3 The Two Bases of Accounting: Accrual-basis:Transactions are recordedwhen revenues areearned or expensesare incurred.Cash-basis:Transactions arerecorded whencash is paid orcash is received.
4 Accrual Versus Cash Example In January 2002, Prensa Insurance sells a three-year health insurance policy to a business client.The contract specifies that the client had to pay $150,000 in advance.Yearly expenses amount to $20,000.What is the income or loss?
5 Accrual Versus Cash Example Accrual-Basis Accounting(000 omitted)Revenues $50 $50 $50ExpensesNet income (loss) $30 $30 $30
6 Accrual Versus Cash Example Cash-Basis Accounting(000 omitted)Cash inflows $150 $ $ 0Cash outflowsNet income (loss) $130 ($20) ($20)
7 Accounting Period Managers adopt an artificial period of time to evaluate performance.
8 Interim Period Statements MonthlyQuarterlySemi-annually
9 Apply the revenue and matching principles. Objective 2Apply the revenue and matching principles.
10 Revenue Principle When is revenue recognized? When it is deemed earned.Recognition of revenue and cash receipts do not necessarily occur at the same time.
11 The Matching Principle What is the matching principle?It is the basis for recording expenses.Expenses are the costs of assets and the increase in liabilities incurred in the earning of revenues.Expenses are recognized when the benefit from the expense is received.
12 Matching Expenses with Revenues Example Parker Floor sells a wood floor for $15,000 on the last day of May.The wood was purchased from the manufacturer for $8,000 in March of the same year.The floor is installed in June.When is income recognized?
13 Matching Expenses with Revenues Example MayRevenues $15,000Cost of goods sold ,000Net income $ 7,000
14 The Time Period Concept It requires that accounting information be reported at regular intervals.Interacts with the revenue principle and the matching principleRequires that income be measured accurately each period
15 Make adjusting entries. Objective 3Make adjusting entries.
16 Adjusting Entries Assign revenue to the period earned. Assign expenses to the period incurred.Bring related asset and liability accounts into correct balance.
17 Two Types Of Adjusting Entries Prepaids or DeferralsAccruals
18 Five Categories Of Adjusting Entries Prepaid expensesAccrued revenuesDepreciationAccrued expensesUnearned revenues
19 Prepaid Insurance Example On January 2, 2005, Parker Floor paid $24,000for a two-year health insurance policy.Prepaid InsuranceCash24,00024,000
20 Prepaid Insurance Example What is the journal entry on December 31, 2005?Dec. 31, Insurance Expense , Prepaid Insurance , To record insurance expense
21 Prepaid Insurance Example What was the determining factor in matching this expense?Time
22 Supplies ExampleWood Enterprise started business the beginning of the month.$800 worth of office supplies were purchased on November 15, 2004, for cash.
23 Supplies Example Office Supplies Cash 800 800 An inventory at month end indicatedthat $200 in office supplies remained.What is the supplies expense?
24 What was the determining factor in matching this expense? Supplies ExampleSupplies ExpenseSuppliesBal. 200600What was the determining factor in matching this expense?Usage
25 Depreciation ExampleOn January 2, Wood Enterprise purchased a truck for $30,000 cash.The truck is expected to last for 3 years.
26 Depreciation ExampleThe cost of the truck must be matched with the accounting periods in which it was used to earn income.What is the journal entry for the year ended December 31, 2005?
27 Depreciation Example Dec. 31, 2005 Depreciation Expense 10,000 Accumulated Depreciation ,000To record depreciation on truck
28 Contra Accounts A contra account has a companion account. A contra account’s normal balance is opposite that of the companion account.Accumulateddepreciation is a contra account toplant assets.
29 Wood Enterprise Example Partial Balance SheetDecember 31, 2005Plant assets:Machinery $30,000Less: Accumulated depreciation 10,000Total $20,000Contra accountBook value
30 Accruals What is an accrual? It is the recognition of an expense or revenue that has arisen but has not yet been recorded.Expenses or revenues are recorded before the cash settlement.
31 Accrued Expenses Example Employees at Mary Business Services are paid every Friday.Weekly salaries total $30,000.The business is closed on Saturday and Sunday.The employees were last paid on April 26, which was a Friday.They will be paid on May 3.
33 Accrued Expenses Example What is the adjusting entry on April 30?They worked April 29 and 30.$30,000 ÷ 5 = $6,000 per day$6,000 × 2 days = $12,000April 30, Salaries Expense , Salaries Payable , To accrue salary expense
34 Accrued Revenues Example During the month of April, Mary Business Services rendered services to customers totaling $15,000.At the end of April, the customers have not as yet been billed.
35 Accrued Revenues Example What is the April 30 adjusting entry?April 30, Accounts Receivable , Service Revenue ,000 To accrue service revenue
36 Accrued Revenues Example What is the determining factor in recognizing this service revenue?Performance
37 Unearned or Deferred Revenue Example In January 2005, Prensa Insurance received $150,000 from a business client to provide health insurance coverage for three years.January 2, Cash , Unearned Revenue 150, Received revenue in advance
38 Unearned or Deferred Revenue Example What is the journal entry on December 31, 2005?Unearned revenue 50, Revenue , To record revenue collected in advanceCorrectliability$100,000Totalaccounted for$150,000Correctrevenue$50,000
39 Notice Adjusting entries always have... one income statement account and...one balance sheet account.Adjusting entries never involve cash.
41 Adjusted Trial Balance The adjusting process starts with the unadjusted trial balance.Adjusting entries are made at the end of the accounting period and then an adjusted trial balance is prepared.The adjusted trial balance serves as the basis for the preparation of the financial statements.
42 adjusted trial balance. Objective 5Prepare the financialstatements from theadjusted trial balance.
43 Financial Statements Financial statements have two parts: The first part includes the following:name of the entitytitle of the statementdate or period coveredThe second part is the body of the statement.
44 Financial Statements Example Prensa InsuranceIncome StatementYear Ended December 31, 2005Revenue from insurance services $50,000Less: Salaries expense ,275Supplies expenseRent expense ,600Utilities expenseInterest expenseDepreciationNet income $30,000
45 Financial Statements Example Prensa InsuranceStatement of Owner’s EquityYear Ended December 31, 2005Prensa Insurance Equity, January 1, $100,000Add: Net income ,000Prensa Insurance Equity, December 31, 2002 $130,000