Chap 7 Adjusting entries .ppt
- 1. ADJUSTING THE ACCOUNTS Liban Ali Abdinur (CPA UK) 1 Chapter 7
- 2. 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.
- 3. What are Adjusting Entries Adjusting entries are journal entries made at the end of an accounting cycle to update certain revenue and expense accounts and to make sure you comply with the matching principle. Adjusting entries are a very important part of the accounting cycle they ensure that you are reporting the company's financial situation accurately. In this lesson you will learn which accounts need adjusting and how those adjustments are made 3
- 4. Adjusting the Accounts Timing Issues The Basics of Adjusting Entries The Adjusted Trial Balance and Financial Statements Time period assumption Fiscal and calendar years Accrual- vs. cash-basis accounting Recognizing revenues and expenses Types of adjusting entries Adjusting entries for deferrals Adjusting entries for accruals Summary of journalizing and posting Preparing the adjusted trial balance Preparing financial statements
- 5. Review The accrual concept states that income is recognized when earned regardless of when collected and expense is recognized when incurred regardless of when paid. The matching principle aims to align expenses with revenues. Expenses should be recognized in the period when the revenues generated by such expenses are recognized 5
- 6. 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 LO 2 Explain the accrual basis of accounting.
- 7. 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 LO 2 Explain the accrual basis of accounting.
- 8. Revenue Recognition Principle Timing Issues Recognizing Revenues and Expenses LO 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.
- 9. Matching Principle Timing Issues Recognizing Revenues and Expenses LO 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.”
- 10. Timing Issues LO 2 Explain the accrual basis of accounting. GAAP relationships in revenue and expense recognition Illustration 3-1
- 11. One of the following statements about the accrual basis of accounting is false. 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 LO 2 Explain the accrual basis of accounting.
- 12. 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 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.
- 13. 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 LO 3 Explain the reasons for adjusting entries.
- 14. 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 LO 4 Identify the major types of adjusting entries. Types of Adjusting entries
- 15. Trial Balance – Each account is analyzed to determine whether it is complete and up-to-date. Phoenix Consulting - Jan. 31st (before adjusting entries) Acct. No. Account Debit Credit 100 Cash 50,000 $ 105 Accounts receivable 35,000 110 Prepaid insurance 12,000 120 Equipment 24,000 130 Investments 300,000 200 Accounts payable 20,000 $ 210 Unearned revenue 24,000 220 Note payable 200,000 300 Austin, capital 40,000 400 Sales 137,000 421,000 $ 421,000 $ LO 4 Identify the major types of adjusting entries. Trial Balance
- 16. Deferrals are either: Prepaid expenses: Prepaid expenses are future expenses that have been paid in advance Unearned revenues. unearned revenue(s) A liability account that reports amounts received in advance of providing goods or services LO 5 Prepare adjusting entries for deferrals. Adjusting Entries for deferrals In accounting this means to defer or to delay recognizing certain revenues or expenses on the income statement until a later, more appropriate time. Revenues are deferred to a balance sheet liability account until they are earned in a later period
- 17. Payment of cash, that is recorded as an asset because service or benefit will be received in the future. insurance supplies advertising Cash Payment Expense Recorded BEFORE LO 5 Prepare adjusting entries for deferrals. rent maintenance on equipment fixed assets (depreciation) Prepayments often occur in regard to: Adjusting Entries for Prepaid Expenses
- 18. Prepaid Expenses Costs that expire either with the passage of time or through use. Adjusting entries to record the expenses that apply to the current accounting period, and to show the unexpired costs in the asset accounts. LO 5 Prepare adjusting entries for deferrals. Adjusting Entries for Prepaid Expenses
- 19. LO 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 Adjusting Entries for Prepaid Expenses
- 20. Example (Insurance): On Jan. 1st, Phoenix Consulting paid $12,000 for 12 months of insurance coverage. Show the journal entry to record the payment on Jan. 1st. Cash 12,000 Prepaid Insurance 12,000 Jan. 1 Debit Credit Prepaid Insurance 12,000 12,000 Debit Credit Cash LO 5 Prepare adjusting entries for deferrals. Adjusting Entries for Prepaid Expenses
- 21. Example (Insurance): On Jan. 1st, Phoenix Consulting paid $12,000 for 12 months of insurance coverage. Show the adjusting journal entry required at Jan. 31st. Prepaid Insurance 1,000 Insurance Expense 1,000 Jan. 31 Debit Credit Prepaid Insurance 12,000 1,000 Debit Credit Insurance Expense 1,000 11,000 LO 5 Prepare adjusting entries for deferrals. Adjusting Entries for Prepaid Expenses
- 22. 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). LO 5 Prepare adjusting entries for deferrals. Adjusting Entries for Prepaid Expenses
- 23. (Depreciation): On Jan. 1st, Phoenix Consulting paid $24,000 for equipment that has an estimated useful life of 20 years. Show the journal entry to record the purchase of the equipment on Jan. 1st. Cash 24,000 Equipment 24,000 Jan. 1 Debit Credit Equipment 24,000 24,000 Debit Credit Cash LO 5 Prepare adjusting entries for deferrals. Example
- 24. (Depreciation): On Jan. 1st, Phoenix Consulting paid $24,000 for equipment that has an estimated useful life of 20 years. Show the adjusting journal entry required at Jan. 31st. ($24,000 / 20 yrs. / 12 months = $100) Accumulated Depreciation 100 Depreciation Expense 100 Jan. 31 Debit Credit Depreciation Expense 100 100 Debit Credit Accumulated Depreciation LO 5 Prepare adjusting entries for deferrals. Example
- 25. Depreciation (Statement Presentation) Accumulated Depreciation is a contra asset account. Appears just after the account it offsets (Equipment) on the balance sheet. LO 5 Prepare adjusting entries for deferrals. Balance Sheet Jan. 31 Assets Equipment 24,000 Accumulated Depreciation (100) Net Equipment 23,900
- 26. Receipt of cash that is recorded as a liability because the revenue has not been earned. rent airline tickets school tuition Cash Receipt Revenue Recorded BEFORE magazine subscriptions customer deposits Unearned revenues often occur in regard to: LO 5 Prepare adjusting entries for deferrals. Adjusting Entries for unearned revenue
- 27. 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. LO 5 Prepare adjusting entries for deferrals.
- 28. LO 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. Illustration 3-10
- 29. : On Jan. 1st, Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. Show the journal entry to record the receipt on Jan. 1st. Unearned Rent Revenue 24,000 Cash 24,000 Jan. 1 Debit Credit Cash 24,000 24,000 Debit Credit Unearned Rent Revenue LO 5 Prepare adjusting entries for deferrals. Example
- 30. : On Jan. 1st, Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. Show the adjusting journal entry required on Jan. 31st. Rent Revenue 8,000 Unearned Rent Revenue 8,000 Jan. 31 Debit Credit Rent Revenue 8,000 24,000 Debit Credit Unearned Rent Revenue 8,000 16,000 LO 5 Prepare adjusting entries for deferrals. Example
- 31. 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 LO 6 Prepare adjusting entries for accruals.
- 32. Revenues earned but not yet received in cash or recorded. rent interest services performed BEFORE Accrued revenues often occur in regard to: Cash Receipt Revenue Recorded Adjusting entry results in: LO 6 Prepare adjusting entries for accruals. Adjusting Entries for Accrued Revenue
- 33. Accrued Revenues An adjusting entry serves two purposes: (1) It shows the receivable that exists, and (2) It records the revenues earned. LO 6 Prepare adjusting entries for accruals.
- 34. Adjusting entries for accrued revenues Increases (debits) an asset account and Increases (credits) a revenue account. LO 6 Prepare adjusting entries for accruals. Illustration 3-13
- 35. : On Jan. 1st, Phoenix Consulting invested $300,000 in securities that return 5% interest per year. Show the journal entry to record the investment on Jan. 1st. Cash 300,000 Investments 300,000 Jan. 1 LO 6 Prepare adjusting entries for accruals. Debit Credit Investments 300,000 300,000 Debit Credit Cash Example
- 36. On Jan. 1st, Phoenix Consulting invested $300,000 in securities that return 5% interest per year. Show the adjusting journal entry required on Jan. 31st. ($300,000 x 5% / 12 months = $1,250) Interest Revenue 1,250 Interest Receivable 1,250 Jan. 31 Debit Credit Interest Receivable 1,250 1,250 Debit Credit Interest Revenue LO 6 Prepare adjusting entries for accruals. Example:
- 37. Expenses incurred but not yet paid in cash or recorded. rent interest BEFORE Accrued expenses often occur in regard to: Cash Payment Expense Recorded taxes salaries Adjusting entry results in: LO 6 Prepare adjusting entries for accruals. Adjusting Entries for Accrued Expenses
- 38. Accrued Expenses An adjusting entry serves two purposes: (1) It records the obligations, and (2) It recognizes the expenses. LO 6 Prepare adjusting entries for accruals.
- 39. Adjusting entries for accrued expenses Increases (debits) an expense account and Increases (credits) a liability account. LO 6 Prepare adjusting entries for accruals. Illustration 3-16
- 40. Notes Payable 200,000 Cash 200,000 Jan. 2 Debit Credit Cash 200,000 200,000 Debit Credit Notes Payable On Jan. 2nd, Phoenix Consulting borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the journal entry to record the borrowing on Jan. 2nd. LO 6 Prepare adjusting entries for accruals. Example:
- 41. On Jan. 2nd, Phoenix Consulting borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the adjusting journal entry required on Jan. 31st. ($200,000 x 9% / 12 months = $1,500) Interest Payable 1,500 Interest Expense 1,500 Jan. 31 Debit Credit Interest Expense 1,500 1,500 Debit Credit Interest Payable LO 6 Prepare adjusting entries for accruals. Example:
- 42. 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. LO 7 Describe the nature and purpose of an adjusted trial balance. The Adjusted Trial Balance
- 43. Which of the following statements is incorrect concerning the adjusted trial balance? a. An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger after all adjustments are made. b. The adjusted trial balance provides the primary basis for the preparation of financial statements. c. The adjusted trial balance lists the account balances segregated by assets and liabilities. d. The adjusted trial balance is prepared after the adjusting entries have been journalized and posted. Review Timing Issues LO 7 Describe the nature and purpose of an adjusted trial balance.
- 44. Financial Statements are prepared directly from the Adjusted Trial Balance. Statement of financial position Income Statement Statement of Cash Flows Owner’s Equity Statement Preparing Financial Statements LO 7 Describe the nature and purpose of an adjusted trial balance.
- 45. Income Statement For the Month Ended Jan. 31, 2008 Revenues: Sales 137,000 $ Interest revenue 1,250 Rent revenue 8,000 Total revenue 146,250 Expenses: Interest expense 1,500 Depreciation expense 100 Insurance expense 1,000 Total expenses 2,600 Net income 143,650 $ Income Statement Preparing Financial Statements LO 7 Describe the nature and purpose of an adjusted trial balance. Adjusted Trial Balance Debit Credit Cash 50,000 $ Accounts receivable 35,000 Interest receivable 1,250 Prepaid insurance 11,000 Equipment 24,000 Accumulated depreciation 100 $ Investments 300,000 Accounts payable 20,000 Interest payable 1,500 Unearned revenue 16,000 Note payable 200,000 Austin, capital 40,000 Sales 137,000 Interest revenue 1,250 Rent revenue 8,000 Interest expense 1,500 Depreciation expense 100 Insurance expense 1,000 423,850 $ 423,850 $
- 46. Statement of Owner's Equity For the Month Ended Jan. 31, 2008 Austin, Capital, Jan. 1 40,000 $ + Net income 143,650 - Drawings 0 Austin, Capital, Jan. 31 183,650 $ Statement of Owner’s Equity Preparing Financial Statements LO 7 Describe the nature and purpose of an adjusted trial balance. Adjusted Trial Balance Debit Credit Cash 50,000 $ Accounts receivable 35,000 Interest receivable 1,250 Prepaid insurance 11,000 Equipment 24,000 Accumulated depreciation 100 $ Investments 300,000 Accounts payable 20,000 Interest payable 1,500 Unearned revenue 16,000 Note payable 200,000 Austin, capital 40,000 Sales 137,000 Interest revenue 1,250 Rent revenue 8,000 Interest expense 1,500 Depreciation expense 100 Insurance expense 1,000 423,850 $ 423,850 $
- 47. Adjusted Trial Balance Debit Credit Cash 50,000 $ Accounts receivable 35,000 Interest receivable 1,250 Prepaid insurance 11,000 Equipment 24,000 Accumulated depreciation 100 $ Investments 300,000 Accounts payable 20,000 Interest payable 1,500 Unearned revenue 16,000 Note payable 200,000 Austin, capital 40,000 Sales 137,000 Interest revenue 1,250 Rent revenue 8,000 Interest expense 1,500 Depreciation expense 100 Insurance expense 1,000 423,850 $ 423,850 $ SOFP Jan. 31, 2008 Assets Cash 50,000 $ Accounts receivable 35,000 Interest receivable 1,250 Prepaid insurance 11,000 Equipment 24,000 Accum. Depreciation (100) Investments 300,000 Total assets 421,150 $ Liabilities & Owner's Equity Accounts payable 20,000 $ Interst payable 1,500 Unearned revenue 16,000 Note payable 200,000 Austin, capital 183,650 Total liab. & equity 421,150 $ Preparing Financial Statements LO 7 Describe the nature and purpose of an adjusted trial balance.
- 48. Some companies use an alternative treatment for prepaid expenses and unearned revenues. When a company prepays an expense, it debits that amount to an expense account. When a company receives payment for future services, it credits the amount to a revenue account. LO 8 Prepare adjusting entries for the alternative treatment of deferrals. Alternative Treatment of Prepaid Expenses and Unearned Revenues
- 49. Example (Insurance): On Dec. 1st, Phoenix Consulting paid $12,000 for 12 months of insurance coverage. Show the journal entry to record the payment on Dec. 1st. Cash 12,000 Insurance Expense 12,000 Dec. 1 Debit Credit Insurance Expense 12,000 12,000 Debit Credit Cash Alternative Treatment for “Prepaid Expenses” LO 8 Prepare adjusting entries for the alternative treatment of deferrals.
- 50. Example (Insurance): On Dec. 1st, Phoenix Consulting paid $12,000 for 12 months of insurance coverage. Show the adjusting journal entry required at Dec. 31st. Insurance Expense 11,000 Prepaid Insurance 11,000 Dec. 31 Debit Credit Insurance Expense 12,000 11,000 Debit Credit Prepaid Insurance Alternative Treatment for “Prepaid Expenses” 11,000 1,000 LO 8 Prepare adjusting entries for the alternative treatment of deferrals.
- 51. Example: On Dec. 1st, Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. Show the journal entry to record the receipt on Dec. 1st. Rent Revenue 24,000 Cash 24,000 Dec. 1 Debit Credit Cash 24,000 24,000 Debit Credit Rent Revenue LO 8 Prepare adjusting entries for the alternative treatment of deferrals. Alternative Treatment for unearned Revenue
- 52. Example: On Dec. 1st, Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. Show the adjusting journal entry required on Dec. 31st. Unearned Rent Revenue 16,000 Rent Revenue 16,000 Dec. 31 Debit Credit Unearned Rent Revenue 16,000 24,000 Debit Credit Rent Revenue 16,000 8,000 LO 8 Prepare adjusting entries for the alternative treatment of deferrals.
- 53. Summary of Basic Relationships for Deferrals Illustration 3A-7 LO 8 Prepare adjusting entries for the alternative treatment of deferrals.