Adjusting Adjusting Accounts for Accounts for
Financial Financial StatementsStatements
PowerPoint Slides to accompanyFundamental Accounting Principles, 14ce
Prepared byJoe Pidutti, Durham College
CHAPTER
3
1. Describe the purpose of adjusting accounts at the end of the period. (LO1)
2. Explain how the timeliness, matching, and revenue recognition principles affect the adjusting process. (LO2)
3. Explain accrual accounting and cash basis accounting and how accrual accounting adds to the usefulness of financial statements. (LO3)
Learning ObjectivesLearning Objectives
2 © 2013 McGraw-Hill Ryerson Limited.
4. Prepare and explain adjusting entries for prepaid expenses, depreciation, unearned revenues, accrued expenses, and accrued revenues. (LO4)
5. Explain how accounting adjustments link
to financial statements. (LO5)6. Explain and prepare an adjusted trial
balance. (LO6)
Learning ObjectivesLearning Objectives
3 © 2013 McGraw-Hill Ryerson Limited.
7. Prepare financial statements from an
adjusted trial balance. (LO7)8. Explain and prepare correcting entries.
(Appendix 3A) (LO8)9. Identify and explain an alternative in
recording prepaids and unearned
revenues. (Appendix 3B) (LO9)
Learning ObjectivesLearning Objectives
4 © 2013 McGraw-Hill Ryerson Limited.
Prepare post-closingtrial balance
Journalize
Close
Prepareunadjusted trial balance
Post
Analyzetransactions
Prepare adjusted
trial balance
Prepare statements
Adjust
2
3
4
6
8
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The Accounting CycleThe Accounting Cycle
5
LO 1
7
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Financial information must be timely and accurate to be useful to decision makers.
• Financial statements need to be prepared at regular intervals (periods).
• Accounts need to be adjusted (updated) to ensure all revenues, expenses,
assets, and liabilities are recorded.
Adjusting the AccountsAdjusting the Accounts
LO 16 © 2013 McGraw-Hill Ryerson Limited.
Adjustments are based on three generally accepted accounting principles:• Timeliness principle.• Revenue recognition principle.• Matching principle.
GAAP and the Adjusting ProcessGAAP and the Adjusting Process
LO 27 © 2013 McGraw-Hill Ryerson Limited.
Timeliness Principle Assumes that the organization’s activities can be
divided into specific time periods such as:• Months• Quarters• Years
Requires that financial statements be presented at least annually.
Accounting PrinciplesAccounting Principles
LO 28 © 2013 McGraw-Hill Ryerson Limited.
Revenue Recognition Principle Revenue is recognized (reported) in the time
period when it is earned regardless when the cash is received.
Matching Principle Expenses are to be matched in the same
accounting period as the revenues they helped to earn.
Accounting PrinciplesAccounting Principles
9 LO 2© 2013 McGraw-Hill Ryerson Limited.
Accrual Basis• Revenues and expenses are recognized
when earned or incurred regardless of when cash is received or paid.
• Consistent with GAAP.
Cash Basis• Revenues and expenses are recognized
when cash is received or paid.• Not consistent with GAAP.
Cash vs. Accrual BasisCash vs. Accrual Basis
LO 310 © 2013 McGraw-Hill Ryerson Limited.
Adjusting AccountsAdjusting Accounts
• Accounts are adjusted at the end of each accounting period to bring an asset or liability account to its proper amount.
• Adjusting entries also update the related expense or revenue accounts.
• These adjustments are necessary for the preparation of financial statements.
LO 411 © 2013 McGraw-Hill Ryerson Limited.
Types:• Prepaid expenses• Depreciation• Unearned revenues• Accrued expenses• Accrued revenues
AdjustmentsAdjustments
12 LO 4© 2013 McGraw-Hill Ryerson Limited.
• Costs paid in advance of receiving their benefits.
• They are recorded as assets.• As these assets are used, their costs
become expenses.• These costs expire with the passage of
time or through use and consumption, e.g., insurance, supplies.
Prepaid ExpensesPrepaid Expenses
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Prepaid Expenses–Example
On January 1, a company purchases an insurance policy that covers three months and costs $1,800.
• The policy will benefit the company for three months and will be expired at the end of three months.
• The cost of the policy should be spread over the time period it benefits the organization. (matching principle).
$600 $600 $600
$1,800January February March
14 LO 4© 2013 McGraw-Hill Ryerson Limited.
Prepaid InsuranceJan. 1 1,800 1,800
Cash
$600 $600 $600
$1,800January February March$
1,800
$1,800
The entry to record the purchase of the insurance policy would be: Prepaid Insurance 1,800
Cash 1,800
15 LO 4
Prepaid Expenses–Example
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Prepaid Insurance Insurance ExpenseJan. 1 1,800Jan.31 600 600balance 1,200
$600 $600 $600
$1,800January February March
$1,800
$1,800
The entry to record the expiry of the insurance for January would be: Insurance Expense 600
Prepaid Insurance 600
16 LO 4
Prepaid Expenses–Example
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Prepaid Insurance Insurance ExpenseJan. 1 1,800Jan.31 600 600Feb.28 600 600balance 600
$600 $600 $600
$1,800January February March
$1,800
$1,800
The entry to record the expiry of the insurance for February would be: Insurance Expense 600
Prepaid Insurance 600
17 LO 4
Prepaid Expenses–Example
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Prepaid Insurance Insurance ExpenseJan. 1 1,800Jan.31 600 600Feb.28 600 600Mar.31 600 600balance 0
$600 $600 $600
$1,800January February March$
1,800
$1,800
The entry to record the expiry of the insurance for March would be: Insurance Expense 600
Prepaid Insurance 600
18 LO 4
Prepaid Expenses–Example
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• Companies acquire assets such as equipment, buildings, vehicles, and patents to generate revenues.
• These assets are expected to provide benefits for more than one accounting period.
• Depreciation is the process of allocating the costs of assets over their expected useful lives.
DepreciationDepreciation
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• Depreciation is based on the matching principle where the cost of an asset is matched over the time the asset helped earn the revenue.
Straight-LineDepreciationExpense
= Asset cost – Estimated residual value
Estimated useful life
DepreciationDepreciation
20 LO 4© 2013 McGraw-Hill Ryerson Limited.
Depreciation - Example
On January 1, 2014, a company purchased a piece of equipment for $72,000. The equipment is expected to have a useful life of four years and have a residual value of $8,000.
= $72,000 - $8,000
4 years
= $16,000/year
Straight-LineDepreciationExpense
= Asset cost – Estimated residual value
Estimated useful life
21 LO 4© 2013 McGraw-Hill Ryerson Limited.
Depreciation - Example
Cash72,000 1/1/14 72,000
Equipment
The entry to record the purchase of the equipment would be:
Equipment 72,000 Cash 72,000
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Depreciation - Example
Depreciation Expense,Depreciation, Equipment
16,000 12/31/14 16,000Equipment
Accumulated
The entry to record Depreciation at the end of the first year would be:
Depreciation Expense, Equipment 16,000 Accumulated Depreciation, Equip. 16,000
23 LO 4© 2013 McGraw-Hill Ryerson Limited.
Depreciation - Example
Depreciation Expense,Depreciation, Equipment
12/31/14 16,00016,000 12/31/15 16,000
balance 32,000
EquipmentAccumulated
The entry to record Depreciation at the end of the second year would be:
Depreciation Expense, Equipment 16,000 Accumulated Depreciation, Equip. 16,000
24 LO 4© 2013 McGraw-Hill Ryerson Limited.
Depreciation - Example
Depreciation Expense,Depreciation, Equipment
12/31/14 16,00012/31/15 16,000
16,000 12/31/16 16,000balance 48,000
EquipmentAccumulated
The entry to record Depreciation at the end of the third year would be:
Depreciation Expense, Equipment 16,000 Accumulated Depreciation, Equip. 16,000
25 LO 4© 2013 McGraw-Hill Ryerson Limited.
Depreciation - Example
Depreciation Expense,Depreciation, Equipment
12/31/14 16,00012/31/15 16,00012/31/16 16,000
16,000 12/31/17 16,000balance 64,000
EquipmentAccumulated
The entry to record Depreciation at the end of the fourth year would be:
Depreciation Expense, Equipment 16,000 Accumulated Depreciation, Equip. 16,000
26 LO 4© 2013 McGraw-Hill Ryerson Limited.
Depreciation - Example
2014 2015 2016 2017Equipment $72,000 $72,000 $72,000 $72,000 Less: Accumulated Depreciation 16,000 32,000 48,000 64,000Equipment-net $56,000 $40,000 $24,000 $8,000
Partial Balance SheetDecember 31
Depreciation, Equipment72,000 01/01/14
12/31/14 16,00012/31/15 16,00012/31/16 16,00012/31/17 16,000
EquipmentAccumulated
27 LO 4© 2013 McGraw-Hill Ryerson Limited.
Cash received in advance of providing products and services.• The company has an obligation to provide
goods or services.• Unearned revenues are liabilities.• As products and services are provided, the
amount of unearned revenues becomes earned revenues.
Unearned RevenuesUnearned Revenues
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Unearned Revenues — Example
On March 1, a company received a $12,000 payment from a customer for maintenance services to be provided over the next two months.
Unearned Revenue12,000 Mar.1 12,000
Cash
The entry to record the receipt of cash would be: Cash 12,000
Unearned Revenue 12,000
29 LO 4© 2013 McGraw-Hill Ryerson Limited.
Unearned Revenues - Example
On March 31, $6,000 of this revenue had been earned.
Maintenance Revenue12,000 Mar.1
6,000 Mar.31 6,0006,000 balance
Unearned Revenue
The entry to record the earned revenue would be: Unearned Revenue 6,000 Maintenance Revenue 6,000
$12,000/2months= $6,000/month
30 LO 4© 2013 McGraw-Hill Ryerson Limited.
Unearned Revenues - Example
By April 30, another $6,000 of this unearned revenue had been earned.
Maintenance Revenue12,000 Mar.1
6,000 Mar.31 6,0006,000 Apr.30 6,000
0 balance
Unearned Revenue
The entry to record the earned revenue would be: Unearned Revenue 6,000 Maintenance Revenue 6,000
$12,000/2months= $6,000/month
31 LO 4© 2013 McGraw-Hill Ryerson Limited.
Costs incurred in a period that are both unpaid and unrecorded. • Adjusting entries must be made to record the
expense for the period and the related liability at the balance sheet date.
• Examples: interest, wages, rent, taxes
Accrued ExpensesAccrued Expenses
32 LO 4© 2013 McGraw-Hill Ryerson Limited.
Accrued Expenses - Example
On December 31, $1,200 of interest has accrued on a company’s bank loan. The payment of the interest is not due until January 1.
The December 31 entry to record the accrued interest would be:
Interest Expense 1,200 Interest Payable 1,200
33 LO 4© 2013 McGraw-Hill Ryerson Limited.
Accrued Expenses - Example
In December, a company incurred $3,700 of utilities expense. The company had not received the utility bill at December 31.
The December 31 entry to record the accrued utilities expense would be:
Utilities Expense 3,700 Accounts Payable 3,700
34 LO 4© 2013 McGraw-Hill Ryerson Limited.
Revenues earned in a period that are both unrecorded and not yet received in cash.• Adjusting entries must be made to record the
revenue for the period and the related asset at the balance sheet date.
• Examples: fees earned, interest earned, rent earned
Accrued RevenuesAccrued Revenues
35 LO 4© 2013 McGraw-Hill Ryerson Limited.
Accrued Revenues - Example
On December 31, $16,500 of consulting fees have been earned but have not been recorded or billed to the client.
The entry to record the accrued consulting fees earned would be:
Accounts Receivable 16,500 Consulting Fees Earned 16,500
36 LO 4© 2013 McGraw-Hill Ryerson Limited.
• Adjustments are only made when financial statements are prepared.
• Affect both the income statement and the balance sheet.
• Do not affect cash.
Adjustments & Financial Adjustments & Financial StatementsStatements
LO 537 © 2013 McGraw-Hill Ryerson Limited.
Q If the year-end adjusting entry to record accrued wages was not recorded, how would this affect the company’s financial statements? Would the balance sheet balance?
A Wages expense-understatedNet income-overstated
Equity-overstatedWages payable-understatedThe balance sheet would balance since liabilities would be overstated and equity would be understated.
Mini-QuizMini-Quiz
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Unadjusted Trial Balance• A listing of accounts and balances that is
prepared before adjustments are recorded.
Adjusted Trial Balance• A listing of accounts and balances that is
prepared after adjustments are recorded and posted to the ledger.
• It is used to prepare financial statements.
Trial BalanceTrial Balance
LO 639 © 2013 McGraw-Hill Ryerson Limited.
• Adjusting entries bring the accounts up-to-date.• The adjusted trial balance is used to prepare the
financial statements in the following order:• Income Statement• Statement of Changes in Equity• Balance Sheet• Statement of Cash Flows
Financial Statement PreparationFinancial Statement Preparation
LO 740 © 2013 McGraw-Hill Ryerson Limited.
Q When and why are adjusting entries prepared?
A They are prepared when a company wishes to issue financial statements. Adjusting entries bring the account balances up-to-date.
ReviewReview
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End of ChapterEnd of Chapter
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