Transcript The Adjusting Process

Chapter 3
1
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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
2
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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)
3
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
1
Differentiate between accrual and cash-basis
accounting
4
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Accrual Basis
Cash Basis
Revenues
recognized when
earned
Revenues
recognized when
cash received
Expenses
recognized when
incurred
Expenses
recorded when
cash paid
Not GAAP
5
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
6
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Accrual basis revenue transactions
Cash-basis revenue transactions
7
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
8
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Accrual basis
Cash-basis
9
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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.
Record expense
10
$2,900
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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.
11
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
2
Define and apply the accounting period
concept, revenue, and matching principles
12
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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?
Value of item or service transferred to customer
14
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
15
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Measure all expenses incurred during the
period
Match the expenses against the revenues
earned during the same period
16
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Requires that accounting information be
reported at regular intervals
Accounts are updated at the end of each
accounting period
17
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
On May 31, Smart Touch recorded
salary expense of $900 that is owed to
an employee at the end of the month.
18
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
3
Explain why adjusting entries are needed
19
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
20
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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.
Never
involve
the cash
account
22
Either
increase
revenue
or
increase an
expense
When
worded as
“accrued”,
journalize
the stated
amount
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
4
Journalize and post adjusting entries
23
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Prepaid
expenses
Depreciation
Accrued
expenses
Accrued
revenues
Unearned
revenues
24
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.
At May 31st, this amount is too high.
One month has been used.
26
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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
account
28
Amount calculated
based on
depreciation method
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.
30
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Expenses incurred before payment is made
Results in a liability
Opposite of a prepaid expense
Examples:
Salaries
Interest
31
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
32
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Revenue earned before cash is received
Results in a receivable
33
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
BEFORE
34
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
35
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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
36
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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
37
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.
38
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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.
Accrued expenses
39
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
The following data at January 31, 2012 is given for
EBM, Inc.
a. Depreciation, $500
b. Prepaid rent expired, $600
c. Interest expense accrued, $300
d. Employee salaries owed for Monday through Thursday of
a five-day workweek; weekly payroll, $13,000
e. Unearned service revenue earned, $1,300
Requirement:
1. Journalize the adjusting entries needed on January 31,
2012.
40
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Journal
ACCOUNTS AND
POST.
DATE
EXPLANATIONS
REF. DEBIT CREDIT
2013
Adjusting Entries
Jan
31 Depreciation expense
500
a.
Accumulated depreciation
500
b.
c.
d.
31 Rent expense
Prepaid rent
600
31 Interest expense
Interest payable
300
600
31 Salary expense
Salary payable
e.
31 Unearned service revenue
Service revenue
41
300
10,400
10,400
1,300
1,300
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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.
42
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
5
Explain the purpose of and prepare an adjusted
trial balance
43
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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.
45
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Supplies on hand,
$300.
Depreciation,
$1,000.
Accrued interest expense, $600.
a) 300
b)1,000
c) 600
46
800
300
19,100
2,000
200
600
2,500
7,400
14,800
4,500
a) 300
600
b)1,000
1,000
c) 600
1,200
2,200 2,200 27,500 27,500
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
6
Prepare the financial statements from the
adjusted trial balance
47
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
The Balance Sheet is
prepared last.
A=L+E
Statement of Retained
Earnings is second
Income Statement is
prepared first.
Revenue - Expenses
48
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
49
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
50
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
51
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Refer to the adjusted trial balance in Exercise 3-21
for the month ended April 30, 2012.
Requirements:
1. Prepare the income statement.
2. Prepare the statement of retained earnings.
3. Prepare the balance sheet.
52
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
53
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Jobs-4-U Employment Service, Inc.
Income Statement
Month Ended April 30, 2012
Revenue:
Service revenue
Expenses:
Salary expense
$
54
10,600
$
6,200
4,400
3,700
Rent expense
1,000
Depreciation expense
1,000
Supplies expense
Total expenses
Net income
$
500
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Jobs-4-U Employment Service, Inc.
Statement of Retained Earnings
Month Ended April 30, 2012
Retained earnings, March 31, 2012
Net income
$ 10,300
4,400
17,900
Dividends
4,800
Retained earnings, April 30, 2012
55
$ 9,900
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Jobs-4-U Employment Service, Inc.
Balance Sheet
April 30, 2012
Assets
Cash
Accounts receivable
Supplies
Equipment
$32,500
Accu. Depr.
(15,400)
Liabilities
$
900
5,600
500
17,100
Salary payable
Stockholders’ Equity
Common stock
13,000
Retained earnings
9,900
Total stockholders’ equity
Total assets
56
$24,100
$ 1,200
Total liabilities and
stockholders’ equity
22,900
$24,100
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
7
57
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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
58
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Initially debit and expense account
Adjust at end of period for unused amount
59
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
60
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Initially credit a revenue account
Adjust at end of period for unearned amount
61
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.
62
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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.
63
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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).
64
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
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.
65
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
The financial statements must be prepared in
order:
income statement first,
statement of retained earnings, second, and
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.
66
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
67
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Copyright
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.
68
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.