PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 3

ADJUSTING ACCOUNTS AND PREPARING FINANCIAL

STATEMENTS

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THE ACCOUNTING PERIODC 1

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Accounting

ACCRUAL BASIS VERSUS CASH BASIS

Accrual Basis

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

Cash Basis

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

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Cash Basis

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

Accounting

ACCRUAL BASIS VERSUS CASH BASIS

Non-GAAPNon-GAAPNon-GAAPNon-GAAP

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Accrual Basis

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

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ACCRUAL BASIS VERSUS CASH BASIS

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.

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.

Jan Feb Mar Apr

-$ -$ -$ -$ May Jun Jul Aug

-$ -$ -$ -$ Sep Oct Nov Dec

-$ -$ -$ 2,400$

Insurance Expense 2009

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ACCRUAL BASIS VERSUS CASH BASIS

Jan Feb Mar Apr

-$ -$ -$ -$ May Jun Jul Aug

-$ -$ -$ -$ Sep Oct Nov Dec

-$ -$ -$ 100$

Jan Feb Mar Apr

100$ 100$ 100$ 100$ May Jun Jul Aug

100$ 100$ 100$ 100$ Sep Oct Nov Dec

100$ 100$ 100$ 100$

Jan Feb Mar Apr

100$ 100$ 100$ 100$ May Jun Jul Aug

100$ 100$ 100$ 100$ Sep Oct Nov Dec

100$ 100$ 100$ -$

Insurance Expense 2009

Insurance Expense 2010

Insurance Expense 2011

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.

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.

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We have delivered theproduct to our customer,

so I think we should recordthe revenue earned.

We have delivered theproduct to our customer,

so I think we should recordthe revenue earned.

RECOGNIZING REVENUES & EXPENSES

Revenue Recognition Principle

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RECOGNIZING REVENUES & EXPENSES

Revenue Recognition PrincipleMatching Principle

Summaryof Expenses

Rent

Gasoline

Advertising

Salaries

Utilities

and . . . .

$1,000

500

2,000

3,000

450

. . . .

Now that we haverecognized the revenue,let’s see what expenses

we incurred togenerate that revenue.

Now that we haverecognized the revenue,let’s see what expenses

we incurred togenerate that revenue.

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

ADJUSTING ACCOUNTS

Prepaid (Deferred) expenses*

Prepaid (Deferred) expenses*

Unearned (Deferred) revenues

Unearned (Deferred) revenues

AccruedexpenseAccruedexpense

AccruedrevenuesAccruedrevenues

Framework for Adjustments

*including depreciation

Paid (or received) cash before expense (or revenue) recognizedPaid (or received) cash before

expense (or revenue) recognizedPaid (or received) cash after

expense (or revenue) recognizedPaid (or received) cash after

expense (or revenue) recognized

AdjustmentsAdjustments

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Here is the checkfor my 24-monthinsurance policy.

Here is the checkfor my 24-monthinsurance policy.

PREPAID (DEFERRED) EXPENSES

Resources paid for prior to

receiving the actual benefits.

Resources paid for prior to

receiving the actual benefits.

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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?

(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 100 Prepaid Insurance 100

To record first month's expired insurance

Dec. 1 2,400 Dec. 31 100Bal. 2,300

Prepaid Insurance 637Dec. 31 100

Insurance Expense 128

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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 1,050 Supplies 1,050

To record supplies used during 2011

Bought 9,720 Dec. 31 1,050Bal. 8,670

Supplies 126Dec. 31 1,050

Supplies Expense 652

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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.

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.

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Straight-LineDepreciationExpense

= Asset Cost - Salvage Value

Useful Life

DEPRECIATION

Depreciation is the process of allocating the cost of a plant asset over its useful life in a

systematic and rational manner.

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END OF CHAPTER 3