Adjusting entries make the revenue recognition and matching principles

Why do you adjust accounts

HAPPEN!

ADJUSTING ENTRIESp.106ADJUSTING ENTRIESp.106

Adjusting entries are required each time financial statements are prepared.

Adjusting entries can be classified as1. prepayments

2. accruals

3. estimates

ADJUSTING ENTRIES p.106ADJUSTING ENTRIES p.106

TYPES OF ADJUSTING ENTRIESTYPES OF ADJUSTING ENTRIES

Prepayments

1. Prepaid Expenses — Expenses paid in cash and recorded as assets before they are used or consumed.

ex:

2. Unearned Revenues — Revenues received in cash and recorded as liabilities before they are earned.

ex:

PREPAYMENTS examples

1. At the end of the accounting period the trial balance indicates there are $5000 of supplies; a physical inventory indicates that there are actually only $1000 of supplies

PREPAYMENTS examples

2. On Sept 1, ABC Co. paid $2400 for a one year fire insurance policy. What is the adjustment at the end of the calendar year (Dec. 31)?

Prepaid expenses are expenses paid in cash and recorded as assets before they are used or consumed.

Prepaid expenses ________ with the passage of time or through ____________________ .

An asset-expense account relationship exists with prepaid expenses.

PREPAID EXPENSESPREPAID EXPENSES

UNEARNED REVENUE example

3. Cubana Airlines sells Mr. S an all-inclusive Cuban holiday for March break. Mr. S pays $3500 on Dec 15th; Record both the original transaction and the adjustment made by Cubana when Mr. S flys to Cuba March 12.

Unearned revenues are revenues received and recorded as ___________ before they are earned.

Unearned revenues are subsequently earned by performing a service or providing a good to a customer.

A ________________ account relationship exists with unearned revenues.

UNEARNED REVENUESUNEARNED REVENUES

TYPES OF ADJUSTING ENTRIESTYPES OF ADJUSTING ENTRIES

Accruals think 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.

ACCRUALSACCRUALS

A different type of adjusting entry is accruals.

Adjusting entries for accruals are required to record revenues earned and expenses incurred in the current period.

The adjusting entry for accruals will

ACCRUAL EXAMPLE: Revenue Recognition and Matching Principal

JB pharma contracts to produce Life brand energy bars for Shoppers on August 10th.

JB purchases $400 K of ingredients on account August 24

JB manufactures $1 mm of energy bars in Sept, and ships them to Shoppers, Sept. 22.

JB incurs $200 of overhead and production costs for the energy bars

Shoppers pays JB December 23.

INTEREST ADJUSTMENTINTEREST ADJUSTMENT P. 113 P. 113

On Oct 1. Pioneer Advertising signed a $5000 three month note payable due January 1. Pioneer’s Interest Adjustment, Oct. 31:

Oct 31:

Face Value of

Note

Annual Interest

Rate

Time (in Terms of

One Year) x x Interest

$5,000 x 6% x 1/12 = $25

=

Accrued expenses are expenses incurred but not yet paid.

A liability-expense account relationship exists. Prior to adjustment, __________ and ________

are ___________. The adjusting entry results in a _____ to an

expense account and a _______ to a liability account.

Examples of accrued expenses include: accounts payable, rent payable, salaries payable, and interest payable.

ACCRUED EXPENSESACCRUED EXPENSES

Adjusting Entries

Asset

Debit Adjusting Entry (+)

Accrued Revenues

Revenue

Credit Adjusting Entry (+)

Accrued Expenses

Expense

Debit Adjusting Entry (+)

Liability

Credit Adjusting Entry (+)

ILLUSTRATION ILLUSTRATION 3-53-5 ADJUSTING ENTRIES FOR ACCRUALSADJUSTING ENTRIES FOR ACCRUALS

TYPES OF ADJUSTING ENTRIESTYPES OF ADJUSTING ENTRIES

Estimates

1. Amortization =

Amortization is the process of allocating the cost of certain capital assets to expense over their useful life in a rational and systematic manner.

Amortization attempts to ______ the cost of a long-term, capital asset to the revenue it generates each period.

AMORTIZATIONAMORTIZATION

AMORTIZATIONAMORTIZATION

Amortization is an _________ rather than a factual measurement of the cost that has expired.

We’re not attempting to reflect the

actual change in value of an asset!

Depreciation DOES NOT represent

the market value of the asset!

Depreciation (Amortization) Straight Line Example

1. Moe purchased a mechanical bull was purchased on September 1, 2006 for $2,000 with an estimated life of five years and an expected salvage value of $200. Calculate the Depreciation for both 2006 (1/2 year rule) and 2007

Dec 31, 2006

Dec 31, 2006

Depreciation (Amortization) Declining Balance Example

Moe moved his business into the new building on August 31, 2006. The building cost $50,000 amortized at 10% over 25 years with no expected salvage value. Calculate the Depreciation for both 2006 (1/2 year rule) and 2007

Dec 31, 2006

Dec 31, 2006

Accumulated AmortizationAmortization Expense

AMORTIZATIONAMORTIZATION

In recording amortization, Amortization Expense is _______ and a contra asset account, Accumulated Amortization, is ___________.

The difference between the cost of the asset and its related accumulated amortization is referred to as the _________________ of the asset.

xxx xxx

AMORTIZATIONAMORTIZATION

Balance Sheet Presentation

Office equipment $5,000

Less: Accumulated amortization 83

Net book value $4,917

Estimate

ILLUSTRATION ILLUSTRATION 3-83-8 SUMMARY OF ADJUSTING ENTRIESSUMMARY OF ADJUSTING ENTRIES

1.Prepaid Assets and Assets overstated Dr. Expenses expenses

expenses Expenses understated Cr. Assets2.Unearned Liabilities and Liabilities overstated Dr. Liabilitiesrevenues revenues Revenues understated Cr. Revenues3.Accrued Assets and Assets understated Dr. Assetsrevenues revenues Revenues understated Cr. Revenues4.Accrued Expenses and Expenses understated Dr. Expensesexpenses liabilities Liabilities understated Cr. Liabilities5.Amortization Expense and Expenses understated Dr. Amort. Exp

contra asset Assets overstated Cr. Accum. Amortization

1.Prepaid Assets and Assets overstated Dr. Expenses expenses

expenses Expenses understated Cr. Assets2.Unearned Liabilities and Liabilities overstated Dr. Liabilitiesrevenues revenues Revenues understated Cr. Revenues3.Accrued Assets and Assets understated Dr. Assetsrevenues revenues Revenues understated Cr. Revenues4.Accrued Expenses and Expenses understated Dr. Expensesexpenses liabilities Liabilities understated Cr. Liabilities5.Amortization Expense and Expenses understated Dr. Amort. Exp

contra asset Assets overstated Cr. Accum. Amortization

Type of Account Accounts before AdjustingAdjustment Relationship Adjustment Entry

ADJUSTED TRIAL BALANCEADJUSTED TRIAL BALANCE

An Adjusted Trial Balance is prepared after all adjusting entries have been journalized and posted.

It shows the balances of all accounts at the end of the accounting period and the effects of all financial events that have occurred during the period.

It proves the equality of the total debit and credit balances in the ledger after all adjustments have been made.

Financial statements can be prepared directly from the adjusted trial balance.

Debit Credit Debit CreditCash 15,200$ 15,200$ Accounts Receivable 200 Advertising Supplies 2,500 1,000 Prepaid Insurance 600 550 Office Equipment 5,000 5,000 Accumulated Amort'n. 83$ Notes Payable 5,000$ 5,000 Accounts Payable 2,500 2,500 Unearned Revenue 1,200 800 Salaries Payable 1,200 Interest Payable 25 C.R. Byrd, Capital 10,000 10,000 C.R. Byrd, Drawings 500 500 Service Revenue 10,000 10,600 Adv. Supplies Expense 1,500 Amortization Expense 83 Insurance Expense 50 Salaries Expense 4,000 5,200 Rent Expense 900 900 Interest Expense 25

28,700$ 28,700$ 30,208$ 30,208$

Pioneer Advertising AgencyTrial Balance

October 31, 2002Before Adjustment After Adjustment

ILLUSTRATION ILLUSTRATION 3-113-11TRIAL BALANCE AND ADJUSTED TRIAL BALANCE COMPAREDTRIAL BALANCE AND ADJUSTED TRIAL BALANCE COMPARED

ILLUSTRATION ILLUSTRATION 3-113-11TRIAL BALANCE AND ADJUSTED TRIAL BALANCE COMPAREDTRIAL BALANCE AND ADJUSTED TRIAL BALANCE COMPARED

PREPARING FINANCIAL STATEMENTSPREPARING FINANCIAL STATEMENTSPREPARING FINANCIAL STATEMENTSPREPARING FINANCIAL STATEMENTS

Financial statements can be prepared directly from an adjusted trial balance.1. The income statement is prepared from the revenue and expense accounts.2. The statement of owner’s equity is derived from the owner’s capital and drawings accounts and the net income (or net loss) shown in the income statement.3. The balance sheet is then prepared from the asset and liability accounts and the ending owner’s capital balance as reported in the statement of owner’s equity.

ILLUSTRATION ILLUSTRATION 3-123-12 PREPARATION OF THE INCOME STATEMENT AND THE PREPARATION OF THE INCOME STATEMENT AND THE

STATEMENT OF OWNER’S EQUITY FROM THE STATEMENT OF OWNER’S EQUITY FROM THE ADJUSTED TRIAL BALANCEADJUSTED TRIAL BALANCE

RevenuesService Revenue 10,600$

ExpensesAdv. Supplies Expense 1,500$ Amortization Expense 83 Insurance Expense 50 Salaries Expense 5,200 Rent Expense 900 Interest Expense 25 Total Expenses 7,758

Net Income 2,842$

Pioneer Advertising AgencyIncome Statement

For the Month Ended October 31, 2002

C.R. Byrd, Capital, October 1 -$ Add: Investments 10,000 Net income 2,842

12,842 Less: Drawings 500 C.R. Byrd, Capital, October 31 12,342$

Statement of Owner's EquityFor the Month Ended October 31, 2002

Pioneer Advertising Agency

Debit CreditCash 15,200$ Accounts Receivable 200 Advertising Supplies 1,000 Prepaid Insurance 550 Office Equipment 5,000 Accumulated Amort'n. 83$ Notes Payable 5,000 Accounts Payable 2,500 Unearned Revenue 800 Salaries Payable 1,200 Interest Payable 25 C.R. Byrd, Capital 10,000 C.R. Byrd, Drawings 500 Service Revenue 10,600 Adv. Supplies Expense 1,500 Amortization Expense 83 Insurance Expense 50 Salaries Expense 5,200 Rent Expense 900 Interest Expense 25

30,208$ 30,208$

Pioneer Advertising AgencyAdjusted Trial Balance

October 31, 2002

Debit CreditCash 15,200$ Accounts Receivable 200 Advertising Supplies 1,000 Prepaid Insurance 550 Office Equipment 5,000 Accumulated Amort'n. 83$ Notes Payable 5,000 Accounts Payable 2,500 Unearned Revenue 800 Salaries Payable 1,200 Interest Payable 25 C.R. Byrd, Capital 10,000 C.R. Byrd, Drawings 500 Service Revenue 10,600 Adv. Supplies Expense 1,500 Amortization Expense 83 Insurance Expense 50 Salaries Expense 5,200 Rent Expense 900 Interest Expense 25

30,208$ 30,208$

Pioneer Advertising AgencyAdjusted Trial Balance

October 31, 2002

Cash 15,200$ Accounts Receivable 200 Advertising Supplies 1,000 Prepaid Insurance 550 Office Equipment 5,000$ Less: Accumulated Amortization 83 4,917

Total Assets 21,867$

Liabilities and Owner's EquityLiabilities Notes Payable 5,000$ Accounts Payable 2,500 Unearned Revenue 800 Salaries Payable 1,200 Interest Payable 25

Total Liabilities 9,525$ Owner's EquityC.R. Byrd, Capital 12,342 Total Liabilities and Owner's Equity 21,867$

October 31, 2002Assets

Pioneer Advertising AgencyBalance Sheet

ILLUSTRATION ILLUSTRATION 3-133-13 PREPARATION OF THE BALANCE SHEET PREPARATION OF THE BALANCE SHEET FROM THE ADJUSTED TRIAL BALANCEFROM THE ADJUSTED TRIAL BALANCE

ILLUSTRATION ILLUSTRATION 3-133-13 PREPARATION OF THE BALANCE SHEET PREPARATION OF THE BALANCE SHEET FROM THE ADJUSTED TRIAL BALANCEFROM THE ADJUSTED TRIAL BALANCE

From Statement of Owner’s

Equity

From Statement of Owner’s

Equity

1. Analyse transactions 2. Journalize the

transactions

3. Post to ledger accounts

4. Prepare a trial balance

5. Journalize and post adjusting entries

6. Prepare adjusted trial

balance

7. Prepare financial

statements

8. Coming next chapter

9. Coming next chapter

STEPS IN THE ACCOUNTING CYCLESTEPS IN THE ACCOUNTING CYCLESTEPS IN THE ACCOUNTING CYCLESTEPS IN THE ACCOUNTING CYCLE