Hello, I'm Professor Brian Bushee. Welcome back. In this video, we are going to wrap up the final four adjusting entries for Relic Spotter. Let's get started. Transaction 25. The account asked, what about the prepaid advertising account? Recall that in transaction number 9, Park paid $8000 upfront on June 30th, 2012 for advertising through June 30th, 2013. We need an adjusting journal entry to recognize an expense for the six months of advertising that has been used up between June 30th, 2012 and December 31, 2012. So we debit advertising expense to recognize the expense and then we have to credit prepaid advertising to reduce the asset so that its balance now is how much is prepaid going forward. I got 4,000 by taking 8,000 that we prepaid for a year and realizing that half a year is gone by. So if you take half a year by 8,000 it's 4,000 for six months. >> How do you know that half of the prepaid advertising has been used up? What if most of the adverts ran in the first few months? Then, more than half has been used up. >> For deferred expenses such as a prepaid asset, we allow managers to either allocate it base on time as we're doing here or based on usage. For example, if the manager thought that the company would have 50 advertisements run over the next year. And so far this period 30 advertisements have run, then what the manager would do is take three-fifths of the prepaid asset as an expense this period and defer the remaining two-fifths to next period. So we allow managers to choose whichever method they want, either a usage or time, based on what they think would best match the business activities of the company. >> Zut alors! If the manager can choose which method to use, then the manager could choose the one with the lowest expense. How do we know what the correct and true method is? >> I hate to break this to you, but there is often no true or a correct way to do something in the accounting system. I often characterize adjusting entries as the creative writing part of the accounting system. We give managers discretion on how to do their adjusting entries because we want them to best capture the true economics or the true business activities of the company. In other words, we give some creative writing to the managers hoping they'll write better non-fiction books. But, of course, there have been cases where managers have abused this digression, where they've used the creative writing part to write better novels or fiction books. Well, you have to do is learn as much as counting as possible, so that you know what the options are. Then think about managers that stand up to manipulate a given situation and approach the financial statements with a healthy degree of skepticism, which you often need to do. >> We post this to T account, so we post a credit to prepaid advertising. Now the balance will be $4,000 which is how much is prepaid as of December 31. And we create an advertising expense T account with debit balance. Transaction 26. The accountant asked what about the notes receivable account? Recall that in transaction number 10, Park borrowed $5,000 from Relic Spotter at a 10% interest rate on June 30, 2012, with the principal and interest due in a lump sum on June 30, 2013. We need an adjusting journal entry to recognize the interest revenue that we've earned by providing the money outstanding for six months. So we're going to credit interest revenue for 250. The debit here is going to be an interest receivable to represent the fact that Rebecca Park owes us $250 in cash. Now where 250 comes from is the total interest is going to be $5,000 of principal times 10% annual interest rate is $500 of interest per year. But it's only being six months, so we take half of that to get $250. >> Why isn't all $500 of interest considered interest receivable? Aren't we going to receive that much in interest between now and June? >> Actually all $500 of the interest is not necessarily receivable between now and June. Let's say Santa Claus brought Rebecca Park $5,000 as a Christmas gift. So on January 2nd, she decided to come in and repay the loan. On that date, she wouldn't owe us $500 of interest, because that's for a year and it's only been six months. She would only owe the $250 of interest that had been accrued so far. So the other $250 is not necessarily receivable unless the money continues to stay outstanding for the next six months. So we can't consider it receivable as of December 31st. Then we post this journal entry to the interest receivable and the interest revenue T accounts. Transaction 27. The accountant asks what about the unearned revenue account? Recall that in transaction number 15 the Penn Antiquities Club paid Relic Spotter $1,200 cash upfront on December 1st, 2012 for unlimited rentals over the next year. We need an adjusting entry here to recognize the revenue we've earned by providing one month of unlimited rentals. So we created rental revenue for a 100. Part of our obligation has gone down by delivering one month of unlimited rentals. So we need to reduce our liability. We debit unearned rental revenue to reduce this obligation. Where does the $100 come from? We got $1,200 upfront for a full year. One-twelfth of a year has gone by. So we only recognize $100 of that $1,200 during the first month >> Could this revenue be recognized based on the number of rentals, instead of based on time? >> But wait with the contact allowing unlimited rentals. It would seem fishy to do this based on the number of rentals? >> Yes, it would seem fishy, if the allocation was done based on number of rentals instead of time when you have a contract which provides unlimited rentals. Yeah, I see you're starting to get it. It's important to understand what the actual business activities of the company are, and then you can see whether the accounting is matching those business activities. If the accounting matches the business activities, as it does in the Relic Spotter case, then you can continue to feel comfortable with managers. But if you saw a mismatch, like unlimited rentals being accounted for based on number of rentals in the period, then you start to be skeptical about whether managers are manipulating or not. We post this to two accounts. We put a debit and unearned rental revenue. So now, the balance in this liabilities is going to be $1,100 which represent how much of an obligation you have on December 31st. We have to deliver 11 more months of unlimited rentals. And then we add a credit to the rental revenue T account. Transaction 28, finally the- >> Finally! Did I ever mention that the word finally is my favorite word in the accounting language? >> Let's try this again. Transaction 28. Finally, the accountant noted that Relic Spotter incurred an estimated income tax expense of $630 for 2012. Park was confused by this because she did not do her taxes until April. We do need an adjusting journal entry here even though Park's not going to file her taxes until April, she's incurred taxes by operating the business during 2012 and we have to show and expense because that is a cost of doing business. So we're going to debit income tax expense for $630, this is money that we owe the government, that's an obligation. So we need to credit a liability income tax payable for 630. Then we post this to T accounts. We create an income tax payable so that we can show on our balance sheet that we owe the IRS. $630 of taxes as of December 31. And we create an expense account, income tax expense, which has a debit balance. >> Pardon! Don't we have to do an adjusting entry for par value? I only showed up today because I thought you were going to discuss par value! >> There is no adjusting entry for par value. We only worry about par value when we are assuming stock, but glad you came anyway. Okay, not that we've finished all of the adjusting entries for Relic Spotter, all we need to do is learn about financial statements, and closing entries. And then we can start doing the balance sheet and income statement for Relic Spotter. I'll see you next time. >> See you next video.
