Presentation on theme: "Adjustments Financial statements need to be accurate. Adjustments are accounting changes recorded to make sure that all account balances are correct."— Presentation transcript:
1Chapter 6 Unit 11 - Completing the Accounting Cycle for a Service Business
2AdjustmentsFinancial statements need to be accurate. Adjustments are accounting changes recorded to make sure that all account balances are correct.
3Adjusting the BooksLet’s say that some workers worked overtime or received bonuses but they were not recorded. Expenses would be too low and salaries payable (liability) would be too low. It is necessary for an adjusting entry to be made to adjust the amount in these accounts to reflect the correct amount.
4Prepaid ExpensesPrepaid expenses are expenses that are paid for in advance. They are classified as current assets (since you have already paid them – it becomes an asset – it is now an item of value to the company). Examples: prepaid rent, insurance, and supplies).
5Prepaid ExpensesWhen a prepaid item is used up (ex. prepaid rent) the value needs to move out of asset (since it is not longer an item of value because we just used it up) and into an expense account. We do this by recording an adjusting entry.
6Prepaid ExpensesAt the end of an accounting period entries are made to record the conversion of prepaid assets to expenses, to correct the balances for the balance sheet, and to record the appropriate expenses for the period on the income statement. These entries are called adjusting entries.
7Prepaid RentCool Company is required to pay for three months rent at a time. This was something in the lease agreement that was signed when they moved into the space they are renting.Each months rent is $1 700, so every three months they write a cheque for $5 100 (paying in advance for three months rent$1 700*3=$5 100).
8Prepaid RentSince they are paying for something they have not used yet we are not going to put this into an expense account – it is going to go into a prepaid rent account.
12SuppliesThis is another prepaid account. When a company purchases supplies they are not all used up in one day – but at the end of the month there are a lot less supplies than at the beginning of the month (if no new supplies were purchased).
13Say Cool Company buys $700 worth of supplies sometime in April.
14SuppliesEvery day small amounts of supplies are used up (paper, pens, staples, tape, etc.).It would be a full time job and very unnecessary for someone to record each time a piece of paper was used, but we do have to account for it sometime.We account for all of the supplies that were used up at the end of a fiscal period (each month).
15SuppliesTo figure out how much you have to adjust for in the supplies account at the end of the month you first need to see how much supplies you still have.
16SuppliesCool Company estimated to have $600 worth of supplies left at the end of April so we figure out that we need to make an adjusting entry for $100 worth of supplies that were used up (we don’t have any longer).Amount we started with $700Amount we have left $600Amount to adjust $100
20Prepaid InsuranceAt the end of the month (April), one month’s insurance has been used up and must be recorded as an expense.To figure out the amount that needs to be recorded take the total and divide it by 12 since there are twelve months in a year.$720/12 = $60 each month
22DepreciationCool Company purchased office equipment for $ on April 14. Examples of office equipment include machines used to run the business, calculators, computers, fax machines, photocopiers, etc. We would record the following transaction:
24DepreciationExpenses are the cost of items used to produce revenue for a business. If you purchase a piece of equipment that you will use to run your business as you use it it becomes an expense to the business.
25DepreciationExample: Cool Company buys a photocopier for $ that it will use for five years and then it will probably be worthless. However, the equipment doesn’t all of a sudden at the end of five years become worthless – it loses some of its value each year. A portion of the cost of the equipment should be assigned or allocated as an expense each year.
26DepreciationThe matching principle states that revenue and expenses need to be matched up in the period they occur and this goes along with this principle.They are using up some of the equipment that they will use to create revenue for the company.
27Recording Depreciation Depreciation is the allocation of the cost of a fixed asset to the fiscal period in which it is used. Depreciation is an expense and will appear on the income statement.To figure out the amount of depreciation you take the amount you paid for it and subtract what you think you can get for it and then divide it by the number of years you think you will use it for.
28Recording Depreciation In our case we don’t think we can get anything for the equipment at the end of the five years (it will be useless – no scrap value or trade-in value). So we take the amount we paid for it and divide it by the five years we think we will be able to use it for. $12 000/5years = $2 400 each year.
29Recording Depreciation The entry to record the depreciation of the equipment at the end of the first year is:
30Recording Depreciation Depreciation Expense – Equipment – appears on the income statement in the expense section.Accumulated Depreciation – Equipment – appears on the balance sheet in the fixed asset section.Accumulated Depreciation is deducted from equipment (to more accurately reflect the assets of the business)
31Recording Depreciation On a balance sheet you would see:
32Recording Depreciation Depreciation is a method of spreading the cost of a fixed asset over the life of that asset.Each fixed asset will have its own depreciation expense and accumulated depreciation account (that is why this one has Equipment after it). You can also use this for building, trucks, machines, etc.
33Accumulated Depreciation Accumulated depreciation is a “contra account”.This is an account that offsets the value of another account.In this case the accumulated depreciation – equipment account brought down the value of the equipment account.
34Accumulated Depreciation Book value is the cost of an asset minus the accumulated depreciation.Here the book value would be $9 600
35Methods of Calculating Depreciation There are two common ways to calculate depreciation :1. Straight –line method (this is the method I used in the previous slides)2. Declining-balance method, fixed percentage
36Straight Line MethodThis method allocates the same amount of depreciation each fiscal period (ex. each year)To figure out the amount of depreciation you take the amount you paid for it and subtract what you think you can get for it and then divide it by the number of years you think you will use it for.
37Straight Line MethodOriginal cost – salvage value = total amount you use for depreciationTotal amount you use for depreciation/ number of years or months you will use it = amount to depreciate each year or month
38Declining-Balance Method, Fixed Percentage This method allocates a great amount of depreciation to the first years of an assets life.Some would say this is more accurate (think of a car – it looses it’s value the most in the first few years).Each year you are going to have a different amount to depreciate.You calculate this by taking a percentage of the book value.