Adjusting Accounts For Financial
Statements
Chapter 3
Wild, Shaw, and Chiappetta
Financial & Managerial Accounting
6th Edition
Copyright © 2016 McGraw-Hill Education. All rights reserved. No
reproduction or distribution without the prior written consent of
McGraw-Hill Education.
03-C1:
Explain the importance of
periodic reporting and the role
of accrual accounting
2
The Accounting Period
C1
3
Accrual Basis versus Cash Basis
C1
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.
4
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
C1
5
Accrual Basis versus Cash Basis
On December 1, 2015, FastForward paid $2,400
cash for a twenty-four month business insurance
policy.
C1
Using the cash basis, the entire $2,400 would be
recognized as insurance expense in 2015. No
insurance expense from this policy would be
recognized in 2016 or 2017, periods covered by
the policy.
6
Accrual Basis versus Cash Basis
On the accrual basis, $100 of insurance
expense is recognized in 2015, $1,200 in
2016, and $1,100 in 2017. The expense is
matched with the periods benefited by the
insurance coverage.
C1
7
Recognizing Revenues
The revenue recognition principle states
that we recognize revenue when the
product or service is delivered to our
customer.
C1
8
Recognizing Expenses
The expense recognition (or matching)
principle aims to record expenses in the
same accounting period as the revenues
that are earned as a result of those
expenses. This matching of expenses with
the revenue benefits is a major part of the
adjusting process.
C1
9
03-P1:
Prepare and explain adjusting
entries
10
Framework for Adjustments
An adjusting entry is made at the end of an accounting
period to reflect a transaction or event that is not yet
recorded.
P1
11
Prepaid (Deferred) Expenses
(ex. Prepaid Insurance, Prepaid Rent, Supplies, etc.
Resources paid for
prior to receiving the
actual benefits.
P1
12
PREPAID INSURANCE
On December 1, 2015, FastForward paid $2,400 to cover
insurance for 24 months that began on December 1 of
2015. Scott recorded the expenditure as Prepaid
Insurance on December 1.
PREPAID INSURANCE
24-month policy
Beginning 12/01
P1
$2,400
13
PREPAID INSURANCE
PREPAID INSURANCE
$2,400
INSURANCE EXPENSE
$100
$100
$2,400/24 months = $100
Insurance Expense is debited
$100 to recognize the amount
of insurance coverage for Dec. and
Prepaid Insurance is credited for $100
to reduce it’s balance.
P1
14
PREPAID INSURANCE
(Balance Sheet)
PREPAID INSURANCE
$2,400
(Income Statement)
INSURANCE EXPENSE
adj $100
$100 adj
Bal.
$2,300
The Balance Sheet will show
$2,300 (23 months) of
Prepaid Insurance remaining!
P1
The Income Statement will
show $100 (1 month) of
insurance expired!
15
Adjusting Journal entry for Insurance
expired:
We’ve seen the adjustment in the T-accounts but we
need to record the adjustment on Dec. 31, in the
General Journal. . .
Insurance Expense
Dec. 1
2,400 Dec. 31
Bal.
2,300
637
100
Prepaid Insurance
Dec. 31
100
Dec. 31 Insurance Expense
Prepaid Insurance
128
100
100
To record first month's expired insurance
P1
16
Another adjusting entry which needs to be
made is for Depreciation
Instead of expensing the cost of a plant asset
(equipment, building, cars, etc.) in the year it is
purchased we allocate or spread out the cost over
their expected useful lives.
The formula for straight-line depreciation is:
Straight-Line
Asset Cost - Salvage Value
Depreciation =
Useful Life
Expense
P1
17
USEFUL LIFE
 The period of time that an asset is expected
to help produce revenues.
 Useful life expires as a result of wear and
tear, or because it no longer satisfies the
needs of the business.
P1
18
SALVAGE VALUE
• The expected market value or selling price
of an asset at the end of its useful life
• Also called:
– Scrap Value or
– Residual Value
P1
19
DEPRECIATION EXAMPLE
FastForward purchased equipment on Dec 1 for
$26,000. It has an estimated useful live of 60 months.
The equipment is expected to be worth about $8,000 at
the end of five years. They purchased the equipment
on Dec 1 but it is now Dec 31.
Because FastForward expects the equipment
to be worth $8,000 when the five years
are over, only $18,000 of the cost needs
to be spread over the next 60 months.
P1
20
STRAIGHT-LINE METHOD
1st step: Calculate Net Cost (the amount to
depreciate).
FORMULA:
Original
Cost
$26,000
P1
Salvage
Value
=
$8,000
=
Net Cost
$18,000
21
Calculating Depreciation Expense
2nd step: Determine depreciation expense
for this accounting period (one month).
FORMULA:
Net Cost
Estimated
Useful Life
P1
$18,000
60 mos.
$300 per
month
Now that we know depreciation for
the month is $300, let’s figure out the
adjusting entry. . .
22
Depreciation adjustment reflected in
our T-accounts looks like this:
Depreciation Expense
Equipment
12/1 26,000
12/31 300
Accumulated Depreciation
12/31 300
The depreciation amount of
$300 is credited to this
account instead of the
asset account.
23
Let’ look at the journal entry for the
adjustment for Depreciation..
Equipment
12/1 26,000
Depreciation Expense
12/31 300
Accumulated Depreciation-Equipment
12/31 300
Dec. 31 Depreciation Expense
Accumulated Depreciation - Equipment
P1
300
300
To record monthly equipment depreciation
24
Depreciation would show up on our
balance sheet like this:
FastForward
Partial Balance Sheet
At February 28, 2016
$
Assets
Cash
.
Equipment
Less: accumulated deprec.
.
.
Total Assets
P1
$ 26,000
(900)
25,100
After three
months of
depreciation
have been
taken, the
Equipment is
shown net of
accumulated
depreciation.
25
NEED-TO-KNOW
For each separate case below, follow the three-step process for adjusting the prepaid asset account.
Step 1: Determine what the current account balance equals.
Step 2: Determine what the current account balance should equal.
Step 3: Record an adjusting entry to get from step 1 to step 2.
Assume no other adjusting entries are made during the year.
Prepaid Insurance.The Prepaid Insurance account has a $5,000 debit balance to start the year. A
review of insurance policies and payments shows that $1,000 of unexpired insurance remains at yearend.
Prepaid Rent. On October 1 of the current year, the company prepaid $12,000 for one year of rent for
facilities being occupied from that day forward. The company debited Prepaid Rent and credited Cash
for $12,000. December 31 year-end statements must be prepared.
Supplies. The Supplies account has an $1,000 debit balance to start the year. Supplies of $2,000
were purchased during the current year and debited to the Supplies account. A December 31 physical
count shows $500 of supplies remaining.
Accumulated Depreciation. The company has only one fixed asset (equipment) that it purchased at
the start of this year. That asset had cost $38,000, had an estimated life of 10 years, and is expected
to be valued at $8,000 at the end of the 10-year life.
P1
26
NEED-TO-KNOW
Prepaid Insurance. The Prepaid Insurance account has a $5,000 debit balance to start the year. A
review of insurance policies and payments shows that $1,000 of unexpired insurance remains at yearend.
Step 1: Determine what the current account balance equals.
Step 2: Determine what the current account balance should equal.
Unadj.
Adj.
Prepaid Insurance
5,000
Adjustment
1,000
$5,000
$1,000
4,000
Step 3: Record an adjusting entry to get from step 1 to step 2.
Date
Dec. 31
General Journal
Insurance expense
Prepaid Insurance
Income Statement
Revenue
Debit Expense
P1
Debit
4,000
Credit
4,000
Balance Sheet
Credit Asset
Liability
27
NEED-TO-KNOW
Prepaid Rent. On October 1 of the current year, the company prepaid $12,000 for one year of rent for
facilities being occupied from that day forward. The company debited Prepaid Rent and credited Cash
for $12,000. December 31 year-end statements must be prepared.
Step 1: Determine what the current account balance equals.
$12,000
Step 2: Determine what the current account balance should equal. $9,000
Oct. 1
Dec. 31
Prepaid Rent
12,000
Adjustment
9,000
3,000
Step 3: Record an adjusting entry to get from step 1 to step 2.
Date
Dec. 31
General Journal
Rent Expense
Prepaid Rent
Income Statement
Revenue
Debit Expense
P1
Debit
3,000
Credit
3,000
Balance Sheet
Credit Asset
Liability
28
NEED-TO-KNOW
Supplies. The Supplies account has a $1,000 debit balance to start the year. Supplies of $2,000
were purchased during the current year and debited to the Supplies account. A December 31 physical
count shows $500 of supplies remaining.
Step 1: Determine what the current account balance equals.
$3,000
Step 2: Determine what the current account balance should equal.
$500
Unadj.
Dec. 31
Supplies
3,000
Adjustment
500
2,500
Step 3: Record an adjusting entry to get from step 1 to step 2.
Date
Dec. 31
General Journal
Supplies Expense
Supplies
Income Statement
Revenue
Debit Expense
P1
Debit
2,500
Credit
2,500
Balance Sheet
Credit Asset
Liability
29
NEED-TO-KNOW
Accumulated Depreciation. The company has only one fixed asset (equipment) that it purchased at
the start of this year. That asset had cost $38,000, had an estimated life of 10 years, and is expected
to be valued at $8,000 at the end of the 10-year life.
Step 1: Determine what the current account balance equals.
Step 2: Determine what the current account balance should equal.
$0
$3,000
Accumulated Depreciation
Unadj.
Adjustment
Dec. 31
0
3,000
3,000 ($38,000 - $8,000)
10 years
Step 3: Record an adjusting entry to get from step 1 to step 2.
Date
Dec. 31
General Journal
Depreciation Expense
Accumulated Depreciation
Income Statement
Revenue
Debit Expense
P1
Debit
3,000
Credit
3,000
Balance Sheet
Credit Contra-Asset
Liability
30
Unearned (Deferred)
Revenues
Cash received in
advance of providing
products or services.
P1
31
NEED-TO-KNOW
For each separate case below, follow the three-step process for adjusting the unearned revenue liability account.
Step 1: Determine what the current account balance equals.
Step 2: Determine what the current account balance should equal.
Step 3: Record an adjusting entry to get from step 1 to step 2.
Assume no other adjusting entries are made during the year.
Unearned Rent Revenue. The company collected $24,000 rent in advance on September 1,
debiting Cash and crediting Unearned Rent Revenue. The tenant was paying 12 months rent in
advance and occupancy began September 1.
Unearned Services Revenue. The company charges $100 per month to spray a house for insects.
A customer paid $600 on November 1 in advance for six treatments, which was recorded with a debit
to Cash and a credit to Unearned Services Revenue. At year-end, the company has applied two
treatments for the customer.
P1
32
NEED-TO-KNOW
Unearned Rent Revenue. The company collected $24,000 rent in advance on September 1,
debiting Cash and crediting Unearned Rent Revenue. The tenant was paying 12 months rent in
advance and occupancy began September 1.
Step 1: Determine what the current account balance equals.
Step 2: Determine what the current account balance should equal.
Unearned Rent Revenue
Sept. 1
Adjustment
8,000
Dec. 31
$24,000
$16,000
24,000
16,000 (8 mos. @ $2,000)
Step 3: Record an adjusting entry to get from step 1 to step 2.
Date
Dec. 31
General Journal
Unearned Rent Revenue
Rent Revenue
Income Statement
Credit Revenue
Expense
P1
Debit
8,000
Credit
8,000
Balance Sheet
Asset
Debit Liability
33
NEED-TO-KNOW
Unearned Services Revenue. The company charges $100 per month to spray a house for insects.
A customer paid $600 on November 1 in advance for six treatments, which was recorded with a debit
to Cash and a credit to Unearned Services Revenue. At year-end, the company has applied two
treatments for the customer.
Step 1: Determine what the current account balance equals.
Step 2: Determine what the current account balance should equal.
Unearned Services Revenue
Nov. 1
Adjustment
200
Dec. 31
$600
$400
600
400
Step 3: Record an adjusting entry to get from step 1 to step 2.
Date
Dec. 31
General Journal
Unearned Services Revenue
Services Revenue
Income Statement
Credit Revenue
Expense
P1
Debit
200
Credit
200
Balance Sheet
Asset
Debit Liability
34
Accrued Expenses
Costs incurred in a
period that are
both unpaid and
unrecorded.
P1
35
NEED-TO-KNOW
For each separate case below, follow the three-step process for adjusting the accrued expense account.
Step 1: Determine what the current account balance equals.
Step 2: Determine what the current account balance should equal.
Step 3: Record an adjusting entry to get from step 1 to step 2.
Assume no other adjusting entries are made during the year.
Salaries Payable. At year-end, salaries expense of $5,000 has been incurred by the company, but is
not yet paid to employees.
Interest Payable. At its December 31 year-end, the company holds a mortgage payable that has
incurred $1,000 in annual interest that is neither recorded nor paid. The company intends to pay the
interest on January 3 of the next year.
P1
36
NEED-TO-KNOW
Salaries Payable. At year-end, salaries expense of $5,000 has been incurred by the company, but is
not yet paid to employees.
Step 1: Determine what the current account balance equals.
Step 2: Determine what the current account balance should equal.
Salaries Payable
Unadj.
Adjustment
Dec. 31
$0
$5,000
0
5,000
5,000
Step 3: Record an adjusting entry to get from step 1 to step 2.
Date
Dec. 31
General Journal
Salaries Expense
Salaries Payable
Income Statement
Revenue
Debit Expense
P1
Debit
5,000
Credit
5,000
Balance Sheet
Asset
Credit Liability
37
NEED-TO-KNOW
Interest Payable. At its December 31 year-end, the company holds a mortgage payable that has
incurred $1,000 in annual interest that is neither recorded nor paid. The company intends to pay the
interest on January 3 of the next year.
Step 1: Determine what the current account balance equals.
Step 2: Determine what the current account balance should equal.
Interest Payable
Unadj.
Adjustment
Dec. 31
$0
$1,000
0
1,000
1,000
Step 3: Record an adjusting entry to get from step 1 to step 2.
Date
Dec. 31
General Journal
Interest Expense
Interest Payable
Income Statement
Revenue
Debit Expense
P1
Debit
1,000
Credit
1,000
Balance Sheet
Asset
Credit Liability
38
Accrued Revenues
Revenues earned in a
period that
are both unrecorded
and not yet received.
P1
39
NEED-TO-KNOW
For each separate case below, follow the three-step process for adjusting the accrued revenue account.
Step 1: Determine what the current account balance equals.
Step 2: Determine what the current account balance should equal.
Step 3: Record an adjusting entry to get from step 1 to step 2.
Assume no other adjusting entries are made during the year.
Accounts Receivable. At year-end, the company has completed services of $1,000 for a client, but
the client has not yet been billed for those services.
Interest Receivable. At year-end, the company has earned, but not yet recorded, $500 of interest
earned from its investments in government bonds.
P1
40
NEED-TO-KNOW
Accounts Receivable. At year-end, the company has completed services of $1,000 for a client, but
the client has not yet been billed for those services.
Step 1: Determine what the current account balance equals.
Step 2: Determine what the current account balance should equal.
$0
$1,000
Accounts Receivable
Unadj.
0
Adjustment
1,000
Dec. 31
1,000
Step 3: Record an adjusting entry to get from step 1 to step 2.
Date
Dec. 31
General Journal
Accounts Receivable
Services Revenue
Income Statement
Credit Revenue
Expense
P1
Debit
1,000
Credit
1,000
Balance Sheet
Debit Asset
Liability
41
NEED-TO-KNOW
Interest Receivable. At year-end, the company has earned, but not yet recorded, $500 of interest
earned from its investments in government bonds.
Step 1: Determine what the current account balance equals.
Step 2: Determine what the current account balance should equal.
Unadj.
Adjustment
Dec. 31
$0
$500
Interest Receivable
0
500
500
Step 3: Record an adjusting entry to get from step 1 to step 2.
Date
Dec. 31
General Journal
Interest Receivable
Interest Revenue
Income Statement
Credit Revenue
Expense
P1
Debit
500
Credit
500
Balance Sheet
Debit Asset
Liability
42
Links to Financial Statements
P1
43
03-P2: Adjusted Trial Balance
44
Adjusted Trial Balance
P2
45
03-P3: Prepare financial
statements from an adjusted
trial balance
46
Preparing Financial Statements
from an Adjusted Trial Balance
Step 1— Prepare income statement using revenue and expense
accounts from trial balance.
Step 2—Prepare statement of retained earnings using retained
earnings and dividends from trial balance; and pull
net income from step 1.
Step 3—Prepare balance sheet using asset and liability account
from trial balance; and pull updated retained earnings
balance from step 2.
Step 4—Prepare statement of cash flows from changes in cash
flows for the period (illustrated later in the book).
P3
47
NEED-TO-KNOW
Use the following adjusted trial balance of Magic Company to prepare its (1) income statement, (2) statement of
Retained earnings, and (3) balance sheet (unclassified), for the year ended, or date of, December 31, 2015. The
Retained Earnings account balance is $45,000 at December 31, 2014.
Magic Company
Adjusted Trial Balance
December 31, 2015
Debit
Credit
Cash
$13,000
Accounts receivable
17,000
Land
85,000
Accounts payable
$12,000
Long-term notes payable
33,000
30,000
Common Stock
Retained Earnings
45,000
Dividends
20,000
Fees earned
79,000
Salaries expense
56,000
Office supplies expense
8,000
Totals
$199,000 $199,000
P3
48
Debit
Credit
Magic Company
Adjusted Trial Balance
December 31, 2015
Debit
Credit
Cash
$13,000
Accounts receivable
17,000
Land
85,000
Accounts payable
$12,000
Long-term notes payable
33,000
30,000
Common Stock
Retained Earnings
45,000
Dividends
20,000
Fees earned
79,000
Salaries expense
56,000
Office supplies expense
8,000
Totals
$199,000 $199,000
P3
The Income
Statement
Magic Company
Income Statement
For Year Ended December 31, 2015
Fees earned
$79,000
Expenses
Salaries expense
$56,000
Office supplies expense 8,000
64,000
Net income
$15,000
49
Debit
Credit
Magic Company
Adjusted Trial Balance
December 31, 2015
Debit
Credit
Cash
$13,000
Accounts receivable
17,000
Land
85,000
Accounts payable
$12,000
Long-term notes payable
33,000
30,000
Common Stock
Retained Earnings
45,000
Dividends
20,000
Fees earned
79,000
Salaries expense
56,000
Office supplies expense
8,000
Totals
$199,000 $199,000
P3
Magic Company
Income Statement
For Year Ended December 31, 2015
Fees earned
$79,000
Expenses
Salaries expense
$56,000
Office supplies expense 8,000
64,000
Net income
$15,000
Magic Company
Statement of Retained Earnings
For Year Ended December 31, 2015
Retained Earnings, Dec. 31 2014
$45,000
Plus: Net income
15,000
Less: Dividends
(20,000)
Retained Earnings, Dec. 31 2015
$40,000
The Statement of
Retained Earnings
50
Debit
Credit
Magic Company
Adjusted Trial Balance
December 31, 2015
Debit
Credit
Cash
$13,000
Accounts receivable
17,000
Land
85,000
Accounts payable
$12,000
Long-term notes payable
33,000
30,000
Common Stock
Retained Earnings
45,000
Dividends
20,000
Fees earned
79,000
Salaries expense
56,000
Office supplies expense
8,000
Totals
$199,000 $199,000
Magic Company
Income Statement
For Year Ended December 31, 2015
Fees earned
$79,000
Expenses
Salaries expense
$56,000
Office supplies expense 8,000
64,000
Net income
$15,000
Magic Company
Statement of Owner’s Equity
For Year Ended December 31, 2015
Retained Earnings, Dec. 31 2014
$45,000
Plus: Net income
15,000
Less: Dividends
(20,000)
Retained Earnings, Dec. 31 2015
$40,000
Magic Company
Balance Sheet
December 31, 2015
Assets
Cash
Accounts receivable
Land
P3
Total assets
$13,000
17,000
85,000
$115,000
Liabilities
Accounts payable
Long-term notes payable
Total liabilities
Equity
Common Stock
Retained Earnings
Total Equity
Total liabilities and equity
$12,000
33,000
45,000
Balance
Sheet
30,000
40,000
70,000
115,000
51
03-P4:
Describe and prepare closing
entries
52
Recording Closing Entries
 Close Credit Balances in
Revenue Accounts to Income
Summary.
 Close Debit Balances in
Expense accounts to Income
Summary.
 Close Income Summary
account to Retained Earnings.
 Close Dividends to Retained
Earnings.
P4
53
NEED-TO-KNOW
Use the adjusted trial balance of Magic Company to prepare its closing entries.
Magic Company
Trial Balance
Magic
Company
December
31,Balance
20X2
Adjusted
Trial
December 31, 2015Debit
Cash
Accounts receivable
Land
Accounts payable
Long-term notes payable
Common Stock
Retained Earnings
Dividends
Fees earned
Salaries expense
Office supplies expense
Totals
P4
Debit
$13,000
17,000
85,000
Credit
Credit
$12,000
33,000
30,000
45,000
20,000
79,000
56,000
8,000
$199,000 $199,000
54
Debit
$13,000
17,000
85,000
Cash
Accounts receivable
Land
Accounts payable
Long-term notes payable
Common stock
Retained earnings
Dividends
20,000
Fees earned
Salaries expense
56,000
Office supplies expense
8,000
Totals
$199,000
Date
Dec. 31
Dec. 31
Dec. 31
Dec. 31
P4
Credit
Expenses
Closing
$12,000
33,000
30,000
45,000
Income summary
64,000
Revenues
Net income
15,000
79,000
15,000
0
Retained earnings
12/31/2014
20,000 Net income
12/31/2015
Dividends
79,000
45,000
15,000
40,000
$199,000
General Journal
Fees earned
Income summary
Debit
79,000
Credit
79,000
Income summary
Salaries expense
Office supplies expense
64,000
Income summary
Retained earnings
15,000
Retained earnings
Dividends
20,000
56,000
8,000
15,000
20,000
55
Debit
$13,000
17,000
85,000
Cash
Accounts receivable
Land
Accounts payable
Long-term notes payable
Common Stock
Retained earnings
Totals
$115,000
Credit
Expenses
Closing
$12,000
33,000
30,000
40,000
$115,000
Income Summary
64,000
Revenues
Net income
15,000
79,000
15,000
0
Dividends
Retained Earnings
12/31/2014
20,000 Net income
12/31/2015
45,000
15,000
40,000
Magic Company
Balance Sheet
December 31, 2015
Assets
Cash
Accounts receivable
Land
Total assets
P4
$13,000
17,000
85,000
$115,000
Liabilities
Accounts payable
Long-term notes payable
Total liabilities
Equity
$12,000
33,000
45,000
Common stock
Retained earnings
Total equity
Total liabilities and equity
30,000
40,000
75,000
115,000
56
03-P5:
Explain and prepare a postclosing trial balance
57
Post-Closing Trial Balance
 List of permanent
accounts and their
balances after posting
closing entries.
 Total debits and credits
must be equal.
P5
58
Post-Closing Trial Balance
P5
59
03-C2:
Identify steps in the accounting
cycle.
60
Accounting Cycle
C2
61
03-C3: Explain and prepare a
classified balance sheet
62
Classified Balance Sheet
Current items are those expected to come due (both
collected and owed) within the longer of one year or
the company’s normal operating cycle.
C3
63
Current Assets
Current assets are expected to be sold,
collected, or used within one year or the
company’s operating cycle.
C3
64
Long-Term Investments
Long-term investments are expected to be held for
more than one year or the operating cycle.
C3
65
Plant Assets
Plant assets are tangible long-lived assets used to
produce or sell products and services.
C3
66
Intangible Assets
Intangible assets are long-term resources used to
produce or sell products and services and that
lack physical form.
C3
67
Current Liabilities
Current liabilities are obligations due within the longer of
one year or the company’s operating cycle.
C3
68
Long-Term Liabilities
Long-term liabilities are obligations not due within
the longer of one year or the company’s operating
cycle.
C3
69
Equity
Equity is the owner’s claim on the assets.
C3
70
NEED-TO-KNOW
Use the adjusted trial balance of Magic Company to prepare its classified
balance sheet as of December 31, 2015.
Magic Company
Magic
Company
Adjusted
Trial Balance
Adjusted
Trial
December Balance
31, 20X2
December 31, 2015
Debit
Credit
Debit
Credit
Cash
$13,000
Accounts receivable
17,000
Land
85,000
Accounts payable
$12,000
Long-term notes payable
33,000
30,000
Common Stock
Retained Earnings
45,000
Dividends
20,000
Fees earned
79,000
Salaries expense
56,000
Trial Balance
Office supplies expense
8,000
Totals
$199,000
$199,000
Debit
Credit
C3
71
NEED-TO-KNOW
Use the adjusted trial balance of Magic Company to prepare its classified balance sheet as of
December 31, 2015.
Magic
Company
Magic
Company
Adjusted
Trial Balance
Adjusted
Trial
Adjusted
Trial Balance
Balance
December
31, 20X2
December
31,
December 31, 20X2
2015
Debit
Credit
DebitDebit Credit
Credit
Cash
$13,000
Accounts receivable
17,000
Land
85,000
Accounts payable
$12,000
Long-term notes payable
33,000
30,000
Common Stock
Retained Earnings
Dividends
Fees earned
45,000
20,000
79,000
Salaries expense
Trial Balance 56,000
Office supplies expense
8,000
Totals
C3
$199,000
Debit $199,000
Credit
Magic Company
Balance Sheet
December 31, 2015
Assets
Current assets
Cash
Accounts receivable
Total current assets
Plant assets
Land
Total plant assets
Total assets
Liabilities
Current liabilities
Accounts payable
Total current liabilities
Long-term liabilities
Long-term notes payable
Total liabilities
Equity
Common Stock
Retained Earnings
Total equity
Total liabilities and equity
$13,000
17,000
30,000
85,000
85,000
$115,000
$12,000
12,000
33,000
$45,000
30,000
40,000
70,000
$115,000
72
Global View
The definition of an asset is similar under U.S. GAAP and IFRS and
involves three basic criteria:
(1) the company owns or controls the right to use the item,
(2) the right arises from a past transaction or event, and
(3) the item can be reliably measured.
Both systems define the initial asset value as historical cost for
nearly all assets.
The definition of a liability is similar under U.S. GAAP and IFRS and
involves three basic criteria:
(1) the item is a present obligation requiring a probable future resource
outlay,
(2) the obligation arises from a past transaction or event, and
(3) the obligation can be reliably measured.
73
Global View
Both U.S. GAAP and IFRS include similar guidance for adjusting accounts. Although
some variations exist in revenue and expense recognition.
74
03-A1:
Compute profit margin and
describe its use in analyzing
company performance.
75
Profit Margin
The profit margin ratio measures the company’s net
income to net sales.
Profit
Net Income
=
Margin
Net Sales
Limited Brands, Inc.
A1
76
03-A2:
Compute the current ratio and
describe what it reveals about
a company’s financial
condition.
77
Current Ratio
Helps assess the company’s ability to pay its
debts in the near future
Current ratio =
Current assets
Current liabilities
Limited Brands, Inc.
A2
78
03-P6: Appendix 3A
Alternative Accounting for
Prepayments
79
Appendix 3A: Alternative
Accounting for Prepayments
An alternative method is to record all prepaid expenses
with debits to expense accounts.
The adjusting entry depends on how the original payment
was recorded.
P6
80
Appendix 3A: Alternative
Accounting for Prepayments
P6
81
Appendix 3A: Alternative Accounting for Revenues
An alternative method is to record all revenues to a liability account or
a revenue account.
The adjusting entry depends on how the original receipt
was recorded.
P6
82
Appendix 3A: Alternative
Accounting for Revenues
P6
83
03-P7: Appendix 2C
Prepare a work sheet and
explain its usefulness.
84
Benefits of a Work Sheet
Aids the
preparation of
financial
statements.
Reduces
possibility of
errors.
Links accounts
and their
adjustments.
P7
Assists in
planning and
organizing an
audit.
Not a
required
report.
Helps in
preparing
interim financial
statements.
Shows the
effects of
proposed
transactions.
85
NEED-TO-KNOW
The following 10-column work sheet contains the year-end unadjusted trial balance for Sampson Company
as of December 31, 2016. Complete the work sheet by entering the necessary adjustments, computing the adjusted
account balances, extending the adjusted balances into the appropriate financial statement columns, and entering
the amount of net income for the period. Note: The common stock account balance was $32,000 at December 31, 2015.
Unadjusted
Trial Balance
No.
Dr.
Cr.
101 Cash
23,000
106 Accounts receivable
8,000
183 Land
52,000
201 Accounts payable
10,000
251 Long-term notes payable
43,000
301 Common Stock
32,000
302 Dividends
10,000
401 Fees earned
70,000
622 Salaries expense
54,000
650 Office supplies expense
8,000
Totals
155,000 155,000
Adjustments
Dr.
Cr.
Adjusted
Trial Balance
Dr.
Cr.
Income
Statement
Dr.
Cr.
Balance Sheet
and Statement of
Ret. Earnings
1. Prepare and complete the work sheet, starting with the unadjusted trial balance and including adjustments
based on the following.
a. The company has earned $9,000 in fees that were not yet recorded at year-end.
b. The company incurred $2,000 in salary expense that was not yet recorded at year-end.
(Hint: For simplicity, assume it records any salary not yet paid as part of accounts payable.)
c. The long-term note payable was issued on December 31 this year. Thus, no interest has yet accrued
on this loan.
P7
Dr.
Cr.
86
Unadjusted
Adjusted
Trial Balance
Trial Balance
Adjustments
No.
Dr.
Cr.
Dr.
Cr.
Dr.
Cr.
101 Cash
23,000
23,000
106 Accounts receivable
8,000
(a) 9,000
17,000
183 Land
52,000
52,000
201 Accounts payable
10,000
(b) 2,000
12,000
251 Long-term notes payable
43,000
43,000
301 Common Stock
32,000
32,000
302 Dividends
10,000
10,000
401 Fees earned
70,000
(a) 9,000
79,000
622 Salaries expense
54,000
(b) 2,000
56,000
650 Office supplies expense
8,000
8,000
Totals
155,000 155,000
11,000
11,000 166,000 166,000
Net income
Totals
Income
Statement
Dr.
Cr.
Balance Sheet
and Statement of
Owner's Equity
Dr.
Cr.
23,000
17,000
52,000
12,000
43,000
32,000
10,000
79,000
56,000
8,000
64,000
15,000
79,000
79,000 102,000
87,000
15,000
79,000 102,000 102,000
a. The company has earned $9,000 in fees that were not yet recorded at year-end.
b. The company incurred $2,000 in salary expense that was not yet recorded at year-end.
(Hint: For simplicity, assume it records any salary not yet paid as part of accounts payable.)
c. The long-term note payable was issued on December 31 this year. Thus, no interest has yet accrued
on this loan.
P7
87
Unadjusted
Adjusted
Trial Balance
Trial Balance
Adjustments
No.
Dr.
Cr.
Dr.
Cr.
Dr.
Cr.
101 Cash
23,000
23,000
106 Accounts receivable
8,000
(a) 9,000
17,000
183 Land
52,000
52,000
201 Accounts payable
10,000
(b) 2,000
12,000
251 Long-term notes payable
43,000
43,000
301 Common Stock
32,000
32,000
302 Dividends
10,000
10,000
401 Fees earned
70,000
(a) 9,000
79,000
622 Salaries expense
54,000
(b) 2,000
56,000
650 Office supplies expense
8,000
8,000
Totals
155,000 155,000
11,000
11,000 166,000 166,000
Net income
Totals
Income
Statement
Dr.
Cr.
Balance Sheet
and Statement of
Ret. Earnings
Dr.
Cr.
23,000
17,000
52,000
12,000
43,000
32,000
10,000
79,000
56,000
8,000
64,000
15,000
79,000
79,000 102,000
87,000
15,000
79,000 102,000 102,000
2. Use information from the completed work sheet in part 1 to prepare adjusting entries.
Date
General Journal
Dec. 31 Accounts Receivable
Debit
9,000
Fees earned
Dec. 31 Salaries expense
Accounts payable
Credit
9,000
2,000
2,000
Dec. 31 No journal entry required
P7
88
3. Prepare the income statement and the statement of retained earnings for the year ended December 31 and
the unclassified balance sheet at December 31.
Debit
$23,000
17,000
52,000
Cash
Accounts receivable
Land
Accounts payable
Long-term notes payable
Common Stock
Dividends
10,000
Fees earned
Salaries expense
56,000
Office supplies expense
8,000
Totals
$166,000
Credit
$12,000
43,000
32,000
79,000
$166,000
Sampson Company
Income Statement
For Year Ended December 31, 2016
Fees earned
$79,000
Expenses
Salaries expense
$56,000
Office supplies expense 8,000
64,000
Net income
$15,000
Sampson Company
Statement of Retained Earnings
For Year Ended December 31, 2016
Retained Earnings, Dec. 31 2015
$
00
Plus: Net income
15,000
Less: Dividends
(10,000)
Retained Earnings, Dec. 31 2016
$ 5,000
Sampson Company
Balance Sheet
December 31, 2016
Assets
Cash
Accounts receivable
Land
P7
Total assets
$23,000
17,000
52,000
$92,000
Liabilities
Accounts payable
Long-term notes payable
Total liabilities
Equity
Common Stock
Retained Earnings
Total liabilities and equity
$12,000
43,000
55,000
32,000
5,000
92,000
89
03-P8: Appendix 3C
Reversing Entries
90
Appendix 4A – Reversing Entries
Reversing entries are optional. They are recorded in
response to accrued assets and accrued liabilities that
were created by adjusting entries at the end of a
reporting period. The purpose of reversing entries is to
simplify a company’s recordkeeping.
Let’s see how the accounting for our payroll
accrual will be handled with and without
reversing entries.
P8
91
P8
92
Without Reversing Entries
P8
With Reversing Entries
93
End of Chapter 3
94