humanities and international exchange faculty shanghai second polytechnic university lesson 3...

Humanities and International Exchange Faculty Shanghai Second Polytechnic University

Lesson 3Lesson 3Adjusting Accounts for Adjusting Accounts for

Financial StatementFinancial Statement

22Humanities and International Exchange Faculty Shanghai Second Polytechnic University

OutlineOutline

Describe the purpose of adjusting accounts at Describe the purpose of adjusting accounts at the end of the period.the end of the period.

Prepare and explain adjusting entries for Prepare and explain adjusting entries for prepaid expenses, amortization, unearned prepaid expenses, amortization, unearned revenues, accrued expenses, and accrued revenues, accrued expenses, and accrued revenues.revenues.

Explain how accounting adjustments link to Explain how accounting adjustments link to financial statements.financial statements.

Explain and prepare an adjusted trial balance.Explain and prepare an adjusted trial balance.


Definition: the continued life of a business is Definition: the continued life of a business is divided into time periods of equal length.divided into time periods of equal length.

Review: Time period conceptReview: Time period concept

This year incomeThis year incomestatementstatement

Next year incomeNext year incomestatementstatement

Last year income Last year income statementstatement

Past Past period period

Current Current periodperiod

Future Future periodperiod

Dec. 31, B/S dateDec. 31, B/S dateDec. 31, B/S dateDec. 31, B/S date

going concerngoing concern

(business will not stop)(business will not stop)


Review: Revenue Recognition PrincipleReview: Revenue Recognition Principle

Revenue is recorded at the time it is eaRevenue is recorded at the time it is earned regardless of whether cash or anorned regardless of whether cash or another asset has been exchanged.ther asset has been exchanged.


Review: Matching PrincipleReview: Matching Principle

Expenses are to be matched in the same accExpenses are to be matched in the same accounting period as the revenues they helped tounting period as the revenues they helped to earn.o earn.


Accrual and cash basisAccrual and cash basis

The accrual basis of accounting matches The accrual basis of accounting matches revenues earned with expenses incurred.revenues earned with expenses incurred.

The cash basis matches revenues received The cash basis matches revenues received with expenses paid. It is not satisfactory for with expenses paid. It is not satisfactory for most businesses because it results in most businesses because it results in financial statements that are not financial statements that are not comparable from period to period, except comparable from period to period, except when the amounts of prepaid, unearned, when the amounts of prepaid, unearned, and accrued items are not material.and accrued items are not material.


Adjust: A Step in Accounting cycleAdjust: A Step in Accounting cycle

1. Analyze Transactions1. Analyze Transactions

2. Journalize2. Journalize

3. Post 3. Post

4. 4. Unadjusted trial balanceUnadjusted trial balance

5. Adjust 5. Adjust

6. Adjusted trial balance6. Adjusted trial balance

7. Prepare finance statements7. Prepare finance statements

8.Close 8.Close

Now that we havecovered the trial

balance, let’sdiscuss adjusting

entries.


Why Need to AdjustWhy Need to Adjust

Some events are not evidenced by the obvious Some events are not evidenced by the obvious documents. the effects of these events are recorded documents. the effects of these events are recorded at the end of the accounting period by means of at the end of the accounting period by means of adjusting entries.adjusting entries.

The purpose of adjusting the accounts at the end The purpose of adjusting the accounts at the end of period is to make the accounting information of period is to make the accounting information comparable from period to period.comparable from period to period.


Why Need to AdjustWhy Need to Adjust

Adjustments are based on three generally aAdjustments are based on three generally accepted accounting principles:ccepted accounting principles: Time period principle.Time period principle. Revenue recognition principle.Revenue recognition principle. Matching principle.Matching principle.


Type of Adjusting EntriesType of Adjusting Entries

AdjustingAdjustingentriesentries

AdjustingAdjustingentriesentries

Accruing unrecordedAccruing unrecorded revenuesrevenues

Accruing unrecordedAccruing unrecorded revenuesrevenues

Converting liabilities toConverting liabilities to revenuesrevenues

Converting liabilities toConverting liabilities to revenuesrevenues

Accruing unrecordedAccruing unrecordedexpensesexpenses

Accruing unrecordedAccruing unrecordedexpensesexpenses

Converting assets toConverting assets to expensesexpenses

Converting assets toConverting assets to expensesexpenses


Adjusting Entries – AccrualsAdjusting Entries – Accruals

Accruals occur when revenues have been Accruals occur when revenues have been earned or expenses incurred but earned or expenses incurred but no cashno cash has has been exchanged.been exchanged.

End of End of accounting period.accounting period.

Cash receivedCash receivedRevenues earnedRevenues earned

Example: interest revenue earned during the Example: interest revenue earned during the period but not received until the next period.period but not received until the next period.Example: interest revenue earned during the Example: interest revenue earned during the period but not received until the next period.period but not received until the next period.


Adjusting Entries – AccrualsAdjusting Entries – Accruals

Example:Example: On Jun 1, 2004, Smith Inc. invests On Jun 1, 2004, Smith Inc. invests $100,000 for a bonds which pays 5% interest $100,000 for a bonds which pays 5% interest per per yearyear.. Smith Inc. will not receive the interest until Smith Inc. will not receive the interest until March 31, 2005. March 31, 2005. On December 31, 2004, Smith, On December 31, 2004, Smith, Inc. need to make the following entry for the Inc. need to make the following entry for the interest earned so far.interest earned so far.


Adjusting Entries – AccruedAdjusting Entries – Accrued

Unrecorded expenses incurredUnrecorded expenses incurred

End of End of accounting periodaccounting period..

Cash paidCash paidExpense incurredExpense incurred

Example: wages should be paid to employees during this Example: wages should be paid to employees during this period but not paid until the next period.period but not paid until the next period.

Example: wages should be paid to employees during this Example: wages should be paid to employees during this period but not paid until the next period.period but not paid until the next period.


Adjusting Entries – AccruedAdjusting Entries – Accrued

Example: On the year-end, Dec. 31, 2004, Smith Inc.’s Example: On the year-end, Dec. 31, 2004, Smith Inc.’s employees have earned total wages of $35,000 for the employees have earned total wages of $35,000 for the Monday, but Smith Inc. will not pay the wages until 5Monday, but Smith Inc. will not pay the wages until 5thth of of next month. So at the end of the accounting period, Smith next month. So at the end of the accounting period, Smith need to make the following entries to accrued the wage need to make the following entries to accrued the wage expenses.expenses.


Adjusting Entries – DeferralsAdjusting Entries – Deferrals

Prepaid expense is used upPrepaid expense is used up

Paid cash forPaid cash for12 month’s rent12 month’s rent

< from July 2004 to June 2005 >< from July 2004 to June 2005 >

7/1/047/1/04 12/31/0412/31/04Year endYear end

6/30/056/30/05



ExampleExample: On July 1, 2004, Smith Inc. paid $20000 for w: On July 1, 2004, Smith Inc. paid $20000 for whole year’s rent covered from 1hole year’s rent covered from 1ststof July to 30of July to 30thth of June. of June. At the end of 2004, $10000 of rent expenses have occurrAt the end of 2004, $10000 of rent expenses have occurred so Smith Inc. need to make the following entries to tred so Smith Inc. need to make the following entries to transfer the deferrals to expenses.ansfer the deferrals to expenses.



End of End of accounting period.accounting period.

Cash receivedCash received Revenues earnedRevenues earned

Example: service revenue received in advance.Example: service revenue received in advance.

Converting liabilities to revenues:Converting liabilities to revenues:



Example: Example: On Oct. 1, 2004, Smith Inc. signed a contract for On Oct. 1, 2004, Smith Inc. signed a contract for providing a special service to Cone. Smith received $50000 for providing a special service to Cone. Smith received $50000 for the service to be provided. At the end of 2004 half of the the service to be provided. At the end of 2004 half of the services have been proved to Cone. Smith should make the services have been proved to Cone. Smith should make the following following entries to record earned revenue.entries to record earned revenue.


Adjust: Allocating the Costs ofAdjust: Allocating the Costs of

long-term assetslong-term assets Certain circumstances require adjusting enCertain circumstances require adjusting en

tries to record accounting estimates. Amortitries to record accounting estimates. Amortization is an example. zation is an example.

Amortization is the process of allocating thAmortization is the process of allocating the costs of assets over their useful lives.e costs of assets over their useful lives.


AmortizationAmortization

Companies acquire capital assets such as equipment, Companies acquire capital assets such as equipment, buildings, vehicles, and patents to generate revenues.buildings, vehicles, and patents to generate revenues.

These assets are expected to provide benefits for more These assets are expected to provide benefits for more than one period.than one period.

The accounting concept of The accounting concept of amortizationamortization involves involves the the systematicsystematic and and rationalrational allocation of cost of a allocation of cost of a long-lived asset to the periods during which it is long-lived asset to the periods during which it is used to generate revenue.used to generate revenue.



On January 1,2004, a company purchased a piece of On January 1,2004, a company purchased a piece of equipment for $100,000. The equipment is expected to equipment for $100,000. The equipment is expected to have a useful life of five years and have a salvage value of have a useful life of five years and have a salvage value of $5000.Asume the company use the straight-line method.$5000.Asume the company use the straight-line method.

Asset Cost - Salvage Value Asset Cost - Salvage Value

Useful LifeUseful Life

Straight-LineStraight-LineAmortizationAmortizationExpenseExpense

==

== $100000 - $5,000 $100000 - $5,000

5 years5 years

= $19000/year= $19000/year



The required journal entry includes a debit The required journal entry includes a debit toto Amortization expenseAmortization expense and a credit to an and a credit to an account called account called accumulated amortizationaccumulated amortization..


Adjusted Trial BalanceAdjusted Trial Balance

The adjusted trial balance is used to check if there The adjusted trial balance is used to check if there are any mistakes in the adjusted accounts and it is are any mistakes in the adjusted accounts and it is used for the financial statement.used for the financial statement.

Assume that Smith Inc. has the following Assume that Smith Inc. has the following unadjusted trial balance:unadjusted trial balance:


Adjusted Trial BalanceAdjusted Trial Balance


Adjusted trial balanceAdjusted trial balance

Debi t Credi t Debi t Credi t Debi t Credi tCash 171000 171000

Short-term i nvestment 100000 100000Accounts Recei vabl e 36000 36000I nterest recei vabl e 2916. 67 2916. 67

Prepai d Expense 20000 10000 10000I nventory 20000 20000

Pl ant and Equi pmemt 250000 250000Accumul ated Depreci ati on 2600 2600Accounts Payabl e 50000 50000

Wages payabl e 35000 35000Unearned Revenue 50000 25000. 00 25000. 00

Pai d Capi tal 500000 500000Sal es Revenue 36000 25000 61000

I nterest Revenue 2916. 67 2916. 67Cost of Sal es 30000 30000

Operati ng expenses 9000 47600. 00 56600. 00total 636000 636000 75516. 67 75516. 67 676516. 67 676516. 67

for the year ended Dec.31Adj usti ng Entri es

SMI TH I nc.

Adj usted tri al bal anceAccounts

unadj usted tri al bal ance

Debi t Credi t Debi t Credi t Debi t Credi tCash 171000 171000

Short-term i nvestment 100000 100000Accounts Recei vabl e 36000 36000I nterest recei vabl e 2916. 67 2916. 67

Prepai d Expense 20000 10000 10000I nventory 20000 20000

Pl ant and Equi pmemt 250000 250000Accumul ated Depreci ati on 2600 2600Accounts Payabl e 50000 50000

Wages payabl e 35000 35000Unearned Revenue 50000 25000. 00 25000. 00

Pai d Capi tal 500000 500000Sal es Revenue 36000 25000 61000

I nterest Revenue 2916. 67 2916. 67Cost of Sal es 30000 30000

Operati ng expenses 9000 47600. 00 56600. 00total 636000 636000 75516. 67 75516. 67 676516. 67 676516. 67

for the year ended Dec.31Adj usti ng Entri es

SMI TH I nc.

Adj usted tri al bal anceAccounts

unadj usted tri al bal ance


Adjustments & Financial Adjustments & Financial StatementsStatements

Adjusting entries bring the accounts up-to-date.Adjusting entries bring the accounts up-to-date.Adjustments are only made when financial Adjustments are only made when financial

statements are prepared.statements are prepared.Adjust entries will affect both the income Adjust entries will affect both the income

statement and the balance sheet.statement and the balance sheet.Will not affect the cash flow of the company.Will not affect the cash flow of the company.

Humanities and International Exchange Faculty Shanghai Second Polytechnic University

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