2. 3-1 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Chapter 3 Measuring Business Income Chapter 3 Measuring Business Income

3. 3-2 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. LEARNING OBJECTIVES 1.Define net income and its two major components, revenues and expenses. 2.Explain the difficulties of income measurement caused by: (a) the accounting period issue, (b) the continuity issue, (c) the matching issue. 3.Define accrual accounting and explain two broad ways of accomplishing it.

4. 3-3 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. 4.State four principal situations that require adjusting entries. 5.Prepare typical adjusting entries. 6.Prepare financial statements from an adjusted trial balance. LEARNING OBJECTIVES (continued) LEARNING OBJECTIVES (continued)

5. 3-4 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Profitability Measurement: The Role of Business Income Objective 1 Define net income and its two major components, revenues and expenses.

6. 3-5 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Profitability Measurement: The Role of Business Income  Profitability and liquidity are the two major goals of a business.  To survive, a business must earn a profit.  Profit, as a word, may be ambiguous.  Net income is the preferred term because it can be defined more precisely from an accounting point of view.

7. 3-6 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Net Income  Net income is the net increase in owner’s equity that results from the operations of a company.  Net Income = Revenues - Expenses. R > E, net profit. R < E, net loss.

8. 3-7 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Revenues  Revenues are increases in OE resulting from selling goods or providing services.  Revenue for a given period equals: Cash + Receivables from goods and services provided.  Liabilities are generally not affected by revenues.  Owner’s investments increase OE but are not revenues.

9. 3-8 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Expenses  Expenses are decreases in OE resulting from the costs of selling goods, rendering services, or performing other business activities.  Expenses are the costs of doing business.  Not all cash payments are expenses.  Prepaid expenses are recorded as assets. As they expire, they become expenses.  Not all decreases in OE arise from expenses.  Withdrawals are not expenses.

10. 3-9 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Discussion Q. Why does the accountant use the term net income instead of profit? A. Profit has many meanings. Accountants use the term net income to define the net increase in owner’s equity produced by business operations. Net income equals revenues minus expenses when revenues exceed expenses.

11. 3-10 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The Accounting Period Issue Objective 2a Explain the difficulties of income measurement caused by the accounting period issue.

12. 3-11 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The Accounting Period Issue  The difficulty of assigning revenues and expenses to a short period of time.  Not all transactions can easily be assigned to a time period.  The accountant makes an assumption about periodicity. The net income for any period of time less than the life of the business, although tentative, is still a useful estimate of the net income for the period. Time periods are usually of equal length for comparability.

13. 3-12 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The Measurement of Business Income  Financial statements may be prepared for any time period, usually a calendar year.  Accounting periods of less than one year are called interim periods.  The fiscal year is the twelve-month accounting period used by a company. Can be the same as the calendar year. Can be different from the calendar year as the needs of the business dictate.

14. 3-13 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Fiscal Year Examples  Year ended June 30, 2001 (The year starts on July 1, 2001 and concludes on June 30, 2002.)

15. 3-14 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Discussion Q. Why does the need for an accounting period cause problems? A. Any measurement of net income over a short period of time is necessarily tentative, and not all transactions can be easily assigned to specific periods. It is necessary to recognize that the life of the business is a useful approximation of the net income for the period.

16. 3-15 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The Continuity Issue Objective 2b Explain the difficulties of income measurement caused by the continuity issue.

17. 3-16 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The Continuity Issue  The measurement of business income requires that certain expenses and revenues be allocated over several accounting periods.  The continuity issue relates to the estimated number of accounting periods in the business entity’s life.  The accountant assumes that an entity is a going concern, that the entity will continue indefinitely.  If a firm is not a going concern, financial statements may be prepared on the basis of the liquidation value of the assets -- that is, what they will bring in cash.

18. 3-17 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The Matching Issue Objective 2c Explain the difficulties of income measurement caused by the matching issue.

19. 3-18 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The Matching Issue  The cash basis of accounting recognizes revenues when received in cash and expenses when paid in cash.  Cash basis accounting has matching problems.  To adequately measure net income, revenues and expenses must be assigned to the appropriate accounting period.  The matching rule states that:  Revenues must be assigned to the accounting period in which the goods are sold or services performed.  Expenses must be assigned to the accounting period in which they are used to produce revenue.

20. 3-19 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The Matching Rule/Principle  Revenues are recorded in the books when they are earned.  Expenses are recorded in the books when they are incurred. (happen)

21. 3-20 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Definition of “incur”  To occur as a result or to bring down upon oneself.  Example: A business incurs rent expense as it occupies a building. This expense happens every day as the business occupies the building.

22. 3-21 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Accrual Accounting Objective 3 Define accrual accounting and explain two broad ways of accomplishing it. Pronounced ah-crew-ahl

23. 3-22 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Accrual Accounting  Accrual accounting “attempts to record the financial effects on an enterprise of transactions and other events and circumstances... in the periods in which those transactions, events, and circumstances occur rather than only in the periods in which cash is received or paid by the enterprise.”  Accrual accounting is an application of the matching rule.

24. 3-23 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Implementation of Accrual Accounting  Accrual accounting is done in two ways. 1. By recording revenues when earned and expenses when incurred.  When a sale is made on credit, revenue is recorded before the cash is received in the Accounts Receivable account.  When an expense is incurred on credit, an expense is recorded before the cash is paid in the Accounts Payable account.

25. 3-24 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved.  Those transactions that span the cutoff period must be allocated to the proper accounting period.  A prepayment of 6 months’ office rent must be adjusted on a monthly basis if accurate monthly financial statements are to be prepared. 2. By adjusting the accounts.

26. 3-25 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Discussion Q. In what two ways is accrual accounting accomplished? A. Accrual accounting is accomplished by (1) recording revenues when earned and expenses when incurred, and (2) making end-of-period adjustments to revenue and expense accounts.

27. 3-26 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The Adjustment Process Objective 4 State four principal situations that require adjusting entries.

28. 3-27 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The Adjustment Process  Adjusting entries are used to apply accrual accounting to transactions that span more than one accounting period.  Adjusting entries involve at least one balance sheet account and at least one income statement account.  Adjusting entries never involve the Cash account (Note: this rule applies to this textbook.)

29. 3-28 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Four Types of Adjusting Entries  Costs have been recorded that must be allocated between two or more accounting periods.  Expenses have been incurred but are not yet recorded.  Revenues have been recorded that must be allocated between two or more accounting periods.  Revenues have been earned but not yet recorded.

30. 3-29 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Deferrals  The recognition of an expense already paid or  A revenue received in advance u A deferral is the postponement of: CASH HAS BEEN RECEIVED OR PAID AHEAD OF TIME!!!!!

31. 3-30 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Deferral means to set aside We are setting aside the recognition of revenue/expense.

32. 3-31 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Accruals  An accrual is the recognition of a revenue or expense that has arisen but has not yet been recorded.

33. 3-32 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Accrual means to gather We can tell an accrual entry because an account ending in “ble” is debited or credited. Receivable/Payable

34. 3-33 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Discussion Q. What do plant and equipment, office supplies, and prepaid insurance have in common? A. They are all assets that must be allocated to expenses over time; this means they all require adjusting entries at the end of the accounting period.

35. 3-34 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Allocating Recorded Costs Between Two or More Accounting Periods Objective 5 Prepare typical adjusting entries.

36. 3-35 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. 3-1 Asset AccountExpense Account Adjusting Entry Credit Adjusting Entry Debit Amount equals cost of goods or services used up or expired 3-1 Asset AccountExpense Account Adjusting Entry Credit Adjusting Entry Debit Amount equals cost of goods or services used up or expired Adjustment for Prepaid Expenses

37. 3-36 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise 2: Allocating Deferred Expenses Prepaid Expenses: Insurance Expense Turn to your text, page 159

38. 3-37 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise 2: Allocating Deferred Expenses Prepaid Expenses: Insurance Expense Prepaid Insurance Transaction Analysis Rules Entry Beg Bal 230 Additions 570 Balance 800

39. 3-38 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The Balance is $800 But this asset has to be adjusted to a balance of $350, because this is the amount of the resource that benefits a future period.

40. 3-39 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise 2: Allocating Deferred Expenses Prepaid Expenses: Insurance Expense Dr. Cr. Dec. 31 Insurance Expense 450 Prepaid Insurance 450 Insurance Expense Dec. 31 450 Prepaid Insurance Transaction Analysis Rules Entry Bal Before Adj 800 Dec. 31 450

41. 3-40 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise 2: Allocating Deferred Expenses Prepaid Expenses: Insurance Expense Dr. Cr. Dec. 31 Insurance Expense 450 Prepaid Insurance 450 Insurance Expense Dec. 31 450 Prepaid Insurance Transaction Analysis Rules Entry Bal Before Adj 800 New Balance 350 Dec. 31 450

42. 3-41 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part b of Problem 2  Now for the insurance part of Problem 2……………. Turn to page 164 in your text --Prob 2, part b

43. 3-42 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part b of Problem 2  There are three policies:

44. 3-43 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part b of Problem 2  There are three policies:  The policy for $7,160 in the beginning balance has expired.  It is now November 30th.

45. 3-44 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. First Policy, Problem 2 part b

46. 3-45 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part b of Problem 2  Second policy:  The policy was purchased on July 1 and will expire on June 30th. Remember: it is now November 30th. So…..5 months have expired! July, August, September, October and November. Use your fingers if you have to!

47. 3-46 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. First and Second Policies, Problem 2 part b

48. 3-47 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. First and Second Policies, Problem 2 part b

49. 3-48 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part b of Problem 2  Third policy:  The policy purchased October 1 is good for 36 months. Two months have passed (October and November)  So 2/36 has expired

50. 3-49 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. All of the Insurance, Problem 2 part b 14544/36 months x 2 mos.

51. 3-50 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. All of the Insurance, Problem 2 part b Balance in the account before adjustment Expense Amount Prepaid

52. 3-51 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Problem 2, Part b Adjusting Journal Entry (AJE) Dr. Cr. Nov 30 Insurance Expense 11,468 Prepaid Insurance 11,468 Insurance Expense June 30 11,468 Prepaid Insurance Transaction Analysis Rules Entry Bal. B/4 Adjust 30,104 New Balance 18,636 Nov. 30 AJE 11,468

53. 3-52 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise 3 Allocating Deferred Expenses Prepaid Expenses: Supplies Expense Turn back to SE 3 on page 159

54. 3-53 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise 3 Allocating Deferred Expenses Prepaid Expenses: Supplies Expense Supplies Beg Bal 190 Purchases 490 Balance 680

55. 3-54 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The Balance is $680 But this asset has to be adjusted to a balance of $220, because this is the amount of supplies we actually have. The rest were used, so they are an expense.

56. 3-55 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise 3 Allocating Deferred Expenses Prepaid Expenses: Supplies Expense Dr. Cr. Dec. 31 Supplies Expense 460 Supplies 460 Supplies Dec. 31 AJE 460 Supplies Expense Transaction Analysis Rules Entry Bal.B/4 Adj 680 Ending Bal 220 Dec. 31 AJE 460

57. 3-56 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part a. of Problem 2 Prepaid Expenses: Supplies Expense Page 164 in text!

58. 3-57 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part a. of Problem 2 Prepaid Expenses: Supplies Expense Supplies Beg Bal 4,348 Purchases9,052 Balance 13,400

59. 3-58 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part a. of Problem 2 The Balance is $13,400 But this asset has to be adjusted to a balance of $2,794 because this is the amount of supplies we actually have. The rest were used, so they are an expense.

60. 3-59 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Computing the adjustment The unadjusted balance of $13,400 minus the actual amount on hand of $2,794 equals $10,606.

61. 3-60 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part a. of Problem 2 Dr. Cr. June 30 Supplies Expense 10,606 Supplies 10,606 Supplies Nov 30 AJE 10,606 Supplies E xpe nse Transaction Analysis Rules Entry BB. 4,348 Purchases 9,052 Bal B/4Adj 13,400 Nov 30 AJE 10,606 Adjusted Bal 2,794

62. 3-61 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Depreciation of Property, Plant & Equipment  Depreciation is the matching of the cost of an asset to the period in which it was used to generate revenue.

63. 3-62 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise 4 Depreciation of PP&E:Office Equipment Dr. Cr. Mar. 31 Depreciation Expense, Off Equipment 50 Accumulated Depreciation, Off Equipment 50 Accumulated Depn, Office Equipment Mar. 31 50 Depreciation Expense, Offi ce Equipment Transaction Analysis Rules Entry Mar. 31 50 Mar. 31 50 Page 159 in the text!

64. 3-63 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Mr. Ivey’s trick to remember the entry D epreciation E xpense A ccumulated D eprecation Just remember DEAD

65. 3-64 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Adjustment for Depreciation 3-2 Accumulated DepreciationDepreciation Expense Adjusting Entry Credit Adjusting Entry Debit Amount equals cost of asset allocated to accounting period CONTRA-ASSET ACCOUNTEXPENSE ACCOUNT

66. 3-65 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. This is the third month of depreciation, so we did this two times before….for the months of January and February!  The beginning balance in Accumulated Deprecation was  $50 X 2mos.=$100

67. 3-66 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise 4 Depreciation of PP&E:Office Equipment Dr. Cr. Mar. 31 Depreciation Expense, Off Equipment 50 Accumulated Depreciation, Off Equipment 50 Accumulated Depn, Office Equipment Prev. Bal 100 Mar. 31 50 New Bal 150 Office Equipment Bal 950 Contra- Asset Acct

68. 3-67 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise 4 Balance Sheet Presentation Cash $ 100 Accounts Receivable 100 Office Equipment$950 Less: Accumulated Depreciation 150 800 TotalAssets $1,000

69. 3-68 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise #5 Recognizing Unrecorded Expenses Accrued Expenses: Accrued Wages

70. 3-69 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise #5 Recognizing Unrecorded Expenses Accrued Expenses: Accrued Wages  Step 1: Compute the daily wage rate.  Rules: All work weeks begin on Monday

71. 3-70 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise #5 Recognizing Unrecorded Expenses Accrued Expenses: Accrued Wages  Step 1: Compute the daily wage rate.  Wages for six days are $690  $690 divided by six is

72. 3-71 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise #5 Recognizing Unrecorded Expenses Accrued Expenses: Accrued Wages  Step 1: Compute the daily wage rate.  Wages for six days are $690  $690 divided by six is $115

73. 3-72 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise #5 Recognizing Unrecorded Expenses Accrued Expenses: Accrued Wages  Step 2: Count the days in the year that has ended.  If July 1 is Tuesday, the end of the year was Monday, June 30

74. 3-73 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise #5 Recognizing Unrecorded Expenses Accrued Expenses: Accrued Wages  Step 2: Count the days in the year that has ended.  If July 1 is Tuesday, the end of the year was Monday, June 30  One day was in June

75. 3-74 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise #5 Recognizing Unrecorded Expenses Accrued Expenses: Accrued Wages  Step 2: Count the days in the year that has ended.  If July 1 is Tuesday, the end of the year was Monday, June 30  One day was in June  The daily wage rate was $115

76. 3-75 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise #5 Recognizing Unrecorded Expenses Accrued Expenses: Accrued Wages  Step 3: Multiply the days in the year that has ended by the daily wage rate and record the wages payable and wages expense.  1 X115 = $115

77. 3-76 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Short Exercise #5 Recognizing Unrecorded Expenses Accrued Expenses: Accrued Wages Dr. Cr. June 30 Wages Expense 115 Wages Payable 115 Wages Payable June 30 115 Wages Expense June 30 115

78. 3-77 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Now look at part g of problem 2 in your text.  Step 1: Compute the daily wage rate.  Step 2: Count the days in the year that has ended.  Step 3: Multiply the days in the year that has ended by the daily wage rate and record the wages payable and wages expense.  Step 4: Make the entry.

79. 3-78 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Now look at part g of problem 2 in your text.  Step 1: 24,600/6 =4,100  Step 2: Count the days in the year that has ended = 4 days  Step 3: 4 days times $4,100 = 16,400  Step 4: Salaries expense 16,400 Salaries payable 16,400

80. 3-79 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part f of Problem 2: Recognizing Unrecorded (Accrued) Expenses Accrued Expenses: Interest Expense

81. 3-80 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part a of Problem 2: Recognizing Unrecorded (Accrued) Expenses Accrued Expenses: Interest Expense Dr. Cr. Nov 30 Interest Expense 30,000 Interest Payable 30,000 Interest Payable Nov 30 AJE 30,000 Interest Expense Transaction Analysis Rules Entry Nov 30 AJE 30,000

82. 3-81 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Adjustment for Unrecorded (Accrued) Expenses

83. 3-82 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part e of Problem 2: A llocating Deferred Revenues Deferred Revenues: Unearned Fees  When did we collect the $$$?  How much do we earn each month from this contract?  How much time has now passed?

84. 3-83 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Allocating Deferred Revenues Deferred Revenues: Unearned Fees Dr. Cr. Nov 30 Unearned Revenue 8,400 Fees Earned 8,400 Unearned Revenue Sept. 1 33,600 Fees Earned Transaction Analysis Rules Entry Nov. 30 AJE 8,400 Nov 30 Adj. Bal 25,200 33,600/12 months times 3 months

85. 3-84 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Adjustment for Unearned (Deferred) Revenues

86. 3-85 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part e of problem 2: Recognizing Unrecorded (Accrued) Revenues

87. 3-86 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Part h of problem 2: Recognizing Unrecorded (Accrued) Revenues Dr. Cr. June 30 Fees Receivable 8,000 Service Revenue 8,000 Fees Receivable Nov. 30 AJE 8,000 Service Revenue Nov. 30 AJE 8,000

88. 3-87 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Adjustment for Unrecorded (Accrued) Revenues 3-4 ASSET ACCOUNT Receivable REVENUE ACCOUNT Revenue Adjusting Entry Debit Adjusting Entry Credit Amount equals price of services performed

89. 3-88 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Discussion Q. Where does unearned revenue appear on the balance sheet? A. Unearned revenue appears as a liability on the balance sheet.

90. 3-89 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Using the Adjusted Trial Balance to Prepare Financial Statements Objective 6 Prepare financial statements from an adjusted trial balance.

91. 3-90 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The Adjusted Trial Balance (ATB)  The ATB is prepared after adjusting entries have been recorded and posted.  The ATB is a listing of all accounts and their balances.  The ATB should have equal debits and credits.  Financial statements are prepared from the ATB by copying the appropriate accounts to the appropriate financial statement.

92. 3-91 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Discussion Q. Why is the income statement the first statement prepared from the adjusted trial balance?  A. The income statement is prepared first because the net income figure is needed to complete the Statement of Owner’s Equity or Retained Earnings Statement in the case of a corporation. These are needed to prepare the Balance Sheet.

93. 3-92 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. Need More Review? To Better Understand How to Prepare the Financial Statements…View the PowerPoint for Chapter 1 on Problem Solving.

94. 3-93 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. 1.Define net income and its two major components, revenues and expenses. 2.Explain the difficulties of income measurement caused by: (a) the accounting period issue, (b) the continuity issue, (c) the matching issue. 3.Define accrual accounting and explain two broad ways of accomplishing it. OK, LET’S REVIEW...

95. 3-94 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. 4.State four principal situations that require adjusting entries. 5.Prepare typical adjusting entries. 6.Prepare financial statements from an adjusted trial balance. AND FINALLY...

96. 3-95 Copyright  Gayle M. Richardson, CPA, Professor. All rights reserved. The End Click on the TaeBo Baby!