Module 3: Accounting Adjustments and Constructing Financial Statements

The Accounting Cycle

T-Accounts and Journal Entries

Capital Investment

Asset (Inventory) Transaction

Cash Dividends All transactions between the company and its shareholders are considered financing transactions. This includes payment of dividends, the issuance of stock, and any subsequent stock repurchase. Financing transactions affect only the balance sheet; they do not affect the income statement.

Adjusting Accounts

Types of Adjustments Cash received or paid before recognition of revenue or expense: Prepaid expenses Unearned revenues Cash received or paid after recognition of revenue or expense Accrued expenses Accrued revenues

Prepaid Expenses (Assets) Assume that Apple pays $200 to purchase time on MTV for future i ads. Apple’s cash account decreases by $200, and an asset called prepaid advertising increases by the same amount. When the ad is aired, the prepaid asset is “used up” and is removed from the balance sheet and recognizing the cost as an expense. Prepaid expenses usually have an original entry that involves cash but not always. The key is to DEFER the expense because it has not been “used” yet! Deferred Expenses create “Assets”. Why? What is the future economic benefit?

Unearned Revenues (Liabilities) Assume that Apple receives $400 cash from a customer as advance payment on a multi-unit iPod sale to be delivered next month. Unearned Revenues must have an original entry that involves cash. The key is to DEFER the REVENUE because it has not been “earned” Unearned Revenues create “Liabilities”. Why?

Recognition of Unearned Revenue as Earned Revenue Assume that Apple delivers the iPods a month later (but still within the fiscal quarter). Every adjusting entry has an Income Statement account and a Balance Sheet account. Why? An adjusting entry never involves the account “Cash.” Why?

Accrued Expenses (Liabilities) Assume that Apple’s sales staff earns $100 of sales commissions this period that will not be paid until next period. When paid, the liability is reduced as is cash. “Used” but not “Paid”. The “Expense” must be recorded to follow the “Matching Principle”. The balance sheet must be updated to reflect the proper “Asset/Liability”

Accrued Revenues (Assets) Assume that Apple delivers iPods to a customer in Germany who will pay next quarter. The sales price for those units is $500 and the cost is $400. “Earned” but not “Received”. The “Revenue” must be recorded to follow the “Revenue Recognition Principle”. The balance sheet must be updated to reflect the proper “Asset/Liability”

Trial Balance The trial balance is a listing of all accounts and their balances at a point in time. Its purpose is to prove the mathematical equality of debits and credits, provide a useful tool to uncover any accounting errors, and help prepare the financial statements.

Adjusted Trial Balance For Apple

Preparation of the Financial Statements Income Statement

Preparation of the Financial Statements Retained Earnings Computation

Preparation of the Financial Statements Balance Sheet

Preparation of the Financial Statements Statement of Stockholders’ Equity

Statement of Cash Flows – Indirect Method Operating cash flows

Changes to Working Capital Accounts

Formal Presentation of Apple’s SCF Can you explain why these adjustments are being made? Level 1---Is Cash Flow from Operating Act. Higher/Lower than accrual basis NI? Level 2--- What I/S account is being adjusted from accrual basis to cash basis? Level 3 ---Is the Cash I/S amount higher/lower than the accrual basis I/S amount?

Closing Process The closing process refers to the ‘zeroing out’ of revenue and expense accounts (the temporary accounts) by transferring their ending balances to retained earnings. Balance sheet accounts carry over from period to period and are called permanent accounts.) The result is that all income statement accounts begin the next period with zero balances.

Closing Process Journal Entries