2. 3-1 A DJUSTMENTS F OR F INANCIAL R EPORTING CHAPTER 3

3. 3-2 Cash-Basis Accounting Accrual Basis Accounting vs. Income Statement paid Expenses recognized as cash is paid. received Revenues recognized as cash is received. Not considered GAAP. incurred Expenses recognized as they are incurred. earned Revenues recognized as they are earned. Mandated by GAAP.

4. 3-3 l Matching Principle u Expenses should be recognized in the same accounting period as are the revenues they generated. (i.e., match revenues and expenses.) Matching - The Most Important Accounting Principle

5. 3-4 l Matching Principle u Expenses should be recognized in the same accounting period as are the revenues they generated. (i.e., match revenues and expenses.) 1998 1999 2000 Revenues XXX Expenses - XX Net Income X Matching - The Most Important Accounting Principle

6. 3-5 l Matching Principle u Expenses should be recognized in the same accounting period as are the revenues they generated. (i.e., match revenues and expenses.) Matching Principle l The Matching Principle is the reason for using the accrual basis of accounting. 1998 1999 2000 Revenues XXX Expenses - XX Net Income X Matching - The Most Important Accounting Principle

7. 3-6 matching l Journal entries are made at the end of each accounting period to bring about a proper matching of revenues and expenses l Economic events (i.e., transactions) have been ongoing but never recorded. Why not? The Need for Adjusting Entries

8. 3-7 matching l Journal entries are made at the end of each accounting period to bring about a proper matching of revenues and expenses l Economic events (i.e., transactions) have been ongoing but never recorded. Why not? l Examples? The Need for Adjusting Entries

9. 3-8 The Need for Adjusting Entries Revenue Example

10. 3-9 12-Month Magazine Subscription The Need for Adjusting Entries Revenue Example 1/1/9812/31/98 1/1/9912/31/99 6/30/986/30/99 When the time necessary to earn a revenue extends into the next period...

11. 3-10... the adjusting process allows us to separate 1998 subscription revenue from from 1999 subscription revenue... When the time necessary to earn a revenue extends into the next period... 12-Month Magazine Subscription 1/1/9812/31/98 1/1/9912/31/99 6/30/986/30/99 The Need for Adjusting Entries Revenue Example

12. 3-11... the adjusting process allows us to separate 1998 subscription revenue from from 1999 subscription revenue as shown. When the time necessary to earn a revenue extends into the next period... 12-Month Magazine Subscription 1/1/9812/31/98 1/1/9912/31/99 6/30/986/30/99 The Need for Adjusting Entries Revenue Example

13. 3-12 12-Month Real Estate Tax Remember, we can also use adjustments to help us match expenses with revenues by making adjusting entries to put expenses in the same period as the related revenues. 1/1/9812/31/98 1/1/9912/31/99 6/30/986/30/99 The Need for Adjusting Entries Expense Example

14. 3-13 Adjusting Journal Entries (AJEs) AJEs use the same recording format as regular journal entries. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit M/DDAccount Name###$$$ Account Name###$$$ journal entry explanation

15. 3-14 Types of Adjusting Entries Deferrals Entries involving transfer of amounts previously recorded in asset and liability accounts to expense and revenue accounts, respectively Accruals Entries involving the initial, or first, recording of assets and liabilities and their related revenues and expenses 104 Who cares?

16. 3-15 Prepaid Expenses An asset awaiting assignment to an expense. Cash (credit) Prepaid Expense (debit) Journal entry when payment is made.

17. 3-16 Prepaid Expenses An asset awaiting assignment to an expense. The prepaid expense is consumed during the period. Cash (credit) Prepaid Expense (debit) Journal entry when payment is made.

18. 3-17 Prepaid Expenses An asset awaiting assignment to an expense. Expense (debit) Prepaid Expense (credit) The prepaid expense is consumed during the period. Cash (credit) Prepaid Expense (debit) Journal entry when payment is made. AJE at end of period

19. 3-18 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit Prepaid Expenses Example On September 1, 1998, Bob’s Bait Shop prepaid its rent for the next twelve months. Rent is $200 per month. Prepare the proper initial journal entry.

20. 3-19 On September 1, 1998, Bob’s Bait Shop prepaid its rent for the next twelve months. Rent is $200 per month. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-SepPrepaid Rent2,400 Cash2,400 to record prepayment of twelve months of rent Prepaid Expenses Example

21. 3-20 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit Prepaid Expenses Example Bob’s fiscal year-end is December 31. Record the adjustment necessary on December 31 for the prepaid rent. Prepare the proper adjusting journal entry.

22. 3-21 Bob’s fiscal year-end is December 31. Record the adjustment necessary on December 31 for the prepaid rent. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 31-DecRent Expense800 Prepaid Rent800 to record recognition of four months of rent expense $200  x 4 months = $800 Prepaid Expenses Example

23. 3-22 Prepaid Expenses Other Examples l Prepaid Insurance u Premiums are paid in advance. l Prepaid Subscriptions u Magazine and newspaper subscriptions are always paid in advance. l Supplies on Hand u Supplies are “charged” to expense periodically.

24. 3-23 Prepaid Expenses Supplies on Hand Blank paper used in a copier is a great example of how supplies on hand transform from being an asset to becoming an expenses. Asset Expense

25. 3-24 Accounting Estimates l Some assets are not fully used up in a single fiscal period. u A truck may last five years, but its value as a resource declines with time and usage.

26. 3-25 Accounting Estimates l Some assets are not fully used up in a single fiscal period. u A truck may last five years, but its value as a resource declines with time and usage. long-term“fixed” l Assets that benefit more than one year are called long-term or “fixed” assets.

27. 3-26 Accounting Estimates The portion of an asset’s utility that is used up must be expensed in the period used. Cash (credit) Fixed Asset (debit) Journal entry when payment is made.

28. 3-27 Accounting Estimates Cash (credit) Fixed Asset (debit) Journal entry when payment is made. The asset’s usefulness is partially consumed during the period. The portion of an asset’s utility that is used up must be expensed in the period used.

29. 3-28 Accounting Estimates Accumulated Depreciation (credit) Depreciation Expense (debit) Cash (credit) Fixed Asset (debit) Journal entry when payment is made. The asset’s usefulness is partially consumed during the period. The portion of an asset’s utility that is used up must be expensed in the period used. AJE at end of period

30. 3-29 Accounting Estimates Accumulated Depreciation (credit) Depreciation Expense (debit) This is called a contra-asset account and has a credit balance. The portion of an asset’s utility that is used up must be expensed in the period used. AJE at end of period

31. 3-30 Accounting Estimates Accumulated Depreciation (credit) Depreciation Expense (debit) This is called a contra-asset account and has a credit balance. The portion of an asset’s utility that is used up must be expensed in the period used. AJE at end of period Balance Sheet Presentation Asset (at cost) $40,000 Less: Accumulated Depr. 5,000 Book Value $35,000 Balance Sheet Presentation Asset (at cost) $40,000 Less: Accumulated Depr. 5,000 Book Value $35,000

32. 3-31 Definition of Book Value Asset cost - Accumulated Depreciation Accounting Estimates

33. 3-32 Book Value = $35,000 Truck Bal. 40,000 Accumulated Dep’n - Truck 5,000 Bal. Accounting Estimates

34. 3-33 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit Accounting Estimates Example On 12/31/97, Putnam Plumbing, recorded $2,000 of Depreciation Expense on a $10,000 truck. Prepare the proper adjusting journal entry.

35. 3-34 On 12/31/97, Putnam Plumbing, recorded $2,000 of Depreciation Expense on a $10,000 truck. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 31-DecDepreciation Expense2,000 Accumulated Depreciation2,000 to record depreciation expense on truck for the year Accounting Estimates Example

36. 3-35 Unearned Revenues Cash (debit) Unearned Revenue (credit) Journal entry when payment is received. earned Assets that have been received, but have not yet been earned.

37. 3-36 Unearned Revenues Cash (debit) Unearned Revenue (credit) earned Assets that have been received, but have not yet been earned. The unearned revenue is earned during the period. Journal entry when payment is received.

38. 3-37 Revenue (credit) Unearned Revenue (debit) Unearned Revenues Cash (debit) Unearned Revenue (credit) earned Assets that have been received, but have not yet been earned. The unearned revenue is earned during the period. AJE at end of period Journal entry when payment is received.

39. 3-38 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit Unearned Revenues Example 10/1/98 On 10/1/98, the Cookeville Gazette received $240 for a one-year subscription. The monthly subscription rate is $20. Prepare the proper initial journal entry.

40. 3-39 10/1/98 On 10/1/98, the Cookeville Gazette received $240 for a one-year subscription. The monthly subscription rate is $20. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-OctCash240 Unearned Subscriptions240 to record receipt of one-year subscription payment Unearned Revenues Example

41. 3-40 The Cookeville Gazette’s fiscal year-end is on 12/31/98 (three months later). Record the adjustment necessary at 12/31/98. Prepare the proper adjusting journal entry. Unearned Revenues Example GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit

42. 3-41 The Cookeville Gazette’s fiscal year-end is on 12/31/98 (three months later). Record the adjustment necessary at 12/31/98. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 31-DecUnearned Subscriptions60 Subscription Revenue60 to record recognition of three months of subscription earned $20  x  3 months = $60 Unearned Revenues Example

43. 3-42 Accrued Assets/Revenues Assets and revenues that remain unrecorded at the end of the period. During the period, revenues are earned, but are not recorded at that time.

44. 3-43 Accrued Assets/Revenues Revenue (credit) Asset (debit) During the period, revenues are earned, but are not recorded at that time. AJE at end of period Assets and revenues that remain unrecorded at the end of the period.

45. 3-44 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit Accrued Assets/Revenues Example On 12/31/97, First Bank owes your company $100 of interest on your account. You will receive the interest on 1/10/98. Prepare the proper adjusting journal entry.

46. 3-45 Accrued Assets/Revenues Example GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 31-DecInterest Receivable100 Interest Revenue100 to record interest earned but not yet received On 12/31/97, First Bank owes your company $100 of interest on your account. You will receive the interest on 1/10/98.

47. 3-46 Accrued Liabilities/Expenses Liabilities and expenses that remain unrecorded at the end of the period. During the period, expenses are incurred, but are not recorded at that time.

48. 3-47 Accrued Liabilities/Expenses Liabilities and expenses that remain unrecorded at the end of the period. Liability (credit) Expense (debit) During the period, expenses are incurred, but are not recorded at that time. AJE at end of period

49. 3-48 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit Accrued Liabilities/Expenses Example At 12/31/97, your company owes $235 of interest to Big Corp. You will not actually pay the interest until 1/10/98. Prepare the proper adjusting journal entry.

50. 3-49 Accrued Liabilities/Expenses Example GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 31-DecInterest Expense235 Interest Payable235 to recognize interest owed to Big Corporation At 12/31/97, your company owes $235 of interest to Big Corp. You will not actually pay the interest until 1/10/98.

51. 3-50 Adjusting Journal Entries Question On 10/1/98, BeeBee Inc. pays $3,600 for a 12-month insurance policy. What kind of transaction would this be called? a.Accrued Liability b.Prepaid Expense c.Accounting Estimate d.Unearned Revenue On 10/1/98, BeeBee Inc. pays $3,600 for a 12-month insurance policy. What kind of transaction would this be called? a.Accrued Liability b.Prepaid Expense c.Accounting Estimate d.Unearned Revenue

52. 3-51 Adjusting Journal Entries Question On 10/1/98, BeeBee Inc. pays $3,600 for a 12-month insurance policy. What kind of transaction would this be called? a.Accrued Liability b.Prepaid Expense c.Accounting Estimate d.Unearned Revenue On 10/1/98, BeeBee Inc. pays $3,600 for a 12-month insurance policy. What kind of transaction would this be called? a.Accrued Liability b.Prepaid Expense c.Accounting Estimate d.Unearned Revenue BeeBee has an asset that is awaiting assignment to an expense account.

53. 3-52 Adjusting Journal Entries Question The last day of 1998 is on a Thursday. CeeCee Inc. will pay its employees on Friday. What kind of adjusting entry is required? a.Accrued Liability b.Accrued Asset c.Accounting Estimate d.Unearned Revenue The last day of 1998 is on a Thursday. CeeCee Inc. will pay its employees on Friday. What kind of adjusting entry is required? a.Accrued Liability b.Accrued Asset c.Accounting Estimate d.Unearned Revenue

54. 3-53 Adjusting Journal Entries Question The last day of 1998 is on a Thursday. CeeCee Inc. will pay its employees on Friday. What kind of adjusting entry is required? a.Accrued Liability b.Accrued Asset c.Accounting Estimate d.Unearned Revenue The last day of 1998 is on a Thursday. CeeCee Inc. will pay its employees on Friday. What kind of adjusting entry is required? a.Accrued Liability b.Accrued Asset c.Accounting Estimate d.Unearned Revenue CeeCee has incurred an obligation to pay its workers after year-end.

55. 3-54 EFFECT OF FAILING TO MAKE ADJUSTING ENTRIES Affects both the Income Statement and the Balance Sheet. Failure to Effect on Effect on RecognizeNet IncomeBalance Sheet Consumption of aOverstatesOverstate Assets Prepaid ExpenseNet IncomeOverstates R/E Earning of anUnderstatesOverstates Liabs Unearned RevenueNet IncomeUnderstates R/E Accrual of AssetsUnderstatesUnderstates Assets Net IncomeUnderstates R/E Accrual of LiabilitiesOverstatesUnderstates Liabs Net IncomeOverstates R/E 117

56. 3-55 ROLL ‘EM ! Video #1 (Approx. 8 min.) Video #2 (Approx. 6 min.) Video #3 (Approx. 8 min.) Video #4 (Approx. 6 min.)

57. 3-56Finally 110 Annual depreciation expense = Asset cost - Estimated Salvage value Estimated years of useful life HOW PRECISE IS ACCOUNTING?

58. 3-57Finally 110 Estimated ^ Annual depreciation expense = Estimated Asset cost - Estimated Salvage value Estimated Estimated years of useful life HOW PRECISE IS ACCOUNTING?

59. 3-58 Why would anyone want to make a CRUDE journal entry? Crude Attempt at Humor