Copyright © 2007 Prentice-Hall. All rights reserved 1 The Adjusting Process Chapter 3

Copyright © 2007 Prentice-Hall. All rights reserved 2 Objective 1 Distinguish accrual accounting from cash-basis accounting

Copyright © 2007 Prentice-Hall. All rights reserved 3 Accrual Basis Vs. Cash Basis Accrual Basis Revenues are recognized when earned and expenses are recognized when incurred. Cash Basis Revenues are recognized when cash is received and expenses recorded when cash is paid. Not GAAP

Copyright © 2007 Prentice-Hall. All rights reserved 4 S3-1S3-1 Service revenue: (a)Cash basis$600 (b)Accrual basis ( )$1,100

Copyright © 2007 Prentice-Hall. All rights reserved 5 Accounting Period Managers adopt an artificial period of time to evaluate performance –Monthly –Quarterly –Semiannually –Annually Interim Statements

Copyright © 2007 Prentice-Hall. All rights reserved 6 Recognizing Revenues and Expenses Three new basic accounting principles Revenue Recognition Matching Time Period

Copyright © 2007 Prentice-Hall. All rights reserved 7 Objective 2 Apply the revenue and matching principles

Copyright © 2007 Prentice-Hall. All rights reserved 8 Revenue Principle When is revenue recognized? –When it is earned –Not necessarily when cash is received How much revenue should be recognized? –Cash value of item transferred to customer

Copyright © 2007 Prentice-Hall. All rights reserved 9 S3-3S3-3 a.When should revenue be recorded? When the magazines are mailed to customers b.How much revenue should be recorded? As of March, three month’s revenue should be recognized

Copyright © 2007 Prentice-Hall. All rights reserved 10 The Matching Principle Measure all expenses incurred during the accounting period When are expenses recognized? –Match the expenses against the revenues earned during the period

Copyright © 2007 Prentice-Hall. All rights reserved 11 Adjusting Entries At the end of an accounting period, ask yourself these questions: –Have I recorded all revenues earned during this accounting period? –Have I recognized all expenses incurred during this accounting period? If the answer is “No”, you need to prepare an adjusting entry

Copyright © 2007 Prentice-Hall. All rights reserved 12 S3-4S3-4 Jan 1 – Paid rent for the entire year GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Jan1Prepaid Rent3,600 Cash3,600 Prepaid rent for 1 year Prepaid rent is an asset – this will benefit the company in the future. Since you have not occupied the apartment yet, it is not an expense yet

Copyright © 2007 Prentice-Hall. All rights reserved 13 S3-4S3-4 Prepaid Rent Jan 1 3, Jan Feb Mar Apr May Jun Jul Aug Sep 30 Bal 900 Rent Expense 300 Bal 2,700 Each month, we’ll recognize rent expense; and each month, we’ll reduce the prepaid account until the year is over

Copyright © 2007 Prentice-Hall. All rights reserved 14 The Time Period Concept Requires that accounting information be reported at regular intervals

Copyright © 2007 Prentice-Hall. All rights reserved 15 Adjusting Entries Prepared at end of an accounting period Recorded to bring an asset or liability account balance to its proper amount –Recognize all revenues when earned –Recognize all expenses incurred

Copyright © 2007 Prentice-Hall. All rights reserved 16 Objective 3 Make adjusting entries

Copyright © 2007 Prentice-Hall. All rights reserved 17 Adjusting Entries At the end of an accounting period, ask yourself these questions: Have I recognized all revenues earned this period? Have I recorded all expenses incurred this period? If the answer is “No”, you need to prepare an adjusting entry

Copyright © 2007 Prentice-Hall. All rights reserved 18 Adjusting Entries Five categories Prepaid expenses Depreciation Accrued revenues Accrued expenses Unearned revenues

Copyright © 2007 Prentice-Hall. All rights reserved 19 Adjusting Prepaid Expenses Resources paid for prior to receiving the actual benefits Prepaid Asset Used up portion = Expense Unused portion = Prepaid

Copyright © 2007 Prentice-Hall. All rights reserved 20 S3-5S3-5 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Apr1Prepaid Rent3,000 Cash3,000 Prepaid rent for 6 months 4/1 3,000 Prepaid Rent

Copyright © 2007 Prentice-Hall. All rights reserved 21 S3-5S3-5 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Apr30Rent Expense500 Prepaid Rent500 To record rent for April 4/1 3,000 Prepaid Rent 4/ Rent Expense 4/ Bal 2,500 Rent is $500 per month ($3,000/6)

Copyright © 2007 Prentice-Hall. All rights reserved 22 Depreciation - process of allocating the cost of a plant asset to expense over its expected useful life Straight-Line Depreciation Expense = Asset Cost Useful Life Adjusting for Depreciation Long term plant assets except for land are depreciated

Copyright © 2007 Prentice-Hall. All rights reserved 23 S3-6S3-6 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT May1Computer Equipment36,000 Cash36,000 Purchased computer 5/1 36,000 Computer Equipment

Copyright © 2007 Prentice-Hall. All rights reserved 24 DepreciationDepreciation Depreciation, for accounting purposes, is not an attempt to assign a market value to assets It is merely a systematic way of allocating some of the cost of the asset to each period that asset helps the company earn revenue Accumulated Depreciation –A contra asset account –Represents the amount of depreciation that has been taken over the life of the asset to date

Copyright © 2007 Prentice-Hall. All rights reserved 25 S3-6S3-6 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT May 31Depreciation Expense, Computer Equipment1,000 Accumulated Depreciation, Computer Equipment1,000 To record depreciation for May Accumulated depreciation is a contra asset account Accumulated depreciation is a contra asset account Income Statement Account Balance Sheet Account

Copyright © 2007 Prentice-Hall. All rights reserved 26 S3-6S3-6 5/31 1,000 Accumulated Depreciation, Computer Equipment 5/31 1,000 Depreciation Expense, Computer Equipment Bal 1,000 5/1 36,000 Computer Equipment Bal 1,000

Copyright © 2007 Prentice-Hall. All rights reserved 27 Book Value Reported on balance sheet Cost minus accumulated depreciation

Your Company Balance Sheet May 31, 20XX Assets Cash $XXXX. Computer Equipment$ 36,000 Less: Accumulated Depreciation (1,000) 35,000 Total Assets $XXXX Book Value S3-6S3-6

Your Company Balance Sheet June 30, 20XX Assets Cash $XXXX. Computer Equipment$ 36,000 Less: Accumulated Depreciation (2,000) 34,000 Total Assets $XXXX Book Value S3-6S3-6 Notice: accumulated depreciation increases each accounting period. The book value gradually gets smaller

Copyright © 2007 Prentice-Hall. All rights reserved 30 Accrued Expenses Costs incurred in a period that are both unpaid and unrecorded

Copyright © 2007 Prentice-Hall. All rights reserved 31 S3-8S3-8 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Dec31Interest Expense700 Interest Payable700 To record accrued interest 12/ Interest Expense /31 Interest Payable When you borrow money, interest expense is accumulating everyday. At the end of an accounting period, you need to figure out how much interest has accrued and recognize the expense. You also have to recognize that you must pay that money sometime in the future.

Copyright © 2007 Prentice-Hall. All rights reserved 32 Accrued Revenues Revenues earned in a period that are both unrecorded and not yet received

Copyright © 2007 Prentice-Hall. All rights reserved 33 Accrued Revenues Your lawn maintenance company agrees to provide 30 hours of work at $60 per hour for Company A. It is also agreed that you will bill them when the work had been completed As of May 31, you have worked 20 hours on this contract. The 20 hours’ worth of revenues earned in May, must be recorded in May, even though you haven’t billed your customer yet

Copyright © 2007 Prentice-Hall. All rights reserved 34 Accrued Revenues GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT May 31Accounts Receivable1,200 Service Revenue1,200 To record accrued revenues 5/31 1,200 Accounts Receivable 1,200 5/31 Service Revenue How much revenue was earned in May? $60 x 20 = $1200

Copyright © 2007 Prentice-Hall. All rights reserved 35 Unearned Revenue Cash received in advance of providing products or services

Copyright © 2007 Prentice-Hall. All rights reserved 36 S 3-9 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Dec31Unearned Subscription Revenue5,000 Subscription Revenue5,000 To record revenue earned When the money is received, the company debits cash and credits Unearned Revenue (a liability recognizing that the company owes their customer a service or product) At the end of an accounting period, you must determine how much of that unearned revenue has actually been earned

Copyright © 2007 Prentice-Hall. All rights reserved 37 TipsTips An adjusting entry will NEVER involve a debit or credit to Cash Each adjusting entry will affect at least one balance sheet account and one income statement account

Copyright © 2007 Prentice-Hall. All rights reserved 38 SummarySummary Prepaid expenses Depreciation Accrued revenues Debit Expense Credit Asset (Prepaid) Debit Depreciation Expense Credit Accumulated Depreciation Debit Receivable Credit Revenue

Copyright © 2007 Prentice-Hall. All rights reserved 39 SummarySummary Accrued expenses Unearned revenues Debit Expense Credit Liability Debit Liability (Unearned) Credit Revenue

E3-19 a Unearned Rent Revenue Rent Revenue 10/1 4,00012/31 1,000 Bal. 3,000 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Dec31Unearned Rent Revenue1,000 Rent Revenue1,000 To record revenue earned This is an example of unearned revenues: $4,000 /12 = $ per month 3 months have expired. $ x 3 = $1,000

E3-19 b Salaries Expense Salaries Payable 12/31 3,000 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Dec31Salary Expense3,000 Salary Payable3,000 To record accrued salaries This is an example of accrued expenses. The company owes employees salaries for two days’ work – Monday and Tuesday

E3-19cE3-19c Supplies Supplies Expense 3,100 12/31 1,900 Bal. 1,200 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Dec31Supplies Expense1,900 Supplies1,900 To record supplies used How much of the supplies have been used up? We stared with $3,100 and ended up with $1,200. The rest was used up

GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Dec31Depreciation Expense, Equipment2,500 Accumulated Depreciation, Equipment2,500 To record depreciation Accumulated Depreciation E3-19dE3-19d 12/31 2,500 Depreciation Expense

E3-19fE3-19f Prepaid Insurance Insurance Expense Bal 1,20012/ Bal. 1,000 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Dec31Insurance Expense200 Prepaid Insurance200 To record insurance expired

Copyright © 2007 Prentice-Hall. All rights reserved 45 Objective 4 Prepare an adjusted trial balance

S 3-10 Scissors Hair Stylists Worksheet December 31, 2005 Trial Balance Adjustments Adjusted Trial Balance Account TitleDr.Cr.Dr.Cr.Dr.Cr. Cash 400 Supplies 700 Equipment 17,000 Accum. depr. - Equip. 1,000 Accounts payable 200 Interest payable Note payable 3,000 Suzanne Byrd, capital 6,000 Service revenue 12,000 Rent expense 4,000 Supplies expense Depreciation expense Interest expense 100 Totals 22,200 a. 500 b. 1,000 c ,000 4, , ,300 2, ,000 6,000 12,000 23,300 1,600

S3-11 S3-11 Scissors Hair Stylists Worksheet December 31, 2005 Adjusted Trial Balance Account TitleDr.Cr. Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Suzanne Byrd, capital Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals ,000 4, , ,300 2, ,000 6,000 12,000 23,300 Net Income $6,300

S3-12 S3-12 Scissors Hair Stylists Worksheet December 31, 2005 Adjusted Trial Balance Account TitleDr.Cr. Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Suzanne Byrd, capital Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals ,000 4, , ,300 2, ,000 6,000 12,000 23,300 Total Assets = $15,600

Copyright © 2007 Prentice-Hall. All rights reserved 49 Scissors Hair Stylists Worksheet December 31, 2005 Adjusted Trial Balance Account TitleDr.Cr. Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Suzanne Byrd, capital Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals ,000 4, , ,300 2, ,000 6,000 12,000 23,300 Income Statement Accounts Balance Sheet Accounts

Copyright © 2007 Prentice-Hall. All rights reserved 50 Objective 5 Prepare the financial statements from the adjusted trial balance

Copyright © 2007 Prentice-Hall. All rights reserved 51 Scissors Hair Stylists Worksheet December 31, 2005 Adjusted Trial Balance Account TitleDr.Cr. Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Suzanne Byrd, capital Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals ,000 4, , ,300 2, ,000 6,000 12,000 23,300 Income Statement Accounts Scissors Hair Stylists Income Statement For the Year Ended December 31, 2005 Service revenue $12,000 Expenses: Rent expense $ 4,000 Supplies expense 500 Depreciation expense 1,000 Interest expense200 Total Expenses 5,700 Net Income $ 6,300

Copyright © 2007 Prentice-Hall. All rights reserved 52 Scissors Hair Stylists Worksheet December 31, 2005 Adjusted Trial Balance Account TitleDr.Cr. Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Suzanne Byrd, capital Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals ,000 4, , ,300 2, ,000 6,000 12,000 23,300 Scissors Hair Stylists Statement of Owner's Equity For the Year Ended December 31, 2005 S. Byrd, Capital, Jan. 1, 2005 $ 6,000 Add: Net Income 6,300 S. Byrd, Capital, Dec. 31, 2005$12,300

Copyright © 2007 Prentice-Hall. All rights reserved 53 Scissors Hair Stylists Worksheet December 31, 2005 Adjusted Trial Balance Account TitleDr.Cr. Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Suzanne Byrd, capital Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals ,000 4, , ,300 2, ,000 6,000 12,000 23,300 Balance Sheet Accounts Scissors Hair Stylists Balance December 31, 2005 AssetsLiabilities Cash $ 400Accounts payable $ 200 Supplies 200Interest payable 100 Equipment $17,000Note payable 3,000 Less: Accumulated Depreciation 2,000 15,000 Total Liabilities $ 3,300 Owner's Equity S. Byrd, Capital 12,300 Total Assets $15,600

Copyright © 2007 Prentice-Hall. All rights reserved 54 End of Chapter 3