ch03 - CHAPTER 3 CHAPTER Adjusting the Adjusting Accounts...

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Unformatted text preview: CHAPTER 3 CHAPTER Adjusting the Adjusting Accounts Accounts ISV Financial Accounting, Sixth Edition Chapter 3 -1 Timing Issues 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” Chapter 3 -2 LO 1 Explain the time period assumption. Timing Issues Review The time period assumption states that: a. revenue should be recognized in the accounting period in which it is earned. b. expenses should be matched with revenues. c. the economic life of a business can be divided into artificial time periods. d. the fiscal year should correspond with the calendar year. Chapter 3 -3 LO 1 Explain the time period assumption. Timing Issues Accrual- vs. Cash-Basis Accounting Accrual-Basis Accounting Transactions recorded in the periods in which the events occur. Revenues are recognized when earned, rather than when cash is received. Expenses are recognized when incurred, rather than when paid. Chapter 3 -4 LO 2 Explain the accrual basis of accounting. Timing Issues Accrual- vs. Cash-Basis Accounting Cash-Basis Accounting Revenues are recognized when cash is received. Expenses are recognized when cash is paid. Cash­basis accounting is not in accordance with generally accepted accounting principles (GAAP). Chapter 3 -5 LO 2 Explain the accrual basis of accounting. Timing Issues Recognizing Revenues and Expenses Revenue Recognition Principle Companies recognize revenue in the accounting period in which it is earned. In a service enterprise, revenue is considered to be earned at the time the service is performed. Chapter 3 -6 LO 2 Explain the accrual basis of accounting. Timing Issues Recognizing Revenues and Expenses Matching Principle Match expenses with revenues in the period when the company makes efforts to generate those revenues. “Let the expenses follow the revenues.” Chapter 3 -7 LO 2 Explain the accrual basis of accounting. Timing Issues GAAP relationships in revenue and expense recognition Illustration 3-1 Chapter 3 -8 LO 2 Explain the accrual basis of accounting. Timing Issues Review One of the following statements about the accrual basis of accounting is false. That statement is: a. Events that change a company’s financial statements are recorded in the periods in which the events occur. b. Revenue is recognized in the period in which it is earned. c. The accrual basis is in accord with generally accepted accounting principles. d. Revenue is recorded only when cash is received, and expense is recorded only when cash is paid. Chapter 3 -9 LO 2 Explain the accrual basis of accounting. The Basics of Adjusting Entries 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. Chapter 3-10 LO 3 Explain the reasons for adjusting entries. The Basics of Adjusting Entries Revenues ­ recorded in the period in which they are earned. Expenses ­ recognized in the period in which they are Expenses ­ recognized in the period in which they are incurred. Adjusting entries ­ needed to ensure that the revenue recognition and matching principles are followed. Chapter 3-11 LO 3 Explain the reasons for adjusting entries. Types of Adjusting Entries Deferrals 1. Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed. 2. Unearned Revenues. Cash received and recorded as liabilities before revenue is earned. Accruals 1. Accrued Revenues. Revenues earnedbut not yet received in cash or recorded. 2. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded. Chapter 3-12 LO 4 Identify the major types of adjusting entries. Trial Balance – Each account is analyzed to determine whether Trial – Each account is analyzed to determine whether it is complete and up­to­date PIONEER ADVERTISING AGENCY INC. Trial Balance October 31, 2008 Account Cash Advertising Supplies Prepaid Insurance Office Equipment Notes Payable Accounts Payable Unearned Revenue Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Rent Expense Chapter 3-13 Debit $ 15,200 2,500 600 5,000 Credit $ 5,000 2,500 1,200 10,000 -0500 10,000 4,000 900 $28,700 $ 28,700 LO 4 Identify the major types of adjusting entries. Adjusting Entries for Deferrals Deferrals are either: Prepaid expenses or Unearned revenues. Chapter 3-14 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Prepaid Expenses” Payment of cash, that is recorded as an asset because service or benefit will be received in the future. Cash Payment BEFORE Expense Recorded Prepayments often occur in regard to: insurance supplies Advertising rent Chapter 3-15 building purchases equipment purchases LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Prepaid Expenses” Prepaid Expenses Costs that expire either with the passage of time or through use. Adjusting entries (1) to record the expenses that apply to the current accounting period, and (2) to show the unexpired costs in the asset accounts. Chapter 3-16 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Prepaid Expenses” Illustration 3-4 Adjusting entries for prepaid expenses Increases (debits) an expense account and Decreases (credits) an asset account. Chapter 3-17 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Prepaid Expenses” Example (Supplies): On Oct. 5th, Pioneer Advertising purchased Example (Supplies) On Oct. 5 advertising supplies costing $2,500. Show the journal entry to record the payment on Oct. 5th. Oct. 5 Advertising Supplies Cash Advertising Supplies Debit 2,500 Credit Debit Cash Credit 2,500 2,500 2,500 Chapter 3-18 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Prepaid Expenses” Example (Supplies): On Oct. 31st, an inventory count reveals that Example (Supplies) On Oct. 31 $1,000 of supplies are still on hand. Show the adjusting journal entry Show the required at Oct. 31. Oct. 31 Advertising Supplies Expense Advertising Supplies Advertising Supplies Debit 2,500 1,000 Chapter 3-19 1,500 1,500 Advertising Supplies Expense Debit 1,500 Credit Credit 1,500 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Prepaid Expenses” Example (Insurance): On Oct. 4th, Pioneer Advertising paid $600 for Example (Insurance) On Oct. 4 a one­year fire insurance policy. Show the journal entry to record the payment on Oct. 4th. Oct. 4 Prepaid Insurance Cash Prepaid Insurance Debit 600 Credit Debit Cash Credit 600 600 600 Chapter 3-20 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Prepaid Expenses” Example (Insurance): On Oct. 4th, Pioneer Advertising paid Example (Insurance) On Pioneer $600 for a one-year fire insurance policy. Show the adjusting journal Show the entry required at Oct. 31st. Oct. 31 Insurance Expense Prepaid Insurance Prepaid Insurance Debit 600 550 Chapter 3-21 50 50 Insurance Expense Debit Credit 50 Credit 50 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Prepaid Expenses” Depreciation Buildings, equipment, and vehicles (long­lived assets) are recorded as assets, rather than an expense, in the year acquired. Companies report a portion of the cost of a long­lived asset as an expense (depreciation) during each period of the asset’s useful life (Matching Principle). Chapter 3-22 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Prepaid Expenses” Example (Depreciation): On Oct. 2nd, Pioneer Advertising paid Example (Depreciation) On Oct. 2 $5,000 for office equipment that has an expected useful life of 10 years. Show the journal entry to record the purchase of the equipment on Oct. 2nd. Oct. 2 Office Equipment Cash Office Equipment Debit 5,000 Credit Debit Cash Credit 5,000 5,000 5,000 Chapter 3-23 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Prepaid Expenses” Example (Depreciation): On Oct. 2nd, Pioneer Advertising paid $5,000 Example (Depreciation) On Oct. 2 for office equipment that has an expected useful life of 10 years. Show the adjusting journal entry required at Oct. 31st. The equipment has a $200 salvage value. ([$5,000­ $200 salvage value] / 5 yrs / 12 months = $40) Oct. 31 Depreciation Expense Accumulated Depreciation Depreciation Expense Debit 40 40 Chapter 3-24 40 40 Accumulated Depreciation Debit Credit 40 Credit LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Prepaid Expenses” Depreciation (Statement Presentation) Accumulated Depreciation­ is a contra asset account. Appears just after the account it offsets (Equipment) on the balance sheet. Office equipment Less: Accumulated depreciation- Office Equipment $5,000 40 $4,960 Book value v.s. Market value Chapter 3-25 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Unearned Revenues” Receipt of cash that is recorded as a liability because the revenue has not been earned. Cash Receipt BEFORE Revenue Recorded Unearned revenues often occur in regard to: rent magazine subscriptions customer deposits for future service Chapter 3-26 sale of airline tickets school tuition LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Unearned Revenues” Unearned Revenues Company makes an adjusting entry to record the revenue that has been earned and to show the liability that remains. The adjusting entry for unearned revenues results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account. Chapter 3-27 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Unearned Revenues” Illustration 3-10 Adjusting entries for unearned revenues Decrease (a debit) to a liability account and Increase (a credit) to a revenue account. Chapter 3-28 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Unearned Revenues” Example: On Oct. 2nd, Pioneer Advertising received $1,200 from R. Knox On Oct. 2 for services to be completed by December 31. Show the journal entry to record the receipt on Oct 2nd. Oct. 2 Cash Unearned Revenue Cash Debit 1,200 Credit Unearned Revenue Debit Credit 1,200 1,200 1,200 Chapter 3-29 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for “Unearned Revenues” Example: On Oct. 2nd, Pioneer Advertising received $1,200 On Pioneer from R. Knox for services to be completed by December 31. from Show the adjusting journal entry required on Oct. 31st. Show the Oct. 31 Unearned Revenue Service Revenue Service Revenue Debit Credit 400 Unearned Revenue Debit 400 Credit 1,200 800 Chapter 3-30 400 400 LO 5 LO Prepare adjusting entries for deferrals. Prepare Adjusting Entries for Accruals Made to record: Revenues earned and Expenses incurred in the current accounting period that have not been recognized through daily entries. Chapter 3-31 LO 6 LO Prepare adjusting entries for accruals. Prepare Adjusting Entries for “Accrued Revenues” Revenues earned but not yet received in cash or recorded. Adjusting entry results in: Revenue Recorded BEFORE Cash Receipt Accrued revenues often occur in regard to: interest accumulated with the passing of time rent services performed Chapter 3-32 LO 6 LO Prepare adjusting entries for accruals. Prepare Adjusting Entries for “Accrued Revenues” Accrued Revenues An adjusting entry serves two purposes: (1) It shows the receivable that exists, and (2) It records the revenues earned. Chapter 3-33 LO 6 LO Prepare adjusting entries for accruals. Prepare Adjusting Entries for “Accrued Revenues” Illustration 3-13 Adjusting entries for accrued revenues Increases (debits) an asset account and Increases (credits) a revenue account. Chapter 3-34 LO 6 LO Prepare adjusting entries for accruals. Prepare Adjusting Entries for “Accrued Revenues” Example: In October Pioneer Advertising earned $200 for advertising In October Pioneer Advertising earned $200 for advertising services that have not been recorded. Show the journal entry to record the accrued revenues in October. Oct. 31 Accounts Receivable Service Revenue Accounts Receivable Debit 200 Credit Service Revenue Debit Credit 200 200 200 Chapter 3-35 LO 6 LO Prepare adjusting entries for accruals. Prepare Adjusting Entries for “Accrued Revenues” Example: In October Pioneer Advertising earned $200 for advertising In October Pioneer Advertising earned $200 for advertising services that have not been recorded. Show the journal entry to record the accrued revenues in October. Oct. 31 Accounts Receivable Service Revenue performed in October and makes the following entry. Nov. 10 Cash Accounts Receivable Chapter 3-36 200 200 Example: On November 10th, Pioneer receives cash of $200 for the services On November 10 200 200 Prepare adjusting entries for accruals. Prepare LO 6 LO Adjusting Entries for “Accrued Expenses” Expenses incurred but not yet paid in cash or recorded. Adjusting entry results in: Expense Recorded BEFORE Cash Payment Accrued expenses often occur in regard to: interest rent taxes salaries Chapter 3-37 LO 6 LO Prepare adjusting entries for accruals. Prepare Adjusting Entries for “Accrued Expenses” Accrued Expenses An adjusting entry serves two purposes: (1) It records the obligations, and (2) It recognizes the expenses. Chapter 3-38 LO 6 LO Prepare adjusting entries for accruals. Prepare Adjusting Entries for “Accrued Expenses” Illustration 3-16 Adjusting entries for accrued expenses Increases (debits) an expense account and Increases (credits) a liability account. Chapter 3-39 LO 6 LO Prepare adjusting entries for accruals. Prepare Adjusting Entries for “Accrued Expenses” Example (Accrued Interest) : On Oct 1st, Pioneer Advertising signed a Example (Accrued On Oct 1 $,5000, 3­month note payable at a rate of 12% per year. The total interest due on the note at its due date is $150 ($5,000 X 12% X 3/12). Show the journal entry to record the borrowing on Oct. 1st. Oct. 1 Cash Notes Payable Cash Debit 5,000 Credit Debit 5,000 Notes Payable Credit 5,000 5,000 Chapter 3-40 LO 6 LO Prepare adjusting entries for accruals. Prepare Adjusting Entries for “Accrued Expenses” Example (Accrued Interest) : On Oct 1st, Pioneer Advertising Example (Accrued On Pioneer signed a $,5000, 3-month note payable at a rate of 12% per year. The interest incurred for the month of October is $50 ([$5,000 x 12%] x 1/12 months). The interest incurred for the month of October is Show the adjusting journal entry required on Oct. 31st. Show the Oct. 31 Interest Expense Interest Payable Interest Expense Debit 50 Credit Debit 50 Interest Payable Credit 50 50 Chapter 3-41 LO 6 LO Prepare adjusting entries for accruals. Prepare Adjusting Entries for “Accrued Expenses” Example (Accrued Salaries) : Pioneer last paid salaries on Oct 26st; the Example (Accrued Pioneer last paid salaries on Oct 26 next pay date is Nov. 9th. As the calendar shows, three working days remain in Oct. (Oct. 29­31). The employees received total salaries of $2,000 for a five­day work week, or $400 per day. Show the adjusting journal entry required on Oct. 31st. Oct. 31 Salaries Expense Salaries Payable Salaries Expense Debit 1,200 Credit Salaries Payable Debit Credit 1,200 1,200 1,200 Chapter 3-42 LO 6 LO Prepare adjusting entries for accruals. Prepare Adjusting Entries for “Accrued Expenses” Example (Accrued Salaries) : Pioneer Advertising pays salaries Example (Accrued Pioneer Advertising pays salaries every two weeks. The next payday is Nov. 9th, when the company will again pay total salaries of $4,000. The payment will consist of $1,200 of salaries payable plus $2,800 of salaries expense. Show the journal entry required on Nov. 9th. Nov. 9 Salaries Payable Salaries Expense Cash 1,200 2,800 4,000 Chapter 3-43 LO 6 LO Prepare adjusting entries for accruals. Prepare 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. Chapter 3-44 LO 7 LO Describe the nature and purpose of an adjusted trial balance. Describe Preparing Financial Statements Financial Statements are prepared directly from the Adjusted Trial Balance. Income Statement Retained Earnings Statement Balance Sheet Statement of Cash Flows Chapter 3-45 LO 7 LO Describe the nature and purpose of an adjusted trial balance. Describe ...
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This note was uploaded on 03/10/2011 for the course ACCOUNTING acct101 taught by Professor Loons during the Spring '08 term at Uni Konstanz.

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