1. Managerial Accounting - 2.1 Measuring Business Income: The Adjusting Process Chapter 3

2. Managerial Accounting - 2.2 It’s Just Lunch ä Disappointed by blind dates and personal ads, – Andrea McGinty founded a prescreened lunch dating service.

3. Managerial Accounting - 2.3 It’s Just Lunch ä In 1996, the business earned revenues of $4.5 million. ä Also, the business earned a net income of $400,000. ä How was this number computed? ä Expenses were deducted from revenues to determine net income.

4. Managerial Accounting - 2.4 Chapter Objectives 1 Distinguish accrual-basis accounting from cash-basis accounting. 2 Apply the revenue and matching principles.

5. Managerial Accounting - 2.5 Chapter Objectives 3 Make adjusting entries at the end of the accounting period. 4 Prepare an adjusted trial balance. 5 Prepare the financial statements from the adjusted trial balance.

6. Managerial Accounting - 2.6 Distinguish accrual-basis accounting from cash-basis accounting. Objective 1

7. Managerial Accounting - 2.7 The Two Bases of Accounting: 1 Accrual-basis 2 Cash-basis

8. Managerial Accounting - 2.8 Accrual Basis ä Accountants record transactions... – when revenues are earned, – or when expenses are incurred, – regardless of when cash changes hands.

9. Managerial Accounting - 2.9 Cash Basis ä Accountants record transactions... – when cash is paid, – or when cash is received, – regardless of when a revenue is earned or an expense is incurred.

10. Managerial Accounting - 2.10 Remember GAAP? ä Generally Accepted Accounting Principles ä GAAP requires that a business use the accrual basis.

11. Managerial Accounting - 2.11 GAAP ä Accountants record revenues as they are earned... – and expenses as they are incurred, – not necessarily when cash is received or paid.

12. Managerial Accounting - 2.12 Accrual Accounting ä Using accrual accounting, Its’ Just Lunch records revenue when it sells dating services, not when it collects cash later. ä Likewise, It’s Just Lunch records expenses when incurred.

13. Managerial Accounting - 2.13 Example ä Salary expense not only includes amounts paid to employees, – it includes any amount owed to employees.

14. Managerial Accounting - 2.14 Dennis’ Landscaping ä Services performed during the month of July - $15,000. ä Cash collected from customers - $6,000. ä Expenses for the month - $12,000. ä Cash paid out - $9,000.

15. Managerial Accounting - 2.15 Cash Basis ä Revenues are the cash collected from customers - $6,000. ä Expenses are the cash paid out during the month - $9,000.

16. Managerial Accounting - 2.16 Cash Basis ä Dennis’ Landscaping lost $3,000 during the month of July.

17. Managerial Accounting - 2.17 Cash Basis ä Revenue: $15,000 Cash In: $6,000 Expenses: $12,000 Cash Out: $9,000 Dennis’ Landscaping Income Statement For the Month Ended July 31, 19xx Revenues $6,000 Expenses 9,000 Net Loss $3,000

18. Managerial Accounting - 2.18 Accrual Basis ä Revenues of $15,000 are recognized for the services performed during the month. ä Expenses are the $12,000 incurred during the month.

19. Managerial Accounting - 2.19 Accrual Basis ä Dennis’ Landscaping made a profit of $3,000.

20. Managerial Accounting - 2.20 Cash Accrual ä Dennis’ Landscaping Income Statement For the Month Ended July 31, 19xxRevenues $6,000 Expenses 9,000 Net Loss $3,000 ä Dennis’ Landscaping Income Statement For the Month Ended July 31, 19xxRevenues $15,000 Expenses 12,000 Net Income $ 3,000

21. Managerial Accounting - 2.21 Why Does GAAP Require the Accrual Basis? ä Because accrual accounting provides a more complete portrayal of operating performance and financial position.

22. Managerial Accounting - 2.22 Problems with Cash Basis ä Over or understatement of... – Revenue – Expense – Accounts receivable – Accounts payable

23. Managerial Accounting - 2.23 The Time Period Concept... – requires that accounting information be reported at regular intervals. – requires that income be measured accurately each period.

24. Managerial Accounting - 2.24 Accounting Period ä Managers adopt an artificial period of time to evaluate performance.

25. Managerial Accounting - 2.25 The Annual Accounting Period Can Be... – a calendar year (January 1st to December 31st), or – a fiscal year (any consecutive 12-month period).

26. Managerial Accounting - 2.26 Interim Period Statements... – are prepared for less than one year. ä Monthly ä Quarterly ä Semi-annually

27. Managerial Accounting - 2.27 Objective 2 Apply the revenue and matching principles.

28. Managerial Accounting - 2.28 Revenue Principle ä Revenue is recognized when it is deemed earned. ä Recognition of revenue and cash receipts do not necessarily occur at the same time. ä Cash could be received at the same time. ä Cash could be received after the earning. ä Cash could be received before the earning.

29. Managerial Accounting - 2.29 The Matching Principle... – is the basis for recording expenses. ä Expenses are the costs of assets and the increase in liabilities incurred in the earning of revenues.

30. Managerial Accounting - 2.30 Expense Recognition ä Expenses are recognized when the benefit from the expense is received. ä Recognition of expenses and cash payments do not necessarily occur at the same time.

31. Managerial Accounting - 2.31 The Time Period Concept... – allows businesses to report accounting information on a regular basis. – interacts with the revenue principle and the matching principle to underlie the use of accruals.

32. Managerial Accounting - 2.32 The Time Period Concept ä In order to measure income accurately, businesses update the revenue and expense accounts before the end of the period.

33. Managerial Accounting - 2.33 Objective 3 Make adjusting entries at the end of the accounting period.

34. Managerial Accounting - 2.34 Adjusting Entries ä At the end of the period accountants prepare financial statements. ä This end-of-period process starts with the unadjusted trial balance.

35. Managerial Accounting - 2.35 Adjusting Entries... – are made to bring accounts to correct balances before preparing financial statements.

36. Managerial Accounting - 2.36 Adjusting Entries... – assign revenue to period earned. – assign expenses to the period incurred. – bring related asset and liability accounts into correct balance.

37. Managerial Accounting - 2.37 Two Types Of Adjusting Entries 1 Prepaids 2 Accruals

38. Managerial Accounting - 2.38 Prepaids ä A prepaid, or deferral, is the postponement of the recognition of an expense already paid or incurred or a revenue already received.

39. Managerial Accounting - 2.39 Prepaid Expenses ä These are goods or services paid for in advance that do not expire during the current accounting period. ä They include miscellaneous assets that will expire or will be used up in the near future.

40. Managerial Accounting - 2.40 Prepaid Expenses ä Examples: – Prepaid rent – Prepaid insurance – Supplies – Buildings – Equipment

41. Managerial Accounting - 2.41 Prepaid Expenses ä On January 2, 19x1, Dennis’ Landscaping paid $1,200 for a one year insurance policy. Prepaid Insurance Cash 1,200 1,200

42. Managerial Accounting - 2.42 Prepaid Expenses ä Jan. 2, 19x1 Prepaid Insurance 1,200 Cash 1,200 Paid insurance

43. Managerial Accounting - 2.43 Prepaid Expenses ä This insurance expense must be matched to the months to which it applies. ä What is the journal entry on January 31, 19x1?

44. Managerial Accounting - 2.44 Prepaid Expenses ä On January 31, 19x1, one month of the 12- month insurance policy has expired. ä $1,200/12 = $100 ä Jan. 31, 19x1 Insurance expense 100 Prepaid insurance 100 One month’s insurance premium

45. Managerial Accounting - 2.45 ??????? ä What was the determining factor in matching this expense? ä Time

46. Managerial Accounting - 2.46 Supplies ä Wordcrafters started business the beginning of the month. ä $500 worth of office supplies were purchased on March 15, 19x1, for cash.

47. Managerial Accounting - 2.47 Supplies Office Supplies Cash 500 Office Supplies 500 Cash or Accounts Payable 500 Purchased office supplies

48. Managerial Accounting - 2.48 Supplies ä An inventory at month end indicated that $120 in office supplies remained. ä Therefore, $380 worth of supplies was used during the month ($500 - $120).

49. Managerial Accounting - 2.49 Supplies ä The cost of supplies must be matched to the period in which they were used. ä What is the journal entry on March 31, 19x1?

50. Managerial Accounting - 2.50 Supplies ä Mar. 31, 19x1 Office Supplies Expense 380 Office Supplies 380 ä One month’s usage of supplies Supplies Expense Supplies 380 500 380 Bal. 120

51. Managerial Accounting - 2.51 ??????? ä What was the determining factor in matching this expense? ä Usage

52. Managerial Accounting - 2.52 Depreciation of Plant Assets ä Plant assets are large prepaid expenses.

53. Managerial Accounting - 2.53 Depreciation... – is a cost allocation of a long-lived asset. ä Depreciation expense is the cost converted from an asset to an expense. ä Estimates are used.

54. Managerial Accounting - 2.54 Dennis’ Landscaping ä On January 2nd, the business purchased a truck for $30,000 cash. ä The truck is expected to last for 3 years.

55. Managerial Accounting - 2.55 Journalizing ä January 2, 19x1 Machinery 30,000 Cash 30,000 Purchase of truck

56. Managerial Accounting - 2.56 Matching Principle ä The cost of the truck must be matched with the accounting periods in which it was used to earn income. ä What would the journal entry be for the year ended December 31, 19x1?

57. Managerial Accounting - 2.57 Straight Line Method ä Cost: $30,000 ä Service life: 3 Years ä Cost/Estimated useful life ä $30,000/3 = $10,000 per year

58. Managerial Accounting - 2.58 Depreciation Expense ä Dec. 31, 19x1 Depreciation Expense 10,000 Accumulated Depreciation 10,000 To record depreciation expense for a one- year period

59. Managerial Accounting - 2.59 Contra Accounts ä A contra account is one that is paired with and deducted from another related account in the financial statements. ä Normal balance is opposite its companion account. ä Accumulated depreciation is a contra account to plant assets.

60. Managerial Accounting - 2.60 Book Value... – is the cost of an asset that has not been depreciated.

61. Managerial Accounting - 2.61 Dennis’ Landscaping ä Partial Balance Sheet December 31, 19x1 ä Plant Assets Machinery $30,000 Less Accumulated Depreciation 10,000 $20,000 ä Contra account Book value

62. Managerial Accounting - 2.62 Dennis’ Landscaping ä Partial Balance Sheet December 31, 19x2 ä Plant Assets Machinery $30,000 Less Accumulated Depreciation 20,000 $10,000 ä Contra account Book value

63. Managerial Accounting - 2.63 Accruals ä An accrual is the recognition of an expense or revenue that has risen but has not yet been recorded. ä Expenses or revenues are recorded before the cash settlement.

64. Managerial Accounting - 2.64 Accrued Expenses... – are expenses that have been incurred but not yet paid.

65. Managerial Accounting - 2.65 Accrued Expenses ä Employees of Mary Business Services are paid every Friday. ä Weekly salaries total $30,000.

66. Managerial Accounting - 2.66 Accrued Expenses ä Mary’s is closed on Saturday and Sunday. ä The employees were last paid on April 26th, which was a Friday.

67. Managerial Accounting - 2.67 Accrued Expenses ä The employees will be paid on May 3rd. ä What is the adjusting entry on April 30th? ä They worked April 29th and 30th. ä $30,000/5 = $6,000 per day ä $6,000 x 2 days = $12,000

68. Managerial Accounting - 2.68 Accrued Expenses ä Apr. 30, 19x1 Salaries Expense 12,000 Salaries Payable 12,000 To accrue two days salaries

69. Managerial Accounting - 2.69 Accrued Revenues ä These are revenues that have been earned but not yet received. ä They are an asset.

70. Managerial Accounting - 2.70 Accrued Revenues ä During the month of August, Dennis’ Landscaping rendered services to customers totaling $15,000. ä At the end of August, the customers have not as yet been billed.

71. Managerial Accounting - 2.71 Accrued Revenues ä What is the August 31st adjusting entry? ä August 31, 19x1 Accounts Receivable 15,000 Service Revenue 15,000 To record unpaid invoices

72. Managerial Accounting - 2.72 ???????? ä What is the determining factor in recognizing this service revenue? ä Performance

73. Managerial Accounting - 2.73 Unearned Revenue ä Collecting cash from customers in advance of doing work creates a liability called unearned revenue.

74. Managerial Accounting - 2.74 Unearned Revenue ä Examples: – Commissions collected In advance – Season tickets to sporting events – Magazine subscriptions

75. Managerial Accounting - 2.75 Unearned Revenue ä On September 1, 19x1, a football team received $200,000 from season ticket holders to attend 16 games.

76. Managerial Accounting - 2.76 Unearned Revenue ä Sept. 1, 19x1 Cash 200,000 Unearned Ticket Revenue 200,000 Season ticket receipts

77. Managerial Accounting - 2.77 Unearned Revenue ä Four of the sixteen games had been played by September 30, 19x1. ä What would the journal entry be?

78. Managerial Accounting - 2.78 Unearned Revenue ä Revenue per game = $200,000/16 ä $12,500 ä $12,500 x 4 = $50,000

79. Managerial Accounting - 2.79 Unearned Revenue ä Sept. 30, 19x1 Unearned ticket revenue 50,000 Ticket revenue 50,000 To record four games

80. Managerial Accounting - 2.80 Notice ä Adjusting entries always have: – one income statement account and – one balance sheet account. ä Adjusting entries never involve cash.

81. Managerial Accounting - 2.81 Objective 4 Prepare an adjusted trial balance.

82. Managerial Accounting - 2.82 Adjusted Trial Balance ä The adjusting process starts with the unadjusted trial balance. ä Adjusting entries are made at the end of the accounting period and then an adjusted trial balance is prepared.

83. Managerial Accounting - 2.83 Adjusted Trial Balance ä The adjusted trial balance verifies the equality of debits and credits after the adjusting process. ä It serves as the basis for the preparation of the financial statements. ä The adjusted trial balance is an internal statement.

84. Managerial Accounting - 2.84 Objective 5 Prepare the financial statements from the adjusted trial balance.

85. Managerial Accounting - 2.85 Prepare the Statements ä The adjusted trial balance is an internal statement used to prepare the financial statements. ä Financial statements are external statements.

86. Managerial Accounting - 2.86 Financial Statements ä The financial statements are: – Income Statement – Statement of Owners’ Equity – Cash Flow Statement – Balance Sheet

87. Managerial Accounting - 2.87 Financial Statements ä Financial statements have two parts: 1 The first part includes the following: – Name of the entity – Title of the statement – Date or period covered 2 The second part is the body of the statement.

88. Managerial Accounting - 2.88 Relationships Among the Statements ä The income statement reports net income or net loss. ä Net income or net loss is determined by subtracting expenses from revenues.

89. Managerial Accounting - 2.89 Relationships Among the Statements ä Revenues and expenses are owners’ equity account. ä Net income or net loss is transferred to the statement of owners’ equity.

90. Managerial Accounting - 2.90 Relationships Among the Statements ä Capital is a balance sheet account. ä The ending balance in the statement of owners’ equity is transferred to the balance sheet.

91. Managerial Accounting - 2.91 Relationships Among the Statements ä The statement of cash flow explains the cause for the change in the cash balance between two balance sheets dates.

92. Managerial Accounting - 2.92 Completing the Accounting Cycle Chapter 4

93. Managerial Accounting - 2.93 Motorola Company ä This company is best known for its computer chips, cellular phones and other electronic products. ä In order to successfully compete, Motorola gets its financial data to management quickly.

94. Managerial Accounting - 2.94 Motorola ä Motorola accomplishes this goal by rapidly closing its books. ä Motorola can close its accounts in just two days.

95. Managerial Accounting - 2.95 Chapter Objectives 1 Prepare an accounting work sheet. 2 Use the work sheet to complete the accounting cycle. 3 Close the revenue, expense and withdrawal accounts.

96. Managerial Accounting - 2.96 Chapter Objectives 4 Correct typical accounting errors. 5 Classify assets and liabilities as current or long-term. 6 Use the current and debt ratios to evaluate a business.

97. Managerial Accounting - 2.97 The Accounting Cycle ä The accounting cycle is the process by which accountants prepare financial statements for an entity for a specific period of time.

98. Managerial Accounting - 2.98 The Accounting Cycle ä For a new business, begin by setting up ledger accounts. ä For an established business, begin with account balances carried over from the previous period.

99. Managerial Accounting - 2.99 Work Performed This Period ä Start with the account balances in the ledger at the beginning of the period. ä Analyze and journalize transactions. ä Post journal entries to the ledger accounts.

100. Managerial Accounting - 2.100 End of Period Work ä Compute the unadjusted balance in each account. ä Make adjustments. ä Prepare the adjusted trial balance. ä Prepare the financial statements.

101. Managerial Accounting - 2.101 End of Period Work ä Journalize and post the adjusting entries. ä Journalize and post the closing entries. ä Prepare the post closing trial balance. This trial balance readies the accounts for the next period.

102. Managerial Accounting - 2.102 Objective 1 Prepare an accounting work sheet.

103. Managerial Accounting - 2.103 Accounting Work Sheet ä A work sheet is a multi-columned document used by accountants to help move data from the trial balance to the financial statements. ä It is an internal document.

104. Managerial Accounting - 2.104 Steps in Preparing the Work Sheet ä Enter the account titles. ä Then enter the unadjusted ending balances in the trial balance column and total.

105. Managerial Accounting - 2.105 The Accounting Work Sheet Adjusted Trial Balance TRIAL BALANCE ADJUSTMENTS ADJ. TRIAL BAL.

106. Managerial Accounting - 2.106 Adjustments a The company has earned revenue of $1,700 which will be collected next month. b Inventory of supplies at month end totaled $150. c Depreciation for the period was calculated as $200.

107. Managerial Accounting - 2.107 The Accounting Work Sheet Adjusted Trial Balance TRIAL BALANCE ADJUSTMENTS ADJ. TRIAL BAL.

108. Managerial Accounting - 2.108 The Accounting Work Sheet Adjusted Trial Balance TRIAL BALANCE ADJUSTMENTS ADJ. TRIAL BAL.

109. Managerial Accounting - 2.109 The Accounting Work Sheet Adjusted Trial Balance ADJ. TRIAL BAL. INC. STATEMENT BALANCE SHEET

110. Managerial Accounting - 2.110 The Accounting Work Sheet Adjusted Trial Balance ADJ. TRIAL BAL. INC. STATEMENT BALANCE SHEET

111. Managerial Accounting - 2.111 The Accounting Work Sheet Adjusted Trial Balance ADJ. TRIAL BAL. INC. STATEMENT BALANCE SHEET

112. Managerial Accounting - 2.112 Objective 2 Use the work sheet to complete the accounting cycle.

113. Managerial Accounting - 2.113 Recording the Adjusting Entries ä The work sheet helps identify the accounts that need adjustments. ä Actual adjustment of the accounts requires journalizing and posting the entries.

114. Managerial Accounting - 2.114 Recording the Adjusting Entries ä The adjusting entries may be recorded in the journal when they are entered on the work sheet. ä Many accountants journalize and post the adjusting entries just before they make the closing entries.

115. Managerial Accounting - 2.115 Objective 3 Close the revenue, expense and withdrawal accounts.

116. Managerial Accounting - 2.116 Closing the Accounts ä Closing the accounts is the end of period process that prepares the accounts for recording transactions during the next period.

117. Managerial Accounting - 2.117 Closing the Accounts ä What accounts are closed at the end of the period? ä Revenue, Expenses and Withdrawals. ä These relate to a specific period and are called temporary accounts.

118. Managerial Accounting - 2.118 Income Summary ä The Income Summary account is used to close the temporary accounts. ä This is the “most temporary” account. ä It is used only to facilitate the closing process.

119. Managerial Accounting - 2.119 Closing the Accounts ä Revenues and Expense accounts are closed to Income Summary. ä Income Summary is closed to Capital. ä Withdrawals are closed to Capital.

120. Managerial Accounting - 2.120 Closing the Accounts ä Net income will be represented by a credit balance in the Income Summary. ä Net loss by a debit balance.

121. Managerial Accounting - 2.121 Flowchart of Closing Process Revenue Income Summary 12,000 7,500 9,000 Salary Exp 3,300 28,500 1,500 1,800 4,45028,500 Rent Exp 800 800 Supplies Exp 350 350 24,050 (Close Revenue Account) (Close Expense Accounts) (Close Income Summary) Withdrawals 2,500 Capital Account (Close Withdrawals Account)

122. Managerial Accounting - 2.122 Postclosing Trial Balance ä The accounting cycle ends with the postclosing trial balance. ä The postclosing trial balance is dated as of the end of the period for which the statements have been prepared.

123. Managerial Accounting - 2.123 Permanent Accounts ä These never close : – Assets – Liabilities – Owners’ equity ä Balances of permanent accounts carry over to the next period.

124. Managerial Accounting - 2.124 Objective 4 Correct typical accounting errors.

125. Managerial Accounting - 2.125 Correcting Errors ä Suppose that Dennis’ Landscaping bought supplies for $3,000 and erroneously debited equipment.

126. Managerial Accounting - 2.126 Correcting Errors ä What was the incorrect entry? ä Debit Equipment and credit Cash. ä What is the correcting entry? ä Debit Supplies and credit Equipment.

127. Managerial Accounting - 2.127 Objective 5 Classify assets and liabilities as current or long-term.

128. Managerial Accounting - 2.128 Liquidity ä This is a measure of how quickly an item can be converted to cash.

129. Managerial Accounting - 2.129 Current or Long-term ä On the balance sheet, assets and liabilities are classified as either current or long-term to indicate their relative liquidity.

130. Managerial Accounting - 2.130 Assets are Classified as Current or Long-term ä Current assets are cash, or will be converted to cash, in one year or within the normal business operating cycle. – Cash – Short term receivables – Inventory – Prepaid expenses

131. Managerial Accounting - 2.131 Assets are Classified as Current or Long-term ä Long-term assets include all other assets. – Property, equipment and intangibles

132. Managerial Accounting - 2.132 Liabilities are Classified as Current or Long-term ä Current liabilities are debts or obligations due within one year or within the operating cycle. – Accounts and salary payables – Short term notes payable – Unearned revenue

133. Managerial Accounting - 2.133 Liabilities are Classified as Current or Long-term ä Long-term liabilities are all other debts due in longer than one year or the entity’s operating cycle.

134. Managerial Accounting - 2.134 The Classified Balance Sheet ä The debit side – Current assets – Long-term assets ä Assets are listed in order of decreasing liquidity.

135. Managerial Accounting - 2.135 The Classified Balance Sheet ä The credit side – Current liabilities – Long-term liabilities ä Liabilities are listed in the order of how soon they must be paid.

136. Managerial Accounting - 2.136 Classified Balance Sheet XYZ Services January 31, 19xx Assets Liabilities Current Assets Current Liabilities Cash 12,100 Accounts Payable 1,200 Accounts Receivable 3,050 Salary Payable 1,100 Supplies 150 Unearned Revenue 1,500 Total Current Assets 15,300 Total Liabilities 3,800 Plant Assets Owners’ Equity Equipment 15,500 Capital 19,300 Less Accum Deprec 7,700 7,800 Total Liabilities and Total Assets 23,100 Equity 23,100

137. Managerial Accounting - 2.137 Different Formats of the Balance Sheet ä The report format lists assets first, then liabilities and then owners’ equity. ä The account format reports assets on the left side and liabilities and owners’ equity on the right side.

138. Managerial Accounting - 2.138 Objective 6 Use the current and debt ratios to evaluate a business.

139. Managerial Accounting - 2.139 Comparative Financial Statements... – are statements that show two or more consecutive periods. ä They enhance the user’s ability to analyze a company’s past performance.

140. Managerial Accounting - 2.140 Evaluating with Ratios ä Two common ratios used to measure liquidity are: 1 Current ratio 2 Debt ratio

141. Managerial Accounting - 2.141 Current Ratio ä This measures the ability of a business to pay its current liabilities with its current assets.

142. Managerial Accounting - 2.142 Current Ratio ä Current assets/Current liabilities ä A ratio of 1.0 or more indicates that a business should have no trouble paying its current bills.

143. Managerial Accounting - 2.143 Debt Ratio ä It indicates the proportion of a business’ assets that are financed with debt. ä It measures their ability to pay both current and long-term debt.

144. Managerial Accounting - 2.144 Debt Ratio ä Total liabilities/Total assets ä The lower the ratio, the safer.

145. Managerial Accounting - 2.145 Trend Analysis ä Decision makers compare various ratios over a period of time, looking for improving trends.