NSU EMB 501 Accounting Ch03

Chapter 3-1

Chapter 3-2

CHAPTER CHAPTER 33

ADJUSTING THE ADJUSTING THE ACCOUNTSACCOUNTS

Accounting Principles, Eighth Edition

Chapter 3-3

Generally a month, a quarter, or a year.Fiscal year vs. calendar yearAlso known as the “Periodicity Assumption”

Timing IssuesTiming IssuesTiming IssuesTiming Issues

Accountants divide the economic life of a business into artificial time periods (Time Period Assumption).

LO 1 Explain the time period assumption.LO 1 Explain the time period assumption.

Jan. Feb. Mar. Apr. Dec.. . . . .

Chapter 3-4

The time period assumption states that:The time period assumption states that:a.a. revenue should be recognized in the accounting

period in which it is earned.

b. expenses should be matched with revenues.

c. the economic life of a business can be divided into artificial time periods.

d. the fiscal year should correspond with the calendar year.

ReviewReview

LO 1 Explain the time period assumption.LO 1 Explain the time period assumption.

Chapter 3-5

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.

Accrual- vs. Cash-Basis Accounting

LO 2 Explain the accrual basis of accounting.LO 2 Explain the accrual basis of accounting.

Chapter 3-6

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).

Accrual- vs. Cash-Basis Accounting

Chapter 3-7

Revenue Recognition Principle

Recognizing Revenues and Expenses

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.

Chapter 3-8

Matching Principle

Recognizing Revenues and Expenses

Match expenses with revenues in the period when the company makes efforts to generate those revenues.

“Let the expenses follow the revenues.”

Chapter 3-9

GAAP relationships in revenue and expense recognition

Illustration 3-1Illustration 3-1

Chapter 3-10

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. This basis is in accord with generally accepted accounting principles.

d. Revenue is recorded only when cash is received, and expense is recorded only when cash is paid.

ReviewReview

Chapter 3-11

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 EntriesThe Basics of Adjusting EntriesThe Basics of Adjusting EntriesThe Basics of Adjusting Entries

LO 3 Explain the reasons for adjusting entries.LO 3 Explain the reasons for adjusting entries.

Chapter 3-12

RevenuesRevenues - recorded in the period in which - recorded in the period in which they are earnedthey are earned.

Expenses Expenses - recognized in the period in which - recognized in the period in which they are incurredthey are incurred.

Adjusting entriesAdjusting entries - needed to ensure that - needed to ensure that the the revenue recognitionrevenue recognition and and matching matching principlesprinciples are followed. are followed.

The Basics of Adjusting EntriesThe Basics of Adjusting EntriesThe Basics of Adjusting EntriesThe Basics of Adjusting Entries

Chapter 3-13

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.

ReviewReview

Chapter 3-14

Types of Adjusting EntriesTypes of Adjusting EntriesTypes of Adjusting EntriesTypes of Adjusting Entries

1. Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed.

Deferrals3. 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.LO 4 Identify the major types of adjusting entries.

Chapter 3-15

Trial BalanceTrial 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$

Trial BalanceTrial BalanceTrial BalanceTrial Balance

LO 4 Identify the major types of adjusting entries.LO 4 Identify the major types of adjusting entries.

Chapter 3-16

Deferrals are either:

Prepaid expenses or

Unearned revenues.

Adjusting Entries for DeferralsAdjusting Entries for DeferralsAdjusting Entries for DeferralsAdjusting Entries for Deferrals

LO 5 LO 5 Prepare adjusting entries for deferrals.Prepare adjusting entries for deferrals.

Chapter 3-17

Payment of cash, that is recorded as an asset because Payment of cash, that is recorded as an asset because service or benefit will be received in the future. service or benefit will be received in the future.

Adjusting Entries for “Prepaid Expenses”Adjusting Entries for “Prepaid Expenses”Adjusting Entries for “Prepaid Expenses”Adjusting Entries for “Prepaid Expenses”

insuranceinsurancesuppliessuppliesadvertisingadvertising

Cash PaymentCash Payment Expense RecordedExpense RecordedBEFORE

rentrentmaintenance on equipmentmaintenance on equipmentfixed assets (depreciation)fixed assets (depreciation)

Prepayments often occur in regard to:Prepayments often occur in regard to:

Chapter 3-18

Prepaid Expenses

Costs that expire either with the passage of time or through use.

Adjusting entries (1) to record the expenses that apply to the current accounting period, and (2) to show the unexpired costs in the asset accounts.

Chapter 3-19

Illustration 3-4Adjusting entries for prepaid expenses

Increases (debits) an expense account and

Decreases (credits) an asset account.

Chapter 3-20

Example Example (Insurance)(Insurance):: On Jan. 1On Jan. 1stst, Phoenix Consulting paid , Phoenix Consulting paid $12,000 for 12 months of insurance coverage. Show the $12,000 for 12 months of insurance coverage. Show the journal entry to record the payment on Jan. 1journal entry to record the payment on Jan. 1stst. .

Cash 12,000Prepaid insurance 12,000Jan. 1

Debit CreditPrepaid Insurance

12,00012,000 12,00012,000

Debit CreditCash

Chapter 3-21

Example Example (Insurance)(Insurance):: On Jan. 1On Jan. 1stst, Phoenix Consulting paid , Phoenix Consulting paid $12,000 for 12 months of insurance coverage. Show the $12,000 for 12 months of insurance coverage. Show the adjusting journal entryadjusting journal entry required at Jan. 31 required at Jan. 31stst. .

Prepaid insurance 1,000Insurance expense 1,000Jan. 31

Debit CreditPrepaid Insurance

12,00012,000 1,0001,000

Debit CreditInsurance expense

1,0001,000

11,00011,000

Chapter 3-22

DepreciationBuildings, 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).

Chapter 3-23

Example Example (Depreciation)(Depreciation):: On Jan. 1On Jan. 1stst, Phoenix Consulting , Phoenix Consulting paid $24,000 for equipment that has an estimated useful paid $24,000 for equipment that has an estimated useful life of 20 years. Show the journal entry to record the life of 20 years. Show the journal entry to record the purchase of the equipment on Jan. 1purchase of the equipment on Jan. 1stst. .

Cash 24,000Equipment 24,000Jan. 1

Debit CreditEquipment

24,00024,000 24,00024,000

Debit CreditCash

Chapter 3-24

Example Example (Depreciation)(Depreciation):: On Jan. 1On Jan. 1stst, Phoenix Consulting , Phoenix Consulting paid $24,000 for equipment that has an estimated useful paid $24,000 for equipment that has an estimated useful life of 20 years. Show the life of 20 years. Show the adjusting journal entryadjusting journal entry required required at Jan. 31at Jan. 31stst. . ($24,000 / 20 yrs. / 12 months = $100)($24,000 / 20 yrs. / 12 months = $100)

Accumulated depreciation 100Depreciation expense 100Jan. 31

Debit CreditDepreciation expense

100100 100100

Debit CreditAccumulated depreciation

100100

Chapter 3-25

Depreciation (Statement Presentation)Accumulated Depreciation—is a contra asset account.

Appears just after the account it offsets (Equipment) on the balance sheet.

Balance Sheet Jan. 31Assets

Equipment 24,000 Accumulated Depreciation (100) Net Equipment 23,900

Chapter 3-26

Receipt of cash that is recorded as a liability because Receipt of cash that is recorded as a liability because the revenue has not been earned.the revenue has not been earned.

Adjusting Entries for “Unearned Revenues”Adjusting Entries for “Unearned Revenues”Adjusting Entries for “Unearned Revenues”Adjusting Entries for “Unearned Revenues”

rentrentairline ticketsairline ticketsschool tuitionschool tuition

Cash ReceiptCash Receipt Revenue RecordedRevenue RecordedBEFORE

magazine subscriptionsmagazine subscriptionscustomer depositscustomer deposits

Unearned revenues often occur in regard to:Unearned revenues often occur in regard to:

Chapter 3-27

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.

Chapter 3-28 LO 5 LO 5 Prepare adjusting entries for deferrals.Prepare adjusting entries for deferrals.

Illustration 3-10Adjusting entries for unearned revenues

Decrease (a debit) to a liability account and

Increase (a credit) to a revenue account.

Chapter 3-29

Example:Example: On Jan. 1On Jan. 1stst, Phoenix Consulting received $24,000 , Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. from Arcadia High School for 3 months rent in advance. Show the journal entry to record the receipt on Jan. 1Show the journal entry to record the receipt on Jan. 1stst. .

Unearned rent revenue 24,000Cash 24,000Jan. 1

Debit CreditCash

24,00024,000 24,00024,000

Debit CreditUnearned Rent Revenue

Chapter 3-30

Example:Example: On Jan. 1On Jan. 1stst, Phoenix Consulting received $24,000 , Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. from Arcadia High School for 3 months rent in advance. Show the Show the adjusting journal entryadjusting journal entry required on Jan. 31 required on Jan. 31stst. .

Rent revenue 8,000Unearned rent revenue 8,000Jan. 31

Debit CreditRent Revenue

8,0008,000 24,00024,000

Debit CreditUnearned Rent Revenue

8,0008,000

16,00016,000

Chapter 3-31

Made to record:

Revenues earned and

Expenses incurred

in the current accounting period that have not been recognized through daily entries.

Adjusting Entries for AccrualsAdjusting Entries for AccrualsAdjusting Entries for AccrualsAdjusting Entries for Accruals

LO 6 LO 6 Prepare adjusting entries for accruals.Prepare adjusting entries for accruals.

Chapter 3-32

Revenues earned but not yet received in cash or Revenues earned but not yet received in cash or recorded.recorded.

Adjusting Entries for “Accrued Revenues”Adjusting Entries for “Accrued Revenues”Adjusting Entries for “Accrued Revenues”Adjusting Entries for “Accrued Revenues”

rentrentinterestinterestservices performedservices performed

BEFORE

Accrued revenues often occur in regard to:Accrued revenues often occur in regard to:

Cash ReceiptCash ReceiptRevenue RecordedRevenue Recorded

Adjusting entry results in:Adjusting entry results in:

Chapter 3-33

Accrued Revenues

An adjusting entry serves two purposes:

(1) It shows the receivable that exists, and

(2) It records the revenues earned.

Chapter 3-34

Illustration 3-13Adjusting entries for accrued revenues

Increases (debits) an asset account and

Increases (credits) a revenue account.

Chapter 3-35

Example:Example: On Jan. 1On Jan. 1stst, Phoenix Consulting invested , Phoenix Consulting invested $300,000 in securities that return 5% interest per year. $300,000 in securities that return 5% interest per year. Show the journal entry to record the investment on Jan. 1Show the journal entry to record the investment on Jan. 1stst. .

Cash 300,000Investments 300,00

0Jan. 1

Debit CreditInvestments

300,000300,000 300,000300,000

Debit CreditCash

Chapter 3-36

Example:Example: On Jan. 1On Jan. 1stst, Phoenix Consulting invested , Phoenix Consulting invested $300,000 in securities that return 5% interest per year. $300,000 in securities that return 5% interest per year. Show the Show the adjusting journal entryadjusting journal entry required on Jan. 31 required on Jan. 31stst. . ($300,000 x 5% / 12 months = $1,250)($300,000 x 5% / 12 months = $1,250)

Interest revenue 1,250Interest receivable 1,250Jan. 31

Debit CreditInterest Receivable

1,2501,250 1,2501,250

Debit CreditInterest Revenue

Chapter 3-37

Expenses incurred but not yet paid in cash or Expenses incurred but not yet paid in cash or recorded.recorded.

Adjusting Entries for “Accrued Expenses”Adjusting Entries for “Accrued Expenses”Adjusting Entries for “Accrued Expenses”Adjusting Entries for “Accrued Expenses”

rentrentinterestinterest

BEFORE

Accrued expenses often occur in regard to:Accrued expenses often occur in regard to:

Cash PaymentCash PaymentExpense RecordedExpense Recorded

taxestaxessalariessalaries

Adjusting entry results in:Adjusting entry results in:

Chapter 3-38

Accrued Expenses

(1) It records the obligations, and

(2) It recognizes the expenses.

Chapter 3-39

Illustration 3-16Adjusting entries for accrued expenses

Increases (debits) an expense account and

Increases (credits) a liability account.

Chapter 3-40

Notes payable 200,000Cash 200,00

0Jan. 2

Debit CreditCash

200,000200,000 200,000200,000

Debit CreditNotes Payable

Example:Example: On Jan. 2On Jan. 2ndnd, Phoenix Consulting borrowed $200,000 , Phoenix Consulting borrowed $200,000 at a rate of 9% per year. Interest is due on first of each 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. month. Show the journal entry to record the borrowing on Jan. 22ndnd..

Chapter 3-41

Example:Example: On Jan. 2On Jan. 2ndnd, Phoenix Consulting borrowed $200,000 , Phoenix Consulting borrowed $200,000 at a rate of 9% per year. Interest is due on first of each at a rate of 9% per year. Interest is due on first of each month. Show the month. Show the adjusting journal entryadjusting journal entry required on Jan. 31 required on Jan. 31stst. . ($200,000 x 9% / 12 months = $1,500)($200,000 x 9% / 12 months = $1,500)

Interest payable 1,500Interest expense 1,500Jan. 31

Debit CreditInterest Expense

1,5001,500 1,5001,500

Debit CreditInterest Payable

Chapter 3-42

Accrued Expenses

(1) It records the obligations, and

(2) it recognizes the expenses.

Chapter 3-43

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.

The Adjusted Trial BalanceThe Adjusted Trial BalanceThe Adjusted Trial BalanceThe Adjusted Trial Balance

LO 7 LO 7 Describe the nature and purpose of an adjusted trial balance.Describe the nature and purpose of an adjusted trial balance.

Chapter 3-44

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.

ReviewReview

Chapter 3-45

Financial Statements are prepared directly from the Adjusted Trial Balance. Financial Statements are prepared directly from the Adjusted Trial Balance.

Balance Sheet

Income Statement

Statement of Cash Flows

Statement of

Retained Earnings

Preparing Financial StatementsPreparing Financial StatementsPreparing Financial StatementsPreparing Financial Statements

Chapter 3-46

Income StatementFor the Month Ended Jan. 31,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

Adjusted Trial Balance Debit CreditCash 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$

Chapter 3-47

Statement of Owners' EquityFor the Month Ended Jan. 31,

Austin, Capital, Jan. 1 40,000$ + Net income 143,650 - Drawings 0Austin, Capital, Jan. 31 183,650$

Statement of Owners’ Equity

423,850$ 423,850$

Chapter 3-48

423,850$ 423,850$

Balance Sheet Jan. 31Assets

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 & Owners' 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$

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