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)
Sometimes 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
Debit
3,000
Unearned Rent Revenue
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. Accumulative 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
Debi t
8,000
1 Equi pment
Cash
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
Description
Dec 31 Depreciaton Expense
Accumulated Depreciation
Page
Debit
1,600
365
Credit
1,600
Equipment
1/1
Accumulated Depreciation
-- Equipment
8,000
12/31 1,600
Bal. 8,000
(Net) Book Value of Equipment
Equipment
- Accumulated Depreciation
= Equipment (net)
(Net) Book Value of Equipment
= 8,000- 1600
Bal. 1,600
Depreciation Expense
12/31 1,600
Bal. 1,600
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 and paid cash. 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 and the adjusting entries that must be made at
June 30 before the company prepare its financial statements.
Transactional Journal Entries
June 1
June 1
June 5
June 15
June 28
Prepaid Insurance
Cash
Debits
$700
Credits
$700
Equipment
Cash
$5,000
Supplies
Cash
$500
$5,000
$500
Notes receivable
Cash
$10,000
Accounts receivable
Sales revenue
Cost of goods sold
Inventory
$1,400
$10,000
$1,400
$500
$500
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Adjusting Journal Entries
June 30
June 30
June 30
June 30
Supplies expense
Supplies
Debits
$350
Credits
$350
Insurance expense
Prepaid insurance
$100
Depreciation expense
Accumulated depreciation
$100
Interest receivable
Interest revenue
$50
$100
$100
$50
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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.
Based on the information provided in previous example, 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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College Caps, Inc.
Adjusted Trial Balance
June 30, 2004
Account
Cash
Accounts Receivable
Supplies
Inventory
Prepaid Insurance
Interest Receivable
Notes Receivable
Equipment
Accumulated Depreciation
Accounts Payable
Income tax payable
Contributed Capital
Retained Earnings
Sales Revenue
Cost of Sales
Depreciate expense
Supplies expense
Insurance expense
Income tax expense
Interest revenue
TOTALS
2
DR
8,150
7,500
300
5,500
600
50
10,000
5,000
as of
CR
100
6,050
120
30,000
550
1,400
500
100
350
100
120
50
38,270
38,270
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College Caps, Inc.
The Income Statement
For the month ended June 30, 2004
Sales Revenue
Cost of Sales
Gross Profit
Depreciate expense
Supplies expense
Insurance expense
Operating Income
Other revenues (expenses)
Interest revenue
Pre-tax Income
Income tax expense
Net Income
1,400
( 500)
900
(100)
( 350)
(100)
350
50
400
(120)
280
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College Caps, Inc.
Statement of Retained Earnings
For the month ended June 30, 2004
Retained Earnings (beg.)
Net Income
Dividend
Retained Earnings (ending)
550
280
(0)
830
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College Caps, Inc.
Balance Sheet
as of June 30, 2004
Assets
Cash
8,150
Accounts Receivable
7,500
Supplies
300
Inventory
5,500
Prepaid Insurance
600
Interest Receivable
50
Notes Receivable
10,000
Current Assets
Equipment
5,000
Accumulated Depreciation
(100)
Total Assets
Liabilities
Accounts Payable
6,050
Income Tax Payable
120
Total Liabilities
Stockholders’ Equity
Contributed Capital
30,000
Retained Earnings
830
Total stockholders’ equity
Total liabilities and stockholders’ equity
32,100
37,000
6,050
30,950
37,000
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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Closing Journal Entry
Dr. Sales revenue
$1,400
Dr. Interest revenue
50
Cr. Cost of sale
Cr. Depreciation exp.
Cr. Supplies expense
Cr. Insurance expense
Cr. Retained Earnings
$500
100
350
100
$400
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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