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STUDY OBJECTIVES After studying this chapter, you should understand: Time period assumptionAdjusting entries for prepayments Accrual basis of accountingAdjusting.

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Presentation on theme: "STUDY OBJECTIVES After studying this chapter, you should understand: Time period assumptionAdjusting entries for prepayments Accrual basis of accountingAdjusting."— Presentation transcript:

1 STUDY OBJECTIVES After studying this chapter, you should understand: Time period assumptionAdjusting entries for prepayments Accrual basis of accountingAdjusting entries for accruals Why adjusting entries are necessary Purpose of an adjusted trial balance Major types of adjusting entries ADJUSTING THE ACCOUNTS

2 The time period assumption assumes that the economic life of a business can be divided into artificial time periods. Accounting time periods are generally a month, a quarter, or a year (fiscal year) STUDY OBJECTIVE 1 TIME PERIOD ASSUMPTION STUDY OBJECTIVE 1 TIME PERIOD ASSUMPTION

3 STUDY OBJECTIVE 2 ACCRUAL vs. CASH-BASIS ACCOUNTING STUDY OBJECTIVE 2 ACCRUAL vs. CASH-BASIS ACCOUNTING Accrual Basis Revenue recognized when earned Expenses are matched against revenues Required by GAAP Accrual Basis Revenue recognized when earned Expenses are matched against revenues Required by GAAP Cash-Basis Revenues and expenses recorded when cash is paid or received Not GAAP Cash-Basis Revenues and expenses recorded when cash is paid or received Not GAAP

4 The revenue recognition principle dictates that revenue be recognized in the accounting period in which it is earned. In a service business, revenue is considered to be earned when the service is performed. REVENUE RECOGNITION PRINCIPLE

5 The practice of expense recognition is referred to as the matching principle. The matching principle dictates that efforts (expenses) be matched with accomplishments (revenues). Revenues earned this month are offset against.... expenses incurred in earning the revenue MATCHING PRINCIPLE

6 Time-Period Assumption Economic life of business can be divided into artificial time periods Revenue-Recognition Principle Revenue recognized in the accounting period in which it is earned Matching Principle Expenses matched with revenues in the same period when efforts are expended to generate revenues GAAP RELATIONSHIPS IN REVENUE & EXPENSE RECOGNITION GAAP RELATIONSHIPS IN REVENUE & EXPENSE RECOGNITION

7 Adjusting entries are needed to ensure that revenue recognition and matching principles are followed 1 Revenues are recorded in the period earned, and...... 2 Expenses are recognized in the period incurred. STUDY OBJECTIVE 3 WHY ADJUSTING ENTRIES ARE NECESSARY STUDY OBJECTIVE 3 WHY ADJUSTING ENTRIES ARE NECESSARY

8 STUDY OBJECTIVE 4 TYPES OF ADJUSTING ENTRIES STUDY OBJECTIVE 4 TYPES OF ADJUSTING ENTRIES Adjusting entries are required each time financial statements are prepared. Two main categories of adjustments are: Adjusting entries are required each time financial statements are prepared. Two main categories of adjustments are: PREPAYMENTS ACCRUALS

9 ADJUSTING ENTRIES: PREPAYMENTS ADJUSTING ENTRIES: PREPAYMENTS Prepaid Expenses Expenses are paid and recorded as assets before they are used or consumed Example: Prepaid Insurance Prepaid Expenses Expenses are paid and recorded as assets before they are used or consumed Example: Prepaid Insurance Unearned Revenues Cash received and recorded as liabilities before revenue is earned Example: Cash received for services provided in future Unearned Revenues Cash received and recorded as liabilities before revenue is earned Example: Cash received for services provided in future

10 ADJUSTING ENTRIES: ACCRUALS ADJUSTING ENTRIES: ACCRUALS Accrued Revenues Revenues earned but Not yet received In cash or recorded Example: Sales of merchandise On account Accrued Revenues Revenues earned but Not yet received In cash or recorded Example: Sales of merchandise On account Accrued Expenses Expenses incurred but not yet paid in cash or recorded Example: Utilities used but not yet paid for Accrued Expenses Expenses incurred but not yet paid in cash or recorded Example: Utilities used but not yet paid for

11 $ 28,700 The Trial Balance is the starting place for adjusting entries. TRIAL BALANCE

12 Adjusting entries for prepayments are required to record the portion of the prepayment representing: 1 the expense incurred, or 2 the revenue earned in the current period. STUDY OBJECTIVE 5 ADJUSTING ENTRIES FOR PREPAYMENTS STUDY OBJECTIVE 5 ADJUSTING ENTRIES FOR PREPAYMENTS

13 Adjusting Entries Asset Unadjusted Balance Credit Adjusting Entry (-) Expense Debit Adjusting Entry (+) Prepaid Expenses Liability Unadjusted Balance Debit Adjusting Entry (-) Revenue Credit Adjusting Entry (+) Unearned Revenues ADJUSTING ENTRIES FOR PREPAYMENTS ADJUSTING ENTRIES FOR PREPAYMENTS

14 Advertising Supplies Expense Oct. 311,500 Advertising Supplies Oct. 52,500Oct. 311,500 311,000 Date Account Titles and Explanation Debit Credit Oct. 31 Advertising Supplies Expense 1,500 Advertising Supplies 1,500 (To record supplies used) JOURNAL ENTRY POSTING ADJUSTMENT October 31, an inventory count reveals that $1,000 of $2,500 of supplies are still on hand. ADJUSTING ENTRIES FOR PREPAYMENTS SUPPLIES ADJUSTING ENTRIES FOR PREPAYMENTS SUPPLIES

15 Insurance Expense63 Oct. 3150 Prepaid Insurance10 Oct. 4600Oct. 3150 31550 DateAccount Titles and ExplanationDebitCredit Oct. 31Insurance Expense50 Prepaid Insurance50 (To record insurance expired) JOURNAL ENTRY POSTING ADJUSTMENT October 31, an analysis of the policy reveals that $50 of insurance expires each month. ADJUSTING ENTRIES FOR PREPAYMENTS INSURANCE ADJUSTING ENTRIES FOR PREPAYMENTS INSURANCE

16 REVIEW QUESTION ADJUSTING ENTRY-SUPPLIES REVIEW QUESTION ADJUSTING ENTRY-SUPPLIES The trial balance shows supplies of $1,350 and supplies expense of $0. If $750 of supplies are on hand at the end of the period, what is the adjusting entry? $600 Supplies $600Supplies Expense CreditDebitAccount The balance in supplies after adjustment is $750, the amount remaining unused. The amount used is transferred to expense.

17 Depreciation is the allocation of the cost of an asset to expense over its useful life. Depreciation is an estimate of expired cost. Depreciation Expense is debited and a contra-asset account, Accumulated Depreciation, is credited Cost – accumulated depreciation = Book value Depreciation Expense XXX Accumulated Depreciation XXX ADJUSTING ENTRIES FOR PREPAYMENTS DEPRECIATION ADJUSTING ENTRIES FOR PREPAYMENTS DEPRECIATION

18 Accumulated Depreciation - Office Equipment Oct. 3140 DateAccount Titles and ExplanationDebitCredit Oct. 31Depreciation Expense40 Accumulated Depreciation - Office Equipment40 (To record monthly depreciation) JOURNAL ENTRY POSTING ADJUSTMENT October 31, depreciation on the office equipment is estimated to be $480 a year, or $40 per month. Depreciation Expense Oct. 3140 ADJUSTING ENTRIES FOR PREPAYMENTS DEPRECIATION ADJUSTING ENTRIES FOR PREPAYMENTS DEPRECIATION

19 Service Revenue Oct. 3110,000 31400 Unearned Revenue Oct. 31400Oct. 21,200 31800 JOURNAL ENTRY POSTING ADJUSTMENT October 31, analysis reveals that, of $1,200 in fees received in advance of performance, $400 has been earned in October. DateAccount Titles and ExplanationDebitCredit Oct. 31Unearned Revenue400 Service Revenue400 (To record revenue for services provided) ADJUSTING ENTRIES FOR PREPAYMENTS UNEARNED REVENUES ADJUSTING ENTRIES FOR PREPAYMENTS UNEARNED REVENUES

20 Adjusting entries for accruals are required to record revenues earned and expenses incurred in the current period. The adjusting entry for accruals will increase both a balance sheet and an income statement account. STUDY OBJECTIVE 6 ADJUSTING ENTRIES FOR ACCRUALS STUDY OBJECTIVE 6 ADJUSTING ENTRIES FOR ACCRUALS

21 Adjusting Entries Asset Debit Adjusting Entry (+) Accrued Revenues Revenue Credit Adjusting Entry (+) Accrued Expenses Expense Debit Adjusting Entry (+) Liability Credit Adjusting Entry (+) ADJUSTING ENTRIES FOR ACCRUALS ADJUSTING ENTRIES FOR ACCRUALS

22 Service Revenue Oct. 3110,000 31400 31200 3110,600 Accounts Receivable Oct. 31200 DateAccount Titles and ExplanationDebitCredit Oct. 31Accounts Receivable200 Service Revenue200 (To accrue revenue for services provided) October 31, the agency earned $200 for advertising services that were not billed to clients before October 31. JOURNAL ENTRY POSTING ADJUSTMENT ADJUSTING ENTRIES FOR ACCRUALS ACCRUED REVENUE ADJUSTING ENTRIES FOR ACCRUALS ACCRUED REVENUE

23 Interest Payable Oct. 3150 Interest Expense Oct. 3150 DateAccount Titles and ExplanationDebitCredit Oct. 31Interest Expense50 Interest Payable50 (To accrue interest on notes payable) JOURNAL ENTRY POSTING ADJUSTMENT October 31, the portion of the interest to be accrued on a 3-month note payable is calculated to be $50. ADJUSTING ENTRIES FOR ACCRUALS ACCRUED INTEREST ADJUSTING ENTRIES FOR ACCRUALS ACCRUED INTEREST

24 Salaries Payable Oct. 311,200 DateAccount Titles and ExplanationDebitCredit Oct. 31Salaries Expense1,200 Salaries Payable1,200 (To record accrued salaries) JOURNAL ENTRY POSTING ADJUSTMENT October 31, accrued salaries are calculated to be $1,200. Salaries Expense Oct. 264,000 311,200 315,200 ADJUSTING ENTRIES FOR ACCRUALS ACCRUED SALARIES ADJUSTING ENTRIES FOR ACCRUALS ACCRUED SALARIES

25 REVIEW QUESTION ADJUSTING ENTRY-SALARIES REVIEW QUESTION ADJUSTING ENTRY-SALARIES $400 Salaries Payable $400Salaries Expense CreditDebitAccount This entry recognizes an expense for the salary earned by Kathy in the last week of September, and a liability for the amount due to Kathy at September 30 th. Kathy Siska earned a salary of $400 for the last week of September. She will be paid on October 1. What is the required adjusting entry?

26 An Adjusted Trial Balance is prepared after all adjusting entries have been journalized and posted. Its purpose is to prove the equality of the total debit and credit balances in the ledger after all adjustments have been made. Financial statements can be prepared directly from the adjusted trial balance. STUDY OBJECTIVE 7 ADJUSTED TRIAL BALANCE STUDY OBJECTIVE 7 ADJUSTED TRIAL BALANCE

27 Service Revenue 10,600 Salaries Expense 5,200 Advertising Supplies Expense 1,500 Rent Expense 900 Insurance Expense 50 Interest Expense 50 Depreciation Expense 40 $ 30,190 PREPARING THE INCOME STATEMENT FROM THE ADJUSTED TRIAL BALANCE PREPARING THE INCOME STATEMENT FROM THE ADJUSTED TRIAL BALANCE INCOME STATEMENT ACCOUNTS INCOME STATEMENT ACCOUNTS

28 PIONEER ADVERTISING AGENCY Income Statement For the Month Ended October 31, 200 6 Revenues Fees earned $ 10,600 Expenses Salaries expense $ 5,200 Advertising supplies expense 1,500 Rent expense 900 Insurance expense 50 Interest expense 50 Depreciation expense 40 Total expenses 7,740 Net income $ 2,860 The income statement is prepared from the revenue and expense accounts. INCOME STATEMENT

29 Service Revenue 10,600 Salaries Expense 5,200 Advertising Supplies Expense 1,500 Rent Expense 900 Insurance Expense 50 Interest Expense 50 Depreciation Expense 40 $ 30,190 PREPARING THE RETAINED EARNINGS STATEMENT FROM THE ADJUSTED TRIAL BALANCE PREPARING THE RETAINED EARNINGS STATEMENT FROM THE ADJUSTED TRIAL BALANCE RETAINED EARNINGS STATEMENT ACCOUNTS BALANCE SHEET ACCOUNTS

30 The retained earnings statement is prepared from the revenue, expense, dividends, and retained earnings accounts. RETAINED EARNINGS STATEMENT

31 Stockholders’ Equity Common Stock 10,000 Retained Earnings 2,360 Total liabilities and owner’s Total assets $ 21,910 equity $ 21,910 The balance sheet is prepared from asset and liability and stockholders equity accounts. BALANCE SHEET


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