Accounting for Deferrals
3.1.2 Analysis of unearned revenue transaction
2) On June 31, 20X7 SuperDels received $3,000 in advance for services to be performed during a year ending July 1, 20X8. On June 31, 20X7 no services had been delivered yet, thus, Mrs. Piksvel could not recognize any revenue at that time. Even though cash in its full amount had already been received, the entire volume of services still needed to be completed before any revenue could be recognized. We can say that the revenue is deferred until services are provided. The deferred revenue amount is the company's liability because it is obligated to perform services. The account that accountants use to record revenue amounts received, but not recognized as revenue in the income statement is called unearned revenue.
Unearned revenue represents cash received and recorded as liabilities before revenue is earned. These amounts are shown in the liabilities section on the balance sheet.
When SuperDels received the cash for future services, assets (Cash) and liabilities (Unearned Revenue) increase by the same amount of $3,000:
Illustration 3-3: Effect of cash advance for services
|
Assets |
... |
Liabilities |
|
Cash |
... |
Unearned Revenue |
Beginning Balances |
$4,400 |
|
$ 0 |
2) Cash Advance |
+3,000 |
|
+3,000 |
Ending Balances |
7,400 |
|
3,000 |
3.1.3 Analysis of car purchase transaction
3) Purchase of the car is an asset exchange transaction because two asset accounts are involved. One asset account (Cash) decreases and the other (Car) increases. The total assets remain unchanged:
Illustration 3-4: Effect of car purchase
|
Assets |
... |
Assets |
|
Cash |
... |
Car |
Beginning Balances |
$7,400 |
|
$ 0 |
3) Car Purchase |
(4,000) |
|
+4,000 |
Ending Balances |
3,400 |
|
4,000 |
3.1.4 Analysis of land purchase transaction
4) Investment in land in amount of $1,000 is also an asset exchange transaction because only asset accounts are affected:
Illustration 3-5: Effect of land purchase
|
Assets |
... |
Assets |
|
Cash |
... |
Land |
Beginning Balances |
$3,400 |
|
$ 0 |
4) Land Purchase |
(1,000) |
|
+1,000 |
Ending Balances |
2,400 |
|
1,000 |
3.1.5 Analysis of operating expense transaction
5) Incurring and paying $300 for expenses leads to decreases in Cash (because the company paid cash) and Equity (Retained Earnings). This represents an asset use transaction:
Illustration 3-6: Effect of cash expenses
|
Assets |
... |
Equity |
|
Cash |
... |
Retained Earnings - Operating Expense |
Beginning Balances |
$2,400 |
|
$ 0 |
5) Cash Expenses |
(300) |
|
(300) |
Ending Balances |
2,100 |
|
(300) |
Note that after this transaction the company has a negative Retained Earnings balance. In further transactions the company will record revenue that will offset the Retained Earnings negative balance.
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