Lecture Principles of financial accouting - Chapter 3: Adjusting accounts and preparing financial statements

Chapter 3

Adjusting Accounts and Preparing
Financial Statements

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Winston Kwok, Ph.D., CPA
McGraw­Hill/Irwin

        Copyright © 2011 by The McGraw­Hill Companies, Inc. All rights reserved.


3 ­ 2

C 1

The Accounting Period


3 ­ 3

C 2

Accrual Basis versus Cash Basis
Accrual Basis

Cash Basis

Revenues are
recognized when
earned and expenses
are recognized when
incurred.

Revenues are
recognized when cash
is received and
expenses are recorded
when cash is paid.


3 ­ 4

C 2

Accrual Basis versus Cash Basis
Accrual Basis

Cash Basis

Revenues are
recognized when
earned and expenses
are recognized when
incurred.

Revenues are

recognized when cash
is received and
expenses are recorded
when cash is paid.

Non-GAAP


3 ­ 5

C 2

Accrual Basis versus Cash Basis

Insurance Expense 2009
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 2011. No insurance
expense from this policy would be recognized in 2012 or
2013, periods covered by the policy.


3 ­ 6

C 2

Accrual Basis versus Cash Basis
Insurance Expense 2009
Jan
Feb
Mar
Apr
$

May

$

Jun

$

Jul

$

Aug

$

Sep

$

Oct

$

Nov

$

Dec

$

-

$

-

$

-

$

100

Insurance Expense 2010
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 2011
Jan
Feb
Mar
Apr
$

100
May

$

100
Jun

$

100
Jul

$

100
Aug

$

100
Sep

$

100
Oct

$

100
Nov

$

100
Dec

$

100

$

100

$

100

$

-

On the accrual basis,
$100 of insurance
expense is recognized in
2011, $1,200 in 2012,
and $1,100 in 2013. The
expense is matched with
the periods benefited by
the insurance coverage.


3 ­ 7

C 2

Recognizing Revenues & Expenses
Revenue Recognition Principle
We
We have
have delivered

delivered the
the
product
product to our
our customer,
so
so II think
think we
we should
should record
the
the revenue
revenue earned.
earned.


3 ­ 8

C 2

Recognizing Revenues & Expenses
Revenue Recognition Principle
Matching Principle
Summary
of Expenses
Rent
Gasoline
Advertising
Salaries
Utilities

and . . . .

$1,000
500
2,000
3,000
450
....

Now that we have
recognized the
the revenue,
let’s see what expenses
we incurred to
generate that revenue.


3 ­ 9

C 3

Adjusting Accounts
 An adjusting entry is recorded to bring an asset or
liability account balance to its proper amount.

Framework for Adjustments
Adjustments
Paid
Paid (or
(or received)

received) cash
cash before
before
expense
expense (or
(or revenue)
revenue) recognized
recognized

Prepaid
Prepaid
(Deferred)
(Deferred)
expenses*
expenses*

*including depreciation

Unearned
Unearned
(Deferred)
(Deferred)
revenues
revenues

Paid
Paid (or
(or received)
received) cash
cash after

after
expense
expense (or
(or revenue)
revenue) recognized
recognized

Accrued
Accrued
expense
expense

Accrued
Accrued
revenues
revenues


3 ­ 10

P 1

Prepaid (Deferred) Expenses
Resources paid
for prior to
receiving the
actual benefits.

Here
Here is

is the
the check
check
for
for my
my 24-month
24-month
insurance
insurance policy.
policy.


3 ­ 11

P 1

Prepaid Insurance
(a) On 12/1/11, FastForward paid $2,400 for insurance for
2-years (24-months, December 2011 through November
2013). FastForward recorded the expenditure as Prepaid
Insurance on 12/31/11.
What adjustment is required?
Dec. 31 Insurance Expense
Prepaid Insurance

100
100

To record first month's expired insurance

Prepaid Insurance
Dec. 1
2,400 Dec. 31
Bal.
2,300

637

100

Insurance Expense
Dec. 31
100

128


3 ­ 12

P 1

Supplies
(b) During 2011, FastForward purchased $9,720 of supplies.
FastForward recorded the expenditures in the asset account,
“Supplies.” On December 31, 2011, a count of the supplies
indicated $8,670 on hand, so $1,050 of supplies were used
during December.
What adjustment is required?
Dec. 31 Supplies Expense
Supplies

1,050
1,050

To record supplies used during 2011

Bought
Bal.

Supplies
9,720 Dec. 31
8,670

126

1,050

Supplies Expense
Dec. 31
1,050

652


3 ­ 13

P 1

Other Prepaid Expenses
1. Other prepaid expenses, such as Prepaid Rent, are

accounted for exactly as Insurance and Supplies.
2. We should note that some prepaid expenses are
both paid for and fully used up within a single
period.
3. For example, a company may pay monthly rent on
the first day of each month. This payment creates a
prepaid expense on the first day of the month that
fully expires by the end of the month.
4. In these special cases, we can record the cash paid
with a debit to the expense account instead of an
asset account.


3 ­ 14

P 1

Depreciation
Depreciation is the process of allocating the
cost of a plant asset over its useful life in a
systematic and rational manner.
Straight-Line
Asset Cost - Residual Value
Depreciation =
Useful Life
Expense


3 ­ 15

P 1

Depreciation
On December 1, 2011, FastForward purchased
equipment for $26,000 cash. The equipment has
an estimated useful life of four years (48 months)
and FastForward expects to sell the equipment at
the end of its life for $8,000 cash.
(c) Let’s record depreciation expense for the
month ended December 31, 2011.


3 ­ 16

P 1

Depreciation
Dec. 31 Depreciation Expense
Accumulated Depreciation - Equipment

375
375

To record monthly equipment depreciation

Contra asset account

Depreciation Expense

Equipment

12/31

12/1 26,000

Accumulated Depreciation
12/31

375

375


3 ­ 17

P 1

Depreciation

$

Equipment is 
Equipment is 
shown net of 
shown net of 
accumulated 
accumulated 
depreciation.
depreciation.

3 ­ 18

P 1

Unearned (Deferred)
Revenues

Cash received in
advance of providing
products or services.

We
We will
will apply
apply this
this cash
cash
you
you gave
gave us
us towards
towards
your
your total
total consulting
consulting fees.
fees.

3 ­ 19

P 1

Unearned (Deferred)
Revenues
On December 26, 2011, FastForward agrees to
provide consulting services to a client for a fixed fee
of $3,000 for 60 days. On this date, the client pays
the entire consulting fee in advance. FastForward
makes the following entry:

Dec. 26 Cash

3,000
Unearned Revenue

Consulting fees received in advance

Unearned Revenue
Dec. 26 3,000

3,000


3 ­ 20

P 1

Unearned (Deferred)

Revenues
(d) On December 31, FastForward earns 5-days of
consulting fees. Each day that passes results in
consulting fees of $50 ($3,000 ÷ 60), so FastForward
earned ($50 × 5 days) $250.

Dec. 31 Unearned Revenue
Consulting Revenue

250
250

To recognize 5-days of consulting fees

Unearned Revenue
Dec 31
250 Dec 26
3,000
Bal
2,750

Consulting Revenue
Dec. 31

250


3 ­ 21

P 1

Accrued Expenses
Costs
Costs incurred
incurred in
in
aa period
period that
that are
are
both
both unpaid
unpaid and
and
unrecorded.
unrecorded.

We’re
We’re about
about one-half
one-half
done
done with
with this job and
want
want to
to be
be paid
paid for
for

our
our work!
work!


3 ­ 22

P 1

Accrued Salaries Expenses
FastForward’s
FastForward’s employee
employee earns
earns $70
$70 per
per day
day and
and is
is paid
paid
every
every two
two weeks
weeks on
on Friday.
Friday. Year-end,
Year-end, 12/31/11,
12/31/11, falls
falls on
on aa

Wednesday.
Wednesday. The
The last
last payday
payday of
of 2011,
2011, is
is Friday,
Friday, 12/26/11.
12/26/11.
From
From 12/26
12/26 until
until year-end
year-end is
is three
three working
working days.
days. The
The
employee
employee has
has earned
earned salaries
salaries of
of $210
$210 for
for Monday
Monday through
through

Wednesday.
Wednesday. They
They will
will not
not be
be paid
paid until
until the
the next
next Friday.
Friday.


3 ­ 23

P 1

Accrued Salaries Expenses
(e) FastForward’s employee has earned but not been paid
on December 31, 2011, $210.

Dec. 31 Salaries Expense
Salaries Payable

210
210

To accrue 3 days' salary (3 x $70)
Salaries Expense
Dec.12

700
Dec.26
700
Dec. 31
210
Bal.
1,610

Salaries Payable
Dec. 31

210


3 ­ 24

Future Payment of
Accrued Expenses

P 1

On January 9, 2012, FastForward will pay the payroll for
the two weeks from December 26, 2011 through January
9, 2012. Here is the journal entry for the payroll:
Jan 9

Salaries Payable (3 days @ $70)
Salaries Expense (7 days @ $70)
Cash (10 days @ $70)
P aid  two­we e k s alary

210
490
700


3 ­ 25

P 1

ACCRUED INTEREST EXPENSES
FastForward
FastForward borrowed
borrowed $6,000
$6,000 from
from First
First National
National Bank
Bank on
on
December
December 1,
1, 2011.
2011. The
The note
note bears
bears interest
interest at
at the
the annual

annual
rate
rate of
of 6%
6% and
and is
is due
due to
to be
be repaid
repaid in
in one
one year.
year. Let’s
Let’s accrue
accrue
interest
interest for
for the
the month
month ended
ended 12/31/11.
12/31/11.
Dec. 31 Interest Expense
Interest Payable

30
30

To accrue interest ($6,000 × 6% × 30/360)

Interest Expense
Dec. 31
30

Interest Payable
Dec. 31

30