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Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 1 of 23 Chapter 3 The Adjusting Process.

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Presentation on theme: "Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 1 of 23 Chapter 3 The Adjusting Process."— Presentation transcript:

1 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 1 of 23 Chapter 3 The Adjusting Process

2 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 2 of 23 Accrual Accounting Versus Cash-Basis Accounting Accrual Basis Revenues recognized when earned Expenses recognized when incurred Cash Basis Revenues recognized when cash received Expenses recorded when cash paid Not GAAP

3 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 3 of 23 Accrual vs. Cash-Basis: Revenue

4 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 4 of 23 Accrual vs. Cash-Basis: Revenue Cash-basis revenue transactions Accrual basis revenue transactions

5 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 5 of 23 Accrual vs. Cash-Basis: Expenses

6 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 6 of 23 Accrual vs. Cash-Basis Accounting Accrual basis Cash-basis

7 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 7 of 23 S3-2: COMPARING ACCRUAL AND CASH-BASIS ACCOUNTING The Johnny Flowers Law Firm uses a client database. Suppose Johnny Flowers paid $2,900 for a computer. Requirements: 1. Describe how the business should account for the $2,900 expenditure under a.the cash basis. b. the accrual basis.

8 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 8 of State why the accrual basis is more realistic for this situation. S3-2: COMPARING ACCRUAL AND CASH-BASIS ACCOUNTING

9 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 9 of 23 Accounting Period Concept Businesses prepare financial statements for specific periods to evaluate performance Basic accounting period = one year Interim periods

10 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 10 of 23 Revenue Recognition Principle When to record revenue? –When it is earned The amount of revenue to recorded? –Value of item or service transferred to customer

11 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 11 of 23 Recording Revenue: The Revenue Recognition Principle

12 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 12 of 23 The Matching Principle Measure all expenses incurred during the period Match the expenses against the revenues earned during the same period

13 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 13 of 23 The Time-Period Concept Requires that accounting information be reported at regular intervals Accounts are updated at the end of each accounting period

14 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 14 of 23 Time-Period Concept On May 31, Smart Touch recorded salary expense of $900 that is owed to an employee at the end of the month.

15 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 15 of 23 Adjusting Entries

16 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 16 of 23 Adjusting Entries Prepared at end of an accounting period Assigns: –Revenues to the period when earned –Expenses to the period when incurred Update asset and liability accounts Need to properly match revenues and expenses to measure: –Net Income –Assets and Liabilities

17 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 17 of 23 Adjusting Entry Rules Never involve the cash account Either increase revenue or increase an expense When worded as “accrued”, journalize the stated amount

18 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 18 of 23 Types of Adjusting Entries Prepaid expenses Depreciation Accrued expenses Accrued revenues Unearned revenues

19 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 19 of 23 Prepaid Expenses Advance payments of expenses Recorded as an asset Adjusting entry records amount used as an expense

20 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 20 of 23 Prepaid Expense: Rent

21 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 21 of 23 Depreciation Plant assets –Long-lived tangible assets used in business operations Depreciation –Allocation of a plant asset’s cost to expense over its useful life

22 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 22 of 23 Depreciation Entry

23 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 23 of 23 Accumulated Depreciation Contra asset Holds sum of all depreciation recorded on a plant asset Book value

24 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 24 of 23 Depreciation Posting

25 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 25 of 23 Accrued Expenses Expenses incurred before payment is made Opposite of a prepaid expense

26 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 26 of 23 Accrued Expense Entries

27 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 27 of 23 Accrued Revenues Revenue earned before cash is received Results in a receivable

28 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 28 of 23 Unearned Revenue Cash is collected before revenue is earned Also called deferred revenue BEFORE

29 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 29 of 23 Unearned Revenue Entries

30 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 30 of 23 Summary of Adjusting Entries To properly measure net income for the period To update the balance sheet

31 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 31 of 23 Summary of Adjusting Entries Category of Adjusting EntryDebitCredit Prepaid expenseExpenseAsset DepreciationExpenseContra asset Accrued expenseExpenseLiability Accrued revenueAssetRevenue Unearned revenueLiabilityRevenue

32 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 32 of 23 S3-5: IDENTIFYING TYPES OF ADJUSTING ENTRIES A select list of transactions for Anuradha’s Goals follows: Apr 1Paid six months of rent, $4, Received $1,200 from customer for six-month service contract that began April Purchased computer for $1,000. Requirement: 1. For each transaction, identify what type of adjusting entry would be needed.

33 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 33 of 23 S3-5: IDENTIFYING TYPES OF ADJUSTING ENTRIES A select list of transactions for Anuradha’s Goals follows: Apr 18 Purchased $300 of office supplies on account. 30 Work performed but not yet billed to customer, $ Employees earned $600 in salary that will be paid May 2.

34 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 34 of 23 E3-22: JOURNALIZING ADJUSTING ENTRIES AND ANALYZING THEIR EFFECT ON THE INCOME STATEMENT The following data at January 31, 2012 is given for EBM, Inc. a. Depreciation, $500 b. Prepaid rent expired, $600 c. Interest expense accrued, $300 d. Employee salaries owed for Monday through Thursday of a five-day workweek; weekly payroll, $13,000 e. Unearned service revenue earned, $1,300 Requirement: 1. Journalize the adjusting entries needed on January 31, 2012.

35 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 35 of 23 E3-22: JOURNALIZING ADJUSTING ENTRIES AND ANALYZING THEIR EFFECT ON THE INCOME STATEMENT Journal DATE ACCOUNTS AND EXPLANATIONS POST. REF.DEBITCREDIT 2013 Adjusting Entries Jan31Depreciation expense Accumulated depreciation 31Rent expense Prepaid rent 31Interest expense Interest payable 31Salary expense Salary payable 31Unearned service revenue Service revenue

36 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 36 of 23 E3-22: JOURNALIZING ADJUSTING ENTRIES AND ANALYZING THEIR EFFECT ON THE INCOME STATEMENT 2. Suppose the adjustments made in Requirement 1 were not made. Compute the overall overstatement or understatement of net income as a result of the omission of these adjustments.

37 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 37 of 23 Adjusted Trial Balance Prepared after adjusting entries are posted Useful step in preparing financial statements Often appears on a work sheet

38 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 38 of 23

39 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 39 of 23 S3-10: PREPARING AN ADJUSTED TRIAL BALANCE

40 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 40 of 23

41 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 41 of 23 Income Statement

42 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 42 of 23 Statement of Retained Earnings

43 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 43 of 23 Balance Sheet

44 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 44 of 23 E3-25: PREPARING THE FINANCIAL STATEMENTS Refer to the adjusted trial balance in Exercise 3-21 for the month ended April 30, Requirements: 1.Prepare the income statement. 2. Prepare the statement of retained earnings. 3. Prepare the balance sheet.

45 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 45 of 23 E3-21: ADJUSTED TRIAL BALANCE

46 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 46 of 23 E3-25: PREPARING THE FINANCIAL STATEMENTS Jobs-4-U Employment Service, Inc. Income Statement Month Ended April 30, 2012 Revenue: Service revenue$ 10,600 Expenses: Salary expense$ 3,700 Rent expense1,000 Depreciation expense1,000 Supplies expense 500 Total expenses 6,200 Net income$ 4,400

47 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 47 of 23 E3-25: PREPARING THE FINANCIAL STATEMENTS Jobs-4-U Employment Service, Inc. Statement of Retained Earnings Month Ended April 30, 2012 Retained earnings, March 31, 2012$ 10,300 Net income 4,400 17,900 Dividends 4,800 Retained earnings, April 30, 2012$ 9,900

48 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 48 of 23 Jobs-4-U Employment Service, Inc. Balance Sheet April 30, 2012 AssetsLiabilities Cash$ 900Salary payable$ 1,200 Accounts receivable5,600 Supplies500Stockholders’ Equity Equipment$32,500Common stock13,000 Accu. Depr. (15,400)17,100Retained earnings9,900 Total stockholders’ equity22,900 Total assets$24,100 Total liabilities and stockholders’ equity$24,100 E3-25: PREPARING THE FINANCIAL STATEMENTS

49 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 49 of 23 Alternative Treatment of Prepaid Expenses Prepaid Expenses (normally) –Advance payments of expenses –Debit an asset account –Adjust at end of period Alternative –Debit an expense account –Adjust at end of period

50 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 50 of 23 Prepaid Expense Initially debit and expense account Adjust at end of period for unused amount

51 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 51 of 23 Unearned (Deferred) Revenues Unearned Revenues (normally) –Advance receipt of revenues–creates liability –Credit a liability account –Adjust at end of period Alternative –Credit a revenue account –Adjust at end of period

52 Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3 rd ed. Pearson Slide 52 of 23 Unearned (Deferred) Revenues Initially credit a revenue account Adjust at end of period for unearned amount


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