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., CA
Copyright © 2015 by McGraw-Hill Education (Asia). All rights reserved
3-2
C1
THE ACCOUNTING PERIOD
3-3
C2
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
C2
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
C2
ACCRUAL BASIS VERSUS CASH BASIS
Example:
FastForward paid $2,400 for a 24-month insurance
policy beginning December 1, 2011.
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 2015. No
insurance expense from this policy would be recognized
in 2016 or 2017, periods covered by the policy.
3-6
C2
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
2015, $1,200 in 2016,
and $1,100 in 2017. The
expense is matched with
the periods benefited by
the insurance coverage.
3-7
C2
RECOGNIZING REVENUES & EXPENSES
Revenue Recognition Principle
We have delivered the
product to our customer,
so I think we should record
the revenue earned.
3-8
C2
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 revenue,
let’s see what expenses
we incurred to
generate that revenue.
3-9
C3
ADJUSTING ACCOUNTS
An adjusting entry is recorded to bring an asset or
liability account balance to its proper amount.
Framework for Adjustments
Adjustments
Paid (or received) cash before
expense (or revenue) recognized
Prepaid
(Deferred)
expenses*
*including depreciation
Unearned
(Deferred)
revenues
Paid (or received) cash after
expense (or revenue) recognized
Accrued
expense
Accrued
revenues
3 - 10
P1
PREPAID (DEFERRED) EXPENSES
Resources paid
for prior to
receiving the
actual benefits.
Here is the check
for my 24-month
insurance policy.
3 - 11
P1
PREPAID INSURANCE
(a) On 12/1/15, FastForward paid $2,400 for insurance for
2-years (24-months, December 2015 through November
2017). FastForward recorded the expenditure as Prepaid
Insurance on 12/31/15.
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
P1
SUPPLIES
(b) During 2015, FastForward purchased $9,720 of supplies.
FastForward recorded the expenditures in the asset account,
“Supplies.” On December 31, 2015, 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
P1
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
P1
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
P1
DEPRECIATION
On December 1, 2015, 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, 2015.
Dec. 2015
$26,000 - $8,000
Depreciation =
=
Expense
48 months
$375 per month
3 - 16
P1
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
P1
DEPRECIATION
FastForward
Partial Statement of Financial Position
At December 31, 2015
Equipment is
shown net of
accumulated
depreciation.
Assets
Cash
.
Equipment
Accumulated depreciation
.
.
Total Assets
$
$ 26,000
(375)
25,625
3 - 18
P1
UNEARNED (DEFERRED)
REVENUES
Cash received in
advance of providing
products or services.
We will apply this cash
you gave us towards
your total consulting fees.
3 - 19
P1
UNEARNED (DEFERRED)
REVENUES
On December 26, 2015, 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
P1
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
P1
ACCRUED EXPENSES
Costs incurred in
a period that are
both unpaid and
unrecorded.
We’re about one-half
done with this job and
want to be paid for
our work!
3 - 22
P1
ACCRUED SALARIES EXPENSES
FastForward’s employee earns $70 per day and is paid
every two weeks on Friday. Year-end, 12/31/15, falls on a
Wednesday. The last payday of 2015, is Friday, 12/26/15.
From 12/26 until year-end is three working days. The
employee has earned salaries of $210 for Monday through
Wednesday. They will not be paid until the next Friday.
3 - 23
P1
ACCRUED SALARIES EXPENSES
(e) FastForward’s employee has earned but not been paid
on December 31, 2015, $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
P1
On January 9, 2016, FastForward will pay the payroll for
the two weeks from December 26, 2015 through January
9, 2016. 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 two- week salary
210
490
700
3 - 25
P1
ACCRUED INTEREST EXPENSES
FastForward borrowed $6,000 from First National Bank on
December 1, 2015. The note bears interest at the annual
rate of 6% and is due to be repaid in one year. Let’s
accrue interest for the month ended 12/31/15.
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
3 - 26
P1
ACCRUED REVENUES
Revenues earned
in a period that
are both
unrecorded and not
yet received.
Yes, I’ve completed your
consulting job, but have not
had time to bill you yet.
3 - 27
P1
ACCRUED SERVICE REVENUE
(f) On December 12, 2015, FastForward agrees to
render consulting services under a 30-day fixed fee
contract for $2,700 ($90 per day). All services are to be
completed by January 10, 2016, when the client will pay
in full.
Dec. 31 Accounts Receivable
1,800
Consulting Revenue
1,800
To accrue revenue (20-days @ $90 per day)
Accounts Receivable
Other receivables
1,900 Receipts
Dec. 31
1,800
Bal.
1,800
1,900
Consulting Revenue
Other revenues
6,050
Dec. 31
1,800
Bal .
7,850
3 - 28
FUTURE RECEIPT OF
SERVICE REVENUES
P1
On January 10, 2016, FastForward completed its
obligation under the consulting contract. The client was
billed $2,700 and FastForward received $2,700 in cash.
Jan 10
Cash
2,700
Accounts Receivable
Consulting Revenue
T o record com p letion of con tract an d cash collection
Revenue in January
10 days @ $90 = $900
1,800
900
3 - 29
A1
LINKS TO FINANCIAL STATEMENTS
3 - 30
P2
FastForward - Trial Balance - December 31, 2015
Unadjusted
Trial Balance
Adjustments
Adjusted
Trial Balance
First, the
initial
unadjusted
amounts are
added to the
worksheet.
3 - 31
P 2
FastForward - Trial Balance - December 31, 2015
Unadjusted
Trial Balance
Adjustments
Adjusted
Trial Balance
Next,
FastForward’s
adjustments
are added.
3 - 32
P 2
FastForward – Adjusted Trial Balance - December 31, 2015
Unadjusted
Trial Balance
Adjustments
Adjusted
Trial Balance
Finally, the
totals are
determined.
3 - 33
P 3
PREPARING FINANCIAL STATEMENTS
Let’s use FastForward’s adjusted trial balance to
prepare the company’s financial statements.
3 - 34
P 3
1. PREPARE THE INCOME STATEMENT
Adjusted
Trial Balance
December 31, 2015
Dr.
Cr.
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accum. depr. - Equip.
Accounts payable
Salaries payable
Unearned revenue
C. Taylor, Capital
C. Taylor, Withdrawals
Consulting revenue
Rental revenue
Depr. expense
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
Totals
$
4,350
1,800
8,670
2,300
26,000
$
375
6,200
210
2,750
30,000
200
7,850
300
$
375
1,610
100
1,000
1,050
230
47,685
$
47,685
FastForward
Income Statement
For the Month Ended December 31, 2015
Revenues:
Consulting revenue
$ 7,850
Rental revenue
300
Operating expenses:
Depr. expense - Equip. $ (375)
Salaries expense
(1,610)
Insurance expense
(100)
Rent expense
(1,000)
Supplies expense
(1,050)
Utilities expense
(230)
Total expenses
(4,365)
Net profit
$ 3,785
3 - 35
P 3
2. PREPARE THE STATEMENT
OF CHANGES IN EQUITY
FastForward
Income Statement
For the Month Ended December 31, 2015
Revenues:
Consulting revenue
$
7,850
Rental revenue
300
Operating expenses:
Depr. expense - Equip. $ (375)
Salaries expense
(1,610)
Insurance expense
(100)
Rent expense
(1,000)
Supplies expense
(1,050)
Utilities expense
(230)
Total expenses
(4,365)
Net profit
$
3,785
Note: Net profit from the Income
Statement carries to the Statement of
Changes in Equity.
FastForward
Statement of Changes in Equity
For the Month Ended December 31, 2015
C. Taylor, Capital 12/1/15
Investment by owner
Net profit
Total
Withdrawal by owner
C. Taylor, Capital 12/31/15
$
$
30,000
3,785
-0-
33,785
33,785
(200)
$ 33,585
3 - 36
P 3
3. PREPARE THE STATEMENT OF FINANCIAL
POSITION
FastForward
Statement of Changes in Equity
For the Month Ended December 31, 2015
FastForward
Statement of Financial Position
12/31/15
Assets
Cash
Accounts Receivable
Supplies
Prepaid Insurance
Equipment
$
$
Accumulated Depreciation
26,000
(375)
Total assets
$
4,350
1,800
8,670
2,300
6,200
210
2,750
9,160
Equity
C Taylor, Capital
Total liabilities and Equity
$
$
$
33,585
42,745
30,000
3,785
-0-
33,785
33,785
(200)
$ 33,585
Adjusted
Trial Balance
December 31, 2015
Dr.
Cr.
25,625
42,745
Liabilities
Accounts Payable
Salaries Payable
Unearned Revenue
Total Liabilities
C. Taylor, Capital 12/1/15
Investment by owner
Net profit
Total
Withdrawal by owner
C. Taylor, Capital 12/31/15
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accum. depr. - Equip.
Accounts payable
Salaries payable
Unearned revenue
C. Taylor, Capital
C. Taylor, Withdrawals
$
4,350
1,800
8,670
2,300
26,000
$
200
375
6,200
210
2,750
30,000
3 - 37
A2
PROFIT MARGIN
The profit margin ratio measures the company’s
net profit to net sales.
Profit
=
Margin
Net Profit
Net Sales
Adidas
3 - 38
P4
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.
3 - 39
END OF CHAPTER 3