1. Chapter 3-1 CHAPTER 3 ADJUSTING THE ACCOUNTS Accounting Principles, Eighth Edition

2. Chapter 3-2 Also known as the “Periodicity Assumption” Timing Issues Accountants divide the economic life of a business into artificial time periods (Time Period Assumption). LO 1 Explain the time period assumption. Jan.Feb.Mar.Apr.Dec......

3. Chapter 3-3 Cash-Basis Accounting Revenues Expenses This is not in accordance with (GAAP). Timing Issues Accrual- vs. Cash-Basis Accounting LO 2 Explain the accrual basis of accounting.

4. Chapter 3-4 Accrual-Basis Accounting Transactions recorded Revenues are recognized Expenses are recognized Timing Issues Accrual- vs. Cash-Basis Accounting LO 2 Explain the accrual basis of accounting.

5. Chapter 3-5 Revenue Recognition Principle Timing Issues Recognizing Revenues and Expenses LO 2 Explain the accrual basis of accounting.

6. Chapter 3-6 Matching Principle Timing Issues Recognizing Revenues and Expenses LO 2 Explain the accrual basis of accounting. Match expenses “Let the expenses follow the revenues.”

7. Chapter 3-7 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 Entries LO 3 Explain the reasons for adjusting entries.

8. Chapter 3-8 Each adjusting entry usually affects: an income statement accountan income statement account one balance sheet accountone balance sheet account Revenues & Expenses - Adjusting entries- Adjusting entries - The Basics of Adjusting Entries LO 3 Explain the reasons for adjusting entries.

9. Chapter 3-9 Types of Adjusting Entries 1.Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed. Deferrals – 2 types 3. 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 – 2 types LO 4 Identify the major types of adjusting entries.

10. Chapter 3-10 Trial Balance Trial Balance – Each account is analyzed to determine whether it is complete and up-to-date. Trial Balance LO 4 Identify the major types of adjusting entries.

11. Chapter 3-11 Deferrals are either: Prepaid expenses OR Unearned revenues. Adjusting Entries for Deferrals LO 5 Prepare adjusting entries for deferrals.

12. Chapter 3-12 Payment of cash, that is recorded as an asset because service or benefit will be received in the future. Adjusting Entries for “Prepaid Expenses” Cash Payment Expense Recorded BEFORE LO 5 Prepare adjusting entries for deferrals. Prepayments often occur in regard to: Jan.Feb.Mar.Apr.Dec......

13. Chapter 3-13 Adjusting Entries for “Prepaid Expenses” LO 5 Prepare adjusting entries for deferrals. Adjusting entries for prepaid expenses Increases (debits) an expense account and Decreases (credits) an asset account. Prior to adjustment: assets are overstated and expenses are understated Prepaid Expenses - costs that expire with the passage of time/usage.

14. Chapter 3-14 Example (Insurance): On Jan. 1 st, Phoenix Consulting paid $12,000 for 12 months of insurance coverage. Show the journal entry to record the payment on Jan. 1 st. Jan. 1 DebitCredit Prepaid Insurance DebitCredit Cash Adjusting Entries for “Prepaid Expenses” LO 5 Prepare adjusting entries for deferrals.

15. Chapter 3-15 Example (Insurance): On Jan. 1 st, Phoenix Consulting paid $12,000 for 12 months of insurance coverage. Show the adjusting journal entry required at Jan. 31 st. Jan. 31 DebitCredit Prepaid Insurance DebitCredit Insurance Expense Adjusting Entries for “Prepaid Expenses” LO 5 Prepare adjusting entries for deferrals.

16. Chapter 3-16 DEPRECIATION - “reducing the value of an asset over time” is an Depreciation – what is it?

17. Chapter 3-17 Depreciation Applies to 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). By being able to record depreciation businesses essentially: (1) adjust/update the value of the asset and (2) increase in their expenses which reduces their Net Income which reduces… TAXES. Adjusting Entries for “Prepaid Expenses”

18. Chapter 3-18 “Real world” application We bought a new $8,500 computer 5 years ago and never recorded any depreciation expense, the balance sheet would still show an asset worth $8,500. Computers that old are not worth anywhere near that amount! At most, you'd be lucky to get a few hundred dollars for scrap. Recording depreciation allows us to reflect the current value of the asset/computers.

19. Chapter 3-19 Depreciation Book Value difference between the cost of any depreciable asset and its related accumulated depreciation this is NOT the same as market value

20. Chapter 3-20 Recording Depreciation Recording depreciation Debit Depreciation Expense Credit Accumulated Depreciation (contra asset)

21. Chapter 3-21 So why do we not record depreciation by crediting the asset account? Because this has the appearance that we have SOLD equipment. Using the Acc Dep account allows us to show a reduction in the value of the asset. Equipment $50,000$2,500

22. Chapter 3-22 Example (Depreciation): On Jan. 1 st, Phoenix Consulting paid $24,000 for equipment that has an estimated useful life of 20 years. Show the journal entry to record the purchase of the equipment on Jan. 1 st. Jan. 1 DebitCredit Equipment DebitCredit Cash Adjusting Entries for “Prepaid Expenses” LO 5 Prepare adjusting entries for deferrals.

23. Chapter 3-23 Example (Depreciation): On Jan. 1 st, Phoenix Consulting paid $24,000 for equipment that has an estimated useful life of 20 years. Show the adjusting journal entry required at Jan. 31 st. ($24,000 / 20 yrs. / 12 months = $100) Jan. 31 DebitCredit Depreciation Expense DebitCredit Accumulated Depreciation Adjusting Entries for “Prepaid Expenses” LO 5 Prepare adjusting entries for deferrals.

24. Chapter 3-24 Depreciation (Statement Presentation) Accumulated Depreciation is a contra asset account. Appears just after the account it offsets (Equipment) on the balance sheet. Adjusting Entries for “Prepaid Expenses” LO 5 Prepare adjusting entries for deferrals.

25. Chapter 3-25 Receipt of cash that is originally recorded as a liability because the revenue has not been earned. i.e. receiving a rent payment on the 1 st of the month Adjusting Entries for “Unearned Revenues” Cash Receipt Revenue Recorded BEFORE Unearned revenues often occur in regard to: LO 5 Prepare adjusting entries for deferrals.

26. Chapter 3-26 LO 5 Prepare adjusting entries for deferrals. Adjusting entries for unearned revenues Decrease (a debit) to a liability account and Increase (a credit) to a revenue account. Adjusting Entries for “Unearned Revenues” Illustration 3-10 Company makes an adjusting entry to record the revenue that has been earned and to show the liability that remains.

27. Chapter 3-27 Example: On Jan. 1 st, Phoenix Consulting received $24,000 from Arcadia High School for 12 months rent in advance. Show the journal entry to record the receipt on Jan. 1 st. Jan. 1 DebitCredit Cash DebitCredit Unearned Rent Revenue Adjusting Entries for “Unearned Revenues” LO 5 Prepare adjusting entries for deferrals.

28. Chapter 3-28 Example: On Jan. 1 st, Phoenix Consulting received $24,000 from Arcadia High School for 12 months rent in advance. Show the adjusting journal entry required on Jan. 31 st. Jan. 31 DebitCredit Rent Revenue DebitCredit Unearned Rent Revenue Adjusting Entries for “Unearned Revenues” LO 5 Prepare adjusting entries for deferrals.

29. Chapter 3-29 Types of Adjusting Entries 1.Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed. Deferrals – 2 types 3. 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 – 2 types LO 4 Identify the major types of adjusting entries.

30. Chapter 3-30 Made to record: Revenues earned OR Expenses incurred in the current accounting period that have not been recognized through daily entries. Adjusting Entries for Accruals LO 6 Prepare adjusting entries for accruals.

31. Chapter 3-31 Revenues earned but not yet received in cash or recorded. i.e. we lend someone some money and they owe us interest that has not yet been paid because it is due only at the end of the year. i.e. We mow a lawn, then say “Pay me later” Adjusting Entries for “Accrued Revenues” Rent,interest, services performed BEFORE Accrued revenues often occur in regard to: Cash Receipt Revenue Recorded Adjusting entry results in: LO 6 Prepare adjusting entries for accruals. Jan.Feb.Mar.Apr.Dec......

32. Chapter 3-32 Accrued Revenues An adjusting entry serves two purposes: (1) It shows the receivable that exists, and (2) It records the revenues earned. Adjusting Entries for “Accrued Revenues” LO 6 Prepare adjusting entries for accruals.

33. Chapter 3-33 Adjusting entries for accrued revenues Increases (debits) an asset account and Increases (credits) a revenue account. LO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Revenues” Illustration 3-13

34. Chapter 3-34 Example: On Jan. 1 st, Phoenix Consulting invested $300,000 in securities that return 5% interest per year. Show the journal entry to record the investment on Jan. 1 st. Jan. 1 LO 6 Prepare adjusting entries for accruals. DebitCredit Investments DebitCredit Cash Adjusting Entries for “Accrued Revenues”

35. Chapter 3-35 Example: On Jan. 1 st, Phoenix Consulting invested $300,000 in securities that return 5% interest per year. Show the adjusting journal entry required on Jan. 31 st. ($300,000 x 5% x 1/12 year = $1,250) Jan. 31 DebitCredit Interest Receivable DebitCredit Interest Revenue Adjusting Entries for “Accrued Revenues” LO 6 Prepare adjusting entries for accruals. I=P x R x T

36. Chapter 3-36 Expenses incurred but not yet paid in cash or recorded. i.e. Our employee has earned their quarterly bonus… but we have NOT paid them yet. i.e. quarterly taxes we are to pay but have not recorded on our books yet Adjusting Entries for “Accrued Expenses” rentinterest BEFORE Accrued expenses often occur in regard to: Cash Payment Expense Recorded taxes Salaries bonuses Adjusting entry results in: LO 6 Prepare adjusting entries for accruals.

37. Chapter 3-37 Accrued Expenses An adjusting entry serves two purposes: (1) It records the obligations, and (2) It recognizes the expenses. Adjusting Entries for “Accrued Expenses” LO 6 Prepare adjusting entries for accruals.

38. Chapter 3-38 Adjusting entries for accrued expenses Increases (debits) an expense account and Increases (credits) a liability account. LO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Expenses” Illustration 3-16

39. Chapter 3-39 Jan. 2 DebitCredit Cash DebitCredit Notes Payable Example: On Jan. 2 nd, Phoenix Consulting borrowed $200,000 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. 2 nd. Adjusting Entries for “Accrued Expenses” LO 6 Prepare adjusting entries for accruals.

40. Chapter 3-40 Example: On Jan. 2 nd, Phoenix Consulting borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the adjusting journal entry required on Feb 28th. ($200,000 x 9% x 2/12 year = $1,500) Jan. 31 DebitCredit Interest Expense DebitCredit Interest Payable Adjusting Entries for “Accrued Expenses” LO 6 Prepare adjusting entries for accruals.

41. Chapter 3-41 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 Balance LO 7 Describe the nature and purpose of an adjusted trial balance.

42. Chapter 3-42 Trial Balance + Adjustments = Adjusted Trial Balance

43. Chapter 3-43 Financial Statements are prepared directly from the Adjusted Trial Balance. Balance Sheet Income Statement Statement of Cash Flows Owner’s Equity Statement Preparing Financial Statements LO 7 Describe the nature and purpose of an adjusted trial balance.