Adjusting Accounts and Preparing Financial Statements

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Chapter 3

• Adjusting Accounts and Preparing Financial
  Statements

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The Accounting Period 1

• To provide timely info, accounting systems
  prepare reports at regular intervals known as
  accounting periods.
• The time period principle means an organizations
  activities can be divided into specific time
  periods such as
• a month (monthly report)
• a three-month period (quarterly reports)
• a six-month period (semi-annual reports)
• a year (annual report)
• Therefore, financial statements prepared
• monthly, quarterly or semi-annually are referred
  to as interim financial reports
• year are referred to as an annual financial
  reports

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The Accounting Period 2

• An annual reporting period is not always a normal
  calendar year (Jan. ? Dec.)
• An business can adopt a fiscal year which
  consists of
• any 12 month consecutive months or
• an annual accounting period of 52 weeks
• Businesses like retail operations (e.g. Macys,
  Target, Toys "R" Us, etc) with seasonal
  variations in sales often choose a natural
  business year end, which is when sales activities
  are at their lowest level for the year generally
  after the holiday season

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Accrual Basis vs. Cash Basis

• Accrual Basis (required by GAAP) revenues are
  recorded when
• Revenues are earned
• Expenses are incurred
• Note Accrual basis supports the GAAP revenue
  recognition concept which requires revenues to be
  recorded regardless of when cash is received or
  paid.
• Cash Basis (does not follow GAAP)
• revenues are reported in the period when cash is
  received
• expenses are reported when cash is paid

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Recording Revenues and Expenses

• Matching principle aims to record expenses in
  the same accounting period (monthly/annually) as
  the revenues that are earned as a result of the
  expenses
• Matches expenses incurred to the related revenue
  earned

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Adjusting Accounts

• Process involves analyzing each account balance
  and the transactions and events that affect it to
  determine any needed adjustments
• Adjustments are necessary for transactions and
  events that extend for more than one accounting
  period
• Purpose to update accounting records to include
  all revenues earned and all expenses incurred.
• Journal entries must be made to bring the
  accounts up-to-date at the end of each month
• All adjusting entries involve at least one Income
  Statement account and at least one Balance Sheet
  Account
• Adjusting entries are required by the accrual
  basis of accounting

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Types of Adjustments

• Deferrals created by deferring or delaying the
  recognition of revenues or expenses deferrals
  are adjusted at the end of the accounting period
• Accruals are unrecorded revenues or expenses
• Both types of transactions and adjustments are
  part of ACCRUAL Basis of accounting

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Accruals and Deferrals

• Accruals
• Action first, dollars later
• E.g., services are performed, payment to be
  received later (Business sends bills to customers
  AR)

• Deferrals
• Dollars first, action later
• E.g., Business pays for items in advance of
  receiving the benefits such as supplies,
  insurance or rent. The action of using the items
  comes later

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Deferrals Prepaid Expenses

• Prepaid expenses
• Items paid for in advance of receiving their
  benefits
• Are classified as assets
• When these assets are used, the used portion of
  their costs becomes expenses
• Most Common examples
• Prepaid Insurance
• Supplies
• Prepaid Rent
• Steps Involved
• 1) Acquire the prepaid expense (record payment)
• 2) Adjust the used portion, (AKA the expense) at
  the end of the accounting period

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Adjusting Prepaid (Deferred) Expenses
P1
Here is the check for my first six months rent.
Resources paid for prior to receiving the actual
benefits.
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Prepaid Insurance
P1

• On December 1, 2007, Scott Company paid
  12,000 for insurance for December 2007 through
  May 2008. Scott recorded the expenditure as
  Prepaid Insurance on December 31.
• What adjustment is required?

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Supplies
P1

• During 2007, Scott Company purchased 15,500
  of supplies. Scott recorded the expenditures as
  Supplies. On December 31, a count of the supplies
  indicated 2,655 on hand.
• What adjustment is required?

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Adjusting for Depreciation
P1

• Depreciation is the process of computing
  expense from allocating the cost of plant and
  equipment over their expected useful lives.

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Adjusting for Depreciation
P1

• On January 1, 2007, Barton, Inc. purchased
  equipment for 62,000 cash. The equipment has an
  estimated useful life of five years and Barton
  expects to sell the equipment at the end of its
  life for 2,000 cash.
• Lets calculate the depreciation expense for
  the year ended December 31, 2007.

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Adjusting for Depreciation
P1
On January 1, 2007, Barton, Inc. purchased
equipment for 62,000 cash. The equipment has an
estimated useful life of five years and Barton
expects to sell the equipment at the end of its
life for 2,000 cash. Lets record depreciation
expense for the year ended December 31, 2007.
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Adjusting for Depreciation
P1
Equipment
Depreciation Expense
1/1 62,000
12/31 12,000
Accumulated Depreciation
12/31 12,000
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Adjusting for Depreciation
P1
Equipment is shown net of accumulated
depreciation.

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Adjusting Unearned (Deferred) Revenues
P1
Cash received in advance of providing products or
services.
Revenue
Liability
Unadjusted Balance
Credit Adjustment
Debit Adjustment
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Adjusting Unearned (Deferred) Revenues
P1

• On October 1, 2007, Ox University sold 1,000
  season tickets to its 20 home basketball games
  for 100 each. Ox University makes the following
  entry

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Adjusting Unearned (Deferred) Revenues
P1

• On December 31, Ox University has played 10 of
  its regular home games, winning two and losing
  eight.

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Adjusting for Accrued Expenses
P1
Were about one-half done with this job and want
to be paid forour work!
Costs incurred in a period that are both unpaid
and unrecorded.
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Adjusting for Accrued Expenses
P1
Barton, Inc. pays its employees every Friday.
Year-end, 12/31/07, falls on a Wednesday. As of
12/31/07, the employees have earned salaries of
47,250 for Monday through Wednesday. They will
not be paid until the next Friday, 1/02/08.
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Adjusting for Accrued Expenses
P1
Barton, Inc. pays its employees every Friday.
Year-end, 12/31/07, falls on a Wednesday. As of
12/31/07, the employees have earned salaries of
47,250 for Monday through Wednesday of the week
ended 1/02/08.
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Adjusting for Accrued Revenues
P1
Yes, Ive completed yourtax return, but have not
hadtime to bill you yet.
Revenues earned in a period that are both
unrecorded and not yet received.
Revenue
Asset
Credit Adjustment
Debit Adjustment
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Adjusting for Accrued Revenues
P1
Smith Jones, CPAs, had 31,200 of work
completed but not yet billed to clients. Lets
make the adjusting entry necessary on December
31, 2007, the end of the companys fiscal year.
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Links to Financial Statements
A1
27

P2
FastForward - Trial Balance - December 31, 2007
First, the initial unadjusted amounts are added
to the worksheet.
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P2
FastForward - Trial Balances - December 31, 2007
Next, FastForwards adjustments are added.
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P2
FastForward - Trial Balance - December 31, 2007
Finally, the totals are determined.
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Preparing Financial Statements
P3

• Lets use FastForwards adjusted trial balance to
  prepare the companys financial statements.

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P3
1. Prepare the Income Statement
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2. Prepare the Statement of Changes in Owners
Equity. Note Net Income from the Income
Statement carries to the Statement of Changes in
Owners Equity.
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Preparation of Balance Sheet
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Profit Margin
A2

• The profit margin ratio measures the companys
  net income to net sales.

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Homework

• Read Chapter 3
• Read and answer the Decision Maker and Decision
  Ethics questions
• Read and answer the Quick Checks
• Visit the Publishers website tools for Ch 3
• Key Terms p. 112 (glossary on web)
• Multiple Choice Quiz p. 113
• Discussion Questions p. 113
• P 3-1A p.119 P 3-2A p. 119-120