Chapter 3 1 Adjusting Attack 2 Accrual versus cashbasis accounting amp key elements of accrual accounting Adjusting entries why what how Using the worksheet to facilitate the process Accrual versus cashbasis accounting ID: 202272
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Slide1
The Adjusting Process
Chapter 3
1Slide2
Adjusting Attack
2
Accrual versus cash-basis accounting & key elements of accrual accounting
Adjusting entries, why, what, how
Using the worksheet
to facilitate the processSlide3
Accrual versus cash-basis accounting3
1Slide4
Accrual Accounting Versus
Cash-Basis
Accounting
4
Accrual Basis
Revenues recognized when earned
Expenses recognized when incurred
Cash Basis
Revenues recognized when cash received
Expenses
recorded when cash paid
Not GAAPSlide5
Accounting Period Concept
For reports to be meaningful, transactions that happen in a period, need to be reported in that period.
Basic accounting period: one yearCalendar yearFiscal year
Interim periods < one year
Monthly
Quarterly
Semi-annually5Slide6
Revenue Recognition Principle
When to record revenue?
When it is earnedWhen service is provided
When the product delivered
When the earnings process is complete
Doing this requires some tools to allow revenue to be captured separate from the cash flow:
Asset: Accounts receivableLiability: Unearned revenueWant to see a time line of these?6Slide7
The Matching Principle
When to record expenses?When the resources is consumed
When an asset is consumedWhen we generate a liability for the use of a service
This “Matches” the expense to the revenues earned
Doing this requires tools to allow expenses to be captured separate from the cash flow:
Prepaid or other assets: These store resources until we use and expense them
Liabilities: Payables associate with expenses eg wages payableWant to see a time line of these?7Slide8
Work it out:
How would each of these events be handled under: Accrual Cash-Basis
Cash sale of $500Credit sale of $900Bought 4 months of supplies
Used 4 months of supplies
Bought a fleet of trucks for cash
In each case, which options portrays more accurately the creation of wealth by the company?
Which shows more accurate financial standing?8Slide9
Explain why adjusting entries are needed9
3Slide10
Display Earnings for the Period
Display Financial Standing at a Point in Time
Must show everything earned and consumed
!
Including what we owe, are owed, and current owner’s equity!
Two primary goals of financial accountingSlide11
How do adjusting entries help meet the goals of accrual accounting?Adjusting entries capture real live transactions that took place, but for which there was no cause to enter during regular daily operations
Our job is to capture and report revenues and expenses, not just to process papers that come across your desk.
When you find a situation where a revenue or expense has occurred, but was not captured by the daily journal entries, you make an adjusting entry to capture it.Slide12
What’s that lady in the red coat doing?Adjustments take place at period end.
The LAST CHANCE to make changes that improve or damage the story told by the financial statements.Remember the conflict of interest inherent in accounting?
Adjusting entries is a high-pressure, last minute opening when fraudulent reporting attempts might be made.
Know how transactions affect the financial statements now and later. Know how to apply GAAP to form a first line defense.Slide13
Non-adjusted Example Situation:Car Broker’s cash basis income statements
All Sales in cashCommissions paid early in month 2
Month 1 Month 2
Sales $100,000 $80,000
COGS
80,000 64,000Commissions (5% of sales) 0 9,000Other Expenses 7,000 7,000Net Income 13,000 0,000Note: In this case we DID NOT make a month end adjustment to record the commissions expense in Month 1. The result: Month 2 bears all of month 1 and month 2’s commissions expense – Ouch!@Slide14
Properly Adjusted Example Situation:An adjustment at month end recognizes the commissions expense in month 1 – when commissions were earned, before paid.
Month 1 Month 2
Sales
$100,000
$80,000
COGS
80,000 64,000Commissions (5% of sales) 5,000 4,000Other Expenses 7,000 7,000Net Income $8,000 $5,000Note: In this case we entered the commissions expense in Month 1 for the commissions “used” in Month 1. So both months bear the commissions expenses that month “used”.Slide15
Adjusting entries capture real revenues and real expenses.
Adjusting entries make our income statement and our balance sheet more useful.Slide16
Adjusting Entries16Slide17
Adjusting Entries
Prepared at end of an accounting periodAssigns: Revenues to the period when earnedExpenses to the period when incurred
Update asset and liability accountsNeed to properly match revenues and expenses to measure:Net Income
Assets and Liabilities
17Slide18
Adjusting Entry Rules
18Slide19
Adjusting entries: Four situations
19Slide20
Journalize and post adjusting entries20
4Slide21
Unearned Revenues:
21
Regular daily journal entry: Collect cash in advance upcoming Nutcracker ballet
Activity: Do 4 weekend shows through November, earning $25,000 in performance revenue
Adjusting entry: Record earnings and reverse the earned portion of the liabilitySlide22
Accrued Revenues:
22
Regular daily journal entry: Collect from customer
Activity: We finish a $4,500 car repair on December 29
th
, customer pickup expected Jan 4th
Adjusting entry: Record earnings and accrue the receivable.Slide23
Prepaid Expense: Rent
23
Adjusting entry: Recognize that we used up one month of that rent.
Regular daily journal entry: Paid cash for three months rent
Activity: After a month passes, do we still really own three months rent?Slide24
Depreciation, a variation on prepaid expenses
Plant assetsLong-lived tangible assets used in business operations
Examples:Land, buildings, equipment, and furnitureDepreciation
Allocation of a plant asset’s cost to expense over its useful life
Conceptual guideline:
If you are wearing it out, depreciate it.
If you are completely consuming the asset and it is disappearing, decrease the account directly.24Slide25
Depreciation: Plant assets
25
Regular daily journal entry: Buying $12,000 gaming systems, {Equipment}.
Activity: Use the equipment for a whole year to help us generate revenue.
Adjusting entry: Recognize one year depreciation expense, and log the accumulated depreciationSlide26
Accumulated Depreciation
Contra assetNormal credit balanceAlways paired with related account
Holds sum of all depreciation recorded on a plant assetBook valueCost minus accumulated depreciation
A hopelessly inaccurate approximation of value
Asset cost basis is maintained untouched
Why?
26Slide27
Accrued Expenses:
27
Regular daily journal entry: Pay them
Activity: We use $900 in employee wages through the end of the month, but do not have to pay until next month.
Adjusting entry: Recognize the use of those wages, and accrue the associate liability.Slide28
Adjusting Entry Pick & Pull
1) Spot revenue / expense2) Accruing or converting?
28
Unearned revenues
Prepaid expenses
Accrued revenues
Depreciation
Accrued expenses
We crashed our uninsured car, but haven’t disposed of it yet.
We sold a house for a client, but the listing agent hasn’t sent the payment yet
We provided laundry service for clients who had paid in advance
We used legal services, but the invoice hasn’t arrived
Used supplies without recording the consumptionSlide29
P3-34A: Journalizing Adjusting entries29
Just do the journal entries as indicated by the adjustment data given in the problem.
** Do not post. Do not prepare an adjusted trial balance. Just do the journal entries. **
Note to self: Now would be a good time to project the problem on the board.Slide30
Day two: Adjusting entriesRecapAdjusting entries in the newsUsing a worksheet to facilitate adjusting entries
Relating the adjusted trial balance to the upcoming financial statements
30Slide31
Adjusting Entries recap
Real journal entries, prepared at the end of an accounting period. Why?
Assign: Revenues to the period when earnedExpenses to the period when incurred
Need to properly match revenues and expenses to measure:
Net Income
Assets and
LiabilitiesThese transactions do not involve cash. Why?31Slide32
Adjusting Entries in the news
AIG: $5 billion write down – no thank you
News!
GE: a $50 million slap on the wrist
News!
Krispy Kreme
Can donuts be crooked? News!www.sec.gov Enforcement releasesSlide33
Explain the purpose of and prepare an adjusted trial balance33
5Slide34
The Adjusted Trial Balance
Reflects adjusting entries to show final figuresRecalculate adjusted balances by incorporating adjustments with your unadjusted trial balance.
Even if you use the worksheet to make adjusting work easier, ALWAYS enter your journal entries in the journal, then POST those journal entries to the ledger accounts.Contain all information for financial statements
Often appears on a work sheet
Tool accountants use at end of period
34Slide35
35Slide36
S3-10: PREPARING AN ADJUSTED TRIAL BALANCE36
Supplies on hand, $300.
Depreciation, $1,000.
Accrued interest expense, $600.
a)
600
a)
600
b)1,000
b)1,000
c) 600
c) 600
800
300
19,100
2,000
200
600
2,500
7,400
14,800
4,500
600
1,000
1,200
2,200
2,200
27,500
27,500
Famous Cut Hair Stylists has begun the preparation of its adjusted trial balance as follows:
Year-end data include the following:
Supplies on hand, $300.
Depreciation, $1,000.
Accrued interest expense, $600.
1. Complete Famous Cut’s adjusted trial balance. Key each adjustment by letter.
800
3
00
19,100
2,000
200
600
2,500
7,400
14,800
4,500
6
00
1,000
1,200Slide37
Complete practice set adjustments
37
Do brain
work on
the worksheet
Use page 69 journal entry steps & Roberts’ Triangle
Find Rev/Exp firstTransfer JE work to the general journalPost to the ledgerComplete and check Adjusted Trial Balance columns to match ledger balances.Slide38
Prepare the financial statements from the adjusted trial balance38
6Slide39
39
Income Statement is prepared first.
Revenue - Expenses
Statement of Retained Earnings is second
The Balance Sheet is prepared last.
A = L + ESlide40
Income Statement
40Slide41
Statement of Retained Earnings
41Slide42
Balance Sheet
42Slide43
E3-25: PREPARING THE FINANCIAL STATEMENTSRefer to the adjusted trial balance in Exercise 3-21 for the month ended April 30, 2012.
Requirements:
Prepare the income statement.2. Prepare the statement of retained earnings.
3. Prepare the balance sheet.
43Slide44
44
E3-21:
ADJUSTED
TRIAL BALANCESlide45
E3-25: PREPARING THE FINANCIAL STATEMENTS45
Jobs-4-U Employment Service, Inc.
Income Statement
Month Ended April 30, 2012
Revenue:
Service
revenue
$ 10,600
Expenses:
Salary
expense
$ 3,700
Rent
expense
1,000
Depreciation
expense
1,000
Supplies
expense
500
Total expenses
6,200
Net income
$
4,400Slide46
E3-25: PREPARING THE FINANCIAL STATEMENTS46
Jobs-4-U Employment Service, Inc.
Statement of Retained Earnings
Month Ended April 30, 2012
Retained earnings, March 31, 2012
$ 10,300
Net income
4,400
17,900
Dividends
4,800
Retained earnings, April 30, 2012
$ 9,900Slide47
47
Jobs-4-U Employment Service, Inc.
Balance Sheet
April 30, 2012
Assets
Liabilities
Cash
$ 900
Salary payable
$ 1,200
Accounts receivable
5,600
Supplies
500
Stockholders’ Equity
Equipment
$32,500
Common stock
13,000
Accu.
Depr
.
(
15,400)
17,100
Retained earnings
9,900
Total stockholders’ equity
22,900
Total assets
$24,100
Total liabilities and stockholders’ equity
$24,100
E3-25:
PREPARING THE FINANCIAL STATEMENTSSlide48
Understand the alternate treatment of unearnedrevenues and prepaid expenses(see Appendix 3A, located at
myaccountinglab.com)
48
7Slide49
Alternative Treatment of PrepaidExpenses
Prepaid
Expenses (normally)Advance
payments of
expenses
Debit an asset account
Adjust at end of periodAlternativeDebit an expense accountAdjust at end of period49Slide50
Prepaid Expense
50
Initially debit and expense account
Adjust at end of period for unused amountSlide51
Unearned (Deferred) RevenuesUnearned Revenues (normally)
Advance receipt of revenues–creates liabilityCredit a liability account
Adjust at end of periodAlternativeCredit a revenue
account
Adjust at end of period
51Slide52
Unearned (Deferred) RevenuesInitially credit a revenue account
52
Adjust at end of period for unearned amount Slide53
Chapter 3 Summary
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.
53Slide54
Chapter 3 SummaryWe 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.
54Slide55
Chapter 3 SummaryThe 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).
55Slide56
Chapter 3 SummaryThe 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.
56Slide57
Chapter 3 SummaryThe 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.
57Slide58
58Slide59
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