Chapter 4: Adjustments, Trial Balance, and Financial Statements

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Chapter 4 Adjustments, Trial Balance, and
Financial Statements

• Acct 2301 Fall 2009
• Cox School of Business, SMU
• Professor Zining Li

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What do We Hope to Learn?

• Accounting Cycle
• Adjusting entries
• What, why, when, and how to adjust?
• Unadjusted and adjusted trial balance
• Preparing financial statements
• Closing process

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Accounting Cycle

1. Identify recordable financial transactions
2. Record the journal entries
3. Post journal entry amounts to T-accounts
4. Prepare the unadjusted trial balance
5. Record adjusting journal entries
6. Prepare the adjusted trial balance
7. Prepare the financial statements
8. Record the closing entries

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Adjusting Entries

• Under accounting, revenues (expenses) are
  recorded when they are earned (incurred)
• Some revenues (expenses) are earned (incurred)
  without any external transaction
• Adjusting entries are needed to record such
  revenues and expenses in the correct period
• Adjustments are made at the end of a reporting
  period

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Timetable of the Adjustment Process
Transactions are recorded all during the period
1/1/04
12/31/04
Adjustments are made at the end of the period,
but before the financial statements are prepared
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What need to be adjusted

• Accruals
• Accrued revenues
• Accrued expenses
• Deferrals
• Deferred revenues
• Deferred expenses

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What need to be adjusted (1)

• Accrued revenues
• Those are revenues that are already earned,
  although cash havent been collected
• Revenues need to be recorded, at the same time,
  assets are increased
• Example interest revenue

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On October 1, 2006, Webb, Inc. invests 10,000
for 6 months in a certificate of deposit that
pays 6 interest per year. Webb will not receive
the interest until the CD matures on March 31,
2007. On December 31, 2006, Webb, Inc. must make
an entry for the interest earned so far.
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What need to be adjusted (2)

• Accrued expenses
• Those are expenses that are already incurred
  through out the accounting period, although cash
  havent been paid
• Expense need to be recorded, at the same time,
  liabilities are increased
• Examples
• Salary expense
• Interest expense
• Tax expense

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• As of 12/27/06, Denton, Inc. had already paid
  1,900,000 in wages for the year. Denton pays
  its employees every Friday. Year-end, 12/31/06,
  falls on a Wednesday. The employees have earned
  total wages of 50,000 for Monday through
  Wednesday of the week ending 1/02/07.

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After we post the entry to the T-accounts, the
account balances look like this
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What need to be adjusted (3)

• Deferred revenues
• Previously recorded as liabilities when cash were
  received before goods were delivered or services
  were rendered
• At the end of reporting period, if the earning
  process is complete, these liability accounts
  need to be reduced, and revenues are recorded
• Examples
• Unearned rent revenue --gt rent revenue
• Unearned franchise revenue --gt franchise revenue
• Unearned subscription revenue --gt subscription
  revenue
• Unearned ticket revenue --gt ticket revenue

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On December 1, 2006, Toms Rentals received a
check for 3,000, for the first four months rent
from a new tenant.
On December 31, 2006, Toms Rentals must adjust
the Unearned Rent Revenue account to reflect that
one month of rent revenue has been earned.
3,000 1/4 750
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After we post the entry to the T-accounts, the
account balances look like this
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What need to be adjusted (4)

• Deferred expenses
• Previously recorded as assets when cash were paid
  before these assets are being used
• At the end of reporting period, the used-up
  amount of these assets need to be reduced, and
  expenses are recorded
• Examples
• Buildings and Equipment (PPE) --gt Depreciation
  expenses
• Supplies --gt Supplies expense
• Prepaid rent --gt Rent expense
• Prepaid insurance --gt Insurance expense

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On January 1, 2006, Matrix, Inc. paid 3,600 for
a 3-year fire insurance policy.
On December 31, 2006, Matrix, Inc. adjust the
Prepaid Insurance Expense account to reflect that
1 year of the policy has expired. 3,600 X 1/3
1,200
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After we post the entry to the T-accounts, the
account balances look like this
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Journal Entry for Depreciation Expense is
different
Dr. Deprecation Expense Cr. Accumulated
Depreciation

• Accumulated Depreciation is a contra-asset
  account it carries a credit balance

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On January 1, 2006, Matrix, Inc. paid 8,000 for
equipment, which is expected to last 5 years
On December 31, 2006, Matrix, Inc. adjust the
Equipment account to reflect that 1 year use of
the equipment 8,000 X 1/5 1,600
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Bal. 2,000
Net Book Value of Equipment

• Equipment
• Accumulated Depreciation
• Equipment (net)

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Adjusting Entries Summary

• Done at the end of reporting period
• No cash account in an adjusting entry
• Revenues and expenses are recorded
• Non-cash asset accounts or liability accounts are
  increased or decreased
• Adjusting entries affect income statement,
  balance sheet, statement of retained earnings
  but NOT cash flow statement

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Exercise Recording transactions with journal
entries
College Caps, Inc. operates a small retail
store in the mall that sells baseball caps. The
following transactions occurred during June 2004.

• June 1 Paid 700 cash for insurance policy
  through December 31, 2004.
• June 1 Purchased store equipment for 5,000 by
  signing a note. The company estimates annual
  depreciation of 1,200.
• June 5 Purchased supplies worth 500 with cash.
• June 15 Loaned 10,000 to the manager of the
  store (as a personal loan) for one year. The
  annual rate of interest on the loan is 12. The
  loan is supported by a note and interest is due
  upon repayment.
• June 28 Earned revenue of 1,400 with delivery of
  custom cap order for SMU football team. SMU must
  pay the bill by July 31. Cost of the caps sold
  was 500.
• June 30 Amount of supplies on hand is 300. The
  balance in the Supplies account was 150 on June
  1.

Record all journal entries, including the
adjusting entries, that must be made at June 30
in order for the company to prepare its financial
statements.
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Exercise Complete the accounting cycle
College Caps, Inc.
Trial Balance
unadjusted
as of June 30, 2004 Account DR
CR Cash 8,150 Accounts
Receivable 7,500
Supplies
650 Inventory
5,500 Prepaid
Insurance 700
Notes Receivable
10,000 Equipment
5,000
Accounts
Payable
6,050 Contributed
Capital 30,000
Retained Earnings 550 Sales Revenue

1,400 Cost of Sales
500 TOTALS 38,000 38,000

1. Post the adjusting entries for the period ended
   June 30, 2004 and prepare an adjusted trial
   balance. Income tax expense should be recorded
   at 30 of pretax net income.
2. Prepare the income statement, statement of
   retained earnings, and balance sheet.

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Closing

• When After all four financial statements are
  prepared
• What all income statement accounts
• Closing means to bring the balances of all the
  income statement accounts to zero
• Key Terms
• Permanent accounts
• Temporary accounts