaid holiday falls on Wednesday.
- Daily Wage: $200
- Unpaid Holiday: Wednesday
- Wages to Recognize at Year End: $200/day x 2 days (Mon-Tue) = $400
- Journal Entry: Debit Wages Expense $400, Credit Wages Payable $400
- Note: In scenarios with unpaid holidays, ensure you only count the days the employee actually worked when calculating the year-end adjusting entry for wages.
Survive Company employs 3 individuals, each making $200 per day. The company's workweek runs from Monday to Friday. Employees receive their full pay for the Monday-to-Friday workweek every Friday. This year, the fiscal year-end falls on a Wednesday, December 31.
Record the adjusting entry on Dec 31st, as well as the entry on Friday, January 2, 2024. Adjusting Entry on Dec 31 (Wednesday)
Wages Expense 1800 Wages Payable 1800 Journal Entry on Jan 2 (Payday!) Wages Payable 1800 Wages Expense 1200 Cash 3000
Survive Company's fiscal year-end is on a Wednesday. According to accrual accounting, the company must record expenses as they occur, not when they're paid. For the three workdays in the current year (Monday, Tuesday, Wednesday), you have incurred $1,800 in wages that haven't been paid yet. You need to record this in your financials as both "Wages Expense" and "Wages Payable" to align with GAAP, which doesn't allow carrying over this year's expenses into next year.
- 3 employees * $200 per employee = $600 per day in Wages Expense incurred
- 3 days (Monday, Tuesday, Wednesday) * $600/day = $1,800
- Debit Wages Expense for 1,800 to recognize the cost of labor for 3 days.
- Credit Wages Payable for 1,800 to record our obligation to pay cash for these wages in the future.
- Clearing the Liability: We start by reversing the $1,800 Wages Payable from our year-end adjusting entry. We do this by debiting Wages Payable for $1,800, effectively zeroing it out.
- Thursday and Friday Wages: Next, we account for the wages for Thursday and Friday, which totals $1,200. How do we get this number? We have 3 employees each making $200 per day, which is $600 per day. For 2 days, that's $600 x 2 = $1,200.
- Total Payout - Cash Credit: Lastly, we credit Cash for $3,000. Why? Because that's the total amount paid to all employees for the whole workweek (Monday to Friday).
- Think about this $3000 amount in the real world:
- Hypothetically, let’s say you actually owned a company with 3 employees, each expecting $200 per day for 5 days.
- Therefore, you'd owe them $600 per day x 5 days = $3,000 for the full week.
- You must credit Cash for this amount; there's no other option. Your “employees” expect their full week's pay on payday, and that's exactly what they should get!
- Refer to the “Timeline View” below for reference.
Pro Tip: Sketch out a similar timeline on your exam. Trust me, you'll grasp the concept much better when you see it laid out visually instead of only in your head. Added Bonus: You’ll impress your professor with an organized timeline like this written on it! Very few of your classmates will show this same level of understanding.
When tackling problems that involve variable pay rates, multiple employees, and specific working days (i.e., "You have x employees who earn $100 per day, etc."), always consider sketching out a timeline.
Creating a visual map of the transactions and important dates can greatly improve your understanding of the problem. This is not just a suggestion; it's a proven method for boosting your performance on exam questions like these. Trust me, visualizing the problem written on paper will give you a significant edge over attempting it in your head!
To see how effective it is, refer to the example below.
📝 Survive Company employs 3 individuals, each making $200 per day. The company's workweek runs from Monday to Friday. Employees receive their full pay for the Monday-to-Friday workweek every Friday. This year, the fiscal year-end falls on a Wednesday, December 31.
Record the adjusting entry on Dec 31st, as well as the entry on Friday, January 2, 2024. Adjusting Entry on Dec 31 (Wednesday)
Wages Expense 1800 Wages Payable 1800 Journal Entry on Jan 2 (Payday) Wages Payable 1800 Wages Expense 1200 Cash 3000
Survive Company employs 3 individuals, each earning $200 per day. The workweek runs from Monday to Friday, with payday every Friday. This week, an unpaid holiday, New Year's Day, falls on Thursday, January 1, 2024.
Record the adjusting entry on Dec 31st, as well as the entry on Friday, January 2, 2024. Adjusting Entry on Dec 31 (Wednesday)
Wages Expense 1800 Wages Payable 1800 Journal Entry on Jan 2 (Payday) Wages Payable 1800 Wages Expense 600 Cash 2400
Survive Company's fiscal year-end is on a Wednesday. According to accrual accounting, the company must record expenses as they occur, not when they're paid. For the three workdays in the current year (Monday, Tuesday, Wednesday), you have incurred $1,800 in wages that haven't been paid yet. You need to record this in your financials as both "Wages Expense" and "Wages Payable" to align with GAAP, which doesn't allow carrying over this year's expenses into next year.
- The calculation remains the same as the previous example: 3 employees * $200 = $600 per day.
- Monday to Wednesday gives us 3 days * $600/day = $1,800.
- So, Debit Wages Expense and Credit Wages Payable by $1,800.
- Clearing Liability: Wages Payable of $1,800 is reversed by debiting it, which zeroes out the liability.
- Thursday is an Unpaid Holiday: New Year's Day means no wages for Thursday.
- Friday Wages: For Friday, we incur $600 in wages (3 employees * $200).
- Cash Outflow: Cash is credited for $2,400, accounting for the total wages of 4 paid days of the workweek.
- Why $2,400?
- You have 3 employees expecting $200 each for 4 working days.
- That sums up to 4 days * $600/day = $2,400. This is the exact amount credited to Cash.
- Refer to the “Timeline View” below for reference.
Pro Tip: Sketch out a similar timeline on your exam. Trust me, you'll grasp the concept much better when you see it laid out visually instead of only in your head. Added Bonus: You’ll impress your professor with an organized timeline like this written on it! Very few of your classmates will show this same level of understanding.
When tackling problems that involve variable pay rates, multiple employees, and specific working days (i.e., "You have x employees who earn $100 per day, etc."), always consider sketching out a timeline.
Creating a visual map of the transactions and important dates can greatly improve your understanding of the problem. This is not just a suggestion; it's a proven method for boosting your performance on exam questions like these. Trust me, visualizing the problem written on paper will give you a significant edge over attempting it in your head!
To see how effective it is, refer to the example below.
📝 Survive Company employs 3 individuals, each making $200 per day. The company's workweek runs from Monday to Friday. Employees receive their full pay for the Monday-to-Friday workweek every Friday. This year, the fiscal year-end falls on a Wednesday, December 31.
Record the adjusting entry on Dec 31st, as well as the entry on Friday, January 2, 2024. Adjusting Entry on Dec 31 (Wednesday)
Wages Expense 1800 Wages Payable 1800 Journal Entry on Jan 2 (Payday) Wages Payable 1800 Wages Expense 1200 Cash 3000
- Adjusting entries for accruing interest can differ based on the nature of the interest accumulation period and the timing of payments or receipts.
- In both cases of interest expense and interest revenue, the fundamental journal entry structure remains the same—Debiting 'Interest Expense' and Crediting 'Interest Payable' for expense; Debiting 'Interest Receivable' and Crediting 'Interest Revenue' for revenue.
- The aim is to accurately account for the interest that has been incurred or earned but not yet paid or received by the year-end.
Survive Company took out a loan of $10,000 on January 1st this year. The interest rate is 2% annually. The company has not made any interest payments yet. By December 31, the fiscal year-end, the company has accrued $200 in interest expense, due to be paid on January 15th of the following year.
Record the adjusting entry on December 31, as well as the entry when the interest is actually paid on January 15. Adjusting Entry on Dec 31
Interest Expense 200 Interest Payable 200 Journal Entry on Jan 15 of the next year Interest Payable 200 Cash 200
Survive Company's fiscal year-end is on December 31. According to accrual accounting principles, the company must record expenses and revenue as they are incurred or earned, not necessarily when they're paid or received.
In this case, $200 in interest expense has been incurred but not paid by the year-end. To align with GAAP, this obligation should be recorded in the current year's financial statements as both "Interest Expense" and "Interest Payable."
- The accrued interest for the period is provided as $200.
- Debit Interest Expense for $200 to recognize the cost of borrowing.
- Credit Interest Payable for $200 to show the obligation to pay this interest in the future.
- The interest payment is actually made on January 15.
- Debit Interest Payable for $200 to remove the liability (since it's now being paid).
- Credit Cash for $200 to reflect the payment, decreasing the cash balance.
Survive Company invested $10,000 in a certificate of deposit on January 1st this year. The interest rate is 2% annually. The company has not received any interest payments yet. By December 31, the fiscal year-end, the company has earned $200 in interest revenue, due to be received on January 15th of the following year.
Record the adjusting entry on December 31, as well as the entry when the interest is actually received on January 15. Adjusting Entry on 12/31
Interest Receivable 200 Interest Revenue 200 Journal Entry on Jan 15 of the next year Cash 200 Interest Receivable 200
Survive Company's fiscal year-end falls on December 31. According to accrual accounting principles, revenue must be recognized when it is earned, not necessarily when it is received. By December 31, $200 in interest revenue has been earned but hasn't been received yet. To align with GAAP, this earned revenue should be recorded in the current year's financial statements as both "Interest Receivable" and "Interest Revenue."
- The earned interest for the period is provided as $200.
- Debit Interest Receivable for $200 to recognize the amount of interest that is to be received.
- Credit Interest Revenue for $200 to show the earned interest revenue.
- The interest revenue is actually received on January 15.
- Debit Cash for $200 to increase the asset account since cash is received.
- Credit Interest Receivable for $200 to remove the liability, as it has now been fulfilled.
On December 31, Survive Company realizes that it has provided $20,000 of consulting services on credit in the current year that have not yet been recorded. The full amount is expected to be collected on January 15th of the following year.
Record the adjusting entry needed on December 31, as well as the entry when the revenue is actually collected on January 15. Adjusting Entry on 12/31
Accounts Receivable 20,000 Consulting Revenue 20,000 Journal Entry on Jan 15 of the next year Cash 20,000 Accounts Receivable 20,000
Survive Company's fiscal year-end falls on December 31. According to the accrual basis of accounting, revenue should be recognized when it is earned, regardless of when payment is received. In this case, Survive Company provided $20,000 in consulting services on credit, which have been earned but not yet received. To align with GAAP, this earned revenue must be recorded in the current year's financials as both "Accounts Receivable" and "Consulting Revenue."
- Survive Company has provided $20,000 of consulting services that haven't been recorded yet.
- Debit Accounts Receivable for $20,000 to recognize the amount that is to be collected.
- Credit Consulting Revenue for $20,000 to record the revenue that has been earned.
- On January 15, the company actually collects the $20,000.
- Debit Cash for $20,000 to increase the asset account since cash is received.
- Credit Accounts Receivable for $20,000 to remove the receivable, as payment has been received, fulfilling the obligation.
Use the R.E.I.D acronym to easily recall the accounts closed at the end of each period!
- Revenues
- Expenses
- Income Summary
- Dividends
Closing Revenue Accounts
With a solid understanding of debits & credits for each account type, closing entries become very straightforward. Let's reference the following framework from Chapter 2 for debits & credits: Assets = Liabilities + Equity Revenues / Expenses (+/-) (-/+) (-/+) (-/+) (+/-)
- Revenues operate on a (-/+) basis, meaning to close (i.e., reduce to zero), we must DEBIT THEM.
- Then, we total the closed revenue accounts, and “dump” them into the Income Summary on the other side of the entry — ensuring debits are equal to credits.
- This is simply a hypothetical scenario.
- Depending on your exam, you may have only one revenue account to close (e.g. Fees Earned), or multiple revenue accounts needing closing (Fees Earned, Consulting Revenue, Rent Revenue, Sales, etc.).
- In essence, the point I’m trying to illustrate is that, whatever revenues you see on the income statement — they will ALL need to be closed!
Use the R.E.I.D acronym to easily recall the accounts closed at the end of each period!
- Revenues
- Expenses
- Income Summary
- Dividends
Closing Expense Accounts
With a solid understanding of debits & credits for each account type, closing entries become very straightforward. Let's reference the following framework from Chapter 2 for debits & credits: Assets = Liabilities + Equity Revenues / Expenses (+/-) (-/+) (-/+) (-/+) (+/-)
- Expenses work the opposite of revenues, like (+/-), which means to close, i.e. reduce them to zero, — we must CREDIT THEM.
- Then, we total the closed expense accounts, and “dump” them into the Income Summary on the other side of the entry — ensuring debits are equal to credits.
- This is simply a hypothetical scenario.
- Depending on your exam, you may have only one expense account to close (e.g. Cost of Goods Sold), or multiple expense accounts needing closing (Depreciation Expense, Wages Expense, Rent Expense, Advertising Expense, etc.).
- In essence, the point I’m trying to illustrate is that, whatever expenses you see on the income statement — they will ALL need to be closed!
Use the R.E.I.D acronym to easily recall the accounts closed at the end of each period!
- Revenues
- Expenses
- Income Summary
- Dividends
- Closing the Income Summary Account (Net Income Scenario)
- Closing this account depends on whether we had a net income (Revenues > Expenses) or a net loss (Revenues < Expenses) for a given period.
- This is best illustrated by using a T Account for Income Summary, which includes entries from the previous steps of closing revenues and expenses (R.E.I.D).
- Refer to the example below, drawing on prior examples of closing entries — which lead to Net Income:
- Simply put, the "Income Summary" account is a summarization of the Net Income or loss.
- Therefore, in this example, context, the $25,000 debit balance in Income Summary represents Net Income!
- This ending balance is derived from the debit to Income Summary of $100,000 (closing revenues) minus the credit to Income Summary of $75,000 (closing expenses),
- Since Revenues were greater than Expenses, this results in our Net Income of $25,000.
- This aligns with the Net Income calculation in an income statement:
- Revenues Equals Net Income or Loss
- Making sense?
- In my opinion, this understanding of how the Income Summary account functions is crucial — as it provides a much deeper comprehension than simply memorizing the closing entry.
- Remembering the closing entry for Income Summary, in a Net Income scenario, becomes way easier when we focus on why Retained Earnings, an equity account (-/+), is credited.
- Recall that crediting an equity account (-/+), like Retained Earnings, will INCREASE that account.
- If we have Net Income, why should we increase Retained Earnings when closing Income Summary?
- Because Net Income for the period does exactly that—it gets added to the Retained Earnings account!
- To illustrate this, reflect on the Statement of Retained Earnings formula from previous chapters:
- PLUS NET INCOME*
- Seeing it?
- Notice that when closing the Income Summary account under a Net Income scenario — we need to increase Retained Earnings by crediting it, since we know that Net Income is added to Retained Earnings!
- If you remember this, you'll automatically know that the opposite side, the debit, goes to Income Summary.
Less Expenses
Beginning R/E
Minus Dividends
Equals Ending R/E
Use the R.E.I.D acronym to easily recall the accounts closed at the end of each period!
- Revenues
- Expenses
- Income Summary
- Dividends
- Closing the Income Summary Account (Net Loss Scenario)
- Revenues
- Expenses
- Income Summary
- Dividends
- Closing the Income Summary Account (Net Loss Scenario)
- Closing this account depends on whether we had a net income (Revenues > Expenses) or a net loss (Revenues < Expenses) for a given period.
- This is best illustrated by using a T Account for Income Summary, which includes entries from the previous steps of closing revenues and expenses (R.E.I.D).
- Refer to the example below, drawing on hypothetical examples of closing entries — which lead to a Net Loss:
- Simply put, the "Income Summary" account is a summarization of the Net Income or loss.
- Therefore, in this example, context, the $25,000 credit balance in Income Summary represents a Net Loss!
- This ending balance is derived from the debit to Income Summary of $75,000 (closing revenues) minus the credit to Income Summary of $100,000 (closing expenses),
- Since Expenses were greater than Revenues, this results in our Net Loss of $25,000.
- This aligns with the Net Income calculation in an income statement:
- Revenues Equals Net Income or Loss
- Making sense?
- In my opinion, this understanding of how the Income Summary account functions is crucial — as it provides a much deeper comprehension than simply memorizing the closing entry.
- Remembering the closing entry for Income Summary, in a Net Loss scenario, becomes way easier when we focus on why Retained Earnings, an equity account (-/+), is debited.
- Recall that debiting an equity account (-/+), like Retained Earnings, will DECREASE that account.
- If we have a Net Loss, why should we decrease Retained Earnings when closing Income Summary?
- Because Net Loss for the period does exactly that—it gets subtracted from the Retained Earnings account!
- To illustrate this, reflect on the Statement of Retained Earnings formula from previous chapters:
- MINUS NET LOSS*
- Seeing it?
- Notice that when closing the Income Summary account under a Net Income scenario — we need to decrease Retained Earnings by debiting it, since we know that Net Income is added to Retained Earnings!
- If you remember this, you'll automatically know that the opposite side, the credit, goes to Income Summary!
Use the R.E.I.D acronym to easily recall the accounts closed at the end of each period!
Less Expenses
Beginning R/E
Minus Dividends
Equals Ending R/E
Use the R.E.I.D acronym to easily recall the accounts closed at the end of each period!
- Revenues
- Expenses
- Income Summary
- Dividends
Closing Dividends (Contra Equity)
With a solid understanding of debits & credits for each account type, closing entries become very straightforward. Let's reference the following framework from Chapter 2 for debits & credits: Assets = Liabilities + Equity Revenues / Expenses (+/-) (-/+) (-/+) (-/+) (+/-)
Contra — i.e. opposite of — Equity? (+/-)
- Dividends operates on a (+/-) basis, meaning to close (i.e., reduce to zero), we must CREDIT the account.
- Recall that debiting an equity account (-/+), like Retained Earnings, will DECREASE that account.
- If we’ve paid Dividends, why does this decrease Retained Earnings?
- Because Dividends for the period do exactly that—they gets subtracted from the Retained Earnings account!
- To illustrate this, reflect on the Statement of Retained Earnings formula from previous chapters:
Beginning R/E
Plus Net Income
- Minus Dividends*
Equals Ending R/E
- Seeing it?
- Connecting the closing of Dividends to the idea that Dividends are subtracted in the Statement of Retained Earnings can be a super useful memorization tool.
- If you remember that Dividends decrease Retained Earnings — it will help you recall that Retained Earnings must be debited when closing out Dividends!
