1. Slide 3-1

2. Slide 3-2 Adjusting the Accounts Financial Accounting, Seventh Edition Accounting 201, Instructor: Judith Paquette

3. Slide 3-3 1. 1.Explain the time period assumption. 2. 2.Explain the accrual basis of accounting. 3. 3.Explain the reasons for adjusting entries. 4. 4.Identify the major types of adjusting entries. 5. 5.Prepare adjusting entries for deferrals. 6. 6.Prepare adjusting entries for accruals. 7. 7.Describe the nature and purpose of an adjusted trial balance. Study Objectives

4. Slide 3-4 Types of adjusting entries Adjusting entries for deferrals Adjusting entries for accruals Summary of journalizing and posting Timing Issues Fiscal and calendar years Accrual- vs. cash- basis accounting Recognizing revenues and expenses Preparing the adjusted trial balance Preparing financial statements The Basics of Adjusting Entries The Adjusted Trial Balance and Financial Statements Adjusting the Accounts

5. Slide 3-5 Generally a month, a quarter, or a year Fiscal year vs. calendar year Also known as the “Periodicity Assumption” Timing Issues Accountants divide the economic life of a business into artificial time periods (Time Period Assumption). SO 1 Explain the time period assumption. Jan.Feb.Mar.Apr.Dec......

6. Slide 3-6 The time period assumption states that: a.revenue should be recognized in the accounting period in which it is earned. b. expenses should be matched with revenues. c. the economic life of a business can be divided into artificial time periods. d. the fiscal year should correspond with the calendar year. Review Timing Issues SO 1 Explain the time period assumption. a.revenue should be recognized in the accounting period in which it is earned. b. expenses should be matched with revenues. c. the economic life of a business can be divided into artificial time periods. d. the fiscal year should correspond with the calendar year. Solution on notes page

7. Slide 3-7 Accrual-Basis Accounting Transactions recorded in the periods in which the events occur. Revenues are recognized when earned, rather than when cash is received. Expenses are recognized when incurred, rather than when paid. Timing Issues Accrual- vs. Cash-Basis Accounting SO 2 Explain the accrual basis of accounting.

8. Slide 3-8 Cash-Basis Accounting Revenues are recognized when cash is received. Expenses are recognized when cash is paid. Cash-basis accounting is not in accordance with generally accepted accounting principles (GAAP). Timing Issues Accrual- vs. Cash-Basis Accounting SO 2 Explain the accrual basis of accounting.

9. Slide 3-9 Revenue Recognition Principle Timing Issues Recognizing Revenues and Expenses SO 2 Explain the accrual basis of accounting. Companies recognize revenue in the accounting period in which it is earned. In a service enterprise, revenue is considered to be earned at the time the service is performed.

10. Slide 3-10 Expense Recognition Principle – (Matching Principle) Timing Issues Recognizing Revenues and Expenses SO 2 Explain the accrual basis of accounting. Match expenses with revenues in the period when the company makes efforts to generate those revenues. “Let the expenses follow the revenues.”

11. Slide 3-11 Timing Issues SO 2 Explain the accrual basis of accounting. GAAP relationships in revenue and expense recognition Illustration 3-1

12. Slide 3-12 Here’s an example of Accrual vs. Cash Accounting A man, Jaewan, starts a company. The company paints buildings, called Sky High Painting A man, Jaewan, starts a company. The company paints buildings, called Sky High Painting Jaewan invests $60,000 of his own money in Sky High Painting Painting. Jaewan invests $60,000 of his own money in Sky High Painting Painting. The company is started on December 1, 2010. The company is started on December 1, 2010. He gets the job to paint a BIG Building in downtown Bellevue. He gets the job to paint a BIG Building in downtown Bellevue. He hires employees and buys paint. He hires employees and buys paint. They paint the building. They paint the building. He pays all his expenses of $50,000 in cash. He pays all his expenses of $50,000 in cash. He bills the customer for $80,000 and goes home on December 31 st, 2010. He bills the customer for $80,000 and goes home on December 31 st, 2010. He gets hit by a car on the way home and dies. He gets hit by a car on the way home and dies.

13. Slide 3-13 Year 1 Year 2 Purchased paint, painted building, paid employees Received payment for work done in year one Activity Accrual basis Cash basis Revenue $80,000 Expense 50,000 Net Income $30,000 Revenue $ 0 Expense 50,000 Net Loss ( $50,000) Revenue $80,000 Expense 0 Net Income $80,000 Revenue $ 0 Expense 0 Net Income $ 0 Illustration 4-2

14. Slide 3-14 Adjusting entries make it possible to report correct amounts on the balance sheet and on the income statement. A company must make adjusting entries every time it prepares financial statements. The Basics of Adjusting Entries SO 3 Explain the reasons for adjusting entries.

15. Slide 3-15 Here’s an example of why we need adjusting entries… A company buys supplies for $900 on October 3 rd. A company buys supplies for $900 on October 3 rd. JE? T Account? JE? T Account? On October 31 st a physical inventory shows that there are only $250 supplies on hand. On October 31 st a physical inventory shows that there are only $250 supplies on hand. How do we adjust the Supplies Account? How do we adjust the Supplies Account?

16. Slide 3-16 Revenues - recorded in the period in which they are earned Revenues - recorded in the period in which they are earned. Expenses - recognized in the period in which they are incurred Expenses - recognized in the period in which they are incurred. Adjusting entries- needed to ensure that the revenue recognition and matching principles are followed. Adjusting entries - needed to ensure that the revenue recognition and matching principles are followed. The Basics of Adjusting Entries SO 3 Explain the reasons for adjusting entries.

17. Slide 3-17 Types of Adjusting Entries 1.Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed. Deferrals 3. Accrued Revenues. Revenues earned but not yet received in cash or recorded. 4. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded. 2. Unearned Revenues. Revenues received in cash and recorded as liabilities before they are earned. Accruals SO 4 Identify the major types of adjusting entries. Illustration 3-2 Categories of adjusting entries Types of Adjusting Entries

18. Slide 3-18 Trial Balance Trial Balance – Illustrations are based on the October 31, trial balance of Pioneer Advertising Agency Inc. Illustration 3-3 Types of Adjusting Entries SO 4 Identify the major types of adjusting entries.

19. Slide 3-19 Deferrals are either: Prepaid expenses OR Unearned revenues. SO 5 Prepare adjusting entries for deferrals. Types of Adjusting Entries Adjusting Entries for Deferrals

20. Slide 3-20 Payment of cash that is recorded as an asset because service or benefit will be received in the future. Adjusting Entries for “Prepaid Expenses” insurancesuppliesadvertising Cash Payment Expense Recorded BEFORE SO 5 Prepare adjusting entries for deferrals. rent maintenance on equipment fixed assets (depreciation) Prepayments often occur in regard to:

21. Slide 3-21 Prepaid Expenses Costs that expire either with the passage of time or through use. Adjusting entries (1) to record the expenses that apply to the current accounting period, and (2) to show the unexpired costs in the asset accounts. Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.

22. Slide 3-22 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals. Adjusting entries for prepaid expenses Increases (debits) an expense account and Decreases (credits) an asset account. Illustration 3-4

23. Slide 3-23 #1 Illustration: Pioneer Advertising Agency purchased advertising supplies costing $2,500 on October 5. Pioneer recorded the payment by increasing (debiting) the asset Advertising Supplies. This account shows a balance of $2,500 in the October 31 trial balance. An inventory count at the close of business on October 31 reveals that $1,000 of supplies are still on hand. Advertising supplies1,500 Advertising supplies expense1,500Oct. 31 Illustration 3-5 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.

24. Slide 3-24 #2 Illustration: On October 4, Pioneer Advertising Agency paid $600 for a one-year fire insurance policy. Coverage began on October 1. Pioneer recorded the payment by increasing (debiting) Prepaid Insurance. This account shows a balance of $600 in the October 31 trial balance. Insurance of $50 ($600 / 12) expires each month. Prepaid insurance50 Insurance expense50Oct. 31 Illustration 3-6 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.

25. Slide 3-25 Depreciation Buildings, equipment, and vehicles (long-lived assets) are recorded as assets, rather than an expense, in the year acquired. Companies report a portion of the cost of a long- lived asset as an expense (depreciation) during each period of the asset’s useful life (Matching Principle). Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.

26. Slide 3-26 #3 Illustration: Pioneer Advertising estimates depreciation on the office equipment to be $480 a year, or $40 per month. Accumulated depreciation40 Depreciation expense40Oct. 31 Illustration 3-7 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals. 1

27. Slide 3-27 Depreciation (Statement Presentation) Accumulated Depreciation is a contra asset account. Appears just after the account it offsets (Equipment) on the balance sheet. Illustration 3-8 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.

28. Slide 3-28 Summary Illustration 3-9 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.

29. Slide 3-29 Receipt of cash that is recorded as a liability because the revenue has not been earned. Adjusting Entries for “Unearned Revenues” rent airline tickets school tuition Cash Receipt Revenue Recorded BEFORE magazine subscriptions customer deposits Unearned revenues often occur in regard to: SO 5 Prepare adjusting entries for deferrals.

30. Slide 3-30 Unearned Revenues Company makes an adjusting entry to record the revenue that has been earned and to show the liability that remains. The adjusting entry for unearned revenues results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account. SO 5 Prepare adjusting entries for deferrals. Adjusting Entries for “Unearned Revenues”

31. Slide 3-31 SO 5 Prepare adjusting entries for deferrals. Adjusting entries for unearned revenues Decrease (a debit) to a liability account and Increase (a credit) to a revenue account. Adjusting Entries for “Unearned Revenues” Illustration 3-10

32. Slide 3-32 Adjusting Entries for “Unearned Revenues” #4 Illustration: Pioneer Advertising Agency received $1,200 on October 2 from R. Knox for advertising services expected to be completed by December 31. Unearned Service Revenue shows a balance of $1,200 in the October 31 trial balance. Analysis reveals that the company earned $400 of those fees in October. Service revenue400 Unearned service revenue400Oct. 31 Illustration 3-11 SO 5 Prepare adjusting entries for deferrals.

33. Slide 3-33 Summary Adjusting Entries for “Unearned Revenues” Illustration 3-12 SO 5 Prepare adjusting entries for deferrals.

34. Slide 3-34 Made to record: Revenues earned and OR Expenses incurred in the current accounting period that have not been recognized through daily entries. SO 6 Prepare adjusting entries for accruals. Types of Adjusting Entries Adjusting Entries for Accruals

35. Slide 3-35 Revenues earned but not yet received in cash or recorded. Adjusting Entries for “Accrued Revenues” rentinterest services performed BEFORE Accrued revenues often occur in regard to: Cash Receipt Revenue Recorded Adjusting entry results in: SO 6 Prepare adjusting entries for accruals.

36. Slide 3-36 Accrued Revenues An adjusting entry serves two purposes: (1) It shows the receivable that exists, and (2) It records the revenues earned. Adjusting Entries for “Accrued Revenues” SO 6 Prepare adjusting entries for accruals.

37. Slide 3-37 Adjusting entries for accrued revenues Increases (debits) an asset account and Increases (credits) a revenue account. SO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Revenues” Illustration 3-13

38. Slide 3-38 #5 Illustration: In October Pioneer Advertising Agency earned $200 for advertising services that had not been recorded. Service Revenue200 Accounts Receivable200Oct. 31 Illustration 3-14 SO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Revenues”

39. Slide 3-39 Summary Illustration 3-15 Adjusting Entries for “Accrued Revenues” SO 6 Prepare adjusting entries for accruals.

40. Slide 3-40 Expenses incurred but not yet paid in cash or recorded. Adjusting Entries for “Accrued Expenses” rentinterest BEFORE Accrued expenses often occur in regard to: Cash Payment Expense Recorded taxessalaries Adjusting entry results in: SO 6 Prepare adjusting entries for accruals.

41. Slide 3-41 Accrued Expenses An adjusting entry serves two purposes: (1) It records the obligations, and (2) It recognizes the expenses. Adjusting Entries for “Accrued Expenses” SO 6 Prepare adjusting entries for accruals.

42. Slide 3-42 Adjusting entries for accrued expenses Increases (debits) an expense account and Increases (credits) a liability account. SO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Expenses” Illustration 3-16

43. Slide 3-43 SO 6 Prepare adjusting entries for accruals. #6 Illustration: Pioneer Advertising Agency signed a three- month note payable in the amount of $5,000 on October 1. The note requires Pioneer to pay interest at an annual rate of 12%. Interest payable50 Interest expense50Oct. 31 Illustration 3-18 Illustration 3-17 Adjusting Entries for “Accrued Expenses”

44. Slide 3-44 SO 6 Prepare adjusting entries for accruals. #7 Illustration: Pioneer Advertising Agency last paid salaries on October 26; the next payment of salaries will not occur until November 9. The employees receive total salaries of $2,000 for a five-day work week, or $400 per day. Thus, accrued salaries at October 31 are $1,200 ($400 x 3 days). Illustration 3-19 Adjusting Entries for “Accrued Expenses”

45. Slide 3-45 SO 6 Prepare adjusting entries for accruals. #7 (con’t) Illustration: Pioneer Advertising Agency last paid salaries on October 26; the next payment of salaries will not occur until November 9. The employees receive total salaries of $2,000 for a five-day work week, or $400 per day. Thus, accrued salaries at October 31 are $1,200 ($400 x 3 days). Salaries payable1,200 Salaries expense1,200Oct. 31 Illustration 3-20 Adjusting Entries for “Accrued Expenses”

46. Slide 3-46 Summary Illustration 3-21 SO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Expenses”

47. Slide 3-47 After all adjusting entries are journalized and posted the company prepares another trial balance from the ledger accounts (Adjusted Trial Balance). Its purpose is to prove the equality of debit balances and credit balances in the ledger. The Adjusted Trial Balance SO 7 Describe the nature and purpose of an adjusted trial balance.

48. Slide 3-48 The Adjusted Trial Balance SO 7 Illustration 3-24 Adjusted trial balance

49. Slide 3-49 Financial Statements are prepared directly from the Adjusted Trial Balance. Balance Sheet Income Statement Retained Earnings Statement Preparing Financial Statements SO 7 Describe the nature and purpose of an adjusted trial balance.

50. Slide 3-50 Preparing Financial Statements Illustration 3-25 Preparation of the income statement and retained earnings statement from the adjusted trial balance SO 7

51. Slide 3-51 Preparing Financial Statements Illustration 3-26 SO 7

52. Slide 3-52 End of Chapter 3

53. Slide 3-53  California adds $6 to $10 of sales tax to the cost of computers and televisions to fund recycling programs.  Each cathode ray tube (CRT) monitor contains 4 – 6 pounds of lead. Consumer electronic products account for about 40% of the lead found in landfills.  Environmental groups put a resolution on a recent Apple Computer ’ s shareholder meeting agenda requiring the company to study how it can increase recycling.  The average household has two to three old computers in its garage or storage area. Is Your Old Computer a Liability?

54. Slide 3-54

55. Slide 3-55 Should companies accrue for environmental cleanup costs as liabilities on their financial statements? YES: As more states impose laws holding companies responsible, and as more courts levy pollution-related fines, it becomes increasingly likely that companies will have to pay large amounts in the future. NO: The amounts still are too difficult to estimate. Putting inaccurate estimates on the financial statements reduces their usefulness. Instead, why not charge the costs later, when the actual environmental cleanup or disposal occurs, at which time the company knows the actual cost?

56. Slide 3-56 Some companies use an alternative treatment for prepaid expenses and unearned revenues. When a company prepays an expense, it debits that amount to an expense account. When a company receives payment for future services, it credits the amount to a revenue account. Alternative Treatment of Prepaid Expenses and Unearned Revenues SO 8 Prepare adjusting entries for the alternative treatment of deferrals. APPENDIX

57. Slide 3-57 Illustration: Pioneer Advertising purchased supplies on October 5 for $2,500 and debited Advertising Supplies Expense for the full amount. What if an inventory of $1,000 of advertising supplies remains on October 31? Alternative Treatment for “Prepaid Expenses” SO 8 Prepare adjusting entries for the alternative treatment of deferrals. Advertising supplies expense1,000 Advertising supplies1,000Oct. 31 Illustration 3A-1

58. Slide 3-58 Alternative Treatment for “Prepaid Expenses” SO 8 Prepare adjusting entries for the alternative treatment of deferrals. Adjustment approaches—a comparison Illustration 3A-2

59. Slide 3-59 Illustration: Assume that Pioneer Advertising received $1,200 for future services on October 2 and credited the entire amount to Service Revenue. If at the statement date Pioneer has not performed $800 of the services, it would make an adjusting entry. Alternative Treatment for “Unearned Revenues” SO 8 Prepare adjusting entries for the alternative treatment of deferrals. Unearned service revenue800 Service revenue800Oct. 31 Illustration 3A-4

60. Slide 3-60 SO 8 Prepare adjusting entries for the alternative treatment of deferrals. Adjustment approaches—a comparison Illustration 3A-5 Alternative Treatment for “Unearned Revenues”

61. Slide 3-61 SO 8 Prepare adjusting entries for the alternative treatment of deferrals. Summary of Additional Adjustment Relationships Illustration 3A-7

62. Slide 3-62 “Copyright © 2010 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” CopyrightCopyright

63. Slide 3-63 SO 2

64. Slide 3-64 Match the description of the concept to the concept. Solution on notes page Timing Issues SO 2 Explain the accrual basis of accounting. g f c b

65. Slide 3-65 One of the following statements about the accrual basis of accounting is false. That statement is: a.Events that change a company’s financial statements are recorded in the periods in which the events occur. b.Revenue is recognized in the period in which it is earned. c.The accrual basis of accounting is in accord with generally accepted accounting principles. d.Revenue is recorded only when cash is received, and expenses are recorded only when cash is paid. Review Timing Issues SO 2 Explain the accrual basis of accounting. Solution on notes page One of the following statements about the accrual basis of accounting is false. That statement is: a.Events that change a company’s financial statements are recorded in the periods in which the events occur. b.Revenue is recognized in the period in which it is earned. c.The accrual basis of accounting is in accord with generally accepted accounting principles. d.Revenue is recorded only when cash is received, and expenses are recorded only when cash is paid.

66. Slide 3-66 Adjusting entries are made to ensure that: a. expenses are recognized in the period in which they are incurred. b. revenues are recorded in the period in which they are earned. c. balance sheet and income statement accounts have correct balances at the end of an accounting period. d. all of the above. Review SO 3 Explain the reasons for adjusting entries. The Basics of Adjusting Entries

67. Slide 3-67 SO 5

68. Slide 3-68 Which of the following statements is incorrect concerning the adjusted trial balance? a.An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger after all adjustments are made. b.The adjusted trial balance provides the primary basis for the preparation of financial statements. c.The adjusted trial balance lists the account balances segregated by assets and liabilities. d.The adjusted trial balance is prepared after the adjusting entries have been journalized and posted. Review Question SO 7 Describe the nature and purpose of an adjusted trial balance. The Adjusted Trial Balance Which of the following statements is incorrect concerning the adjusted trial balance? a.An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger after all adjustments are made. b.The adjusted trial balance provides the primary basis for the preparation of financial statements. c.The adjusted trial balance lists the account balances segregated by assets and liabilities. d.The adjusted trial balance is prepared after the adjusting entries have been journalized and posted.