9e_ch03_inst

Transcript 9e_ch03_inst

2 Differentiate between accrual and cash-basis accounting Define and apply the accounting period concept, revenue recognition and matching principles, and time period concept Explain why adjusting entries are needed Journalize and post adjusting entries Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

3 Explain the purpose of and prepare an adjusted trial balance Prepare the financial statements from the adjusted trial balance Understand the alternate treatment of unearned revenues and prepaid expenses (see Appendix 3A, located at myaccountinglab.com) Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Accrual Basis Revenues recognized when earned Expenses recognized when incurred

Cash Basis Revenues recognized when cash received Expenses recorded when cash paid

Not GAAP

The Johnny Flowers Law Firm uses a client database. Suppose Johnny Flowers paid $2,900 for a computer.

Requirements:

1. Describe how the business should account for the $2,900 expenditure under a. the cash basis.

Record expense $2,900 b. the accrual basis.

S3-2: COMPARING ACCRUAL AND CASH-BASIS ACCOUNTING

2. State why the accrual basis is more realistic for this situation.

The accrual basis is more realistic because the computer is an asset and it will benefit the business for more than one year. To record the cost of the computer as an expense is unrealistic.

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 Semi-annually 13 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

When to record revenue?

When it is earned When service is provided When the product delivered When the earnings process is complete Not when cash is received, accrual method The amount of revenue to recorded?

Prepared at end of an accounting period Assigns: Revenues to the period when earned Expenses to the period when incurred Update asset and liability accounts Need to properly match revenues and expenses to measure: Net income Assets and Liabilities 21 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

22 Never involve the cash account Either increase revenue or increase an expense When worded as “accrued”, journalize the stated amount Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Advance payments of expenses Examples: Rent Insurance Supplies Recorded as an asset Adjusting entry records amount used as an expense 25 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

26 At May 31 st , this amount is too high. One month has been used.

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 27 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

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 29 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Cash is collected before revenue is earned Results in a liability Owes a product or service or refund Also called deferred revenue 34 BEFORE Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

A select list of transactions for Anuradha’s Goals follows: Apr 1 Paid six months of rent, $4,800.

Prepaid expense 10 Received $1,200 from customer for six-month service contract that began April 1.

Unearned revenues 15 Purchased computer for $1,000.

Depreciation

Requirement:

1. For each transaction, identify what type of adjusting entry would be needed.

A select list of transactions for Anuradha’s Goals follows: Apr 18 Purchased $300 of office supplies on account.

Prepaid expense 30 Work performed but not yet billed to customer, $500.

Accrued revenues 30 Employees earned $600 in salary that will be paid May 2.

The following data at January 31, 2012 is given for EBM, Inc.

a .

Depreciation, $500

Prepaid rent expired, $600

Interest expense accrued, $300

Employee salaries owed for Monday through Thursday of a five-day workweek; weekly payroll, $13,000

Unearned service revenue earned, $1,300

Requirement

: 1. Journalize the adjusting entries needed on January 31, 2012.

Journal DATE 2013 Jan ACCOUNTS AND EXPLANATIONS

Adjusting Entries

31 Depreciation expense a.

Accumulated depreciation POST.

REF. DEBIT CREDIT 500 500 b.

600 c.

31 Rent expense Prepaid rent 31 Interest expense Interest payable 31 Salary expense Salary payable 300 10,400 600 300 10,400 e.

31 Unearned service revenue Service revenue 1,300 1,300

2. Suppose the adjustments made in Requirement 1 were not made. Compute the overall overstatement or understatement of net income as a result of the omission of these adjustments.

Net income would be

overstated

by $10,500.

To properly measure net income for the period The entry affects a revenue or an expense To update the balance sheet The entry affects an asset or a liability 41 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Category of Adjusting Entry

Prepaid expense Depreciation Accrued expense Accrued revenue Unearned revenue

Debit

Expense Expense Expense Asset Liability

Credit

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 44 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

a) 300 $ 800 600 19,100 b)1,000 c) 600 $ 2,000 200 600 2,500 7,400 14,800 a) 300 b)1,000 c) 600 4,500 300 1,000 1,200 $1,900 $1,900 $27,500 ______ $27,500 46

48 The Balance Sheet is prepared last.

A = L + E Statement of Retained Earnings is second Income Statement is prepared first.

Refer to the data in Short Exercise 3-10.

Famous Cut Hair Stylists Income Statement Year Ended December 31, 2012

Revenue: Service revenue Expenses: Rent expense Interest expense Depreciation expense Supplies expense Total expenses Net income $ 4,500 1,200 1,000 300 52 $ 14,800 7,300 $ 7,500 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Net income

Famous Cut Hair Stylists Statement of Owner’s Equity Year Ended December 31, 2012

Compute Famous Cut’s total assets at December 31, 2012.

Cash Supplies Equipment Accu. Depr.

ASSETS

$19,100 (2,000)

Famous Cut Hair Stylists Balance Sheet December 31, 2012

$ 800

LIABILITIES

Accounts payable 300 Interest payable Notes payable 17,100 Total liabilities

OWNER’ S EQUITY

Prepaid Expenses (normally) Advance payments of expenses Debit an asset account Adjust at end of period Alternative Debit an expense account Adjust at end of period 56 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Unearned Revenues (normally) Advance receipt of revenues–creates liability Credit a liability account Adjust at end of period Alternative Credit a revenue account Adjust at end of period 58 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Cash-basis accounting and accrual accounting are different. Accrual accounting records revenues and expenses when they are earned/incurred. Cash-basis accounting records revenues and expenses when cash is received or paid.

The principles guide us as to when (the time period and accounting period concepts) and how (the revenue recognition and matching principles) to record revenues and expenses.

We adjust accounts to make sure the balance sheet shows the value of what we own (assets) and what we owe (liabilities) on a specific date. We also adjust to make sure all revenues and expenses are recorded in the period they are earned or incurred. Adjusting journal entries either credit a revenue account or debit an expense account, but they NEVER affect the Cash account.

The adjusting process has two purposes: 1. To capture all transactions that should be reported in the period shown on the income statement. Every adjustment affects a revenue or an expense. 2. To update the balance sheet so that all accounts are properly valued. Every adjustment affects an asset or a liability (but never the Cash account).

The adjusted trial balance includes all the transactions captured during the period on the trial balance plus/minus any adjusting journal entries made at the end of the period. The adjusted trial balance gives us the final adjusted values that we use to prepare the financial statements.

The financial statements must be prepared in order: 1. income statement 2. statement of retained earnings 3. balance sheet, third. It is important for accountants to prepare accurate and complete financial statements as other people rely on the data to make decisions.

Copyright

66 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher.

Printed in the United States of America.

9e_ch03_inst

Transcript 9e_ch03_inst

Not GAAP

2. State why the accrual basis is more realistic for this situation.

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