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Revenues and Expenses

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Unearned revenues
Some businesses offer services or goods such as rent, insurance, and magazines to acquire payments in advance. Such businesses receive and record revenues before they have been earned. In this case, we talk about unearned revenues. Unearned revenues are a type of liability because the business is obligated to deliver services or goods. During the useful life of the services or goods, the unearned revenues are recognized, increasing the owners’ equity.
Let’s see what journal entries related to unearned revenues have to be placed.
Example: A business receives cash of $36 000 as an advance rental for office space and equipment that will be used for 12 months.
This transaction affects two accounts: The cash account and the Unearned Revenues account.
A cash account is an asset account that increases, and the business has to place a debit record on it. Unearned revenues is a revenue account that increases too, and the business has to place a credit record on it.
The useful life of the rent is 12 months. Therefore, every month the business has to recognize part of the unearned revenues as Rent revenues, which revenues affect the owners’ equity. This transaction is called “adjustment.”
Every month Unearned revenue account has to be debited by $3 000, and Rent Revenues has to be credited by $3 000.
Prepaid expenses
Some businesses make payments in advance for services or goods such as rent, insurance, magazines. These businesses record expenses before some benefits have been received. And such expenses are known as prepaid expenses. They can be treated like assets because the business expects to receive some benefit in the form of a service or goods. During the useful life of the services or goods, the prepaid expenses are spread to an expense account, decreasing the owners’ equity.
Let’s see what journal entries related to prepaid expenses should be placed.
Example: A business pays $24 000 as an advance rental for office space and equipment, which it will use for 12 months.
This transaction affects two accounts: Cash account and Prepaid Expenses account.
A prepaid expense account is an asset account that increases, and a debit record has to be placed on it. Conversely, a cash account is an asset account that decreases and a credit record have to be placed on it.
The useful life of the rent is 12 months. Therefore, every month the business should recognize part of the prepaid expenses as rent expenses, which affect the owners’ equity. This transaction is called “adjustment.”
Every month Rent Expenses account should be debited by $2 000, and the Prepaid expenses account should be credited by $2 000.
Unrecorded expenses
As we already know, all expenses are recorded for the period they are incurred, no matter when the money goes out. Therefore, to accrue an expense means to record the expense for the period it is incurred and affect the owners’ equity.
Unrecorded expenses are expenses incurred in the current period but paid later. For example, wages earned in the current month but paid in the next month are a good example. Another appropriate example is interest, paid on borrowed money.
Such unrecorded expenses are recorded in the period they are incurred, decreasing the owners’ equity for the same period and leading to liability increase for this period.

Assets =
Liabilities +
Owners’ equity


+
-














When the company pays its obligations to its employees or the financial organization, its liabilities decrease and its assets decrease, too.
Assets =
Liabilities +
Owners’ equity
-
-
















To understand this principle better, we’ll look at two examples.
Example 1:
A company pays its employees in the current months for the previous month. For example, in January, the employees earn total wages of $64 000, and they will get their wages in February. To ensure accurate financial statements for January, the company should accrue the wages earned in January at the end of this month. So said simply, the company should show that wages expense decreases the owner’s equity in January when the wages are earned, not in February when they are paid and increases the company’s liabilities.
Following the accrual double-entry accounting system rules, the business has to make a debit record on the Wages expense account and credit record on Accrued wages payable account.
Journal
Account Title
Debit
Credit
Wages expenses
64 000


Accrued wages payable


64 000








And when the company pays the wages in February, the accountant should decrease its obligation to employees and the money. Accrued wages payable account has to be debited, and Cash account has to be credited.

Journal
Account Title
Account Title
Credit
Accrued wages payable
64 000


Cash


64 000








Example 2:
In June, a company borrowed a one year loan of $60 000 at an interest rate of 6%. Every month the company receives a benefit of this loan but pays for this service at the end of the loan period. The company’s expense each month for using the bank loan is 1/12 from the whole interest. 1/12*0.06*30 000=$300. The amount of $300 is not paid in June but is an expense incurred in this month. This is why the accountant makes a record in June to accrue this part of the interest expense.
Following the accrual double-entry accounting system rules, the business must make a debit record on the Interest expense account and credit record on the Accrued payable account. And you should make this record every month.

Journal
Account Title
Debit
Credit
Interest expenses
300


Accrued interest payable


300








And when the company pays the whole interest after one year, the accountant should decrease its obligation to the bank and the money. Accrued interest payable should be debited, and you should credit the Cash account.

Journal
Account Title
Debit
Credit
Accrued interest payable
3 600


Cash


3 600








Unrecorded revenues
Under the accrual basis of accounting, revenues should be recorded for the period they are earned, no matter when the money is received. In this way revenues are matched with the expenses for the period in which the revenues are earned and affect the owner’s equity in the same period.
Unrecorded revenues are revenues earned in the current period, but the money is received later. Thus, for example, interest revenue on loans is exactly such unrecorded revenue.
Unrecorded revenues are recorded in the period in which they are earned increase the owners’ equity for the same period and lead to assets increase for this period.

Assets =
Liabilities +
Owners’ equity
+


+














When the company receives its money one type of asset increases and another decreases.
Assets =
Liabilities +
Owners’ equity
+
-


















Example: Let’s see what happens in the organization which lends $60 000 to a company from the previous video.
The total interest revenue that the organization will earn on this loan is $3 600. The organization receives the payment at the end of the loan period, but actually, it earns part of these revenues every month. This is why the accountant should accrue or record $300 interest revenues every month and increase the assets.
Following the rules of the accrual double-entry accounting system, the following monthly record has to be made: debit record on Accrued interest receivable account and credit record on Interest revenue account. And you should make this record every month.
Journal
Account Title
Debit
Credit
Accrued interest receivable
300


Interest Revenue


300








And when the organization receives the whole interest after one year, the accountant should decrease its interest receivable and increase the money. You should debit a cash account, and Accrued interest receivable should be credited.
Journal
Account Title
Debit
Credit
Cash
3 600


Accrued interest receivable


3 600