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UIL 2017 Capital Conference UIL Accounting & : Timing is Everything!

What We Will Do in This Session:

1. Gauge your level of confidence regarding this topic area

2. Review some basic accounting theory and some terms and definitions

3. Examine an example of a transaction to create a Deferred and to create a Deferred (always a Action)

4. Review theory behind end-of-fiscal period (we will cover four types) (these four NEVER affect Cash)

5. Examine an example of a transaction to create an Accrued Revenue and to create an Accrued Expense (these two NEVER affect Cash)

6. Make an adjusting entry to adjust amount or clear a Deferred Revenue and to adjust amount or clear a Deferred Expense

7. Examine Cash Actions that occur in the future to adjust amount or clear an Accrued Revenue and to adjust amount or clear an Accrued Expense

8. Examine Reversing Entries (why bother?)

9. Summarize some theory facts that we have covered today

10. Gauge your level of confidence regarding this topic area

Basic Facts about Our Company Used in Sample Transactions: • Company uses accounting • Company prepares adjusting entries monthly in order to prepare monthly financial statements • Company closes the temporary capital accounts only at the end of the , which is December 31 • The T-accounts on the following page show the balances in the accounts prior to the transactions we will work together.

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Balance Sheet (A=L+C) Cash 3600

Liabilities 200

Owners’ Capital 2800

Income Statement 1400 2000

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Deferrals

Question: Good grief, why start here? Answer: Because you already know one of these.

Question: What does it mean to defer? Answer: To put off doing until later

Question: Put off, like procrastinate? Put off what? Answer: Defer recognizing (recording) revenue or expense (Defer the impact on the and instead “park it” on the temporarily).

Trans #1 : On December 1, purchased a one-year insurance premium by writing a check for $1,200.

• Cash event creates a deferred expense. • A deferred expense could be called a “prepaid” expense (like Prepaid Insurance) • A deferred expense sits on the Balance Sheet until it is ready to grow up to be a “real” expense. • The insurance premium is “charged” to expense with the passage of time. • Don’t be tempted to classify this as an expense just because it has the word “expense” in it. It is an : something of value that is owned, that will benefit a FUTURE period. • Isn’t it clever that assets and expenses each have a normal balance side on the debit side? Makes it easy to “slide” the asset from the Balance Sheet to the Income Statement when the deferred expense has “grown up” into an expense. (Clever.)

Trans #2 : On November 20, received a $500 deposit for work we will perform in the following month of December.

• Cash event creates a deferred revenue. • A deferred revenue account title typically used is Unearned Revenue. • A deferred revenue sits on the Balance Sheet until it is ready to grow up to be a “real” revenue. • Don’t be tempted to classify this as a revenue account just because it has the word “revenue” in it. It is a liability. • A deferred revenue is UNearned. If we don’t perform (do the work), we must give back the deposit. Therefore, on the day we receive the cash until the day we have earned it, we OWE it to the person who gave us the cash in the first place. Sounds like a liability. • Isn’t it clever that liabilities and revenue each have a normal balance side on the credit side? Makes it easy to “slide” the liability from the Balance Sheet to the Income Statement when the deferred revenue has “grown up” into a revenue. (Really Clever.)

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Time has passed. It is December 31.

Time to do the endofyear accounting stuff, like prepare the Worksheet.

• No one gives us a document that says what adjusting entries need to be made.

• Analyze EACH account on the Balance Sheet.

• Good practice involves analyzing the Income Statement accounts as well. For example, when the insurance was purchased, if we posted that to Insurance Expense, we would need to back out a portion from expense and move some of it to the prepaid asset account. This is beyond our scope today.

• We will look at the deferred expense on the Balance Sheet to see if anything has “grown up” to be an expense. If so, we will move that amount to the Income Statement. (Debit Insurance Expense; Credit Prepaid Insurance $100)

• We will look at the deferred revenue on the Balance Sheet to see if any or all of it has “grown up.” If so, we will move that amount to the Income Statement. (Debit Unearned Revenue; Credit Revenue $500)

• We will look for any revenue earned that we have not yet received.

• We will look for any expense incurred that we have not yet paid.

Trans #3 : Work was performed and finished on December 30 for $1,500, but we have not yet prepared the customer invoice. The clerk will prepare the invoice after she has a Happy New Year AND she takes a two week vacation. We want to issue financial statements the first week of January.

Trans #4 : In order to perform the project finished in Trans #3, a substantial amount of printing was outsourced to a printing company. The purchase order was for $300, but the invoice has not been received. There could be a minimal delivery charge that we agreed to verbally. The invoice will be entered into our accounting system when the Accounts Payable clerk returns from medical leave sometime in mid-January.

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Are you peeking? ☺

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Balance Sheet (A=L+C) Assets Cash 3600 1200 created deferral created 500 Dec 31 2900 Prepaid Insurance If Accts Rec is used, deferral created 1200 then the subsidiary 100 AJE Dec 31 & control Dec 31 1100 account will be out of balance on Dec 31.

Accrued Revenue Receivable AJE accrual created 1500

Liabilities Accounts Payable 200

Unearned Revenue 500 deferral created AJE Dec 31 500 0 Dec 31

Accrued Expense Payable If Accts Pay is used, 300 AJE accrual created then the subsidiary ledger & control account will be out of balance on Dec 31.

Owners’ Capital 2800

Income Statement Expenses Revenues 1400 2000 def exp now incurred def rev now (insurance) 100 500 earned accr exp (printing) 300 1500 accr rev Dec 31 1800 4000 Dec 31

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The next step is to prepare the financial statements for December 31.

Company Name Balance Sheet December 31, 20xx Assets Cash 2900 Prepaid Insurance 1100 Accrued Revenue Receivable 1500 Total Assets 5500

Liabilities Accounts Payable 200 Accrued Expense Payable 300 Total Liabilities 500

Owner’s Owner, Capital January 1, 20xx 2800 2200 Owner, Capital December 31, 20xx 5000 Total Liabilities and Owner’s Equity 5500

Company Name Income Statement For the Year Ended December 31, 20xx Revenue 4000 Expenses 1800 Net Income 2200

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After financial statements are prepared, journalize and post all adjusting entries.

The next step is to close the temporary capital accounts:

General Journal Revenue 4000 Income Summary 4000 Income Summary 1800 Expenses 1800 Income Summary 2200 Owner, Capital 2200

Owner’s Capital 2800 2200 from Income Summary

5000 Dec 31 after closing entries

Income Summary 4000 from revenue from expenses 1800 2200 Net Income close Net Income to Capital 2200 0 Dec 31 after closing

Expenses Revenues 1400 2000 def exp now incurred def rev now (insurance) 100 500 earned accr exp (printing) 300 1500 accr rev Dec 31 1800 4000 Dec 31 4000 close revenue close expenses 1800 Dec 31 after closing 0 0 Dec 31 after closing

Reversing Entries:

General Journal Revenue 1500 Accrued Revenue Receivable 1500 Accrued Expense Payable 300 Expenses (printing) 300

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Balance Sheet (A=L+C) Assets Cash 3600 1200 deferral created deferral created 500 Dec 31 2900 Prepaid Insurance deferral created 1200 100 AJE Dec 31 Dec 31 1100

Accrued Revenue Receivable AJE accrual created 1500 1500 REVERSAL Jan 1 after reversal 0

Liabilities Accounts Payable 200

Unearned Revenue 500 deferral created AJE Dec 31 500 0 Dec 31

Accrued Expense Payable 300 AJE accrual created REVERSAL 300 0 Jan 1 after reversal

Owners’ Capital 5000

Income Statement Expenses Revenues 1500 REVERSAL 300 It looks weird, but REVERSAL have faith It looks weird, but have faith

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More Time Has Passedit is January 20.

The Accounts Receivable Clerk is back from vacation. She prepares the customer invoice for $1,500 just as she normally would. She does not have to know WHEN the revenue is actually earned. When she creates the invoice, the software will debit Accounts Receivable and credit Revenue just like normal.

Accounts Receivable Jan 20 invoice 1,500

Revenue REVERSAL 1,500 1,500 Jan 20 invoice

Net effect to Revenue in the new fiscal year is ZERO, because we wanted the revenue earned to be on last year’s Income Statement.

______

We received the invoice of $300 from the printing company. Because we are a loyal customer, the printing company did not charge us for the delivery. On January 21, the invoice is entered into Accounts Payable by the clerk who is feeling well after being on medical leave. The clerk does not need to know what period of time the expense was incurred. The software will debit expense and credit Accounts Payable just like normal.

Accounts Payable

300 Jan 21 invoice

Expense 300 REVERSAL Jan 21 invoice 300 Net effect to Expense in the new fiscal year is ZERO, because we wanted the expense incurred to be on last year’s Income Statement.

Hopefully, you can see the benefit of Reversing Entries. They allow all the accounting clerks to do their jobs in the normal way.

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Remember: • An adjusting journal entry (AJE) to ADJUST a deferral or CREATE an accrual will affect at least one Balance Sheet account and at least one Income Statement account. • Account Relationships: Accrued Revenue—asset, revenue Accrued Expense—liability, expense Deferred Revenue—liability, revenue Deferred Expense—asset, expense • Failure to make accrual and deferral adjustments will cause accounts on BOTH financial statements to be either understated or overstated. • Accruals and deferrals ensure financial statements are more comparable from one reporting period to the next. • Accruals and deferrals follow the and the Principle. • The CREATION of a deferral affects CASH. • The CREATION of an accrual does NOT affect CASH. • An adjusting journal entry for an accrual or a deferral does NOT affect CASH. • An existing accrual is expected to have a FUTURE impact on CASH. • Typically the creation of an accrual as an adjusting entry will be reversed at the beginning of the next fiscal period.

The following pages are the “paper handout” used during this session.

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UIL 2017 Capital Conference

UIL Accounting

Accounting Accruals & Deferrals: Timing is Everything!

DECEMBER JANUARY 31 1

Time Sheet for Accruals & Deferrals

Consider Your Perspective is in the NOW column, when you are preparing the end-of-period worksheet.

PAST NOW FUTURE Creation of Deferral End-of-Period AJE’s Resolution of an Accrual (Cash Action) (NO Cash Action) (Cash Action)

Accrued Revenue:

Accr. Revenue Rec DR Cash in Bank DR Fees Income CR Accr. Revenue Rec CR

Accrued Expense:

Salary Expense DR Salary Payable DR Salary Payable CR Cash in Bank CR

Deferred Revenue:

Cash in Bank DR Unearned Revenue DR Unearned Revenue CR Fees Income CR

Deferred Expense:

(or Prepaid Expense) Supplies DR Supplies Expense DR Cash in Bank CR Supplies CR

This chart considers that Reversing Entries were NOT used.

It is possible for a deferred revenue or a deferred expense to require more than one accounting reporting period in the future to finally be disposed or eliminated. For example: when an attorney receives a deposit on a long-term engagement that spans several accounting reporting periods.

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Balance Sheet (A=L+C) Assets Cash 3600

Liabilities Accounts Payable 200

Owners’ Capital 2800

Income Statement Expenses Revenues 1400 2000

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Exercises

Write the two types of

Exercise 1: AJE Account Relationships accounts in relationship for each item at the left

1. Accrued Revenue

2. Accrued Expense

3. Deferred Revenue

4. Deferred Expense

Exercise 2: Four Types of Timing Differences Write the correct letter from the box at left

Expense paid by cash and recorded as assets before A Accrued Revenue 1. they are used or consumed Revenue earned but not yet received in cash or B Accrued Expense 2. recorded Revenue received in cash and recorded as liabilities C Deferred Revenue 3. before they are earned

D Deferred Expense 4. Expense incurred but not yet paid by cash or recorded

Exercise 3: Four Timing Differences

Match each situation with one the following terms:

Terms Answer Situation A Accrued Revenue 1. an expense not yet incurred; paid in advance B Accrued Expense 2. rent not yet collected; already earned C Deferred Expense 3. an expense incurred; not yet paid or recorded D Deferred Revenue 4. office supplies on hand; used next 5. a revenue not yet earned; collected in advance 6. a revenue earned; not yet collected 7. property taxes incurred; not yet paid 8. rent revenue collected; not yet earned

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KEY for Exercises

Ex. 1 Ex. 2 Ex. 3 1. asset/revenue 1. D 1. C 2. liability/expense 2. A 2. A 3. liability/revenue 3. C 3. B 4. asset/expense 4. B 4. C 5. D 6. A 7. B 8. D