Adjusting Accounts & Preparing
Financial Statements
Chapter 3
Accounting period

Time principle period
– Specific time periods for accounting
activities
– Fiscal year
• Consisting of any 12 months period other than
ending on December 31
– Natural year
• Ends December 31
Accounting basis

Accrual basis
– Uses the adjusting process to recognize
revenues when earned and to match
expenses with revenues

Cash Basis
– Recognized revenues when cash is
received and records expenses when cash
is paid
Revenue Recognition

Matching principle
– Aims to record
expenses in the
same accounting
period as the
revenues that are
earned as a result of
these expenses
Adjustments

Adjusting entries
– To correct for transactions and events that
extend over more than one period
• Deferred – wait till cash is paid
• Accrual –
– Rule
• Debit the expense
• Credit the asset or liabilities
• For the amount used up
Prepaid insurance
Suppose that we purchase $2,400 for
insurance for one year on May 1.
Record the adjustments on December
31.
 $2,400/12 = $200 x 8months = $1,600
 Insurance expense 1600
 Prepaid insurance
1600

Supplies
Suppose that supplies account has a
balance of $4,000 and inventory shows
$1,000. Record the supplies used up.
 Balance 4,000
 Inventory1,000
 Used up 3,000

Supplies
Supplies expense 3,000

Supplies
3,000

Depreciation

Plant assets/Fixed Assets
– Assets which are tanigble and long lived
– Building and machinery

Depreciation
– The reduction in value of an asset due to
its use
Depreciation

Depreciation expense
– Annual reduction in value of asset

Accumulated depreciation
– Contra asset
– Increases with a credit
– Total reduction in value of an asset
Unearned revenues
Refers to cash received in advance of
services provided
 Suppose that unearned revneue has a
balance of $7,000 but records shows
only $3,000 is unearned
 Balance $7,000
 Should be 3,000
 Earned
4,000

Unearned Revenues

Unearned revenues
– A liability
– If we do not complete the work then we are
liable to refund the monies.
– Once the work is completed then the
liability does not exist
Unearned revenues 4,000

Fees earned
4000

Accrued expenses
Refers to costs that are incurred in a
period that are unpaid and unrecorded
 Accrued salaries

– Salaries owed at the end of the period to
be made next period
– Suppose year ends on Wed, do we pay on
Wed or wait until Friday
Salaries

Suppose salaries at year end is $400
Salaries expense 400
 Salaries payable
400

Accrued revenues
Refers to revenues earned in a period
that are both unrecorded and not yet
received in cash
 Unrecorded accounts receivable

Trial Balance

Unadjusted trial balance
– is a list of account balances before
adjustments
– Used to make adjusting entries

Adjusted trial balance
– Used to prepare financial statements
Financial Statements

Four basic financial statements
– Income statement
– Statement of Retained Earnings
– Balance Sheet
– Statement of Cash flows
Income Statement
•Results of operations for a business
•Shows revenues minus expenses
Rob Co
Income Statement
For period ending
12/31/04
Revenues
Sales
$75,000
Expense
Salaries exp
$25,000
Rent exp
$10,000
Total exp
Net income
35,000
$40,000
Statement of Retained Earnings
Changes in net worth and equity
Rob Co
Statement of Retained Earnings
For period ending 12/31/04
Beginning Retained Earnings
+Net income
-Dividends
Ending Retained Earnings
$60,000
40,000
100,000
20,000
$80,000
Balance sheet
Rob Co
Balance Sheet
December 3, 2004
Assets
Cash
Truck
$45,000
75,000
Total Assets
$120,000
Liabilities
Accts pay
$10,000
Total liab.
$10,000
Stockholder’s Equity
Common Stock
$30,000
Retained Earnings
$80,000
Total S.E.
$110,000
Total S.E. & Liabilities
$120,000
Statement of Cash Flows

Inflows and outflow of cash from
– Operations
– Investments
– Financing
Accounting Cycle
Record entries in the journal
 Post to ledger
 Prepare unadjusted Trial Balance
 Record and post adjusting entries
 Prepare adjusted trial balance
 Prepare financial statements

 Record
and post closing entries
Closing Entries

Temporary accounts
– Accumulate data related to one accounting
period
•
•
•
•
Revenue
Expense
Dividends
Income summary
Close revenues

Revenues
– Income summary

DR
Cr
Debit whatever revenue accounts you
have on the trial balance for their ending
balance and the total is credited to
income summary
Close Expenses
Income summary

Expenses


DR
CR
Credit each expense account separately
for the amount of the balance in the
account and debit income summary for
the total
Close Income Summary
Income Summary DR

Retained earnings

CR
For the balance in the income summary account
Income Summary
Debit
Total expenses
Credit
Total revenues
Net income
Close Dividends
Dividends reduce the equity of the
business and the amount retained in the
business
 Retained earnings DR

Dividends
CR
 For the amount of the balance in the
dividend account

Transactions
Fees earned
$50,000
 Rent expense
10,000
 Supplies expense
5,000
 Dividends
2,000
 Retained earnings $30,000
 Record the closing entries

Close revenues
Fees earned 50,000

Income summary

50,000
Close Expenses
Income Summary $15,000
 Rent expense
 Supplies expense

$10,000
5,000
Close Income Summary
Income Summary $35,000

Retained earnings
$35,000

Income Summary
DR
Expenses
$15,000
CR
$50,000
Revenues
$35,000 net income
Close Dividends
Retained earnings $2,000

Dividends
$2,000

Retained Earnings
DR
$2,000
Dividends
CR
$30,000 Balance
$35,000 net income
$63,000 ending balance
Classification of Accounts

Current assets
– Expected to be
collected in less than
one year
– Cash
– Accounts receivable
– Supplies
– Inventory

Plant Asset
– Long lived tangible
assets
– Factory building
– Machinery and
equipment