1. Adjustments, Financial Statements, and the Quality of Earnings Chapter 4 McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.

2. Accounting Cycle l Prepare financial statements. l Disseminate statements to users. l Prepare financial statements. l Disseminate statements to users. l Close revenues, gains, expenses, and losses to Retained Earnings. During the period: l Analyze transactions. l Record journal entries. l Post amounts to general ledger. During the period: l Analyze transactions. l Record journal entries. l Post amounts to general ledger. At the end of the period: l Adjust revenues and expenses. At the end of the period: l Adjust revenues and expenses. Start of Period

3. McGraw-Hill/Irwin Slide 3 Types of Adjustments There are four types of adjustments.ExpensesExpenses 3.Prepaid Expenses. 4.Accrued Expenses. 3.Prepaid Expenses. 4.Accrued Expenses.RevenuesRevenues 1.Unearned Revenues. 2.Accrued Revenues. 1.Unearned Revenues. 2.Accrued Revenues.

4. McGraw-Hill/Irwin Slide 4 End of accounting period. Cash received.Revenues earned. Example includes rent received in advance (an unearned revenue). Unearned Revenues

5. McGraw-Hill/Irwin Slide 5 End of accounting period. Cash receivedRevenues earned Example includes interest earned during the period (accrued revenue). Accrued Revenue

6. McGraw-Hill/Irwin Slide 6 End of accounting period. Cash paid. Examples include prepaid rent, advertising, and insurance. Prepaid Expenses Expense incurred.

7. McGraw-Hill/Irwin Slide 7 Accrued Expenses As of 12/27/09, Denton, Inc. had already paid $1,900,000 in wages for the year. Denton pays its employees every Friday. Year-end, 12/31/09, falls on a Wednesday. The employees have earned total wages of $50,000 for Monday through Wednesday of the week ending 1/02/10.

8.  Certain circumstances require adjusting entries to record accounting estimates.  Examples include...  Depreciation  Bad debts  Income taxes  Certain circumstances require adjusting entries to record accounting estimates.  Examples include...  Depreciation  Bad debts  Income taxes Accrued Expenses Involving Estimates

9. The income statement contains revenues and expenses. Earnings Per Share (EPS) must be reported on the income statement.

10. McGraw-Hill/Irwin Slide 10 Statement of Stockholders’ Equity Net income appears on the statement of stockholders’ equity as an increase in Retained Earnings. From the Income Statement

11. McGraw-Hill/Irwin Slide 11 Balance Sheet – Liabilities & Stockholders’ Equity From the Statement of Stockholders’ Equity.

12. McGraw-Hill/Irwin Slide 12 Closing the Books Even though the balance sheet account balances carry forward from period to period, the income statement accounts do not. Closing entries: 1.Transfer net income (or loss) to Retained Earnings. 2.Establish a zero balance in each of the temporary accounts to start the next accounting period. Closing entries: 1.Transfer net income (or loss) to Retained Earnings. 2.Establish a zero balance in each of the temporary accounts to start the next accounting period.

13. McGraw-Hill/Irwin Slide 13 Closing the Books Two steps are used in the closing process... 1. Close revenues and gains to Retained Earnings. 2. Close expenses and losses to Retained Earnings.

14. McGraw-Hill/Irwin Slide 14 Post-Closing Trial Balance After all temporary accounts have been closed, we prepare a post-closing trial balance. Only assets, liabilities, and stockholders’ equity accounts will appear. All revenue, expense, gain and loss accounts will have a zero balance.