Chapter 3 The Matching Concept and the Adjusting

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Chapter 3 The Matching Concept and the Adjusting Process Financial and Managerial Accounting 8

Chapter 3 The Matching Concept and the Adjusting Process Financial and Managerial Accounting 8 th Edition Warren Reeve Fess Power. Point Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electroni presentation is used with the permission of NVTech Inc.

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Objectives 1. Explain how the matching concept relates to the accrual basis accounting. Afterofstudying

Objectives 1. Explain how the matching concept relates to the accrual basis accounting. Afterofstudying this 2. Explain why chapter, adjustments are necessary and you should list the characteristics of to: adjusting entries. be able 3. Journalize entries for accounts requiring adjustment. 4. Summarize the adjustment process and prepare an adjusted trial balance. 5. Use vertical analysis to compare financial statement items with each other and with industry averages.

The Matching Concept

The Matching Concept

Reporting Revenue and Expenses TWO METHODS Cash Basis of Accounting Accrual Basis of Accounting

Reporting Revenue and Expenses TWO METHODS Cash Basis of Accounting Accrual Basis of Accounting

Under the cash basis for the accounting period concept, revenues and expenses are reported

Under the cash basis for the accounting period concept, revenues and expenses are reported in the income statement in the period in which cash is received or paid.

Under the accrual basis for the accounting period concept, revenues are reported in the

Under the accrual basis for the accounting period concept, revenues are reported in the income statement in the period in which they are earned.

Accrual Basis of Accounting ü Revenue reported when earned ü Expense reported when incurred

Accrual Basis of Accounting ü Revenue reported when earned ü Expense reported when incurred ü Properly matches revenues and expenses in determining net income ü Requires adjusting entries at end of period

The matching concept supports reporting revenues and related expenses in the same period. Paid

The matching concept supports reporting revenues and related expenses in the same period. Paid $10, 000 for an advertising campaign for a $10, 000 product thataswill recorded an be introduced asset in 2003. 2005. 2004 Sold the advertised $10, 000 product. expensed in 2005 to match revenues 2005

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Capital Stock Dividends Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Unadjusted trial balance 2 2 20 1 065 220 000 400 000 800 00 900 00 360 00 25 000 00 4 000 00 16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Capital Stock Dividends Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense 2 2 20 1 065 220 000 400 000 800 00 900 00 360 00 25 000 00 Assets 4 000 00 16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Capital Stock Dividends Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense 2 2 20 1 065 220 000 400 000 800 00 900 00 360 00 25 000 00 4 000 00 Liabilities 16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Capital Stock Dividends Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense 2 2 20 1 065 220 000 400 000 800 00 900 00 360 00 25 000 00 4 000 00 16 340 00 Owners’ (Stockholders’ Equity 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Capital Stock Dividends Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense 2 2 20 1 065 220 000 400 000 800 00 900 00 360 00 25 000 00 4 000 00 16 340 00 Revenue 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Capital Stock Dividends Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense 2 2 20 1 065 220 000 400 000 800 00 900 00 360 00 25 000 00 Expenses 4 000 00 16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00

Net. Solutions Chart of Accounts 1. 11 12 14 15 17 18 19 2.

Net. Solutions Chart of Accounts 1. 11 12 14 15 17 18 19 2. 21 22 23 3. 31 32 33 Assets Cash 4. Revenue Accounts Receivable 41 Fees Earned Supplies 42 Rent Revenue Prepaid Insurance Land 5. Expenses Office Equipment 51 Wages Expense Accumulated Depreciation 19 52 Rent Expense Accumulated Depreciation 53 Depreciation Expense Liabilities 54 Utilities Expense Accounts Payable 55 Supplies Expense Wages Payable 56 Insurance Expense Unearned Rent 59 Miscellaneous Expense Owners’ (Stockholders’ Equity Capital Stock Retained Earnings Dividends

Deferred Expenses (Prepaid Expenses)

Deferred Expenses (Prepaid Expenses)

Net. Solutions Trial Balance December 31, 2005 Cash 2 065 00 Accounts Receivable 2

Net. Solutions Trial Balance December 31, 2005 Cash 2 065 00 Accounts Receivable 2 220 00 Supplies 2 000 00 Prepaid Insurance 2 400 00 Some of these supplies Land 20 have 000 00 Office Equipment 1 800 been used. On December 31, 00 a Accounts Payable 900 00 count reveals that $760 of Unearned Rent 360 00 supplies are on hand. Capital Stock 25 000 00 Dividends 4 000 00 Fees Earned 16 340 00 Wages Expense 4 275 00 Rent Expense 1 600 00 Utilities Expense 985 00 Supplies Expense 800 00 Miscellaneous Expense 455 00 42 600 00

Supplies (balance on trial balance) Supplies on hand, December 31 Supplies used 2005 1

Supplies (balance on trial balance) Supplies on hand, December 31 Supplies used 2005 1 Dec. 31 Supplies Expense Supplies 2 55 14 $2, 000 – 760 $1, 240 1 240 00 3 4 Bal. Supplies Expense Supplies 14 2, 000 Dec. 31 1, 240 Bal. 800 Dec. 76031 1, 240 2, 040 55

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Capital Stock Dividends Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense 2 2 20 1 065 220 000 400 000 800 00 The prepayment for 24 months of 900 insurance does not reflect that 360 25 000 December’s insurance 4 000 has 00 theoretically expired. 16 340 00 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00

4 56 31 Insurance Expense 5 100 00 15 Prepaid Insurance 100 00 6

4 56 31 Insurance Expense 5 100 00 15 Prepaid Insurance 100 00 6 7 Bal. Prepaid Insurance 2, 400 Dec. 31 2, 300 Insurance Expense 100 Dec. 31 15 Note: You probably have the idea of how posting flows, so the rest of the slides will omit the arrows. 56

Effect of Omitting Adjustment

Effect of Omitting Adjustment

Deferred Revenue (Unearned Revenue)

Deferred Revenue (Unearned Revenue)

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Capital Stock Retained Earnings Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense 2 2 20 1 065 220 000 400 000 800 00 Three months’ rent, $360, was received on December 1. As of December 31, only $120 has been 900 360 earned. 00 00 25 000 00 4 000 00 16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00

7 8 23 31 Unearned Rent 120 00 42 Rent Revenue 120 00 9

7 8 23 31 Unearned Rent 120 00 42 Rent Revenue 120 00 9 10 Unearned Rent Dec. 31 120 Bal. 23 360 240 Rent Revenue Dec. 31 42 120

Effect of Omitting Adjustment

Effect of Omitting Adjustment

Accrued Expenses (Accrued Liabilities)

Accrued Expenses (Accrued Liabilities)

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Capital Stock Dividends Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense 2 065 00 2 220 00 accrued At the end of December, 2 000 00 wages amounted to $250. 2 400 00 Currently, Wages Expense is 20 00 1 800 understated and there is 00 no liability 900 00 shown for these wages. 360 00 25 000 00 4 000 00 16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00

10 11 31 Wages Expense 51 250 00 22 Wages Payable 250 00 12

10 11 31 Wages Expense 51 250 00 22 Wages Payable 250 00 12 13 Wages Payable Dec. 31 22 250 Wages Expense Bal. Dec. 31 4, 275 250 51

Effect of Omitting Adjustment

Effect of Omitting Adjustment

Accrued Revenues (Accrued Expenses)

Accrued Revenues (Accrued Expenses)

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Capital Stock Dividends Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense 2 065 00 2 220 00 2 000 00 400 00 Net. Solutions provided 2$500 20 00 in services during December 1 800 00 for which the customer has not been billed. 900 00 360 00 25 000 00 4 000 00 16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00

13 14 31 Accounts Receivable Fees Earned 12 41 500 00 15 16 Accounts

13 14 31 Accounts Receivable Fees Earned 12 41 500 00 15 16 Accounts Receivable 12 Bal. 2, 220 Dec. 31 500 2, 720 Fees Earned 41 Bal. 16, 340 Dec. 31 500 16, 840

Effect of Omitting Adjustment

Effect of Omitting Adjustment

Fixed Assets

Fixed Assets

Land has an infinite life; therefore, it does not depreciate.

Land has an infinite life; therefore, it does not depreciate.

Building A building has a limited life, so it must be depreciated. The contra

Building A building has a limited life, so it must be depreciated. The contra account used in the adjusting entry is Accumulated Depreciation—Building

Equipment Because equipment has a limited life, it depreciates. The contra account used is

Equipment Because equipment has a limited life, it depreciates. The contra account used is Accumulated Depreciation—Equipment

Net. Solutions estimates the depreciation on its office equipment to be $50 for the

Net. Solutions estimates the depreciation on its office equipment to be $50 for the month of December. 16 17 18 19 31 Depreciation Expense 53 50 00 Accumulated Depreciation— 19 Office Equipment Accumulated Depreciation— Office Equipment 19 Dec. 31 50 50 00 Depreciation Expense 53 Dec. 31 50

Net. Solutions’ balance sheet would show the office equipment at cost, less the accumulated

Net. Solutions’ balance sheet would show the office equipment at cost, less the accumulated depreciation. Office equipment Less accumulated depreciation $1, 800 50 $1, 750 Book value

Effect of Omitting Adjustment

Effect of Omitting Adjustment

Summary of Basic Adjustments

Summary of Basic Adjustments

Net. Solutions’ Adjusted Trial Balance for December 31, 2005

Net. Solutions’ Adjusted Trial Balance for December 31, 2005

Net. Solutions Adjusted Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance

Net. Solutions Adjusted Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accumulated Depreciation Accounts Payable Wages Payable Unearned Rent Capital Stock Dividends Fees Earned Rent Revenue Wages Expense Rent Expense Utilities Expense 2 065 00 2 720 00 760 00 2 300 00 20 00 1 800 00 50 900 250 240 25 000 00 00 4 000 00 16 840 00 120 00 4 525 00 1 600 00 985 00 Continued

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land

Net. Solutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Utilities Expense Supplies Expense Insurance Expense Miscellaneous Expense 2 065 00 2 720 00 760 00 2 300 00 20 00 1 800 00 985 00 2 040 00 100 00 455 00 43 400 00

Vertical Analysis and Interpretation

Vertical Analysis and Interpretation

J. Holmes, Attorney-at-Law, P. C. Income Statements For the Years Ended December 31, 2005

J. Holmes, Attorney-at-Law, P. C. Income Statements For the Years Ended December 31, 2005 and 2006 Fees earned Operating expenses: Wages expense Rent expense Utilities expense Supplies expense Miscellaneous exp. Total operating expenses Net income 2006 2005 Amount Percent $187, 500 $150, 000 $60, 000 15, 000 12, 500 2, 700 2, 300 $45, 000 12, 000 9, 000 3, 000 1, 800 $92, 500 $95, 000 $70, 800 $79, 200

2006 2005 Amount Percent Fees earned $187, 500 100. 0% Operating expenses: Wages expense

2006 2005 Amount Percent Fees earned $187, 500 100. 0% Operating expenses: Wages expense $60, 000 Rent expense 15, 000 Utilities expense 12, 500 Supplies expense 2, 700 Miscellaneous exp. 2, 300 Total operating expenses $92, 500 Net income $95, 000 $150, 000 100. 0% $45, 000 12, 000 9, 000 3, 000 1, 800 $70, 800 $79, 200

2006 2005 Amount Percent Fees earned $187, 500 100. 0% Operating expenses: Wages expense

2006 2005 Amount Percent Fees earned $187, 500 100. 0% Operating expenses: Wages expense $60, 000 32. 0% Rent expense 15, 000 38. 0% Utilities expense 12, 500 Supplies expense 2, 700 Miscellaneous exp. 2, 300 Total operating expenses $92, 500 Net income $95, 000 $150, 000 100. 0% $60, 000 $45, 000 $187, 500 $15, 000 12, 000 $187, 500 9, 000 3, 000 1, 800 $70, 800 $79, 200

2006 2005 Amount Percent Fees earned $187, 500 100. 0% Operating expenses: Wages expense

2006 2005 Amount Percent Fees earned $187, 500 100. 0% Operating expenses: Wages expense $60, 000 32. 0% Rent expense 15, 000 38. 0% Utilities expense 12, 500 6. 7% Supplies expense 2, 700 1. 4% Miscellaneous exp. 2, 300 1. 2% Total operating expenses $92, 500 49. 3% Net income $95, 000 50. 7% $150, 000 100. 0% $45, 000 12, 000 9, 000 3, 000 1, 800 30. 0% 8. 0% 6. 0% 2. 0% 1. 2% $70, 800 $79, 200 47. 2% 52. 8%

Chapter 3 The End

Chapter 3 The End