Adjusting Entries for Accrued Expenses (Financial Accounting Tutorial #19) INSTRUCTOR: If you've been watching from the beginning of this series, you know that we're covering step number four which will be about adjusting entries. So we've just made it past the midpoint of the accounting cycle, working our ways towards the finish. I definitely applaud you guys for covering all these concepts, because the accounting cycle's a really comprehensive circular model, and there's a lot of different interrelated, confusing parts. But in this tutorial, we're going to be covering the theory behind adjusting entries. I'll be providing an example to tie everything together, help you understand, and I'll also be providing some supplement adjusting entry videos to give you an idea of all the different adjusting entries that might come up on a quiz or a test. So hopefully, that helps, and let's actually go over some rules. So I actually kind of enjoy adjusting entries. They're actually one of the things I found pretty fun to do within financial accounting. Let me just get rid of this layer, bring up these rules I've come up with to help guide you through this really confusing period about adjusting entries. And the first one is that adjusting entries are all about revenues and expenses. So adjusting entries look like journal entries. We'll have a debit and a credit, and one type of adjusting entry, or a revenue adjusting entry, might look something like this. You might have unearned revenue being debited and revenue being credited. So this would demonstrate that unearned revenue is being converted to revenue and being reported on the income statement, thus having earned that revenue and it being-- because obviously, unearned revenue does not show up on the income statements. Only earned revenue does, and we've now converted it to earned revenue performing this adjusting entry. And that is a revenue adjusting entry, and we also have an expense adjusting entry which might look something like this. Salaries expense being debited, and salaries payable being credited. And there's many different types of expense adjusting entries, like interest expense and credit interest payable, but I just put here one type of expense adjusting entry. And the one thing I wanted to note is that, when you actually have an adjusting entry, you'll never see revenues and expenses together as an adjusting entry. So you'll never see debit salaries expense and credit revenue as an account. You'll either see an expense adjusting entry or a revenue adjusting entry, so they'll always be separate. And the second rule is that these adjusting entries never involve cash. They never, ever, ever involve cash. So if you are performing an adjusting entry on a quiz or a test, they ask you to write it down, and your debiting or crediting cash. You can expect it to be wrong, because you'll never have to debit or credit cash for an adjusting entry. You will have journal entries that do involve cash. So if you look at this adjusting entry right here, like I said, we have earned this revenue by writing down this adjusting injury. But the initial journal entry would look something like this-- cash being debited and unearned revenue being credited. Which means that we've received cash for a service that we haven't performed, because unearned revenue means we haven't performed a service. And when we actually perform the service, we write down this adjusting entry which converts the unearned revenue to revenue. So that shows that adjusting entries never involve cash. Adjusting entries are all about either revenue adjusting entries or expense adjusting entries. Never write down cash. And the third rule is that adjusting entries are used to show the passage of time or the passing of time, and that's a little ambiguous of the statements. But I'll clear that up through an example I'm going to provide in a second which is about a payroll for the month of August for our company. So let's actually get rid of all of this and bring that up. So this is a payroll schedule for the month of August, and we're actually going to say that we are at August 31st. So it's the end of the month. We're preparing for internal use our balance sheet and our income statement to get an idea of our assets outstanding, our liabilities outstanding, our revenues, expenses for the month. And the green highlighted number, the 10th and the 24th, are paydays, and if you haven't noticed, I've actually written right here that the workers receive $1,000 biweekly which means every two weeks. So on the 10th, they receive $1,000, on the 24th, they receive $1,000, and on the 7th of September, they'll receive another $1,000 which will actually be the basis of this example. Because this creates a problem when the payday actually falls into the next month, because we'll actually have to perform an adjusting entry to help solve this cutoff issue. So before we talk about that, I thought I might note that this entry for actually paying the workers will come up like this, or it should be something like this. Where we'll be debiting salaries expense, crediting cash to show that we are paying them for their work, we're incurring an expense. And if you remember, we are preparing the income statement, because it is the month end. And if you remember, an income statement does have revenues and expenses, and in this example, we're talking about a certain expense which is salaries expense. Now, if you look at this entry on the 24th, we have debit salaries expense credit cash. And that's going to be the last salaries expense entry, because that is the last time we pay them in the month of August. Because for the rest of August, we're not actually paying them in cash. So what's going to happen is the salaries expense, we're not actually recording anything for this week. Then, we will not have reported any expense for the last week of August. So our salaries expense will be understated which is not a good thing. It won't be an accurate income statement and won't show all the expenses we have incurred in the month of August. And this will also cause a conflict with the matching principle. And if you remember from a lecture in class, you might have heard that the matching principle, the point of it is to show that the expenses-- or I should actually say that the revenues that are earned through August. So let's say in August we earned revenues for every single week, and in the month of August, we want to show all of the expenses that generated those revenues. And if we don't show the last week of expenses, then we're not matching all of the revenues earned with the expenses that we incurred. So we need to show all of the expenses for the month of August, and to do that, we're going to perform an adjusting entry in this last week. So the adjusting entry that we're actually going to perform is going to be an expense adjusting entry, because obviously, this is not a revenue adjusting entry. We're not earning any money. We're paying employees. And if you remember from the rules-- let me just bring them down. It's clustered up there at the top-- adjusting entries are all about revenues and expenses, which means that we're going to be either making a revenue or an expense entry. We've stated that we're making an expense entry, and this is not going to involve cash. So right away, you know we're not using the account of cash. So what are we going to use? Well, like I said, salaries expense is understated, unless we report another expense for this week. So we're going to debit salaries expense. And since we're not paying them yet until the 7th of September, we need to show that we are going to pay them, which is salaries payable, which is a liability showing that we're going to pay them in the future. And the number associated for each of these accounts will be-- since we're paying them $1,000 biweekly, or every two weeks, that means we're paying them $500 every week which is half of $1,000. So we're just going to say debit salaries expense $500 and credit salaries payable $500, and this is known as an accrued-- accrued expense adjusting entry. And I'm just abbreviating the adjusting entry part, because it's really long. I don't have a lot of room. But the term accrued is synonymous with owing, because as you can see, the amounts payable to the employees has not actually been paid yet. So we actually are not reporting an outflow of cash. We're actually reporting that we owe them money which is an accrued expense, because accrued always means owing. So that is our adjusting entry, and when we now report this adjusting entry, all of the expense for August will be matched with all of the revenues for August. And our income statement will be correct in that we've reported everything in the period of August. So that was one type of adjusting entry, and we'll learn about the others. And I actually have created this table to just show you that we've covered this one right here, accrued expenses. You'll actually notice that these two adjusting entries are opposites of each other, and these two are opposites as well. So prepaid expenses are that we've paid for them initially, and accrued expenses are that we haven't paid for them yet. But we've actually consumed the expense, or we've used the expense or have incurred an expense, I should actually say. And we'll learn about all these different adjusting entries in the supplement videos I am going to provide. So hopefully, you understand the accrued expense entry I just went over, and I'll provide examples in the next videos. So thanks for watching, and I'll see you guys in the next tutorial. If you have any questions regarding accounting or any of the material within our videos, you can tweet us @notepirate. You can like us on Facebook to receive updates or to share any quick anecdotes about how our videos might have helped. And like always, thanks for watching us on YouTube.