1. © 2007 McGraw-Hill Ryerson Ltd.
The Accounting Cycle
Analyze
transactions
Prepare
post-closing
trial balance 1 9
Journalize 2 2
Close 8
Post 3
Prepare
statements 7
Prepare
unadjusted
trial balance 4
Adjust 5
Prepare
adjusted
trial balance 6
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2. Adjusting the Accounts
Financial information must be timely and accurate to be useful to decision makers.
Financial statements need to be prepared at regular intervals (periods).
Accounts need to be adjusted (updated) to ensure all revenues, expenses, assets, and liabilities are recorded.
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3. GAAP and the Adjusting Process
Adjustments are based on three generally accepted accounting principles:
Time period principle.
Revenue recognition principle.
Matching principle.
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4. Accounting Principles
Time Period Principle
Assumes that the organization’s activities can be divided into specific time periods such as:
Months
Quarters
Years
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5. Accounting Principles
Revenue Recognition Principle
Revenue is recorded at the time it is earned regardless of whether cash or another asset has been exchanged.
Matching Principle
Expenses are to be matched in the same accounting period as the revenues they helped to earn.
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6. © 2007 McGraw-Hill Ryerson Ltd.
Cash vs. Accrual Basis
Accrual Basis
Revenues and expenses are recognized when earned or incurred regardless of when cash is received or paid.
Consistent with GAAP.
Cash Basis
Revenues and expenses are recognized when cash is received or paid.
Not consistent with GAAP.
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7. © 2007 McGraw-Hill Ryerson Ltd.
Adjustments
Types:
Prepaid expenses
Amortization
Unearned revenues
Accrued expenses
Accrued revenues
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8. © 2007 McGraw-Hill Ryerson Ltd.
Prepaid Expenses
Costs paid in cash and recorded as assets before they are used are called prepaid expenses.
These costs expire with the passage of time or through use and consumption, e.g., insurance, supplies.
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9. Prepaid Expenses–Example
On January 1, a company purchases an insurance policy that covers three months and costs $1,800.
The policy will benefit the company for three months and will be expired at the end of three months.
The cost of the policy should be spread over the time period it benefits the organization. (matching principle).
$600
$1,800
January
February
March
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10. Prepaid Expenses — Example
The entry to record the purchase of the insurance policy would be: Prepaid Insurance 1, Cash ,800
$1,800
$1,800
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11. Prepaid Expenses — Example
The entry to record the expiry of the insurance for January would be: Insurance Expense Prepaid Insurance
$1,800
$1,800
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12. Prepaid Expenses — Example
The entry to record the expiry of the insurance for February would be: Insurance Expense Prepaid Insurance
$1,800
$1,800
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13. Prepaid Expenses — Example
The entry to record the expiry of the insurance for March would be: Insurance Expense Prepaid Insurance
$1,800
$1,800
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14. Asset Cost - Salvage Value
Amortization
Amortization is the process of allocating the costs of assets over their useful lives.
Companies acquire capital assets such as equipment, buildings, vehicles, and patents to generate revenues.
These assets are expected to provide benefits for more than one period.
Straight-Line
Amortization
Expense =
Asset Cost - Salvage Value
Useful Life
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15. © 2007 McGraw-Hill Ryerson Ltd.
Unearned Revenues
Cash received in advance of providing products and services.
The company has an obligation to provide goods or services.
Unearned revenues are liabilities.
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16. Unearned Revenues — Example
On March 1, a company received a $12,000 payment from a customer for maintenance services to be provided over the next two months.
The entry to record the receipt of cash would be: Cash , Unearned Revenue ,000
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17. Unearned Revenues - Example
On March 31, $6,000 of this revenue had been earned.
The entry to record the earned revenue would be: Unearned Revenue , Maintenance Revenue ,000
$12,000/2months= $6,000/month
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18. Unearned Revenues - Example
By April 30, another $6,000 of this unearned revenue had been earned.
The entry to record the earned revenue would be: Unearned Revenue , Maintenance Revenue ,000
$12,000/2months= $6,000/month
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19. © 2007 McGraw-Hill Ryerson Ltd.
Accrued Expenses
Costs incurred in a period that are both unpaid and unrecorded.
Adjusting entries must be made to record the expense for the period and the related liability at the balance sheet date.
Examples: interest, wages, rent, taxes
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20. Accrued Expenses - Example
On December 31, $1,200 of interest has accrued on a company’s bank loan. The payment of the interest is not due until January 1.
The December 31 entry to record the accrued interest would be:
Interest Expense , Interest Payable ,200
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21. Accrued Expenses - Example
In December, a company incurred $3,700 of utilities expense. The company had not received the utility bill at December 31.
The December 31 entry to record the accrued utilities expense would be:
Utilities Expense , Utilities Payable ,700
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22. © 2007 McGraw-Hill Ryerson Ltd.
Accrued Revenues
Revenues earned in a period that are both unrecorded and not yet received in cash.
Adjusting entries must be made to record the revenue for the period and the related asset at the balance sheet date.
Examples: fees earned, interest earned, rent earned
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23. Accrued Revenues - Example
On December 31, $16,500 of consulting fees have been earned but have not been recorded or billed to the client.
The entry to record the accrued consulting fees earned would be:
Accounts Receivable , Consulting Fees Earned ,500
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24. Adjustments & Financial Statements
Adjustments are only made when financial statements are prepared.
Affect both the income statement and the balance sheet.
Do not affect cash.
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25. © 2007 McGraw-Hill Ryerson Ltd.
Trial Balance
Unadjusted Trial Balance
Prepared before adjustments are recorded.
Adjusted Trial Balance
Used to prepare financial statements.
Prepared after adjustments are recorded and posted.
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26. Financial Statement Preparation
Adjusting entries bring the accounts up-to-date.
The adjusted trial balance is used to prepare the financial statements in the following order:
Income Statement
Statement of Owner’s Equity
Balance Sheet
Cash Flow Statement
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27. © 2007 McGraw-Hill Ryerson Ltd.
Review
When and why are adjusting entries prepared?
They are prepared when a company wishes to issue financial statements. Adjusting entries bring the account balances up-to-date.
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28. Correcting Errors — Example
Alternative 1 -Prepare a single correcting entry.
The original entry was recorded as:
Interest Expense , Cash ,200
The correcting entry would be:
Salaries Expense , Interest Expense ,200
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29. Correcting Errors — Example
Alternative 2 -Reverse the original entry and enter the correct entry.
The original entry was recorded as:
Interest Expense , Cash ,200
The entry to reverse this would be:
Cash , Interest Expense ,200
The correct entry would be:
Salaries Expense , Cash ,200
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30. Classified Balance Sheet
A balance sheet that presents the assets and liabilities in relevant subgroups.
It provides users with more useful information for decision making.
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31. Current assets are assets that are expected to be sold, collected, or used within the longer of one year or the company’s operating cycle.
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McGraw-Hill
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32. Long-term investments are assets not used in day-to-day operating activities and are expected to be held for more than one year or the operating cycle.
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33. Property, plant and equipment are tangible capital assets used in day-to day operating activities to produce or sell products and services and are used for more than one accounting period or operating cycle.
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34. Intangible assets are long-term resources used to produce or sell products and services. They lack physical form and their benefits are uncertain.
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Ryerson Ltd.

35. © 2007 McGraw-Hill Ryerson Ltd.
Current liabilities are obligations due within one year or the company’s operating cycle, whichever is longer.
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36. © 2007 McGraw-Hill Ryerson Ltd.
Long-term liabilities are obligations not due within the longer of one year or the company’s operating cycle.
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37. Multi Step Income Statement
An income statement that contains one or more subtotals that highlight significant relationships.
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38. Single Step Income Statement
An income statement that groups all revenues together and then lists and deducts alls expenses together without drawing any intermediate sub totals.
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39. © 2005 McGraw-Hill Ryerson Limited.
Gross Profit
The excess of sales revenue over the cost of the inventory that was sold
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40. © 2005 McGraw-Hill Ryerson Limited.
Operating income
Gross profit less all operating expenses
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41. Gross Margin Percentage
Gross Profit divided by sales
Useful to retailer in choosing a pricing strategy and in judging results
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42. © 2005 McGraw-Hill Ryerson Limited.
Return on Sales Ratio
Net income divided by sales
Shows the relationship between net income to sales revenue.
Followed closely by managers
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43. Return on Stockholder’s Equity
Net income divided by invested capital
Regarded as the ultimate measure of overall accomplishment.
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44. © 2005 McGraw-Hill Ryerson Limited.

45. © 2005 McGraw-Hill Ryerson Limited.
IASB
International Accounting Standards Board
An organization charged with responsibility for developing a common set of accounting standards to be used hthe world.
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46. © 2007 McGraw-Hill Ryerson Ltd.
End of Chapter
© 2007 McGraw-Hill Ryerson Ltd.