Transcript Chapter 3 Operating Activities and Income statement

Chapter 4: Adjustments, Trial
Balance, and Financial Statements
Acct 2301 Fall 2009
Cox School of Business, SMU
Professor Zining Li
What do We Hope to Learn?
• Accounting Cycle
• Adjusting entries
– What, why, when, and how to adjust?
• Unadjusted and adjusted trial balance
• Preparing financial statements
• Closing process
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Accounting Cycle
1.
2.
3.
4.
5.
6.
7.
8.
Identify recordable financial transactions
Record the journal entries
Post journal entry amounts to T-accounts
Prepare the unadjusted trial balance
Record adjusting journal entries
Prepare the adjusted trial balance
Prepare the financial statements
Record the closing entries
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Adjusting Entries
•
•
•
•
Under accounting, revenues (expenses) are
recorded when they are earned (incurred)
Some revenues (expenses) are earned (incurred)
without any external transaction
Adjusting entries are needed to record such
revenues and expenses in the correct period
Adjustments are made at the end of a reporting
period
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Timetable of the Adjustment Process
Transactions are
recorded all during
the period
1/1/04
12/31/04
Adjustments are made at
the end of the period,
but before the financial
statements are prepared
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What need to be adjusted
• Accruals
– Accrued revenues
– Accrued expenses
• Deferrals
– Deferred revenues
– Deferred expenses
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What need to be adjusted (1)
• Accrued revenues
– Those are revenues that are already earned,
although cash haven’t been collected
– Revenues need to be recorded, at the same
time, assets are increased
• Example: interest revenue
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On October 1, 2006, Webb, Inc. invests $10,000 for 6 months in a certificate of deposit
that pays 6% interest per year. Webb will not receive the interest until the CD matures on
March 31, 2007.
On December 31, 2006, Webb, Inc. must make an entry for the interest earned so far.
GENERAL JOURNAL
Date
Description
Dec 31 Interest Receivable
Interest Revenue
$10,000 × 6% × 3/12 = $150
Interest Receivable
Debit
150
Credit
150
Interest Revenue
12/31 150
12/31 150
Bal.
Bal.
150
150
What need to be adjusted (2)
• Accrued expenses
– Those are expenses that are already incurred through
out the accounting period, although cash haven’t
been paid
– Expense need to be recorded, at the same time,
liabilities are increased
• Examples:
– Salary expense
– Interest expense
– Tax expense
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• As of 12/27/06, Denton, Inc. had already paid $1,900,000 in
wages for the year. Denton pays its employees every Friday.
Year-end, 12/31/06, falls on a Wednesday. The employees have
earned total wages of $50,000 for Monday through Wednesday
of the week ending 1/02/07.
GENERAL JOURNAL
Date
Description
Dec 31 Wages Expense
Wages Payable
Debit
50,000
Credit
50,000
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After we post the entry to the T-accounts, the
account balances look like this:
Wages Expense
As of
12/27 $1,900,000
12/31
50,000
Bal.
$1,950,000
Wages Payable
12/31 50,000
Bal. 50,000
What need to be adjusted (3)
• Deferred revenues
– Previously recorded as liabilities when cash were received before
goods were delivered or services were rendered
– At the end of reporting period, if the earning process is complete,
these liability accounts need to be reduced, and revenues are
recorded
• Examples
–
–
–
–
Unearned rent revenue --> rent revenue
Unearned franchise revenue --> franchise revenue
Unearned subscription revenue --> subscription revenue
Unearned ticket revenue --> ticket revenue
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On December 1, 2006, Tom’s Rentals received a check for
$3,000, for the first four months’ rent from a new tenant.
GENERAL JOURNAL
Date
Dec 1 Cash
Description
Unearned Rent Revenue
Debit
3,000
Credit
3,000
On December 31, 2006, Tom’s Rentals must adjust the Unearned
Rent Revenue account to reflect that one month of rent revenue has
been earned. $3,000 × 1/4 = $750
GENERAL JOURNAL
Date
Description
Dec 31 Unearned Rent Revenue
Rent Revenue
Debit
750
Credit
750
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After we post the entry to the T-accounts, the
account balances look like this:
Unearned Rent
Revenue
12/31 750 12/1 3000
Bal. 2,250
Rent Revenue
12/31
750
Bal.
750
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What need to be adjusted (4)
• Deferred expenses
– Previously recorded as assets when cash were paid before these
assets are being used
– At the end of reporting period, the “used-up” amount of these
assets need to be reduced, and expenses are recorded
• Examples
–
–
–
–
Buildings and Equipment (PP&E) --> Depreciation expenses
Supplies --> Supplies expense
Prepaid rent --> Rent expense
Prepaid insurance --> Insurance expense
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On January 1, 2006, Matrix, Inc. paid $3,600 for a 3-year fire
insurance policy.
GENERAL JOURNAL
Date
Jan.
Description
1 Prepaid Insurance
Cash
Debit
3,600
Credit
3,600
On December 31, 2006, Matrix, Inc. adjust the Prepaid
Insurance Expense account to reflect that 1 year of the
policy has expired. $3,600 X 1/3 = $1,200
GENERAL JOURNAL
Date
Description
Dec 31 Insurance Expense
Prepaid Insurance
Page
Debit
1,200
365
Credit
1,200
After we post the entry to the T-accounts, the
account balances look like this:
Prepaid
Insurance
1/1
3,600 12/31 1,200
Bal. 2,400
Insurance Expense
12/31 1,200
Bal. 1,200
Journal Entry for Depreciation Expense is
different
Dr. Deprecation Expense
Cr. Accumulated Depreciation
• Accumulated Depreciation is a contraasset account; it carries a credit balance
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On January 1, 2006, Matrix, Inc. paid $8,000 for equipment,
which is expected to last 5 years
GENERAL JOURNAL
Date
Jan.
Descr ipti on
1 Equi pment
Cash
Debi t
8,000
Credit
8,000
On December 31, 2006, Matrix, Inc. adjust the Equipment
account to reflect that 1 year use of the equipment
$8,000 X 1/5 = $1,600
GENERAL JOURNAL
Date
Descr ipti on
Dec 31 Depr eci aton Expense
Accumulated Depreci ation
Page
Debi t
2,000
365
Credit
2,000
Equipment
1/1
Accumulated Depreciation
-- Equipment
8,000
12/31 2,000
Bal. 8,000
Bal. 2,000
Depreciation Expense
Net Book Value of Equipment:
Equipment
- Accumulated Depreciation
= Equipment (net)
12/31 2,000
Bal. 2,000
Adjusting Entries: Summary
•
•
•
•
Done at the end of reporting period
No cash account in an adjusting entry
Revenues and expenses are recorded
Non-cash asset accounts or liability accounts
are increased or decreased
• Adjusting entries affect income statement,
balance sheet, statement of retained earnings;
but NOT cash flow statement
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Exercise: Recording transactions with journal entries
College Caps, Inc. operates a small retail store in the mall that sells baseball
caps. The following transactions occurred during June 2004.
•June 1
Paid $700 cash for insurance policy through December 31, 2004.
•June 1 Purchased store equipment for $5,000 by signing a note. The company
estimates annual depreciation of $1,200.
•June 5
Purchased supplies worth $500 with cash.
•June 15 Loaned $10,000 to the manager of the store (as a personal loan) for one
year. The annual rate of interest on the loan is 12%. The loan is supported by a
note and interest is due upon repayment.
•June 28 Earned revenue of $1,400 with delivery of custom cap order for SMU
football team. SMU must pay the bill by July 31. Cost of the caps sold was $500.
•June 30 Amount of supplies on hand is $300. The balance in the Supplies
account was $150 on June 1.
Record all journal entries, including the adjusting entries, that must be made at
June 30 in order for the company to prepare its financial statements.
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Exercise: Complete the accounting cycle
College Caps, Inc.
Trial Balance – unadjusted
as of June 30, 2004
Account
DR
Cash
Accounts Receivable
Supplies
Inventory
Prepaid Insurance
Notes Receivable
Equipment
Accounts Payable
Contributed Capital
Retained Earnings
Sales Revenue
Cost of Sales
8,150
7,500
650
5,500
700
10,000
5,000
TOTALS
38,000
CR
6,050
30,000
550
1,400
500
38,000
1.
Post the adjusting entries for the period ended June 30, 2004 and prepare an adjusted
trial balance. Income tax expense should be recorded at 30% of pretax net income.
2.
Prepare the income statement, statement of retained earnings, and balance sheet.
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Closing
• When: After all four financial statements are
prepared
• What: all income statement accounts
• Closing means to bring the balances of all the
income statement accounts to zero
• Key Terms
– Permanent accounts
– Temporary accounts
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