Transcript Financial Accounting and Accounting Standards

Financial
Accounting,
Seventh Edition
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3-1
Adjusting
the
Accounts
GAAP Relationships
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3-2
Time Period Assumption
Accountants divide the economic life of a business
into artificial time periods (Time Period Assumption).
.....
Jan.
Feb.
Mar.
Apr.
Dec.
Generally a month, a quarter, or a year
Fiscal year vs. calendar year
Also known as the “Periodicity Assumption”
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3-3
Revenue Recognition Principle
We have delivered the
product to our customer,
so I think we should record
the revenue earned.
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3-4
Expense Recognition Principle (Matching Principle)
Recognizing Revenues and Expenses
Match expenses with revenues in
the period when the company
makes efforts to generate those
revenues.
“Let the expenses follow the
revenues.”
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3-5
Cash Basis Accounting (NOT
ALLOWED UNDER GAAP)
Example:
A company paid $2,400 for a 24 month insurance
policy on September 1, 2012
Insurance Expense 2012
Jan
Feb
Mar
Apr
$
May
$
Jun
$
Jul
$
Aug
$
Sep
$
Oct
$
Nov
$
Dec
$ 2,400
$
-
$
-
$
-
On the cash basis the entire $2,400 would be recognized as
insurance expense in September 2012. No insurance expense from
this policy would be recognized in 2013 or 2014, periods covered
Slide
by the policy.
3-6
Accrual Basis of Accounting
(REQUIRED BY GAAP)
Insurance Expense 2012
Jan
Feb
Mar
Apr
$
May
$
Jun
$
Jul
$
Aug
$
Sep
$
Oct
$
Nov
$
Dec
$
100
$
100
$
100
$
100
Insurance Expense 2013
Jan
Feb
Mar
Apr
$
100
May
$
100
Jun
$
100
Jul
$
100
Aug
$
100
Sep
$
100
Oct
$
100
Nov
$
100
Dec
$
100
$
100
$
100
$
100
Insurance Expense 2014
Jan
Feb
Mar
Apr
$
100
May
$
100
Jun
$
100
Jul
$
100
Aug
100
Slide Sep
$
100
Oct
$
100
Nov
$
100
Dec
$
-
$
-
$
-
$
3-7$
-
On the accrual basis,
only $400 of insurance
expense is recognized
in 2012, $1,200 in
2013, and $800 in
2014. The expense is
matched with the
periods benefited by
the insurance coverage.
The Basics of Adjusting Entries
Adjusting entries - needed to ensure that
the revenue recognition and matching
principles are followed.
Adjusting entries make it possible to report
correct amounts on the balance sheet and
on the income statement.
A company must make adjusting entries
every time it prepares financial statements.
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3-8
Framework for Adjusting Entries
An adjusting entry is recorded to bring an asset
or liability account balance to its proper
amount.
Framework for Adjusting Entries
Adjustments
Paid (or received) cash before
expense (or revenue) recognized
Prepaid
(Deferred)
expenses
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3-9
Unearned
(Deferred)
revenues
Paid (or received) cash after
expense (or revenue) recognized
Accrued
expenses
Accrued
revenues
Types of Adjusting Entries
Types of Adjusting Entries
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3-10
Deferrals
Accruals
1. Prepaid Expenses.
Expenses paid in cash and
recorded as assets before
they are used or consumed.
3. Accrued Revenues.
Revenues earned but not
yet received in cash or
recorded.
2. Unearned Revenues.
Revenues received in cash
and recorded as liabilities
before they are earned.
4. Accrued Expenses.
Expenses incurred but not
yet paid in cash or
recorded.
Tips for Adjusting Entries
1.
Each adjusting entry always involves at
least one Balance Sheet account
(asset/liability) and one Income
Statement account (revenue/expense).
2.
Adjusting entries never involve the
Account.
3.
Adjusting entries are generally made at
the End of the accounting period.
Cash
Remember the mnemonic device – BICE!
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3-11
Adjusting Entries for “Prepaid Expenses”
Here is the check
for my first
12 months’ rent.
Resources paid for
prior to receiving
actual benefits
Asset
Unadjusted
Balance
Credit
Adjustment
Expense
Debit
Adjustment
Increases (debits) an expense account and
Decreases (credits) an asset account.
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3-12
Example of Prepaid Rent
On September 1, 2012, a tenant paid $4,800 for
one year’s rent in advance (starting the same day).
What is the adjusting entry on Dec 31, 2012?
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3-13
Example of Prepaid Insurance
On September 1, 2012, a company paid $1,200 for
six months’ insurance in advance (through March 1,
2013). What is the adjusting entry on December 31,
2012?
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3-14
Example : (Prepaid) Supplies
During 2012, a company purchased $1,500 of supplies and
recorded them in the Supplies account. A Dec 31 physical
count indicates $ 600 of supplies on hand. What is the
adjusting entry on Dec 31, 2012?
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3-15
Knowledge Check # 1:
On April 1, 2012, a company paid the
$1,350 premium on a three-year
insurance policy with benefits beginning on
that date. What will be the insurance
expense on the annual income statement
for the year ended December 31, 2012?
1.
2.
3.
4.
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3-16
$300.
$1,350.
$1,012.50.
$337.50.
Knowledge Check # 2:
Jeffrey Company's Office Supplies
account shows a beginning balance of
$1,600 and an ending balance of $1,400.
If office supplies expense for the year is
$3,100, calculate total amount of office
supplies purchased during the period?
1.
2.
3.
4.
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3-17
$2,900
$2,700
$3,300
$3,700
Example of Depreciation of an Asset
On January 1, 2012, a company purchased a computer
equipment for $5,000. The computer is expected to last 5
years, and have no salvage value. Using straight line method,
what is the adjusting entry on Dec 31, 2012?
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3-18
Adjusting Entries for Depreciation
Depreciation (Statement Presentation)
Accumulated Depreciation is a contra asset account.
Appears just after the account it offsets
(Equipment) on the balance sheet.
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3-19
Unearned (Deferred) Revenues
Cash Received in
advance of
providing products
or services
Liability
Debit
Adjustment
Unadjusted
Balance
Example: University of
Maryland sells tickets
for all home basketball
games before the
season starts
Revenue
Credit
Adjustment
Decrease (a debit) to a liability account and
Increase (a credit) to a revenue account.
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3-20
Example of Unearned (Deferred) Revenues
On September 1, 2012, College Park Garden
Apartments received $4,800 from a new tenant for
one year’s rent in advance (starting the same day).
What is the adjusting entry on March 31, 2013?
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3-21
Knowledge Check # 4:
During the current year ended December 31,
clients paid fees in advance for accounting
services amounting to $25,000. If $3,500 of
these fees remain unearned on December 31 of
this year, which of the following will be included
in the December 31 adjusting entry?
1.
2.
3.
4.
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3-22
A debit to Unearned Accounting Fees for $25,000
A debit to Accounting Fees Earned for $21,500.
A credit to Accounting Fees Earned for $21,500.
A credit to Unearned Accounting Fees for $21,500
Adjusting Entries for “Accrued Revenues”
Revenues earned
in a period that
are not received
or recorded
Asset
Debit
Adjustment
Yes, I’ve completed your
project, but have not had
time to bill you yet.
Revenue
Credit
Adjustment
Increases (debits) an asset account and
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3-23
Increases (credits) a revenue account.
Example : Accrued Revenues
On April 1, 2011 Bank of Maryland made a loan of $12,000
to a customer. The principal is due on March 31, 2015.
However, interest of 8% is due every year on March 31.
What is the bank’s adjusting entry on December 31, 2011?
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3-24
Example : Accrued Revenues –
Follow-up Journal entry
On April 1, 2011 Bank of Maryland made a loan of $12,000
to a customer. The principal is due on March 31, 2016.
However, interest of 8% is due every year on March 31.
What is the bank’s journal entry when the customer makes
an interest payment on March 31, 2012?
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3-25
Knowledge Check #3:
A customer signed a three-month note payable to
Bank of Maryland in the amount of $5,000 on
November 1. The note requires the customer to
pay interest at 12%. Which of the following will be
part of the journal entry made by the bank on
December 31?
1.
2.
3.
4.
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3-26
Debit Interest Receivable 100
Debit Interest Receivable 200
Debit Interest Receivable 150
Debit Interest Receivable 600
Adjusting Entries for “Accrued Expenses”
Costs incurred in a
period that are
both unpaid and
unrecorded
Expense
We’re about one-half
done with this job and
want to be paid for
our work!
Liability
Debit
Adjustment
Credit
Adjustment
Increases (debits) an expense account and
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3-27
Increases (credits) a liability account.
Adjusting Entries for “Accrued Expenses”
Lazar Company paid salaries on October 26; the next
payment of salaries will not occur until November 9.
The employees receive total salaries of $5,000 for a
five-day work week, or $1,000 per day.
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3-28
Example: “Accrued Expenses”
Lazar Company last paid salaries on October 26; the next
payment of salaries will not occur until November 9. The
employees receive total salaries of $5,000 for a five-day
work week, or $1,000 per day. What is the adjusting journal
entry on October 31?
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3-29
Accrued Expenses: Subsequent Entry
Lazar Company last paid salaries on October 26; the next
payment of salaries will not occur until November 9. The
employees receive total salaries of $5,000 for a five-day
work week, or $1,000 per day. What is the journal entry
made on November 9?
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3-30
Knowledge Check #5:
A company pays two office employees each Friday at the
rate of $100 per day for each employee for a five-day week
that begins on Monday. If the monthly accounting period
ends on Tuesday and the employees worked on both
Monday and Tuesday, the month-end adjusting entry is:
1.
2.
3.
4.
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3-31
Debit Unpaid Salaries $600 and credit Salaries Payable $600.
Debit Salaries Expense $400 and credit Salaries Payable $400.
Debit Salaries Expense $600 and credit Salaries Payable $600.
Debit Salaries Payable $400 and credit Salaries Expense $400.
Knowledge Check #6:
A company pays each of its two office employees each
Friday at the rate of $100 per day each for a five-day week
that begins on Monday. If the monthly accounting period
ends on Tuesday, the journal entry on Friday will include:
1.
2.
3.
4.
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3-32
Debit Unpaid Salaries $400 and debit Salaries Expense $600.
Debit Salaries Expense $400 and credit Salaries Payable $400.
Debit Salaries Expense $400 and debit Salaries Payable $600.
Debit Salaries Payable $400 and debit Salaries Expense $600.
Links to Financial Statements
Summary of Adjustments and Financial Statement Links
Before Adjustment
Income
Balance
Statement
Sheet Account
Account
Type
Adjusting Entry
Prepaid
Asset
Expense
Dr. Expense
Expenses
Overstated
Understated
Cr. Asset
Unearned
Liability
Revenue
Dr. Liability
Revenues
Overstated
Understated
Cr. Revenue
Accrued
Liability
Expense
Dr. Expense
Expenses
Understated
Understated
Cr. Liability
Accrued
Asset
Revenue
Dr. Asset
Revenues
Understated
Understated
Cr. Revenue
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3-33
Knowledge Check #7:
A not-so-good accountant forgot to make the adjusting
entry for an unearned revenue account at the end of the
accounting period. As a result of in the financial
statements prepared by this accountant,
1.
2.
3.
4.
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3-34
Liabilities will be overstated, and net income will be overstated.
Liabilities will be overstated, and net income will be
understated.
Liabilities will be understated, and net income will be
overstated.
Liabilities will be understated, and net income will be
understated.
The Adjusted Trial Balance
After all adjusting entries are journalized
and posted the company prepares another
trial balance from the ledger accounts
(Adjusted Trial Balance).
Its purpose is to prove the equality of
debit balances and credit balances in the
ledger.
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3-35
The Adjusted Trial Balance
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3-36
Preparing Financial Statements
Financial Statements are prepared directly from the
Adjusted Trial Balance.
Income
Statement
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3-37
Retained
Earnings
Statement
Balance
Sheet
End of Chapter 3
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3-38