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 insurance1600

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 CoIncome StatementFor period ending 12/31/04

Revenues

Sales $75,000

Expense

Salaries exp $25,000

Rent exp $10,000

Total exp 35,000

Net income $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 $60,000+Net income 40,000 100,000-Dividends 20,000Ending Retained Earnings $80,000

Balance sheetRob Co

Balance SheetDecember 3, 2004

Assets

Cash $45,000

Truck 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 statementsRecord and post closing entries

Closing Entries

Temporary accounts– Accumulate data related to one accounting

period• Revenue• Expense• Dividends• Income summary

Close revenues

Revenues DR– Income summary 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 DR Expenses 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

Income Summary

Debit Credit

Total expenses Total revenues

Net income

For the balance in the income summary account

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 $10,000 Supplies expense 5,000

Close Income Summary

Income Summary $35,000 Retained earnings $35,000

Income Summary

DR CR

$15,000 $50,000

$35,000 net income

RevenuesExpenses

Close Dividends

Retained earnings $2,000 Dividends $2,000

Retained Earnings

DR

$2,000Dividends

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