l Iab Rev Methods

Liability and Revenue Methods

accruals deferralscash AFTER event cash BEFORE event

© Copyright 2007 by M. Ray Gregg. All rights reserved.


Deferrals and accruals are presented in Chapters 3 and 4. In first discussion a handout was distributed to practice alternatives of accounting for ASSET and EXPENSE and for LIABILITY and REVENUE methods.

This presentation attempts to cover the lower half of the handout dealing with liability and revenue methods of accounting for unearned revenue. To follow along you will need the handout distributed in class or available elsewhere online.



These facts are stated on the handout:

The unearned advertising revenue at the beginning of the year is $20,000, revenues received in advance during the year total $130,000, and the unearned advertising revenue at the end of the year is $18,000.



These instructions are stated on the handout for part (a):

Record the following directly in the T accounts for Unearned Advertising Revenue and Advertising Revenue, employing the system of initially recording advertising fees as a LIABILITY. Identify each entry by number: (1) beginning balance; (2) revenues received during the period; (3) adjusting entry at the end of the period; (4) closing entry; (5) reversing entry, if necessary.



First, let’s establish whether we are dealing with an ACCRUAL or a DEFERRAL. Just as in class, it is always best, even in this presentation, for you to make up your mind, answer it to yourself, before you see the answer here.

Have you decided?



Let’s find a hint in the facts on the handout and on a previous slide:

These facts are stated on the handout:

The unearned advertising revenue at the beginning of the year is $20,000, revenues received in advance during the year total $130,000, and the unearned advertising revenue at the end of the year is $18,000.

Accrual or deferral? Have you decided?



Still unsure? Then reconsider the time line illustration:

accruals deferralscash AFTER event cash BEFORE event

The problem suggests we received the cash in advance; we have to work to earn it. This must be a DEFERRAL.



So let’s get started. Re-read the instructions. In which account should be beginning balance appear?

Advertising RevenueUnearned Advertising



Wait. Before we answer that question, let’s be sure you know all about these two accounts – classifications, normal balances, financial statements, real or nominal, closed or not closed, etc. Contrast them.






You answer all those questions for Unearned Advertising before looking at the answers on the next slide.





LiabilityCreditBalance SheetRealNot Closed






Now do the same thing for Advertising Revenue. No peeking!






RevenueCreditIncome StatementNominalClosed (1st step)






RevenueCreditIncome StatementNominalClosed (1st step)



So think about the original question. In which account should be beginning balance appear?






20,000

Because?





20,000

Because we have chosen to use the LIABILITY method.



Now the next question on the instructions: (2) revenues received during the period. In which account?


20,000

You decide.





20,000

Why?

130,000





20,000

The key to administering methods is CONSISTENCY. We have picked a method and we should follow that method all during that year.

130,000


Comparison of Methods

Key to administering methods is

CONSISTENCY

J F M A M J J A S O N D

20x1 20x2All during that year



How many times do you think we collected cash from customers? Once? No. Lots. How many times did we have to decide what to credit?


20,000

Only ONCE. Because the key to administering methods is CONSISTENCY! Pick a method and stick with it allduring that year.

130,000



Let’s think of a word (adjective) to describe the balance of Unearned Advertising BEFORE adjustment.


20,000

You decide.

130,000



The balance of Unearned Advertising before adjustment is MIXED. Both earned and unearned are “stirred” together in that account.


20,000130,000

Consider doing nothing. Liabilities are overstated, revenue is understated, net income in understated.



Making an adjusting entry will make both financial statements better. What adjusting entry should we make.


20,000130,000

You decide.



Under these circumstances the adjusting entry should transfer the earned portion from the unearned account to the revenue account.


20,000130,000





20,000130,000

132,000 132,000

Some are probably wondering where to get the $132,000.





20,000130,000

132,000 132,000

$20,000 + $130,000 - $18,000 = $132,000





20,000130,000

132,000 132,000

Think of a term to describe the $132,000.





20,000130,000

132,000 132,000

Think of a term to describe the $132,000.





20,000130,000

132,000 132,000

What is the balance of the unearned account now? And what does it represent?





20,000130,000

132,000 132,000


B = 18,000





20,000130,000

132,000 132,000


B = 18,000





20,000130,000

132,000 132,000

One of these two accounts needs to be closed. Which one? You decide.

B = 18,000





20,000130,000

132,000 132,000

Advertising Revenue would be closed in the first step of closing entries.

B = 18,000





20,000130,000

132,000 132,000

Advertising Revenue would be closed in the first step of closing entries.

B = 18,000

132,000



(5) Make the reversing entry, if necessary.


20,000130,000

132,000 132,000

B = 18,000

132,000



(5) Make the reversing entry, if necessary. Let’s decide.


20,000130,000

132,000 132,000

B = 18,000

132,000





20,000130,000

132,000 132,000

B = 18,000

132,000

1. “All accruals need to be reversed” – won’t work – deferral.





20,000130,000

132,000 132,000

B = 18,000

132,000

1. “All accruals need to be reversed” – won’t work – deferral.2. If an adj entry creates bal in BS account – no, Un Adv had a bal.





20,000130,000

132,000 132,000

B = 18,000

132,000


Does the decision tree help?


III. DeferralsB. 4. b. Decision tree conclusion

LiabilityMethod





20,000130,000

132,000 132,000

B = 18,000

132,000


Does the decision tree help? This AJE does NOT need to be reversed.





20,000130,000

132,000 132,000

B = 18,000

132,000


But those are rules, rules, rules! Wouldn’t it be betterto UNDERSTAND it?





20,000130,000

132,000 132,000

B = 18,000

132,000

CONSISTENCY! … all during that year, and… from one year to the next

What is the “key” in administering “methods?”





20,000130,000

132,000 132,000

B = 18,000

132,000

Liability.

Which method did we use THIS year?





20,000130,000

132,000 132,000

B = 18,000

132,000

Liability.

Which method should we use NEXT year?





20,000130,000

132,000 132,000

B = 18,000

132,000

Liability.

In which account should be beginning balance appear?





20,000130,000

132,000 132,000

B = 18,000

132,000

In the liability account.

In which account should be beginning balance appear? Where is it now?





20,000130,000

132,000 132,000

B = 18,000

132,000



Then leave it alone. No reversing entry is necessary.



These instructions are stated on the handout for part (b):

Record the following directly in the T accounts for Unearned Advertising Revenue and Advertising Revenue, employing the system of initially recording advertising fees as REVENUE. Identify each entry by number: (1) beginning balance; (2) revenues received during the period; (3) adjusting entry at the end of the period; (4) closing entry; (5) reversing entry, if necessary.









20,000

Because?





20,000

Because we have chosen to use the REVENUE method.





You decide.

20,000




Advertising Revenue

Why?

130,00020,000

Unearned Advertising





The key to administering methods is CONSISTENCY. We have picked a method and we should follow that method all during that year.

130,00020,000



How many times do you think we collected cash from customers? Once? No. Lots. How many times did we have to decide what to credit?


Only ONCE. Because the key to administering methods is CONSISTENCY! Pick a method and stick with it allduring that year.

130,00020,000



Let’s think of a word (adjective) to describe the balance of Advertising Revenue BEFORE adjustment.


You decide.

130,00020,000



The balance of Advertising Revenue before adjustment is MIXED. Both earned and unearned are “stirred” together in that account.


Consider doing nothing. Revenue is overstated, liabilities are understated, net income in overstated.

130,00020,000



Making an adjusting entry will make both financial statements better. What adjusting entry should we make.


You decide.

130,00020,000



Under these circumstances the adjusting entry should transfer the unearned portion from the earned account to the liability account.


130,00020,000





18,00018,000

The $18,000 was described in the problem as unearned.

130,00020,000






B = 132,000

18,00018,000130,00020,000






B = 132,000

18,00018,000130,00020,000





Advertising Revenue 132,000Income Summary 132,000

B = 132,000

18,00018,000130,00020,000





Advertising Revenue 132,000Income Summary 132,000

18,00018,000130,00020,000

132,000



(5) Make the reversing entry, if necessary.


18,00018,000130,00020,000

132,000





18,00018,000 20,000132,000 130,000





1. “All accruals need to be reversed” – won’t work – deferral.

18,00018,000 20,000132,000 130,000





1. “All accruals need to be reversed” – won’t work – deferral.2. If an adjusting entry creates balance in a BS account....

18,00018,000 20,000132,000 130,000






18,00018,000 20,000132,000

The $18,000 credit in Unearned Advertising is the FIRST entry in that Balance Sheet account. It DOESneed to be reversed.

130,000






Does the decision tree help?

18,00018,000 20,000132,000 130,000


III. DeferralsB. 6. Reversing Entries Necessary?

RevenueMethod






Does the decision tree help? This AJE DOES need to be reversed.

18,00018,000 20,000132,000 130,000






But those are rules, rules, rules! Wouldn’t it be betterto UNDERSTAND it?

18,00018,000 20,000132,000 130,000





CONSISTENCY! … all during that year, and… from one year to the next

What is the “key” in administering “methods?”

18,00018,000 20,000132,000 130,000





Revenue.

Which method did we use THIS year?

18,00018,000 20,000132,000 130,000





Revenue.

Which method should we use NEXT year?

18,00018,000 20,000132,000 130,000





Revenue.


18,00018,000 20,000132,000 130,000







18,00018,000 20,000132,000 130,000







There is no “normal” transaction next year that will move the balance to the revenue account where it belongs.

18,00018,000 20,000132,000 130,000







It needs to be reversed.

18,00018,000 20,000132,000 130,000



(5) Make the reversing entry,.


18,00018,000 20,000132,000

Reversing entries are the exact opposite of adjustingentries.

130,000





Unearned Advertising 18,000Advertising Revenue 18,000

18,00018,000 20,000132,000


130,000





Unearned Advertising 18,000Advertising Revenue 18,000

18,00018,000 20,000132,000


18,000

18,000

130,000





The $18,000 credit balance is UNEARNED at the beginning of the year, but it will be EARNED this year.No other entry will be necessary during the year.

18,00018,000 20,000132,000


18,000

18,000

130,000


Conclusion

Congratulations on completing this out-of-class lesson. You deserve a thousand brownie points!

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I hope you understood it and hope that it will be beneficial to you. I would appreciate your comments or suggestions about its effectiveness.

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l Iab Rev Methods