ch03.pdf
- 1. Chapter 3-1
- 2. Chapter 3-2 Adjusting the Accounts Accounting Principles, Ninth Edition Chapter three
- 3. Chapter 3-3 1. Explain the time period assumption. 2. Explain the accrual basis of accounting. 3. Explain the reasons for adjusting entries. 4. Identify the major types of adjusting entries. 5. Prepare adjusting entries for deferrals. 6. Prepare adjusting entries for accruals. 7. Describe the nature and purpose of an adjusted trial balance. Study Objectives
- 4. Chapter 3-4 • Types of adjusting entries • Adjusting entries for deferrals • Adjusting entries for accruals • Summary of journalizing and posting Timing Issues • Fiscal and calendar years • Accrual- vs. cash- basis accounting • Recognizing revenues and expenses • Preparing the adjusted trial balance • Preparing financial statements The Basics of Adjusting Entries The Adjusted Trial Balance and Financial Statements Adjusting the Accounts
- 5. Chapter 3-5 • Generally a month, a quarter, or a year. • Fiscal year vs. calendar year • Also known as the “Periodicity Assumption” Timing Issues Accountants divide the economic life of a business into artificial time periods (Time Period Assumption). SO 1 Explain the time period assumption. Jan. Feb. Mar. Apr. Dec. . . . . .
- 6. Chapter 3-6 The time period assumption states that: a. revenue should be recognized in the accounting period in which it is earned. b. expenses should be matched with revenues. c. the economic life of a business can be divided into artificial time periods. d. the fiscal year should correspond with the calendar year. Review Timing Issues SO 1 Explain the time period assumption.
- 7. Chapter 3-7 Accrual-Basis Accounting • Transactions recorded in the periods in which the events occur • Revenues are recognized when earned, rather than when cash is received. • Expenses are recognized when incurred, rather than when paid. Timing Issues Accrual- vs. Cash-Basis Accounting SO 2 Explain the accrual basis of accounting.
- 8. Chapter 3-8 Cash-Basis Accounting • Revenues are recognized when cash is received. • Expenses are recognized when cash is paid. • Cash-basis accounting is not in accordance with generally accepted accounting principles (GAAP). Timing Issues Accrual- vs. Cash-Basis Accounting SO 2 Explain the accrual basis of accounting.
- 9. Chapter 3-9 Revenue Recognition Principle Timing Issues Recognizing Revenues and Expenses SO 2 Explain the accrual basis of accounting. Companies recognize revenue in the accounting period in which it is earned. In a service enterprise, revenue is considered to be earned at the time the service is performed.
- 10. Chapter 3-10 Matching Principle Timing Issues Recognizing Revenues and Expenses SO 2 Explain the accrual basis of accounting. Match expenses with revenues in the period when the company makes efforts to generate those revenues. “Let the expenses follow the revenues.”
- 11. Chapter 3-11 Timing Issues SO 2 Explain the accrual basis of accounting. GAAP relationships in revenue and expense recognition Illustration 3-1
- 12. Chapter 3-12 SO 2 Explain the accrual basis of accounting.
- 13. Chapter 3-13 One of the following statements about the accrual basis of accounting isfalse . That statement is: a. Events that change a company’s financial statements are recorded in the periods in which the events occur. b. Revenue is recognized in the period in which it is earned. c. The accrual basis of accounting is in accord with generally accepted accounting principles. d. Revenue is recorded only when cash is received, and expenses are recorded only when cash is paid. Review Timing Issues SO 2 Explain the accrual basis of accounting.
- 14. Chapter 3-14 • Adjusting entries make it possible to report correct amounts on the balance sheet and on the income statement. • A company must make adjusting entries every time it prepares financial statements. The Basics of Adjusting Entries SO 3 Explain the reasons for adjusting entries.
- 15. Chapter 3-15 • Revenues - recorded in the period in which they are earned. • Expenses - recognized in the period in which they are incurred. • Adjusting entries - needed to ensure that the revenue recognition and matching principles are followed. The Basics of Adjusting Entries SO 3 Explain the reasons for adjusting entries.
- 16. Chapter 3-16 Adjusting entries are made to ensure that: a. expenses are recognized in the period in which they are incurred. b. revenues are recorded in the period in which they are earned. c. balance sheet and income statement accounts have correct balances at the end of an accounting period. d. all of the above. Review Timing Issues SO 3 Explain the reasons for adjusting entries.
- 17. Chapter 3-17 Types of Adjusting Entries 1. Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed. Deferrals 3. Accrued Revenues. Revenues earned but not yet received in cash or recorded. 4. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded. 2. Unearned Revenues. Revenues received in cash and recorded as liabilities before they are earned. Accruals SO 4 Identify the major types of adjusting entries. Illustration 4-2 Categories of adjusting entries
- 18. Chapter 3-18 Trial Balance – Each account is analyzed to determine whether it is complete and up-to-date. Illustration 3-3 Trial Balance SO 4 Identify the major types of adjusting entries.
- 19. Chapter 3-19 Deferrals are either: • Prepaid expenses OR • Unearned revenues. Adjusting Entries for Deferrals SO 5 Prepare adjusting entries for deferrals.
- 20. Chapter 3-20 Payment of cash that is recorded as an asset because service or benefit will be received in the future. Adjusting Entries for “Prepaid Expenses” • insurance • supplies • advertising Cash Payment Expense Recorded BEFORE SO 5 Prepare adjusting entries for deferrals. • rent • maintenance on equipment • fixed assets (depreciation) Prepayments often occur in regard to:
- 21. Chapter 3-21 Prepaid Expenses • Costs that expire either with the passage of time or through use. • Adjusting entries (1) to record the expenses that apply to the current accounting period, and (2) to show the unexpired costs in the asset accounts. Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.
- 22. Chapter 3-22 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals. Adjusting entries for prepaid expenses • Increases (debits) an expense account and • Decreases (credits) an asset account. Illustration 3-4
- 23. Chapter 3-23 Illustration: Pioneer Advertising Agency purchased advertising supplies costing $2,500 on October 5. Sierra recorded the payment by increasing (debiting) the asset Advertising Supplies. This account shows a balance of $2,500 in the October 31 trial balance. An inventory count at the close of business on October 31 reveals that $1,000 of supplies are still on hand. Advertising supplies 1,500 Advertising supplies expense 1,500 Oct. 31 Illustration 3-5 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.
- 24. Chapter 3-24 Illustration: On October 4, Pioneer Advertising Agency paid $600 for a one-year fire insurance policy. Coverage began on October 1. Pioneer recorded the payment by increasing (debiting) Prepaid Insurance. This account shows a balance of $600 in the October 31 trial balance. Insurance of $50 ($600 / 12) expires each month. Prepaid insurance 50 Insurance expense 50 Oct. 31 Illustration 3-6 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.
- 25. Chapter 3-25 Depreciation • Buildings, equipment, and vehicles (long-lived assets) are recorded as assets, rather than an expense, in the year acquired. • Companies report a portion of the cost of a long- lived asset as an expense (depreciation) during each period of the asset’s useful life (Matching Principle). Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.
- 26. Chapter 3-26 Illustration: Pioneer Advertising estimates depreciation on the office equipment to be $480 a year, or $40 per month. Accumulated depreciation 40 Depreciation expense 40 Oct. 31 Illustration 3-7 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.
- 27. Chapter 3-27 Depreciation (Statement Presentation) • Accumulated Depreciation is a contra asset account. • Appears just after the account it offsets (Equipment) on the balance sheet. Illustration 3-8 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.
- 28. Chapter 3-28 Summary Illustration 3-9 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.
- 29. Chapter 3-29 Receipt of cash that is recorded as a liability because the revenue has not been earned. Adjusting Entries for “Unearned Revenues” • rent • airline tickets • school tuition Cash Receipt Revenue Recorded BEFORE • magazine subscriptions • customer deposits Unearned revenues often occur in regard to: SO 5 Prepare adjusting entries for deferrals.
- 30. Chapter 3-30 Unearned Revenues • Company makes an adjusting entry to record the revenue that has been earned and to show the liability that remains. • The adjusting entry for unearned revenues results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account. SO 5 Prepare adjusting entries for deferrals. Adjusting Entries for “Unearned Revenues”
- 31. Chapter 3-31 SO 5 Prepare adjusting entries for deferrals. Adjusting entries for unearned revenues • Decrease (a debit) to a liability account and • Increase (a credit) to a revenue account. Adjusting Entries for “Unearned Revenues” Illustration 3-10
- 32. Chapter 3-32 Adjusting Entries for “Unearned Revenues” Illustration: Pioneer Advertising Agency received $1,200 on October 2 from R. Knox for advertising services expected to be completed by December 31. Unearned Service Revenue shows a balance of $1,200 in the October 31 trial balance. Analysis reveals that the company earned $400 of those fees in October. Service revenue 400 Unearned service revenue 400 Oct. 31 Illustration 3-11 SO 5 Prepare adjusting entries for deferrals.
- 33. Chapter 3-33 Summary Adjusting Entries for “Unearned Revenues” Illustration 3-12 SO 5 Prepare adjusting entries for deferrals.
- 34. Chapter 3-34 SO 5 Prepare adjusting entries for deferrals.
- 35. Chapter 3-35 Made to record: • Revenues earned and OR • Expenses incurred in the current accounting period that have not been recognized through daily entries. Adjusting Entries for Accruals SO 6 Prepare adjusting entries for accruals.
- 36. Chapter 3-36 Revenues earned but not yet received in cash or recorded. Adjusting Entries for “Accrued Revenues” • rent • interest • services performed BEFORE Accrued revenues often occur in regard to: Cash Receipt Revenue Recorded Adjusting entry results in: SO 6 Prepare adjusting entries for accruals.
- 37. Chapter 3-37 Accrued Revenues An adjusting entry serves two purposes: (1) It shows the receivable that exists, and (2) It records the revenues earned. Adjusting Entries for “Accrued Revenues” SO 6 Prepare adjusting entries for accruals.
- 38. Chapter 3-38 Adjusting entries for accrued revenues • Increases (debits) an asset account and • Increases (credits) a revenue account. SO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Revenues” Illustration 3-13
- 39. Chapter 3-39 Illustration: In October Pioneer Advertising Agency earned $200 for advertising services that had not been recorded. Service Revenue 200 Accounts Receivable 200 Oct. 31 Illustration 3-14 SO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Revenues”
- 40. Chapter 3-40 Summary Illustration 3-15 Adjusting Entries for “Accrued Revenues” SO 6 Prepare adjusting entries for accruals.
- 41. Chapter 3-41 Expenses incurred but not yet paid in cash or recorded. Adjusting Entries for “Accrued Expenses” • rent • interest BEFORE Accrued expenses often occur in regard to: Cash Payment Expense Recorded • taxes • salaries Adjusting entry results in: SO 6 Prepare adjusting entries for accruals.
- 42. Chapter 3-42 Accrued Expenses An adjusting entry serves two purposes: (1) It records the obligations, and (2) It recognizes the expenses. Adjusting Entries for “Accrued Expenses” SO 6 Prepare adjusting entries for accruals.
- 43. Chapter 3-43 Adjusting entries for accrued expenses • Increases (debits) an expense account and • Increases (credits) a liability account. SO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Expenses” Illustration 3-16
- 44. Chapter 3-44 SO 6 Prepare adjusting entries for accruals. Illustration: Pioneer Advertising Agency signed a three-month note payable in the amount of $5,000 on October 1. The note requires Pioneer to pay interest at an annual rate of 12%. Interest payable 50 Interest expense 50 Oct. 31 Illustration 3-18 Illustration 3-17 Adjusting Entries for “Accrued Expenses”
- 45. Chapter 3-45 SO 6 Prepare adjusting entries for accruals. Illustration: Pioneer Advertising Agency last paid salaries on October 26; the next payment of salaries will not occur until November 9. The employees receive total salaries of $2,000 for a five-day work week, or $400 per day. Thus, accrued salaries at October 31 are $1,200 ($400 x 3 days). Salaries payable 1,200 Salaries expense 1,200 Oct. 31 Illustration 3-20 Adjusting Entries for “Accrued Expenses”
- 46. Chapter 3-46 Summary Illustration 3-21 SO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Expenses”
- 47. Chapter 3-47 After all adjusting entries are journalized and posted the company prepares another trial balance from the ledger accounts (Adjusted Trial Balance). Its purpose is to prove the equality of debit balances and credit balances in the ledger. The Adjusted Trial Balance SO 7 Describe the nature and purpose of an adjusted trial balance.
- 48. Chapter 3-48 The Adjusted Trial Balance
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