Accounting Fundamentals II: Lesson 6 Page 1 of 7

Accounting Fundamentals II: Lesson 6 (printer-friendly version)

Your Instructor: Charlene Messier

INSTRUCTIONS:

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Chapter 1

Introduction

In this lesson, we will cover accrued revenue and accrued

expenses. Businesses don't always receive all of a fiscal
period's revenue during that actual fiscal period. Likewise,
not all expenses incurred during a fiscal period are paid
during that period. Matching up revenue and expenses
during the period in which they occurred is referred to as
matching expenses with revenue.

To get a true picture of the well-being of a business,

adjustments must be made to match revenue and expenses
in the fiscal period in which they actually occurred, not when
they were received or paid. This is important in determining if
the business had a net income or a net loss for the period.

In this lesson, we will determine accrued revenue and expenses. We'll also make adjusting entries in
the General Journal and post to the General Ledger to ensure that our accounts are completely up to
date at the end of the fiscal period.

You will need to print out two new General Journal pages for this lesson. You'll find them by clicking
Lesson 6 Forms in the Supplementary Material.

Chapter 2

Accrued Revenue

Accrued revenue is income that the business has earned in one fiscal period but didn't receive until the
following fiscal period. By making an adjusting entry, all the revenue earned in the fiscal period will
actually be reported in that fiscal period's financial records, even though it will not be received until a
later date.

Interest Income

One example of accrued revenue is interest earned on a note receivable. This is the most common
type of accrued income. A note receivable earns interest each day, but the interest may not actually be
received until the maturity date of the note, which could be in a future fiscal period. The interest earned
must be determined at the end of a fiscal period and reported as income even though it has not yet
been received. This amount of interest is referred to as accrued interest income.

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The two accounts affected by accrued interest income are Interest Receivable and Interest Income.
The amount of interest earned is determined using the same formula used to determine interest for the
entire period of the note, except it is calculated using only the time period that remains in the fiscal
period. That amount is then debited to the Interest Receivable account and credited to the Interest
Income account. Let's calculate the interest due on a note receivable in the amount of $5,000.00,
dated November 16, for 90 days at a rate of 5%.

First, we'll determine the number of days left in the year from November 16th to December 31st. There
are 14 days remaining in November and 31 days in December, for a total of 45 days. Here's the
formula for determining the interest due from November 16th to December 31st:

$5,000.00 × 5% × 45/360 = $31.25

Remember, this is not the total interest due on this note. This is only the interest actually earned from
the date the note was issued until the last day of the year. The remaining interest will be recorded in
the next fiscal period when it is earned.

Let's journalize this amount of interest income:

Transaction #59: December 31, Determined the interest income on a note receivable
dated November 16th in the amount of $5,000.00 at a rate of 5% for the period ending
December 31st, $31.25, Memorandum #8.

Please use your General Journal page 13 for this transaction as it is an adjusting entry and page 13
was used for a previous adjusting entry. Adjusting entries all go on their own separate journal page.

In the General Journal, page 13, enter the date, December 31. Enter M8 in the Doc. No. column. In the
Account Title column, enter Interest Receivable and put $31.25 in the Debit column. On the next line,
enter Interest Income in the Account Title column and in the Credit column, enter $31.25. Post these
amounts to the General Ledger.

Closing the Interest Income Account

At the end of each fiscal period, Teammates, Inc. closes out all income accounts. This is necessary so
that all the income accounts will have zero balances at the start of the new year. A closing entry simply
closes out the account balance so the account will have a zero balance when the new fiscal period
begins. Interest Income is one account that is closed out. Let's journalize the transaction to close this
account out:

Please begin a new General Journal page for your closing entries. This will be General Journal page
14. On the first line in the Account Title column, write Closing Entries. This will be the only entry on that
line.

Transaction #60: December 31, Close out the Interest Income account in the General
Ledger to end of fiscal period, $273.75, Memorandum #9.

This amount includes the $31.25 we just calculated plus the $242.50 balance presently showing in the
Interest Income account in the General Ledger.

To journalize this closing entry, enter the date, December 31, in the Date column on the second line of
General Journal page 14. Enter M9 in the Doc. No. column. In the Account Title column, enter Interest
Income. Put $273.75 in the Debit column. On the next line, put Income Summary in the Account Title
column and enter $273.75 in the Credit column. When this transaction is posted to the General Ledger,
the Interest Income account will be closed out and the amount of interest income will be put into the
Income Summary account. Do not post this transaction at this time. It will be posted at the end of the
fiscal period with other closing entries.

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Chapter 3

Accrued Expenses

Accrued expenses are expenses that are incurred in one fiscal period but not paid until a later fiscal
period. Adjusting entries must be made for these expenses so that the amount is recorded during the
period in which the expense was actually incurred. Once again, we'll use the General Journal page 13
for these adjusting entries.

One example of an accrued expense would be interest payable

on a note payable. If a note payable was issued in one fiscal
period with a maturity date in another fiscal period, part of the
interest must be considered an expense for the first period. For
example, a note payable issued on November 21st with a
maturity date of January 11th would have some interest due in
one year and some in the next year. The interest due in the
current year must be calculated and entered into the accounts
so that it is considered an expense in that period. The process
is the same as with a note receivable, but the interest is money
that the business owes on a note payable, not interest it will receive on a note receivable.

Let's journalize a transaction for interest on a note payable:

Transaction #61: December 31, Determined the interest expense on a note payable
issued November 21st with a maturity date of January 11th in the amount of $5,000.00 at
a rate of 6%, $33.33, Memorandum #10.

The interest amount was determined by the following formula:

$5,000.00 × 6% × 40/360 = $33.33

This is the interest due for 40 days, the number of days between when the note was issued, November
21st, and the end of the year, December 31st.

To journalize this transaction, enter the date, December 31st on the next line in the General Journal
page 13, which is the Adjusting Entry page. Put M10 in the Doc. No. column. Enter Interest Expense in
the Account Title column and put $33.33 in the Debit column. On the next line, put Interest Payable in
the Account Title column and enter $33.33 in the Credit column. When these amounts are posted to
the General Ledger accounts, the interest expense for the current year will appear in the Interest
Expense account where it will be considered when determining the net income of the business for the
year. Post this transaction to the General Ledger.

Other accounts may require adjusting entries for accrued income and/or accrued expenses, but the
process is the same. Therefore, we will cover only these two examples.

Chapter 4

Reversing Entries for Accrued Income and Accrued Expenses

A reversing entry is an entry made at the beginning of a new fiscal

period to reverse an adjusting entry made in the previous fiscal
period. In effect, what a reversing entry does is to put back into the
account the amount that was taken out by an adjusting entry. By
doing this, there is no confusion as to how much interest has been
entered into the appropriate account when the total amount of
interest is paid or received. Reversing entries are usually dated
January 1st of the new fiscal period. However, because I don't
want to go into another month and a new fiscal period, I am going

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to have you use December 31st as the date for these transactions.

Reversing Entry for Accrued Interest Income

When a note receivable is received, it includes the value of the note plus the entire amount of interest
due. However, part of that interest was figured into the previous year's income with an adjusting entry.
In order to keep accurate records and not become confused when the note receivable is paid in full,
accountants record reversing entries for the same amount of interest that was adjusted in the previous
fiscal period. Then, when the full interest is paid, the only amount that will increase the Interest Income
account in the General Ledger is that which was actually earned during the new fiscal period.

Remember, all income accounts have credit balances, so if the amount of the adjusting entry in a
previous fiscal period is entered into the Interest Income account, it will decrease that credit balance.
Therefore, the credit balance will correctly show the actual amount of interest income earned in the
new period.

For example, if the Interest Income account balance is $500.00 and an adjusting entry of $25.00 was
entered into that account at the end of the last fiscal period, you cannot count that $25.00 again when
the note is paid. Rather than keep track of each adjusting entry and each partial amount of interest on
every note receivable, the company will reverse the $25.00 entry. That way, when the entire note is
paid, the full amount of interest can be credited to Interest Income without repeating the $25.00 earned
in the last period.

To do this, the business will debit Interest Income for the $25.00. This debit entry will reduce the credit
balance, thereby taking it out of the Interest Income balance. When the entire amount of interest is
received, the total amount, including the $25.00, can be entered without fear of duplicating that amount
of interest income claimed in the previous fiscal period. This is simply an easy way of not claiming
interest income twice.

Let's journalize a transaction to reverse interest income. You will need to print another General Journal
page. This will be page 15.

Transaction #62: December 31, Record reversing entry for interest income recorded in
the previous year, $31.25, Memorandum #11.

To journalize this transaction, first enter Reversing Entries on the first line of your new General Journal
page 15 in the Account Title column. Enter M11 in the Doc. No. column. On the next line, enter the
date and put Interest Income in the Account Title column. Put $31.25 in the Debit column. On the next
line, put Interest Receivable in the Account Title column and enter $31.25 in the Credit column.

When this transaction is posted to the General Ledger, you will see that the Interest Income account is
decreased and the Interest Receivable account is also decreased. Now, when the note receivable is
paid in full, the entire amount of interest can be posted to Interest Income as a credit as that account's
balance has already been reduced by the amount accrued in the previous fiscal period.

Do not post this transaction to the General Ledger at this time. It should be posted at the beginning of
the new fiscal period after all end-of-fiscal period work is completed and the accounts are set up for the
new fiscal period.

Reversing Entry for Accrued Interest Expense

Once again, similar to interest income, it is easier to make a reversing entry into the Interest Expense
account at the beginning of the new fiscal period than to try to keep track of how much expense was
incurred in the previous period and how much was actually incurred in the new period. Therefore, we
will be making a reversing entry into Interest Expense.

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Expense accounts have a normal debit balance. If we enter a credit entry into an expense account, it
will decrease the debit balance. Therefore, we will be entering a credit entry for the amount of interest
we paid in the previous fiscal period. Then, when the entire amount of interest is entered as a debit to
that account, the balance will be correct.

Let's journalize the reversing entry for interest expense on the note payable in Transaction #61 in the
amount of $33.33.

Transaction #63: December 31, Record a reversing entry for interest expense in the
amount of $33.33, Memorandum #12.

To journalize this transaction, use the next available line on your General Journal page 15, which is
labeled Reversing Entries. Enter the date and put M12 in the Doc. No. column. Put Interest Payable in
the Account Title column and enter $33.33 in the Debit column. On the next line, enter Interest
Expense and put $33.33 in the Credit column. When these amounts are posted, the Interest Expense
account will be reduced and when the note is paid in full, the entire amount of interest can be entered
in that account.

Once again, do not post this transaction at this time. It should be posted to the General Ledger at the
beginning of the new fiscal period after all end-of-fiscal period work has been completed.

Chapter 5

Conclusion

Wow! We have covered a lot of ground in this lesson. You have learned about accrued revenue
(income earned in one fiscal period but received in another) and accrued expenses (an expense
incurred in one fiscal period but paid in another). You have journalized and posted adjusting entries in
order to have the General Ledger accounts reflect these accrued activities.

Finally, you have journalized and posted reversing entries in the new fiscal period so that when a note
payable is paid or a note receivable is received, the full interest can be entered into its respective
account with no duplication of entries.

These are rather complex concepts and take practice to fully comprehend. Just think of getting paid or
paying interest in the correct fiscal period in which it was earned or due and it should be easier for you
to remember.

Accurate accounting allows for income and expenses to be considered in the fiscal period in which
they occurred, not necessarily when they were paid or received.

As usual, when you feel you have mastered the concepts in this lesson, please take the quiz for
Lesson 6. Good luck!

Supplementary Material

Lesson 6 Forms
/crs/pix/af2/L06-Forms.pdf
Here are the two new General Journal forms that you'll need to
download and print to complete the work in this lesson.

Lesson 6 Solutions
/crs/pix/af2/L06-Solutions.pdf
All finished? Click here to check your work against this lesson's
solution forms. You can either print them or check the amounts
online. Unfortunately, some of the wider forms can only appear
sideways, so printing may be your better option. If you don't mind

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tilting your head, you'll be able to see what you need to see on the
screen while saving some printer ink and paper! Note: Only those
forms and accounts with new entries in them will appear in each
lesson's solutions. If you're curious about a transaction in a
previous lesson, you'll have to go back to that lesson's Solution
link.

Accrued Expenses
http://www.aipb.org/pdf/AdjustingEntries.pdf
This site provides an overview of accrued expenses with examples
and quizzes.

Accruals and Deferrals

http://www.middlecity.com/ch04.shtml
Here is an excellent explanation of accrued income and how it is
journalized.

FAQs

Q: What is an accrued expense?

A: An accrued expense is an expense that was incurred in one fiscal period but not paid
until the following fiscal period.

Q: Why is it important to enter accrued income and expenses into the ledger accounts at
the end of the fiscal period?

A: If accrued income and expenses were not entered into the ledger accounts at the end
of the fiscal period, the business would not have an accurate picture of the net income or
loss for the period. Accrued income would make the net income increase, and accrued
expenses would make the net income decrease. Therefore, all income and expenses
must be considered in determining the financial status of the business.

Q: Why aren't Accounts Receivable considered accrued income?

A: Accounts Receivable are an asset to the business, and the balances are carried
forward into the next fiscal period. The amount of the sale has already been posted to the
Sales account, so income is in effect being considered in determining the net income or
loss for the fiscal period.

Q: What is the purpose of a reversing entry?

A: A reversing entry is used at the beginning of a new fiscal period. It decreases the
balance in either Interest Income or Interest Expense so that when the Note Payable or
Note Receivable is paid in full, the total amount of interest collected can be entered with
no duplication. It is the most reliable way to ensure that interest income or interest
expense is not overstated. This could easily happen if the adjusting entry was left in the
account (increasing the account balance), and then when the note was paid or received
in full, the total amount of interest was again entered into the account. By reversing the
entry, the partial amount of interest is taken out of the account, and the full amount can
be entered on the maturity date of the note.

Q: How is the interest due on a Note Payable determined when the issue date is in one
fiscal period and the maturity date is in another?

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A: The formula is the same as that for determining the total interest on a note. However,
only the days from the date of issuance until the last day of the fiscal period are used in
determining the interest. This is not the total interest due on the note, only partial interest
until the last day of the fiscal period.

Course content © 1997-2007 by Charlene Messier. All rights reserved. Reproduction or redistribution
of any course material without prior written permission is prohibited.

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