The Matching Concept

1
Chapter 3

• The Matching Concept
• and
• the Adjusting Process

2
Recording Revenues and Expenses

• Cash Basis revenues and expenses are reported
  in the period in which cash is received or paid
• Accrual Basis (required by GAAP) recorded when
• Revenues are earned
• Expenses are incurred
• Note recorded regardless of when cash is
• received or paid.

3
Period and Matching Concepts

• Accounting Period Concept determine the
  appropriate period revenues and expenses of the
  business should be reported (monthly)
• Matching Concept to report revenues and related
  expenses are recorded in the same period (month).
  Match expenses incurred to the related revenue
  earned.

4
Adjusting Entry Process

• 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

5
Types of Adjustments

• Deferrals created by deferring or delaying the
  recognition of revenues or expenses deferrals
  are adjusted at month-end
• Accruals unrecorded revenues or expenses

6
Deferred Expenses (Prepaid Expenses) (1)

• Initially recorded as assets but turn into
  expenses
• over time as assets are used-up
• Examples
• 1) Supplies
• 2) Prepaid Rent
• 3) Prepaid Insurance
• Steps Involved
• 1) Pay one year of prepaid expense (record
  payment)
• 2) Adjust used portion at the end of each month
  

7
Deferred Expenses (Prepaid Expenses) (2)

• Example Paid for 6 months of insurance in
  advance prepaid insurance
• The portion of insurance coverage that has
  expired is becomes an expense
• Original entry
• Prepaid Insurance 600
• Cash 600
• Adjusting entry monthly to recognize expense
• Insurance Expense 100
• Prepaid Insurance 100

8
Deferred Revenue (Unearned Revenue) (1)

• Initially recorded as a liability but becomes
  a revenue over time as revenue is earned
• Examples
• 1) Unearned Rent
• 2) Magazine Subscriptions
• Steps Involved
• 1) Received one year payment in advance (record
• receipt)
• 2) Adjust earned portion at the end of each
  month

9
Deferred Revenue (Unearned Revenue) (2)

• Example Receive payment of two months of rent
  in advance Unearned Rent
• The portion of unearned rent that was used
  becomes rent revenue aka rent income
• Original entry
• Cash 2400
• Unearned rent 2400
• Adjusting entry to recognize one month rent
• Unearned rent 1200
• Rent Income 1200

10
Accrued Expenses (1)

• Expenses that have been incurred or accrued
  but
• have not been recorded at month-end
• Examples
• 1) Wages Expense
• 2) Repair Expense
• Steps Involved
• 1) Identify unrecorded expenses at month-end
• 2) Record these expenses

11
Accrued Expenses (2)

• Example Wages accrued but not paid Wages
  Expense
• The portion of wages accrued or incurred for
  the period but not yet paid
• Original entry
• None
• Adjusting entry to recognize wages accrued
• Wages Expense 500
• Wages Payable 500

12
Accrued Revenues (1)

• Revenues that have been earned but have not
• been recorded at month-end
• Examples
• 1) Unbilled Services
• 2) Interest on Notes Receivable
• Steps Involved
• 1) Identify unrecorded revenues at month-end
• 2) Record these revenues

13
Accrued Revenues (2)

• Example Interest Income (revenue)
• Recording interest revenues incurred for the
  period but have not been received
• Original entry
• None
• Adjusting entry
• Interest Receivable 50
• Interest Income 50

14
Fixed Assets (1)

• Physical resources that are owned and used by
• a business and are permanent or have a long
• life
• Depreciation the decrease in usefulness of a
  fixed asset over its life
• Accumulated Depreciation an account that
  accumulates the depreciation recorded on fixed
  assets
• Contra Asset Account an account offset against
  a related asset account on the balance sheet
• Book Value the cost of a fixed asset minus
  Accumulated Depreciation on the fixed asset

15
Fixed Assets (2)

• Example Delivery Van (asset)
• Cost of van 12,000
• Useful life 3 years 12,000/3 4,000
• Original entry for purchase of Delivery Van
• Delivery Van 12,000
• Cash 12,000
• Adjusting entry to recognize 1 yr of
  depreciation
• Depreciation Expense- DV 4,000
• Acc. Dep. Delivery Van 4,000

16
Fixed Assets (3)

• Accumulated Depreciation Contra-asset account
  (account that works against another account to
  reduce the value of it)
• Normal Credit Balance
• Reported on the Classified Balance Sheet
• Delivery Van 12,000
• Less Acc. Dep. 4,000
• Net Book Value of Van 8,000

17
Points to Remember for Fixed Assets

• Fixed or Plant Assets must be used by the
  business
• Depreciation expense is a noncash expense
• Depreciation is not related to the assets value
• Normal balance of Accumulated Depreciation is
  CREDIT
• Accumulated Depreciation accumulates until the
  item has been fully depreciated

18
Adjustment Process

• Regular monthly journal entries
• Unadjusted Trial Balance (Debits Credits?)
• Adjusting journal entries
• Adjusted Trial Balance (Debits Credits?)
• Monthly Financial Statements

19
Accounting Cycle

• Analyze transactions and record in journal
  daily
• Post to ledger daily
• Prepare trial balance, make adjusting entries,
  adjusted trial balance - EOM
• Prepare Financial Statements EOM

20
Financial Analysis and Interpretation

• Vertical Analysis Items are shown as a
  percentage of a total within the statement
• Income Statement All items shown as a
  percentage of total revenues
• Balance Sheet All items shown as a percentage
  of total assets or total liabilities and owners
  equity
• See Exhibit 9 shows common-size income
  statement for 2 years

21
Homework Assignment

• Key Terms page 119 (quiz)
• Illustrative problem page 119-121
• Self-Examination Questions page 121
• Class Discussion Questions page 122
• Problems
• P 3-1A
• P 3-5A