1. Chapter 3-1

2. Chapter 3-2 CHAPTER 3 ADJUSTING THE ACCOUNTS Financial Accounting, Sixth Edition

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

5. Chapter 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). LO 1 Explain the time period assumption. Jan.Feb.Mar.Apr.Dec......

6. Chapter 3-6 The time period assumption states that: a. 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 LO 1 Explain the time period assumption.

7. Chapter 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 LO 2 Explain the accrual basis of accounting.

8. Chapter 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 LO 2 Explain the accrual basis of accounting.

9. Chapter 3-9 Revenue Recognition Principle Timing Issues Recognizing Revenues and Expenses LO 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. Chapter 3-10 Matching Principle Timing Issues Recognizing Revenues and Expenses LO 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. Chapter 3-11 Timing Issues LO 2 Explain the accrual basis of accounting. GAAP relationships in revenue and expense recognition Illustration 3-1

12. Chapter 3-12 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 is in accord with generally accepted accounting principles. d.Revenue is recorded only when cash is received, and expense is recorded only when cash is paid. Review Timing Issues LO 2 Explain the accrual basis of accounting.

13. Chapter 3-13 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 LO 3 Explain the reasons for adjusting entries.

14. Chapter 3-14 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 LO 3 Explain the reasons for adjusting entries.

15. Chapter 3-15 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 Timing Issues LO 3 Explain the reasons for adjusting entries.

16. Chapter 3-16 Types of Adjusting Entries Deferrals 1.Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed. 2.Unearned Revenues. Cash received and recorded as liabilities before revenue is earned. Accruals 1.Accrued Revenues. Revenues earned but not yet received in cash or recorded. 2.Accrued Expenses. Expenses incurred but not yet paid in cash or recorded. LO 4 Identify the major types of adjusting entries.

17. Chapter 3-17 Trial Balance Trial Balance – Each account is analyzed to determine whether it is complete and up-to-date. Trial Balance LO 4 Identify the major types of adjusting entries. PIONEER ADVERTISING AGENCY INC. Trial Balance October 31, 2008 AccountDebitCredit Cash$ 15,200 Advertising Supplies2,500 Prepaid Insurance600 Office Equipment5,000 Notes Payable$ 5,000 Accounts Payable2,500 Unearned Revenue1,200 Common Stock10,000 Retained Earnings0 Dividends500 Service Revenue10,000 Salaries Expense4,000 Rent Expense900 $28,700 $ 28,700

18. Chapter 3-18 Deferrals are either: Prepaid expenses or Unearned revenues. Adjusting Entries for Deferrals LO 5 Prepare adjusting entries for deferrals.

19. Chapter 3-19 Payment of cash, that is recorded as an asset because service or benefit will be received in the future. Adjusting Entries for “Prepaid Expenses” insurancesuppliesAdvertisingrent Cash Payment Expense Recorded BEFORE LO 5 Prepare adjusting entries for deferrals. Prepayments often occur in regard to: building purchases equipment purchases

20. Chapter 3-20 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” LO 5 Prepare adjusting entries for deferrals.

21. Chapter 3-21 Adjusting Entries for “Prepaid Expenses” LO 5 Prepare adjusting entries for deferrals. Illustration 3-4 Adjusting entries for prepaid expenses Increases (debits) an expense account and Decreases (credits) an asset account.

22. Chapter 3-22 Example (Insurance): On Oct. 4 th, Pioneer Advertising paid $600 for a one-year fire insurance policy. Show the journal entry to record the payment on Oct 4 th. Cash600 Prepaid insurance600Oct. 4 DebitCredit Prepaid Insurance 600600 DebitCredit Cash Adjusting Entries for “Prepaid Expenses” LO 5 Prepare adjusting entries for deferrals.

23. Chapter 3-23 Example (Insurance): On Oct. 4th, Pioneer Advertising paid $600 for a one-year fire insurance policy. Show the adjusting journal entry required at Oct. 31 st. Prepaid insurance50 Insurance expense50Oct. 31 DebitCredit Prepaid Insurance 60050 DebitCredit Insurance Expense 50 550 Adjusting Entries for “Prepaid Expenses” LO 5 Prepare adjusting entries for deferrals.

24. Chapter 3-24 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” LO 5 Prepare adjusting entries for deferrals.

25. Chapter 3-25 Example (Depreciation): On Oct. 2 nd, Pioneer Advertising paid $5,000 for office equipment that has an expected useful life of 10 years. Show the journal entry to record the purchase of the equipment on Oct. 2 nd. Cash5,000 Equipment5,000Oct. 2 DebitCredit Equipment 5,0005,000 DebitCredit Cash Adjusting Entries for “Prepaid Expenses” LO 5 Prepare adjusting entries for deferrals.

26. Chapter 3-26 Example (Depreciation): On Oct. 2 nd, Pioneer Advertising paid $5,000 for office equipment that has an expected useful life of 10 years. Show the adjusting journal entry required at Oct. 31 st. The equipment has a $200 salvage value. ([$5,000- $200 salvage value] / 5 yrs / 12 months = $40) Accumulated depreciation40 Depreciation expense40Jan. 31 DebitCredit Depreciation Expense 4040 DebitCredit Accumulated Depreciation 40 Adjusting Entries for “Prepaid Expenses” LO 5 Prepare adjusting entries for deferrals.

27. Chapter 3-27 Depreciation (Statement Presentation) Accumulated Depreciation—is a contra asset account. Appears just after the account it offsets (Equipment) on the balance sheet. Adjusting Entries for “Prepaid Expenses” LO 5 Prepare adjusting entries for deferrals. Office equipment$5,000 Less: Accumulated depreciation-Office Equipment 40 $4,960

28. Chapter 3-28 Receipt of cash that is recorded as a liability because the revenue has not been earned. Adjusting Entries for “Unearned Revenues” rent magazine subscriptions customer deposits for future service Cash Receipt Revenue Recorded BEFORE sale of airline tickets school tuition Unearned revenues often occur in regard to: LO 5 Prepare adjusting entries for deferrals.

29. Chapter 3-29 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. LO 5 Prepare adjusting entries for deferrals. Adjusting Entries for “Unearned Revenues”

30. Chapter 3-30 LO 5 Prepare adjusting entries for deferrals. Illustration 3-10 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”

31. Chapter 3-31 Example: On Oct. 2 nd, Pioneer Advertising received $1,200 from R. Knox for services to be completed by December 31. Show the journal entry to record the receipt on Oct 2 nd. Unearned Revenue1,200 Cash1,200Oct. 2 DebitCredit Cash 1,2001,200 DebitCredit Unearned Rent Revenue Adjusting Entries for “Unearned Revenues” LO 5 Prepare adjusting entries for deferrals.

32. Chapter 3-32 Example: On Oct. 2nd, Pioneer Advertising received $1,200 from R. Knox for services to be completed by December 31. Show the adjusting journal entry required on Oct. 31 st. Service Revenue400 Unearned Revenue400Oct. 31 DebitCredit Service Revenue 4001,200 DebitCredit Unearned Revenue 400 800 Adjusting Entries for “Unearned Revenues” LO 5 Prepare adjusting entries for deferrals.

33. Chapter 3-33 Made to record: Revenues earned and Expenses incurred in the current accounting period that have not been recognized through daily entries. Adjusting Entries for Accruals LO 6 Prepare adjusting entries for accruals.

34. Chapter 3-34 Revenues earned but not yet received in cash or recorded. Adjusting Entries for “Accrued Revenues” interestrent services performed BEFORE Accrued revenues often occur in regard to: Cash Receipt Revenue Recorded Adjusting entry results in: LO 6 Prepare adjusting entries for accruals.

35. Chapter 3-35 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” LO 6 Prepare adjusting entries for accruals.

36. Chapter 3-36 Illustration 3-13 Adjusting entries for accrued revenues Increases (debits) an asset account and Increases (credits) a revenue account. LO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Revenues”

37. Chapter 3-37 Example: October Pioneer Advertising earned $200 for advertising services that have not been recorded. Show the journal entry to record the accrued revenues in October. Example: In October Pioneer Advertising earned $200 for advertising services that have not been recorded. Show the journal entry to record the accrued revenues in October. Service Revenue200 Accounts Receivable200Oct. 31 LO 6 Prepare adjusting entries for accruals. DebitCredit Accounts Receivable 200200 DebitCredit Service Revenue Adjusting Entries for “Accrued Revenues”

38. Chapter 3-38 Expenses incurred but not yet paid in cash or recorded. Adjusting Entries for “Accrued Expenses” interestrent BEFORE Accrued expenses often occur in regard to: Cash Payment Expense Recorded taxessalaries Adjusting entry results in: LO 6 Prepare adjusting entries for accruals.

39. Chapter 3-39 Accrued Expenses An adjusting entry serves two purposes: (1) It records the obligations, and (2) It recognizes the expenses. Adjusting Entries for “Accrued Expenses” LO 6 Prepare adjusting entries for accruals.

40. Chapter 3-40 Illustration 3-16 Adjusting entries for accrued expenses Increases (debits) an expense account and Increases (credits) a liability account. LO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Expenses”

41. Chapter 3-41 Notes payable5,000 Cash5,000Oct. 1 DebitCredit Cash 5,0005,000 DebitCredit Notes Payable Example: On Oct 1 st, Pioneer Advertising signed a $,5000, 3- month note payable at a rate of 12% per year. The total interest due on the note at its due date is $150 ($5,000 X 12% X 3/12). Show the journal entry to record the borrowing on Oct. 1 st. Adjusting Entries for “Accrued Expenses” LO 6 Prepare adjusting entries for accruals.

42. Chapter 3-42 Example: On Oct 1st, Pioneer Advertising signed a $,5000, 3- month note payable at a rate of 12% per year. The total interest due on the note at its due date is $150 ([$5,000 x 12%] / 12 months). Show the adjusting journal entry required on Oct. 31 st. Interest payable50 Interest expense50Oct. 31 DebitCredit Interest Expense 5050 DebitCredit Interest Payable Adjusting Entries for “Accrued Expenses” LO 6 Prepare adjusting entries for accruals.

43. Chapter 3-43 Accrued Expenses An adjusting entry serves two purposes: (1) It records the obligations, and (2) it recognizes the expenses. Adjusting Entries for “Accrued Expenses” LO 6 Prepare adjusting entries for accruals.

44. Chapter 3-44 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 LO 7 Describe the nature and purpose of an adjusted trial balance.

45. Chapter 3-45 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 Timing Issues LO 7 Describe the nature and purpose of an adjusted trial balance.

46. Chapter 3-46 Financial Statements are prepared directly from the Adjusted Trial Balance. Balance Sheet Income Statement Statement of Cash Flows Retained Earnings Statement Preparing Financial Statements LO 7 Describe the nature and purpose of an adjusted trial balance.

47. Chapter 3-47 Income Statement Preparing Financial Statements LO 7 Describe the nature and purpose of an adjusted trial balance. AccountDebitCredit Cash$ 15,200 Accounts Receivable200 Advertising Supplies1,000 Prepaid Insurance550 Office Equipment5,000 Accumulated Depreciation-Off Equip$40 Notes Payable5,000 Accounts Payable2,500 Unearned Revenue800 Salaries Payable1,200 Interest Payable50 Common Stock10,000 Retained Earnings0 Dividends500 Service Revenue10,600 Salaries Expense5,200 Advertising Supplies Expense1,500 Rent Expense900 Insurance Expense50 Interest Expense50 Depreciation Expense40 $ 30,190 $ 30,190 PIONEER ADVERTISING AGENCY INC. Income Statement For the Month Ended October 31, 2008 Revenues Service Revenue10,600 Expenses Salaries Expense5,200 Advertising Supplies Expense1,500 Rent Expense900 Insurance Expense50 Interest Expense50 Depreciation Expense 40 Total expenses7,740 Net income$ 2,860

48. Chapter 3-48 Retained Earnings Statement Preparing Financial Statements LO 7 Describe the nature and purpose of an adjusted trial balance. AccountDebitCredit Cash$ 15,200 Accounts Receivable200 Advertising Supplies1,000 Prepaid Insurance550 Office Equipment5,000 Accumulated Depreciation-Off Equip$40 Notes Payable5,000 Accounts Payable2,500 Unearned Revenue800 Salaries Payable1,200 Interest Payable50 Common Stock10,000 Retained Earnings0 Dividends500 Service Revenue10,600 Salaries Expense5,200 Advertising Supplies Expense1,500 Rent Expense900 Insurance Expense50 Interest Expense50 Depreciation Expense40 $ 30,190 $ 30,190 PIONEER ADVERTISING AGENCY INC. Retained Earnings Statement For the Month Ended October 31, 2008 Retained earnings, October 1 $ 0 Add: Net income 2,860 2,860 Less: Dividends 500 Retained Earnings, October 312,360

49. Chapter 3-49 Balance Sheet Preparing Financial Statements LO 7 Describe the nature and purpose of an adjusted trial balance. AccountDebitCredit Cash$ 15,200 Accounts Receivable200 Advertising Supplies1,000 Prepaid Insurance550 Office Equipment5,000 Accumulated Depreciation-Off Equip$40 Notes Payable5,000 Accounts Payable2,500 Unearned Revenue800 Salaries Payable1,200 Interest Payable50 Common Stock10,000 Retained Earnings0 Dividends500 Service Revenue10,600 Salaries Expense5,200 Advertising Supplies Expense1,500 Rent Expense900 Insurance Expense50 Interest Expense50 Depreciation Expense40 $ 30,190 $ 30,190 PIONEER ADVERTISING AGENCY INC. Balance Sheet October 31, 2008 Assets Cash $ 15,200 Accounts Receivable200 Advertising Supplies1,000 Prepaid Insurance550 Office Equipment$5,000 Accumulated Depreciation-Off Equip404,960 Total Assets $ 21,910 Liabilities and Stockholders’ Equity Liabilities Notes Payable $ 5,000 Accounts Payable2,500 Unearned Revenue800 Salaries Payable1,200 Interest Payable 50 Total liabilities9,550 Stockholders’ Equity Common Stock10,000 Retained Earnings 2,360 Total liabilities and stockholders’ equity $ 21,910

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