Accounting: The Language of Business (Part 15)

“Creativity is great-but not in accounting.” —Charles Scott

The Matching Concept and the Adjusting Process (Part D)

by

Charles Lamson

Deferred Revenue (Unearned Revenue)

According to NetSolutions' trial balance on December 31, the balance in the unearned rent account is $360. This balance represents the receipt of 3 months' rent on December 1 for December, January, and February. At the end of December, the unearned rent account should be decreased (debited) by $120, and the rent revenue account should be increased (credited) by $120. The $120 represents the rental revenue for one month ($360/3). The adjusting journal entry and T accounts are shown below.

After the adjustment has been recorded and posted, the unearned rent account, which is a liability, has a credit balance of $240. The amount represents a deferral that will become revenue in a future period. The rent revenue account has a balance of $120, which is revenue of the current period.

If the preceding adjustment of unearned rent and rent revenue is not recorded, the financial statements prepared on December 31 will be misstated. On the income statement, Rent Revenue and the net income will be understated by $120. On the balance sheet, Unearned Rent will be overstated by $120, and Chris Clark, Capital will be understated by $120. The effects of omitting this adjusting entry are shown below.

Accrued Expenses (Accrued Liabilities)

Some types of services, such as insurance, are normally paid for before they are used. These prepayments are deferrals. Other types of services are paid for after the service has been performed. For example, wages expense accumulates or accrues hour by hour and day by day, but payment may be made only weekly, biweekly, or monthly. The amount of such an accrued but unpaid item at the end of the accounting period is both an expense and a liability. In the case of wages expense, if the last day of a pay period is not the last day of the accounting period, the accrued wages expense and the related liability must be recorded in the accounts by an adjusting entry. This adjusting entry is necessary so that expenses are properly matched to the period in which they were incurred.

At the end of December accrued wages for NetSolutions were $250. This amount is an additional expense of December and is debited to the wages expense account. It is also a liability as of December 31 and is credited to wages payable. The adjusting journal entry and T accounts are as follows. 

After the adjustment has been recorded and posted, the debit balance of the wages expense account is $4,525, which is the wages expense for the two months, November and December. The credit balance of $250 in Wages Payable is the amount of the liability for wages owed as of December 31.

*WARREN, REEVE, FESS, 2005, ACCOUNTING, 21ST ED., PP. 108-111*

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