1. Certified General Accountants
Module 1
Certified General Accountants
Financial Accounting Fundamentals (FA1) Module 3 Adjusting the accounts, preparing the statements and completing the accounting cycle
© 2010 McGraw-Hill Ryerson Limited.

2. © 2010 McGraw-Hill Ryerson Limited.
Adjusting Accounts for Financial Statements
C H A P T E R 4
Slides Content
1-5 Learning objectives and the accounting cycle
6-12 Adjusting the accounts
13-18 Prepaid expenses
19-27 Depreciation
28-31 Unearned revenues
32-36 Accrued expenses and revenues
Adjustments and financial statements
Adjusted trial balance
40-41 Financial statement preparation
42-45 Appendix 4A-Error corrections
46-51 Appendix 4B-Alternative recording methods and end of chapter
© 2010 McGraw-Hill Ryerson Limited.

3. © 2010 McGraw-Hill Ryerson Limited.
Learning Objectives
Explain the need for financial statements and account adjustments at the end of regular accounting periods. (Level 1)
Prepare adjusting entries for prepaid expenses, deprecation, unearned revenues, accrued expenses and accrued revenues. (Level 1)
Prepare an adjusted trial balance and use it to prepare financial statements. (Level 1)
© 2010 McGraw-Hill Ryerson Limited.

4. © 2010 McGraw-Hill Ryerson Limited.
Learning Objectives
Prepare financial statements for a service business from the information in a work sheet. (Level 2)
Prepare closing entries for a service business.(Level 1)
Prepare a post-closing trial balance. (Level 1)
© 2010 McGraw-Hill Ryerson Limited.

5. © 2010 McGraw-Hill Ryerson Limited.
Learning Objectives
Explain the steps in the accounting cycle. (Level 1)
Prepare a classified balance sheet. (Level 1)
Calculate the current ratio and interpret and apply this ratio in decision-making scenarios. (Level 2)
© 2010 McGraw-Hill Ryerson Limited.

6. © 2010 McGraw-Hill Ryerson Limited.
The Accounting Cycle
Analyze
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
© 2010 McGraw-Hill Ryerson Limited.

7. © 2010 McGraw-Hill Ryerson Limited.
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.
© 2010 McGraw-Hill Ryerson Limited.

8. © 2010 McGraw-Hill Ryerson Limited.
GAAP and the Adjusting Process
Adjustments are based on three generally accepted accounting principles:
Timeliness principle.
Revenue recognition principle.
Matching principle.
© 2010 McGraw-Hill Ryerson Limited.

9. © 2010 McGraw-Hill Ryerson Limited.
Accounting Principles
Timeliness Principle
Assumes that the organization’s activities can be divided into specific time periods such as:
Months
Quarters
Years
Requires that financial statements be presented at least annually.
© 2010 McGraw-Hill Ryerson Limited.

10. © 2010 McGraw-Hill Ryerson Limited.
Accounting Principles
Revenue Recognition Principle
Revenue is recognized (reported) in the time period when it is earned regardless when the cash is received.
Matching Principle
Expenses are to be matched in the same accounting period as the revenues they helped to earn.
© 2010 McGraw-Hill Ryerson Limited.

11. © 2010 McGraw-Hill Ryerson Limited.
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.
© 2010 McGraw-Hill Ryerson Limited.

12. © 2010 McGraw-Hill Ryerson Limited.
Adjusting Accounts
Accounts are adjusted at the end of each accounting period to bring an asset or liability account to its proper amount.
Adjusting entries also update the related expense or revenue accounts.
These adjustments are necessary for the preparation of financial statements.
© 2010 McGraw-Hill Ryerson Limited.

13. © 2010 McGraw-Hill Ryerson Limited.
Adjustments
Types:
Prepaid expenses
Depreciation
Unearned revenues
Accrued expenses
Accrued revenues
© 2010 McGraw-Hill Ryerson Limited.

14. © 2010 McGraw-Hill Ryerson Limited.
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.
© 2010 McGraw-Hill Ryerson Limited.

15. 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
© 2010 McGraw-Hill Ryerson Limited.

16. Prepaid Expenses — Example
The entry to record the purchase of the insurance policy would be: Prepaid Insurance 1, Cash ,800
$1,800
$1,800
© 2010 McGraw-Hill Ryerson Limited.

17. Prepaid Expenses — Example
The entry to record the expiry of the insurance for March would be: Insurance Expense Prepaid Insurance
$1,800
$1,800
© 2010 McGraw-Hill Ryerson Limited.

18. © 2010 McGraw-Hill Ryerson Limited.
Depreciation
Companies acquire assets such as equipment, buildings, vehicles, and patents to generate revenues.
These assets are expected to provide benefits for more than one accounting period.
Depreciation is the process of allocating the costs of assets over their useful lives.
© 2010 McGraw-Hill Ryerson Limited.

19. Asset cost – Estimated residual value
Depreciation
Depreciation is based on the matching principle where the cost of an asset is matched over the time the asset helped earn the revenue.
Straight-Line
Depreciation
Expense =
Asset cost – Estimated residual value
Estimated Useful Life
© 2010 McGraw-Hill Ryerson Limited.

20. Depreciation - Example
On January 1,2011, a company purchased a piece of equipment for $72,000. The equipment is expected to have a useful life of four years and have a residual value of $8,000.
Straight-Line
Depreciation
Expense =
Asset cost – Estimated residual value
Estimated Useful Life =
$72, $8,000
4 years
= $16,000/year
© 2010 McGraw-Hill Ryerson Limited.

21. Depreciation - Example
The entry to record the purchase of the equipment would be:
Equipment 72, Cash ,000
© 2010 McGraw-Hill Ryerson Limited.

22. Depreciation - Example
The entry to record Depreciation at the end of the fourth year would be:
Depreciation Expense, Equipment 16,000
Accumulated Depreciation, Equip. 16,000
© 2010 McGraw-Hill Ryerson Limited.

23. Depreciation - Example
© 2010 McGraw-Hill Ryerson Limited.

24. © 2010 McGraw-Hill Ryerson Limited.
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.
As products and services are provided, the amount of unearned revenues becomes earned revenues.
© 2010 McGraw-Hill Ryerson Limited.

25. 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
© 2010 McGraw-Hill Ryerson Limited.

26. 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
© 2010 McGraw-Hill Ryerson Limited.

27. 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
© 2010 McGraw-Hill Ryerson Limited.

28. © 2010 McGraw-Hill Ryerson Limited.
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
© 2010 McGraw-Hill Ryerson Limited.

29. 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
© 2010 McGraw-Hill Ryerson Limited.

30. 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 , Accounts Payable ,700
© 2010 McGraw-Hill Ryerson Limited.

31. © 2010 McGraw-Hill Ryerson Limited.
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
© 2010 McGraw-Hill Ryerson Limited.

32. 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
© 2010 McGraw-Hill Ryerson Limited.

33. © 2010 McGraw-Hill Ryerson Limited.
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.
© 2010 McGraw-Hill Ryerson Limited.

34. © 2010 McGraw-Hill Ryerson Limited.
Trial Balance
Unadjusted Trial Balance
A listing of accounts and balances that is prepared before adjustments are recorded.
Adjusted Trial Balance
A listing of accounts and balances that is prepared after adjustments are recorded and posted to the ledger.
It is used to prepare financial statements.
© 2010 McGraw-Hill Ryerson Limited.

35. © 2010 McGraw-Hill Ryerson Limited.
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 Changes in Equity
Balance Sheet
Statement of Cash Flows
© 2010 McGraw-Hill Ryerson Limited.

36. © 2010 McGraw-Hill Ryerson Limited.
Appendix 4B: Alternatives in Recording Prepaids and Unearned Revenues
Prepaid Expenses
Often recorded as assets when paid.
Adjusting entries transfer expired portion to expense accounts at period end.
Alternative Treatment
Record as an expense when paid.
Adjusting entries transfer unused portion of prepaid from the expense to the asset account.
© 2010 McGraw-Hill Ryerson Limited.

37. © 2010 McGraw-Hill Ryerson Limited.
Appendix 4B: Alternatives in Recording Prepaids and Unearned Revenues
Example:
On January 1, a company purchases an insurance policy that covers 3 months and costs $1,800.
On January 31, $600 ($1,800 x 1/3) of the policy has expired and $1,200 ($1,800 x 2/3) remains unexpired.
© 2010 McGraw-Hill Ryerson Limited.

38. © 2010 McGraw-Hill Ryerson Limited.
Prepaids- Example
Payment Recorded as an Asset Payment Recorded as an Expense
Jan.1 Prepaid Insurance 1,800 Insurance Expense 1,800
Cash , Cash ,800
Jan.31 Insurance Expense Prepaid Insurance 1,200
Prepaid Insurance Insurance Expense ,200
© 2010 McGraw-Hill Ryerson Limited.

39. © 2010 McGraw-Hill Ryerson Limited.
Appendix 4B: Alternatives in Recording Prepaids and Unearned Revenues
Unearned Revenues
Often recorded as liabilities when cash is received.
Adjusting entries transfer earned portion to revenue accounts at period end.
Alternative Treatment
Record as revenues when cash is received.
Adjusting entries transfer unearned portion of the payment from the revenue account to the unearned account.
© 2010 McGraw-Hill Ryerson Limited.

40. © 2010 McGraw-Hill Ryerson Limited.
Alternatives in Accounting for Prepaids and Unearned Revenues-Appendix 4B
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.
On March 31, $6,000 ($12,000/2) of the revenue has been earned and $6,000 ($12,000/2) remains unearned.
© 2010 McGraw-Hill Ryerson Limited.

41. Unearned Revenues- Example
Receipt Recorded as a Liability Receipt Recorded as a Revenue
Mar.1 Cash , Cash ,000
Unearned Revenue , Maintenance Revenue ,000
Mar.31 Unearned Revenue Maintenance Revenue ,000
Maintenance Revenue Unearned Revenue ,000
© 2010 McGraw-Hill Ryerson Limited.

42. © 2010 McGraw-Hill Ryerson Limited.
Completing the Accounting Cycle and Classifying Accounts
C H A P T E R 5
Slides Content
1-4 Learning objectives and the accounting cycle
5-12 The worksheet
13-19 Closing entries
20-24 Post closing trial balance
25-33 Classified balance sheet
34-37 Appendix 5A-Reversing entries
Appendix 5B-Current ratio
40 End of chapter
© 2010 McGraw-Hill Ryerson Limited.

43. © 2010 McGraw-Hill Ryerson Limited.
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
Prepare
adjusted
trial balance 5 6
© 2010 McGraw-Hill Ryerson Limited.

44. © 2010 McGraw-Hill Ryerson Limited.
The Worksheet
An optional working paper that can be used to simplify the preparation of financial statements.
It is:
Prepared before adjusting entries are made.
Not distributed to decision makers.
Helpful in preventing errors.
Often used by auditors.
© 2010 McGraw-Hill Ryerson Limited.

45. © 2010 McGraw-Hill Ryerson Limited.
A Blank Worksheet
Steps:
Enter unadjusted trial balance.
Enter adjustments.
Prepare adjusted trial balance.
Extend adjusted trial balance columns.
Enter net income (or loss) and balance financial statement columns.
Prepare financial statements.
© 2010 McGraw-Hill Ryerson Limited.

46. Prepare Unadjusted Trial Balance © 2010 McGraw-Hill Ryerson Limited.
Step 1
Prepare Unadjusted Trial Balance
© 2010 McGraw-Hill Ryerson Limited.

47. © 2010 McGraw-Hill Ryerson Limited.
Step 2
Enter Adjustments
© 2010 McGraw-Hill Ryerson Limited.

48. Prepare Adjusted Trial Balance
Step 3
Prepare Adjusted Trial Balance
© 2010 McGraw-Hill Ryerson Limited.

49. Step 4 Extend Adjusted Amounts to Statement Columns
© 2010 McGraw-Hill Ryerson Limited.

50. Enter net income (or loss) and balance financial statement columns.
Step 5
Enter net income (or loss) and balance financial statement columns.
© 2010 McGraw-Hill Ryerson Limited.

51. Prepare financial statements from worksheet information.
Step 6
Prepare financial statements from worksheet information.
© 2010 McGraw-Hill Ryerson Limited.

52. © 2010 McGraw-Hill Ryerson Limited.
The Closing Process
The closing process occurs at the end of an accounting period after financial statements are prepared.
Closing entries:
Reset revenue, expense and withdrawal account balances to zero at the end of the period.
Update the capital account to reflect net income (or loss) and drawings from the period just ending.
© 2010 McGraw-Hill Ryerson Limited.

53. Four-Step Closing Process (REID)
Close Revenue accounts to Income Summary account.
Close Expense accounts to Income Summary account.
Close Income Summary account to Owner’s Capital account.
Close Drawings (Withdrawals) account to the Capital account.
© 2010 McGraw-Hill Ryerson Limited.

54. Four-Step Closing Process (REID)
Example
Please see the Adjusted Trial Balance illustration in the textbook.
© 2010 McGraw-Hill Ryerson Limited.

55. Step 1: Close Revenue accounts to Income Summary
Teaching Revenue ,850
Equip. Rental Revenue
Income Summary ,150
© 2010 McGraw-Hill Ryerson Limited.

56. Step 2: Close Expense Accounts to Income Summary
Depreciation Expense
Salaries Expense ,470
Interest Expense
Insurance Expense
Rent Expense ,000
Supplies Expense ,050
Utilities Expense
© 2010 McGraw-Hill Ryerson Limited.

57. Step 3: Close Income Summary to Capital
Virgil Klimb, Capital ,065
© 2010 McGraw-Hill Ryerson Limited.

58. Step 4: Close Drawings to Capital
Virgil Klimb, Capital
Virgil Klimb, Withdrawals
© 2010 McGraw-Hill Ryerson Limited.

59. © 2010 McGraw-Hill Ryerson Limited.
Account Balances after Closing
After closing:
All temporary accounts (revenue, expense, and withdrawal accounts will have zero balances.
The capital account will be updated to reflect net income (or loss) and withdrawals from the period just ending.
All other accounts will be unchanged.
© 2010 McGraw-Hill Ryerson Limited.

60. © 2010 McGraw-Hill Ryerson Limited.
Post-Closing Trial Balance
A list of balances for all accounts not closed.
It verifies that:
Total debits = total credits for permanent accounts.
All temporary accounts have zero balances.
© 2010 McGraw-Hill Ryerson Limited.

61. © 2010 McGraw-Hill Ryerson Limited.
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
Prepare
adjusted
trial balance 5 6
© 2010 McGraw-Hill Ryerson Limited.

62. © 2010 McGraw-Hill Ryerson Limited.
Classified Balance Sheet
A classified balance sheet:
Organizes assets and liabilities into important subgroups.
Provides users with more useful information for decision making.
© 2010 McGraw-Hill Ryerson Limited.

63. © 2010 McGraw-Hill Ryerson Limited.
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.
© 2010 McGraw-Hill Ryerson Limited.

64. © 2010 McGraw-Hill Ryerson Limited.
Long-term investments are held for more than one year or the operating cycle.
© 2010 McGraw-Hill Ryerson Limited.

65. © 2010 McGraw-Hill Ryerson Limited.
Property, plant and equipment are tangible assets used for more than one accounting period to produce or sell products and services.
© 2010 McGraw-Hill Ryerson Limited.

66. © 2010 McGraw-Hill Ryerson Limited.
Intangible assets are long-term resources used to produce or sell products and services. They lack physical form.
© 2010 McGraw-Hill Ryerson Limited.

67. © 2010 McGraw-Hill Ryerson Limited.
Current liabilities are obligations due to be paid or settled within the longer of one year or the company’s operating cycle.
© 2010 McGraw-Hill Ryerson Limited.

68. © 2010 McGraw-Hill Ryerson Limited.
Long-term liabilities are obligations due beyond the longer of one year or the company’s operating cycle.
© 2010 McGraw-Hill Ryerson Limited.

69. Equity is the owner’s claim on the assets of a company.
© 2010 McGraw-Hill Ryerson Limited.

70. © 2010 McGraw-Hill Ryerson Limited.
Appendix 5A Reversing Entries
Optional entries used to simplify record keeping.
They are:
Prepared on the first day of the new accounting period.
Prepared for adjusting entries that created accrued assets and liabilities.
© 2010 McGraw-Hill Ryerson Limited.

71. Reversing Entries - Example
DP Company rents unused office space to a tenant for $2,400 per month. The company had not received October’s rent payment from the tenant by October 31. Payment is expected on November 3.
The entry to record the accrued revenue would be:
Oct Accounts Receivable ,400
Rent Revenue ,400
© 2010 McGraw-Hill Ryerson Limited.

72. © 2010 McGraw-Hill Ryerson Limited.
Appendix 5A
Reversing Entries are Not used Reversing Entries are Used
Oct Accounts Receivable 2,400 Accounts Receivable 2,400
Rent Revenue , Rent Revenue ,400
© 2010 McGraw-Hill Ryerson Limited.

73. © 2010 McGraw-Hill Ryerson Limited.
Appendix 5A
Reversing Entries are Not used Reversing Entries are Used
Nov. 1 No entry Rent Revenue ,400
Accounts Receivable 2,400
Nov.3 Cash , Cash , Accounts Receivable , Rent Revenue ,400
© 2010 McGraw-Hill Ryerson Limited.

74. © 2010 McGraw-Hill Ryerson Limited.
Appendix 5B Using the Information
Current ratio: A ratio that is used to evaluate a company’s ability to pay its short-term obligations.
Current ratio =
Current assets
Current liabilities
© 2010 McGraw-Hill Ryerson Limited.

75. © 2010 McGraw-Hill Ryerson Limited.
Appendix 5B Using the Information
Current ratio =
Current assets
Current liabilities
This ratio:
Should not be used in isolation as a measure of liquidity.
Will vary from industry to industry.
May be tracked over time to spot trends.
May be used to compare to industry norms.
© 2010 McGraw-Hill Ryerson Limited.

76. © 2010 McGraw-Hill Ryerson Limited.
End of Module
© 2010 McGraw-Hill Ryerson Limited.