The Adjusting Process Chapter 3 Learning Objective 1

The Adjusting Process Chapter 3

Learning Objective 1 Differentiate between accrual and cash-basis accounting Copyright (c) 2009 Prentice Hall.

Accrual Basis vs. Cash Basis Accrual Basis Cash Basis Revenues are recognized when earned and expenses are recognized when incurred. Revenues are recognized when cash is received and expenses recorded when cash is paid. Not GAAP Copyright (c) 2009 Prentice Hall. All rights reserved. 3

Accrual vs. Cash Basis: Revenue Accrual – Revenue recognized when services provided Cash –

Accrual vs. Cash-Basis: Expenses Accrual – Expense recognized when incurred Cash – Expense recognized

Learning Objective 2 Define and apply the accounting period concept, revenue, and matching principles

Accounting Period Businesses prepare financial statements for specific periods to evaluate performance Basic accounting period = one year ◦ Calendar year ◦ Fiscal year Interim periods ◦ Financial statements of less than one year Monthly Quarterly Semiannually Copyright (c) 2009 Prentice Hall. All rights reserved. 7

Revenue Principle When to record revenue? ◦ When it is earned When service is provided or product delivered This is not necessarily the time when cash is received What amount of revenue should be recorded? ◦ Value of item or service transferred to customer Copyright (c) 2009 Prentice Hall. All rights reserved. 8

The Matching Principle Measure all expenses incurred during the accounting period Match the expenses against the revenues earned during the same period Copyright (c) 2009 Prentice Hall. All rights reserved. 9

The Time-Period Concept Requires that accounting information be reported at regular intervals Accounts are updated at the end of each accounting period Copyright (c) 2009 Prentice Hall. All rights reserved. 10

? Which Principle…. . Which principle is a guide to accounting for expenses. Identify all expenses incurred during the period, measure the expenses, and match them against the revenue earned during that same time period. A. Time-Period Principle B. Matching Principle C. Revenue Principle D. Objectivity Principle E. Reliability Principle Copyright (c) 2009 Prentice Hall. All rights reserved. 11

? Which Principle…. . Which principle is a guide to accounting for expenses. Identify all expenses incurred during the period, measure the expenses, and match them against the revenue earned during that same time period. A. Time-Period Principle B. Matching Principle C. Revenue Principle D. Objectivity Principle E. Reliability Principle Copyright (c) 2009 Prentice Hall. All rights reserved. 12

? Which Principle…. . Which principle says: Record revenue only after you have earned it. A. Time-Period Principle B. Matching Principle C. Revenue Principle D. Objectivity Principle E. Reliability Principle Copyright (c) 2009 Prentice Hall. All rights reserved. 13

? Which Principle says…. . Record revenue only after you have earned it. A. Time-Period Principle B. Matching Principle C. Revenue Principle D. Objectivity Principle E. Reliability Principle Copyright (c) 2009 Prentice Hall. All rights reserved. 14

Learning Objective 3 Explain why adjusting entries are needed Copyright (c) 2009 Prentice Hall.

Adjusting Entries Prepared at end of an accounting period Assign: ◦ Revenues to the period when earned ◦ Expenses to the period when incurred Update asset and liability accounts Need to properly measure: ◦ Net Income ◦ Assets & Liabilities Copyright (c) 2009 Prentice Hall. All rights reserved. 16

Adjusting Entry Rules Never involve cash Either increase revenue or increase an expense “Accrued”

Learning Objective 4 Journalize and post adjusting entries Copyright (c) 2009 Prentice Hall. All

Types of Adjusting Entries Prepaid expenses Depreciation Accrued expenses Accrued revenues Unearned revenues Copyright

Prepaid Expenses Advance payments of expenses Examples: ◦ Rent ◦ Insurance ◦ Supplies Recorded as an asset Adjusting entry records amount used as an expense Copyright (c) 2009 Prentice Hall. All rights reserved. 20

Short Exercise 3 -6 GENERAL JOURNAL DATE REF DESCRIPTION DEBIT CREDIT Apr 1 Prepaid Rent 4, 800 Cash 4, 800 Prepaid rent for 6 months Prepaid rent 4/1 4, 800 Copyright (c) 2009 Prentice Hall. All rights reserved. 21

Short Exercise 3 -6 (continued) GENERAL JOURNAL DATE REF DESCRIPTION DEBIT Apr 30 Rent expense Prepaid rent To record rent expired in April Prepaid rent 4/1 4, 800 4/30 800 CREDIT 800 Rent expense 4/30 800 Bal 4, 000 Copyright (c) 2009 Prentice Hall. All rights reserved. 22

Depreciation Plant assets ◦ Long-lived tangible assets used in business operations Examples: ◦ Land, buildings, equipment, and furniture Depreciation ◦ Allocation of a plant asset’s cost to expense over its useful life ◦ Land is not depreciated Copyright (c) 2009 Prentice Hall. All rights reserved. 23

Depreciation Entry GENERAL JOURNAL DATE 12 REF DESCRIPTION 31 Depreciation expense DEBIT $$$$ Accumulated depreciation Contra-asset account CREDIT $$$$ Amount calculated based on depreciation method Copyright (c) 2009 Prentice Hall. All rights reserved. 24

Accumulated Depreciation Contra asset ◦ Normal credit balance ◦ Always paired with related account Holds sum of all depreciation recorded on a plant asset Book value: ◦ Cost minus accumulated depreciation Copyright (c) 2009 Prentice Hall. All rights reserved. 25

Accrued Expenses incurred before payment is made ◦ Results in a liability Opposite of

Accrued Expense Entries GENERAL JOURNAL DATE REF DESCRIPTION Dec 31 Interest expense Interest payable To record accrued interest DEBIT CREDIT $$$$$ GENERAL JOURNAL DATE REF DESCRIPTION Dec 31 Salaries expense Salaries payable DEBIT CREDIT $$$$ To record accrued salaries Copyright (c) 2009 Prentice Hall. All rights reserved. 27

Accrued Revenues Revenue earned before cash is received Results in a receivable GENERAL JOURNAL DATE REF DESCRIPTION Dec 31 Accounts receivable Service revenue DEBIT CREDIT $$$$ To record accrued revenues Copyright (c) 2009 Prentice Hall. All rights reserved. 28

Unearned Revenue Cash is collected before revenue is earned ◦ Results in a liability as the company owes a product or service or they will have to give the money back Also called deferred revenue BEFORE Copyright (c) 2009 Prentice Hall. All rights reserved. 29

Unearned Revenue Entries GENERAL JOURNAL DATE REF DESCRIPTION DEBIT CREDIT Dec 1 Cash $$$$ Unearned revenue $$$$ To record cash received before service is provided GENERAL JOURNAL DATE REF DESCRIPTION Dec 31 Unearned revenue Service revenue DEBIT CREDIT $$$$ To record earned portion of unearned revenue Copyright (c) 2009 Prentice Hall. All rights reserved. 30

Summary of Adjusting Entries To properly measure net income on the income statement ◦ Each adjusting entry affects a revenue or an expense To update the balance sheet ◦ Each adjusting entry affects an asset or a liability Copyright (c) 2009 Prentice Hall. All rights reserved. 31

Summary of Adjusting Entries Category of Adjusting Entry Debit Credit Prepaid expense Expense Asset Depreciation Expense Contra asset Accrued expense Expense Liability Accrued revenue Asset Revenue Unearned revenue Liability Revenue Copyright (c) 2009 Prentice Hall. All rights reserved. 32

? Which types of adjusting entries are natural opposites? A. PRE-PAID & DEPRECIATION B. PRE-PAID & ACCRUALS C. UNEARNED & DEPRECIATION D. ACCUMULATED DEPRECIATION & ACCRUALS E. DEPRECIATION & ACCRUALS Copyright (c) 2009 Prentice Hall. All rights reserved. 33

? Which types of adjusting entries are natural opposites? A. PRE-PAID & DEPRECIATION B. PRE-PAID & ACCRUALS C. UNEARNED & DEPRECIATION D. ACCUMULATED DEPRECIATION & ACCRUALS E. DEPRECIATION & ACCRUALS Copyright (c) 2009 Prentice Hall. All rights reserved. 34

Learning Objective 5 Explain the purpose of and prepare an adjusted trial balance

Adjusted Trial Balance Prepared after adjusting entries are posted Useful step in preparing financial statements Often appears on a work sheet ◦ Tool accountants use at end of period Copyright (c) 2009 Prentice Hall. All rights reserved. 36

Any Company Worksheet December 31, 2010 Account Title Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Josie Smith, Capital Josie Smith, W/D Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals Trial Balance Dr. 5, 400 700 17, 000 1, 000 4, 000 100 27, 200 Cr. 1, 000 200 9, 000 6, 000 12, 000 27, 200 Adjustments Adjusted Trial Balance Dr. Cr. a. 500 b. 1, 000 c. 100 a. 500 b. 1, 000 c. 100 1, 600 200 1, 000 4, 000 500 1, 000 28, 300 Cr. 2, 000 100 9, 000 6, 000 12, 000 28, 300

Learning Objective 6 Prepare the financial statements from the adjusted trial balance

The Financial Statements Income statement • Reports revenue and expenses • Determines net income Statement of owner’s equity • Shows why Capital changed during the period • Computes ending Capital Balance sheet • Reports assets, liabilities, and owner’s equity • Needs ending Capital to balance Copyright (c) 2009 Prentice Hall. All rights reserved. 39

Any Company Worksheet December 31, 2010 S 3 -10 Account Title Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Josie Smith, Capital Josie Smith, W/D Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals Adjusted Trial Balance Dr. 5, 400 200 17, 000 1, 000 4, 000 500 1, 000 28, 300 Cr. 2, 000 200 100 9, 000 6, 000 12, 000 28, 300 Balance sheet Income statement

Income Statement Copyright (c) 2009 Prentice Hall. All rights reserved. 41

Statement of Owner’s Equity Any Company Statement of Owner’s Equity Year ended December 31, 2010 Josie Smith, Capital, January 1, 2010 $ 5, 000 Add: Net income 6, 300 Josie Smith, Capital, December 31, 2010 $11, 300 Copyright (c) 2009 Prentice Hall. All rights reserved. 42

Copyright (c) 2009 Prentice Hall. All rights reserved. 43

? NET INCOME flows from? A. Balance Sheet to Income Statement B. Income Statement to Balance Sheet C. Income Statement to Statement of Cash Flow D. Income Statement to Statement of Equity E. Statement of Equity to Income Statement F. Statement of Cash Flow to Statement of Equity Copyright (c) 2009 Prentice Hall. All rights reserved. 44

? NET INCOME flows from? A. Balance Sheet to Income Statement B. Income Statement to Balance Sheet C. Income Statement to Statement of Cash Flow D. Income Statement to Statement of Equity E. Statement of Equity to Income Statement F. Statement of Cash Flow to Statement of Equity Copyright (c) 2009 Prentice Hall. All rights reserved. 45

The Adjusted Trial Balance Sheet shows? A. Balance Sheet B. Income Statement C. Statement of Cash Flow D. Statement of Equity E. Balance Sheet & Income Statement F. Statement of Cash Flow & Statement of Equity Copyright (c) 2009 Prentice Hall. All rights reserved. 46

The Adjusted Trial Balance Sheet shows? A. Balance Sheet B. Income Statement C. Statement of Cash Flow D. Statement of Equity E. Balance Sheet & Income Statement F. Statement of Cash Flow & Statement of Equity Copyright (c) 2009 Prentice Hall. All rights reserved. 47

End of Chapter 3