Module 4 Adjusting Journal Entries

Question 1

Here are some key indicators to look for in identifying explicit transactions:

Answer 1

(1) A transfer of resources, usually cash
(2) Invoices, receipts or other paper documentation
(3) A specific event or activity that clearly triggers a journal entry
(4) Clarity regarding when to record and how much to record

Question 2

Until this point, the majority of the transactions we have seen in modules 1-3 have been explicit transactions. These transactions were triggered by some sort of activity, event, or transfer of resources (usually cash) from one party to another. Explicit transactions are often accompanied by invoices, receipts, or other paper documentation that initiate the recording of the transaction.

Answer 2

Recall from 2.2.3, when Bikram Yoga sold six 3-month yoga memberships and received $2,100 in cash. Upon the receipt of cash, Bikram Yoga likely generated a receipt for the customer, thus creating a paper trail. These ‘triggers’ prompted Bikram Yoga to record a journal entry in which they debited cash for $2,100 and credited deferred revenue for $2,100.

Similarly, recall from 2.2.4, when Cardullo’s paid $2,400 in cash for 12 months of insurance coverage. When the insurance company received the cash from Cardullo’s, they likely provided them with a document or receipt to serve as proof of insurance. These ‘triggers’ prompted Cardullo’s to record a journal entry in which they debited prepaid insurance for $2,400 and credited cash for $2,400.

Question 3

Implicit Transactions & Adjusting JE

Answer 3

Implicit transactions arise due to the nature of the accrual accounting method, which follows the revenue recognition principle and the matching principle. Under this method, revenue should be recognized in the period in which it is earned and realizable, not necessarily when the cash is received. Expenses should be recognized in the period in which the related revenue is recognized rather than when the related cash is paid. In order to do this we must make adjusting journal entries, which are implicit transactions. Implicit transactions do not involve a specific triggering activity, event, or transfer of resources from one party to another. Often, implicit transactions represent changes in value related to the passage of time.

Question 4

There are four basic types of adjusting journal entries:

(1) Recognizing expenses related to a prepaid asset

Answer 4

Suppose a company pays cash for one year’s worth of rent. They will now have an asset account, prepaid rent, on their books. As each month passes, that asset is worth less and less, and it will need to be reduced or expensed accordingly.

Question 5

There are four basic types of adjusting journal entries:

2) Recognizing revenues related to deferred revenue (also called unearned revenue

Answer 5

Suppose a company receives cash from a customer for a year-long, monthly magazine subscription. The company will now have an obligation to provide magazines to their customer. They will record a liability, deferred revenue, on their books. As each month passes, and the magazines are provided, the liability account needs to be reduced and revenue needs to be recognized as earned.

Question 6

There are four basic types of adjusting journal entries:

(3) Accruing of unrecorded expenses

Answer 6

Entries related to unrecorded expenses usually occur at the end of the accounting period, during the closing process. The purpose of this type of entry is to account for any expenses that weren’t recorded throughout the year because there was insufficient information. Some examples would be accruing for property tax or interest expense, or accounting for inventory shrinkage.

Question 7

There are four basic types of adjusting journal entries:

(4) Accruing of unrecorded revenues

Answer 7

Similar to the accrual for unrecorded expenses, unrecorded revenues are usually accounted for at the end of the accounting period. This type of entry reflects revenues that have been earned but not yet billed. For example, suppose a firm provides consulting services for a client in December. At year end, the firm has yet to send the client a bill for those services. Since the service has been provided, and the client will be billed eventually, revenue must be recorded.

Question 8

Here are some key indicators to look for in identifying implicit transactions:

Answer 8

(1) No transfer of resources
(2) No invoices or other paper documentation
(3) No specific event or activity that clearly triggers a journal entry, just the passing of time
(4) Judgement regarding when to record and how much to record