Reporting and Preparing Financial Statements

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Reporting and Preparing Financial Statements
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What have we done thus far?

• Transaction Analysis
• Journal Entry preparation
• Post to General ledger the journal entries
• Preparation of Unadjusted Trial Balance

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What will be doing in this chapter?

• Adjusting Entriesthe next step in the accounting
  cycle.
• Posting Adjusting Entries to the General Ledger
• Prepare the Adjusted Trial Balance
• Prepare the Financial Statements
• Prepare the Closing Entries
• Prepare the Post-Closing Trial Balance (end of
  the cycle for a particular financial statement
  cycle)

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The next step

• Adjusting Entries
• The summarizes
  all of the transactions that have occurred and
  been record for the period the financial
  statements will coverfor our purposeswell
  assume a year

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• These numbers must be __________ so that the
  financial statements reflect the financial
  position of the firm according to
• __________________________ (GAAP)

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• The primary reason that the unadjusted trial
  balance numbers must be tweaked is due to the
  fact that we are preparing financial statements
  periodically.
• The _____________________ allows us to prepare
  financial statements annually, quarterly,
  monthly, even weekly if management needed the
  information internally.

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Time Period Assumption

• Fact Many transactions that occur in one year
  may impact current year and subsequent years
  financial statements this means that we need to
  analyze, prepare entries, post to the ledger this
  impact as it occurs.
• Accounting assumes that the impact on subsequent
  periods can be estimated and recorded in those
  periods.

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The Big Picture

• Keep in mind that the reason that we are
  preparing these adjustments is so that the
  financial statements properly reflect the
  __________________ of the company at the time the
  financials are being prepared and

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• ___________is properly measured

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Categories of Adjustments

• Deferrals
• Accruals
• These are convenient groupings for you to learn
  these adjustments But

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• Dont get too caught up in trying to identify
  which categorythe important thing is identifying
  what needs to be adjusted and what the adjustment
  entry is
• The books are wrong and we need to fix them.

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Deferrals

• Prepaid itemssometime prior to year end, the
  company prepaid for a service or productthe
  benefit of that service or product will be
  received over time in the ________________________
  __________
• The adjusting entry involves determining how much
  of that service or product has been received by
  the companythe benefit has been received (and
  presumably revenue earned at least partially as a
  result of that benefit received) so an
  ____________________________________
• Examples

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• For example, car insurance is typically paid in 6
  month incrementsto cover insurance for the next
  6 months.
• Lets say a company pays 6,000 in insurance on
  9/1 that covers the period 9/1/03 to 2/28/04.

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• When the payment is made, the journal entry is
• 9/1

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• The company prepares financial statements every
  year. Its fiscal year-end coincides with the
  calendar year-end (December 31).
• How much of this insurance is now expired (the
  benefit of this expiration having been received
  by the company)?

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• ?
• ____________ expiration per month
• From 9/1 to 12/31 is ____ months (fingers help
  with this)
• So at 12/31, ______________ is expired

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• We need to record this expenseour asset is now
  only 2,000 not the original 6,000. This is a
  cost of doing businessthe owners are charged
  for this cost profit is reduced.
• 12/31 Insurance Exp. (-OE) 4,000
• Prepaid Ins (-A) 4,000

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This is the ending balance of Prepaid Rent--it is
an asset on the balance sheet
This is the insurance expense for the period--it
is shown on the income statement
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The other category of deferralsUnearned Revenues

• Unearned Revenuesthe company received cash for a
  service or product to be provided to a customer
  in the future _____________________________
• The required year-end adjusting entry involves
  determining how much of this amount is earned and
  _____________________________________.

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• Examples of unearned revenues
• For Duck football, season ticket holders prepay
  for their tickets. To the U of O, this is a
  liabilityunearned ticket revenue. As the games
  occur, some of that amount is earned and
• An entry to record the amount earned is necessary.

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• Assume that on 6/1/03, an alumni pays 300 for 6
  tickets to U of O games for the Fall, 2003
  season.
• On 6/1/03, the journal entry is

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• By the end of September, 2 of the games the fan
  paid for have been played.
• At Sept. 30, how much of the 300 has been earned?

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• ?
• _____ games ____ per game 2 ___
• The U of O no longer has as large a liability, it
  has earned _____.

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• The journal entry to record the revenue earned
  and the reduction of the liability is

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Supplies

• Another example of an account that usually needs
  to be adjusted at year-end is supplies.
• Supplies (such as office supplies) (this is not
  merchandise purchased for resalewell handle
  that in a later chapter) are purchased and then
  used over time.

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• Practically, a company does not keep track of
  small items as they are usedsuch as every time a
  pad of paper is taken out of the supply closet.
• Instead, the company ______the supplies at
  year-end and using what the supplies cost, they
  determine a year-end value for supplies on hand.

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• The supplies account balance before adjustment
  usually includes any balance on hand from the
  ___________ and any purchases of supplies during
  the current year.
• The adjusting entry _______ the supplies account
  by the amount that was used up.
• That amount is the ________ between the account
  balance and the supplies on hand at year-end.

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Example of Supplies Adjustment

• At the beginning of the year, our company has
  200 in the Supplies account. During the year,
  1,000 of Supplies were purchased by the
  companythe entry to record this purchase is

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• Nothing has affected the supplies account since
  this purchase so
• The balance in the Supplies account is _______.
• Our fearless accounting intern braves the
  supplies cabinet on 12/31/03 and counts the
  supplies on hand. The amount on hand is 400.

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• So _______ of supplies have been used.
• The adjustment is

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Depreciation

• Long-lived, tangible plant assets (like
  buildings, machinery, equipment) aid the company
  in producing _______________.
• For example, General Motors has 62.824 billion
  (historical cost) in Property ( Land, Building
  and land improvements, Machinery and Equipment,
  Construction in Progress) and additional 9.2
  billion for Special tools.

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• Over time, the _____________ of the property
  (except for landwe assume) is used up in order
  to build carswhich when sold will bring revenues
  to the company.
• Depreciation expense is the ___________ of the
  cost of the property (except for land) over the
  period that it is used in production resulting
  in saleable cars.

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• By systematically _________ a portion of the cost
  of the property (except for land) in each year,
  expenses are a better reflection of the real
  costs of earning revenue.
• Remember that the principle underlying the
  recognition of expenses is M___________recording
  expenses in the period related revenue is earned
  and recorded.

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• In 2002, General Motors depreciation expense was
  4.7 billion for property and 2.6 billion for
  special tools (called amortization for these
  toolsthe concept is the same as depreciation).

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• The predominant depreciation method for General
  Motors is _________.
• About 90 of all long-lived tangible property for
  all companies are depreciated using
  ______________.

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Straight Line Depreciation Method

• As the name implies, equal amounts of
  depreciation expense are recorded each year for
  an asset depreciated under straight-line.
• The formula is
• (Original Historical Cost Salvage Value)
• Estimated Useful Life

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Salvage Value

• Also called residual value, scrap value
• It is the amount that we expect the company to
  receive in the future when the asset is worn out
  for our purposes (or obsolete) and we will be
  selling it.

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• Example of computing straight-line depreciation
• On 1/1/03, X company purchases a drill press for
  100,000. The company expects to use the press
  in operations for 5 years and estimates that it
  will receive 10,000 when it retires the press
  from service in 5 years.

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• Historical cost--100,000
• Estimated useful life5 years
• Salvage value--10,000
• Annual depreciation expense

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• The impact on the accounting equation
• Assets Liabilities Owners Equity
• ________________

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• Journal Entry
• What the heck is this ____________________________
  ____ account? Why dont we just credit the asset
  account directly?

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Contra Asset accounts

• The impact of depreciation is to reduce the book
  value of the asset being depreciated and owners
  equity (via depreciation exp.).
• However, instead of crediting the asset account
  to accomplish thiswe establish a new type of
  accountthe _____________ account.

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• As the name implies it is contra or against the
  asset. This account is listed under plant,
  property and equipment on the balance sheet and
  ______________ from the PPE total (which is still
  original historical cost).
• The effect on assets is the same as if the asset
  account had been credited directly.

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• Example of balance sheet presentation
• Co. X
• Partial Balance Sheet
• At Dec. 31, 2003
• Assets
• Machine 100,000
• Less Accumulated Depreciation 18,000
• Net machine 82,000

This is the book value or carrying value of the
asset
Its the same as if the machine account had been
credited directly
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The second year

• Depreciation expense for the drill press is the
  same in the second year as in the first since
  straight line is being used
• 2nd year entry
• Depreciation Expense 18,000
• Acc. Depr. 18,000

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• The impact on the accounting equation 2nd year
  depreciation expense
• Assets Liabilities Owners Equity
• -18,000 -18,000

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• Example of balance sheet presentation
• Co. X
• Partial Balance Sheet
• At Dec. 31, 2004
• Assets
• Machine 100,000
• Less Accumulated Depreciation 36,000
• Net machine 64,000

This is the book value or carrying value of the
asset
Its the same as if the machine account had been
credited directly
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• Notice how the accumulated depreciation account
  is increasing
• when the journal entry is recorded for the second
  year, ____________________________________________
  _______________________

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• Since accumulated depreciation is a balance sheet
  account, its balance is ______________this is
  the same for all balance sheet accountsthey are
  called __________________ accounts.

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• On the other hand, depreciation expense is is not
  _____________ over time. The balance at year-end
  just represents what occurred in that year.
• All revenue, expense, gain, loss, dividend
  accounts are nominal or temporary accounts.

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• Notice that the revenue, expense, gain, loss
  accounts are included in the income statement.
• Their net effect is transferred to Retained
  Earnings ( a real account) once all the financial
  statements are prepared.
• Then the revenue, expense, gain, loss accounts
  balances are zero after this transfer (which is
  called closing).

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• After the revenue, expense, gain, loss account
  balances are transferred to Retained Earnings,
• we can start recording the transactions for the
  next year.

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• Dividends are not an ______________, but their
  declaration reduces the owners retained
  earnings.
• Like revenues, expenses, gains and losses, the
  dividend account balance impact is transferred to
  Retained Earnings in these closing entries.

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Accruals

• The other major category of adjustments are
  called accruals.
• These represent transactions that have occurred
  as of year-end but are not recorded on the books
  yet.

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The two general categories of accruals

• Accrued Revenues
• Accrued Liabilities (also known as accrued
  expenses)

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Accrued Revenues

• A company earns revenue before year-end, but has
  not billed the customer yet.
• The billing or invoicing of the customer
  generally triggers the preparation of journal
  entries and, subsequent, posting to the general
  ledger.

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• Here the revenue is earned and we can estimate
  how much we are to collect so
• We need to record the revenue in the period in
  which it was earned and the related receivable
• Entry
• Accounts Receivable 1,000
• Revenue 1,000

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Accrued Liabilities (aka accrued expenses)

• Here a liability exists usually as a result of a
  service performed for us or product consumed by
  us that has not yet been recorded on the books.
  The company has received the benefit and has
  incurred a liability.
• Example
• Our bookkeeper, Jason, earns 20 per hour. He is
  paid weekly each Friday for that weeks work. He
  works 40 hours per week.

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• Assume that year-end falls on a Wednesday. Jason
  was last paid the previous Friday. His paycheck
  is usually what triggers recording wage expense
  (and the corresponding credit is to Cash).
• Our company has received Jasons labor for 3 days
  this week so we owe him 480.
• 3 days 8 hours per day 20/hour.

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• This is nowhere on the books. Yet it is an
  expense of the year which is ending.
• If we dont record this amount, income will be
  overstated (not enough expense recorded) for the
  year which is ending.

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• Adjusting Entry
• Salary Expense (-OE) 480
• Salary Payable (L) 480

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Another common type of accrualinterest
expense/interest payable

• When a company borrows money from someone else
  (many times from a bank), the cost of that
  transaction is interest.
• Interest is based upon a percentage of the amount
  borrowed and time.
• Interest payments usually trigger recording
  interest expense, but if the interest payment
  date does not fall on the date the year endssome
  interest is owed and that amount is not on the
  books.

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• The company has received the benefit of the use
  of that moneyso even if the payment is due at
  some time in the future, both an expense and
  liability exist.
• Example On October 1, 2003, our company borrows
  100,000 from J Bank. The terms of the borrowing
  are 5 annual interest, both the interest and the
  original amount borrowed are to be paid to J in
  one year.

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• At 12/31/03, the company owes interestwhich will
  be paid in another 9 months.
• No event (like a payment) has triggered
  recording interest expense
• Interest expense and the payable must be recorded
  or accrued via an adjusting entry.

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• On 10/1/03 the entry to record the borrowing was

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• At 12/31/03, the adjusting entry is
• Computation -____________________