Journal entries, adjusting entries, reversing entries, closing

CPA Exam Forum FAR FAR Review Journal entries, adjusting entries, reversing entries, closing

This topic contains 24 replies, has 0 voices, and was last updated by  Roxwella 3 years, 10 months ago.

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  • #174821

    Future-CPA
    Member

    Hello,

    For the life of me, I can not comprehend journal entries,adjusting entries, reversing entries, closing, accruals, and deferrals. What is weird is I understand the concepts, I understand debits and credits, and the theory behind them. However, whenever I see a problem with different dates, accruals , prepaid expenses or unearned revenues, and they ask to prepare the reversing entries or adjusting journals or closings, I am completely lost and don’t know what accounts should be used to prepare those entries. I am not an Accountant and have never worked in the closing process so I do not know if that is a factor, but please can someone explain this to me or tell me what I should do to get it once and for all. I feel like I will never understand this section!!!!!!

    Thanks,

    Future-CPA

    #382600

    mla1169
    Participant

    Thats a pretty tall order! Do you understand clearly the concept of accrual accounting?

    #382601

    Future-CPA
    Member

    Yes I believe I do, I understand when revenues and expenses need to be recognized if that’s what you are referring to.

    Thanks!

    #382602

    musicamor
    Member

    @future-cpa…what exactly do you not understand? If you understand the concepts, then why wouldn’t you understand journal entries, closing, etc?

    When we speak of accruals, you typically are accruing expense; therefore, you debit expense and credit accrued liabilities.

    When we speak of deferrals, you typically are deferring expense as prepaid (think magazine subscriptions); therefore your debit a prepaid (current) asset and credit cash

    We speak of closing, I believe you mean closing out to retained earnings, income/(loss) realized in the period. Therefore, if you have income, you debit the P&L and credit retained earnings. If you have a loss, you credit the P&L and debit retained earnings.

    A reversing entry is simply an entry that addresses the timing of certain expenditures. For example, if the accounts payable department is unable to post the utility bill for the year–let’s say 12/31/12–acconting would book a reversing accrual that will reverse in the subsequent period (1/1/13) and offset with the invoice posted by accounts payable (“A/P”). On 12/31/12, we debit utility expense and credit accrued liabilities; on 1/1/13, we automatically generate a contra entry–credit utility expense and debit accrued liabilities–assuming that A/P has posted the invoice. Make sense?

    #382603

    Roma
    Member

    During the financial close process, a number of journal entries are made to ensure that the income statement and balance sheet comply with GAAP, with particular emphasis on ensuring: 1) revenues / expenses are in the proper period, and 2) items on the balance sheet are properly valued. Often, these journal entries relate to ensuring the GL is maintained on an accrual basis, and not cash basis.

    Accruals = adjustments where recognition in the GL precedes cash disbursement/receipt. Expenses / revenues should be recognized in the period the underlying activity occurs. For example, a consultant provides services in December but no invoice is received – an accrual journal entry is made to debit expense and credit A/P.

    Deferrals = adjustments where cash received first and recognition is at a later period. An example would be that a company receives a customer deposit in December, but the services will not be performed until January. The receipt of cash would thus debit cash and credit deferred (or unearned) income.

    Reversing Entries = occurs when an accrual is made to a period, but literally is reversed out in the subsequent period (usually thru GL system), as a GL entry will be recorded via a normal transaction (often AP or AR). In the accrual example above, the expense entry would be accrued in December, but reverse out in January. The vendor invoice will come thru the A/P system in January which will again debit expense and credit A/P. So ….. the net effect to expense in January will be $0.

    Adjusting Entries = relate to period end adjustments in the GL, in particular to valuation accounts (assets) or on provisions (liabilities). Examples would include: 1) changes in A/R allowance for bad debts, 2) changes for warranty or legal provisions.

    When you are looking at problems with prepaid assets / unearned revenues, the first step is to determine what balance SHOULD remain in these balance sheet accounts at the end of the period. Look at the INFO in the problem and calculate the proper balance. The difference between the proper balance and what is ACTUALLY in the account becomes the amount of your journal entry. For example, if you determine that $500 SHOULD BE in your prepaid taxes account compared to the ACTUAL $1,000 account balance, then you would make an adjusting journal entry debiting property tax expense for $500 and crediting prepaid taxes for $500.

    Sorry if I confused you even more. Good luck!

    #382604

    Future-CPA
    Member

    Hello Musicamor,

    Thank you for explaining those, but see I understand all of those concepts. However, when faced with a problem I do not know how to apply them, I know it might sound weird, but that is the truth. Let me give you an example. When I read the problem below, I feel so overwhelmed that I don’t know where to start and what to do to arrive at the final answer….

    Interest Receivable at 1/1/2010 is $1,000. Cash collected for interest on notes receivable during 2010 was $4,500. The 2010 income statement correctly reports Interest Revenue in the amount of $5,200. What adjusting entry must have been made on December 31, 2010?

    A. Debit Interest Revenue and credit Interest Receivable, $700.

    B. Debit Unearned Interest Revenue and credit Interest Revenue, $700.

    C. Debit Interest Revenue and credit Interest Receivable $4,200.

    D. Debit Interest Receivable and credit Interest Revenue, $1,700.

    #382605

    Future-CPA
    Member

    Roma,

    Thank you so much, that actually clarified some of the questions I had as to how to solve problems. Because that is my main issue, I understand what accruals are, what deferrals are, etc. But I am unable to solve problems as I don’t know what steps to take to arrive to the answer.

    The paragraph below was particularly helpful, thanks a lot.

    “When you are looking at problems with prepaid assets / unearned revenues, the first step is to determine what balance SHOULD remain in these balance sheet accounts at the end of the period. Look at the INFO in the problem and calculate the proper balance. The difference between the proper balance and what is ACTUALLY in the account becomes the amount of your journal entry. For example, if you determine that $500 SHOULD BE in your prepaid taxes account compared to the ACTUAL $1,000 account balance, then you would make an adjusting journal entry debiting property tax expense for $500 and crediting prepaid taxes for $500.”

    #382606

    musicamor
    Member

    @future-cpa…has anyone showed you the “BASE” formula?

    Beginning balance

    Add: something

    Subtract: somthing

    Ending balance:

    The question above gives us parts of the formula above, so all we need to do is “solve for ‘X.'”

    Try solving the problem using that formula and see if you come up with the correct answer. You are given the beginning balance, so plug that in. Next, we’re talking interest receivable so interest income would be a debit (add) to interest receivable, so you have that piece. Cash received for interest would be a credit (subtract). Then you’re left with determining the ending balance.

    #382607

    10YRS
    Member

    Future CPA,why dont you try taking an accounting basic class in some college,that would really help you.

    #382608

    Future-CPA
    Member

    Musicamor,

    No, I never heard of this base formula. Beginning Balance of what? Just going out on a loop, my thoughts from your base formula is Beg Bal:1,000+$4,500 of cash collected= Ending Bal of $5500? Now if I understand well, Interest Revenue Earned during the period was $5200, so there is an excess of $300 that probably needs to be adjusted…. But how? ( am I on the right track or did i totally miss it 🙂 )

    #382609

    Future-CPA
    Member

    10YRS, That’s actually what I am doing, my background is in Finance and I need 7 more accounting classes to be able to sit for the CPA. I am currently taking a class called Financial Reporting 1 online, however they expect you to know all of these and do not review them, I haven’t done any accounting since college ( graduated in 2004), so I am not familiar with these concepts, and the class I am currently taking doesn’t offer alot of information, so I am trying to learn these on my own 🙁 I am pretty sure it might be very basic to you Accountants, but I am having a hard time grasping them…

    #382610

    Kricket
    Participant

    How comfortable are you with T-accounts?

    #382611

    Future-CPA
    Member

    From the few times, I have used them, I seemed to understand them 🙂

    #382612

    spongfunk
    Member

    The 1,000 is just distractor information in this problem. Therefore since Revenue is a temporary account closed out to Retained Earnings every year, your beginning balance on 1/1 is 0. So it would work like this:

    Your revenue is 0 at the benning of the year. All cash collections will have been recorded as revenue, but since that is only $4,500 and your Revenue is correctly stated as 5,200 that means there is 700 unaccounted for in the Revenue account. Now you have it narrowed down to 2 answers and you know it’s B because you have to INCREASE Revenue which is a credit to the account.

    Unearned Revenue is a liability account so you would be decreasing unearned revenue and increasing earned revenue. This would happen after you have substantially earned the revenue and therefore would need to recognize it.

    #382613

    Future-CPA
    Member

    spongfunk, believe it or not, that was my answer to this question but it is false according to the exam I took.

    #382614

    spongfunk
    Member

    What did it say the correct answer was?

    #382615

    Roxwella
    Member

    Interest Receivable at 1/1/2010 is $1,000. Cash collected for interest on notes receivable during 2010 was $4,500. The 2010 income statement correctly reports Interest Revenue in the amount of $5,200. What adjusting entry must have been made on December 31, 2010?

    A. Debit Interest Revenue and credit Interest Receivable, $700.

    B. Debit Unearned Interest Revenue and credit Interest Revenue, $700.

    C. Debit Interest Revenue and credit Interest Receivable $4,200.

    D. Debit Interest Receivable and credit Interest Revenue, $1,700.

    This is what I would think, and it takes imagination. At the beginning of the year people owe you 1000 in interest (the problem states that this is as of 1/1/2010, meaning that it is an amount of interest due to you from last year, that would be expected to be collected this year) . During this year, you collect 4500 in cash from interest payments, 1000 of which was owed to you from the previous year, this leaves 3500 in cash from interest during the current year. If your final income statement says that you had a final amount of interest revenue of 5200, that means that between 3500 and 5200 you have adjusted interest revenue (which would be a receivable because you did not receive it in cash payments of interest that would be attributable to this years interest revenue). So 5200 revenue during year-3500 cash collected for this years interest=1700 in adjustment that adds to interest receivable. So Id go with D…?

    #382616

    Kricket
    Participant

    Try looking at this and see if it makes sense to you.

    https://docs.google.com/open?id=0B4fedXLjvhzSMS1qZzhFTXFUYWs

    #382617

    Future-CPA
    Member

    Spongfunk, Roxwella got the right answer. It was D.

    Roxwella, see when you put it that way, it makes sense, I understand your thought process. I guess the thing is there are so many ways to think about this problem, i-e what Spongfunk originally thought, and thats what my issues are. I don’t know how to get to the right answer. IF you could for example tell me why the other answers are wrong, maybe I can understand the logics behind this. Thanks a lot for helping.

    Kricket, I will take a look at that link. Thank you!

    #382618

    Future-CPA
    Member

    Kricket,

    Thank you so much. That also made a lot of sense and is very helpful. My only question is this, when I read questions like this, I sometimes don’t know how to determine what was earned in this current year i-e the problem does state that $5200 was earned this year, but how do I know that the $4500 cash is for this years earnings since there is nothing that specifies it in the problem, I think thats what confuses me when i see problems like this, maybe i’m overthinking it as I have a “Finance” brain which is so different from an “Accounting” brain

    #382619

    musicamor
    Member

    Future-CPA…did you apply the base formula? If you did, you would’ve gotten the correct answer D:

    Beginning balance: $1,000

    Add: interest per P&L $5,200

    Subtract: cash received ($4,500)

    Ending balance $1,700

    We need an additional accrual of $1,700 based on the facts provided.

    #382620

    Future-CPA
    Member

    Hello Musicamor, could you please expand on the Base formula. What do you add/substract, never heard of the formula before, just want to know what it means and what the result means so I can apply it further. Thanks a lot

    #382621

    Roxwella
    Member

    First point, a receivable at the beginning of the year is never something you wipe away and forget about. I kinda think the issue you guys had with this problem is just reading it thoroughly.

    -When I read it, instantly I notice that they are talking about two distinct accounts. They are talking about cash received from interest, and they are talking about interest revenue.

    -Second, when I read any CPA exam question, Im looking for loose connections that they are providing. A full set of financial statements gives a whole story, while a MCQ has only a tiny portion of the picture. With all these questions you must assume, ALL OTHER THINGS BEING EQUAL in order to get anywhere. In effect this means, in this particular answer, that all receivables from a previous period (unless it says otherwise) are collected in the next year.

    -So, you connect the two concepts. IF we are searching for loose connections between cash received and revenue recognized, we can instantly see that an interest receivable has to get bigger (and this actually gives you the answer in this particular case).

    The BASE formula they are talking about (though I haven’t really used it before), is simply a study method for an absolute truth in the world. If you have an account for something with a starting balance and an ending balance, you know the amount of change by default.

    Say

    B-Beg Account -500

    Add

    Subtract

    E-Ending Account -1200

    What was the change? Well. it was an addition of 700. This concepts works both ways, and you do need to be comfortable using the idea forwards, and then backwards if need be.

    Say

    B-?

    A-700

    S-0

    E-1200

    What was the beginning balance? Well, it was the ending balance, minus what was added during the year. So 1200-700=500 beginning balance.

    Hope that makes some sense. The concepts are elementary, but when accounting terminology and language is thrown in, it gets confusing quickly. Really, the only way to get better at these though is practice practice practice.

    Goodluck!

    #382622

    Future-CPA
    Member

    Thank you Roxwella, that definitely gives me a new perspective and a new way at looking at things to solve these problems. That was very helpful!

    #382623

    Roxwella
    Member

    I have found again and again that the explanations given come from the wrong place for me to understand them. Real life explanations of accounting principles make much more sense than accounting explanations of accounting principles 😉

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