Chapter 3 accounting

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<p>Accounting Principles, 9th EditionWeygandt.Kieso.Kimmel</p> <p>Chapter 3</p> <p>Adjusting the Accounts</p> <p>Aims of Lecture Explain the time period assumption. Explain the accrual basis of accounting. Explain why adjusting entries are needed. Identify the major types of adjusting entries.</p> <p>Aims of Lecture Prepare adjusting entries for deferrals. Prepare adjusting entries for accruals. Describe the nature and purpose of an adjusted trial balance.</p> <p>Timing Issues</p> <p>The time period assumption assumes that the economic life of a business can be divided into artificial time periods. Time Period assumption is also known as periodicity assumption.</p> <p>Fiscal &amp; Calendar Years</p> <p>Accounting time periods are generally a month, a quarter, or a year. Monthly and quarterly time periods are called interim time periods. Accounting time period of one year in length is known as a fiscal year. Most businesses use the calendar year.</p> <p>Accrual- vs. Cash-Basis Accounting</p> <p>According to Accrual basis of accounting companies record transactions that change its financial statements in which the events occur. Under Cash basis accounting, Companies recognize any revenue or expense when they received cash or pay out cash respectively. Cash basis accounting is not in accordance with generally accepted accounting principle (GAAP).</p> <p>Recognizing Revenues &amp; Expenses Revenue recognition principle</p> <p>Revenue must be recognized in the accounting period in which it is earned. In a service enterprise, revenue is considered to be earned at the time service is performed.</p> <p>Recognizing Revenues &amp; Expenses Matching Principle</p> <p>A simple rule in accounting- Lets the expenses follow the revenues. Expense recognition is the matching principle. Efforts (expenses) must be matched with accomplishments (revenues).</p> <p>GAAP Relationship in Revenue &amp; Expense RecognitionTime-Period Assumption</p> <p>Economic life of business can be divided into artificial time periods Revenue-Recognition PrincipleRecognize revenue in the accounting period in which it is earned</p> <p>Matching PrincipleMatch Expenses with revenues in the same period when the company make efforts to generate those revenues</p> <p>Revenue &amp; Expense RecognitionIn accordance with GAAP</p> <p>The Basic of Adjusting EntriesAdjusting entries are made in order for:</p> <p>revenues to be recorded in the period in which they are earned. expenses to be recognized in the period in which they are incurred. Adjusting entries make it possible to report correct amount on the balance sheet and on the income statement. A company must make adjusting entries every time it prepares financial statements.</p> <p>Types of Adjusting EntriesAdjusting entries are classified as either deferrals or accruals. Deferrals Prepaid Expenses: Expenses paid in cash and recorded as assets before they are used or consumed. Unearned revenues: Cash receives and recorded as liabilities before revenue is earned.</p> <p>Types of Adjusting EntriesAccruals</p> <p>Accrued revenues: Revenues earned but not yet received in cash or recorded. Accrued expenses: Expenses incurred but not yet paid in cash or recorded.</p> <p>Trial BalancePIONEER ADVERTISING AGENCY Trial Balance October 31, 2010Cash Advertising Supplies Prepaid Insurance Office Equipment Notes Payable Accounts Payable Unearned Revenue C. R. Byrd, Capital C. R. Byrd, Drawing Service Revenue Salaries Expense Rent Expense Debit $ 15,200 2,500 600 5,000 Credit</p> <p>$ 5,000 2,500 1,200 10,000 500 10,000 4,000 900</p> <p>$ 28,700</p> <p>$ 28,700</p> <p>The Trial Balance is the starting place for adjusting entries.</p> <p>Adjusting Entries for DeferralsDeferrals are either prepaid expenses or unearned revenues.</p> <p>Prepaid Expenses: expenses paid in cash and recorded as assets before they are used or consumed. Prepaid expenses are costs that expire either with the passage of time or through use. An asset-expense account relationship exists with prepaid expenses.</p> <p>Adjusting Entries for Deferrals Prior to adjustment assets are overstated and expenses are understated. An adjusting entry for prepaid expense increase (debit) an expense account and decreases (credit) an asset account. For example: supplies, insurance and depreciation.</p> <p>Adjusting Entries for Prepaid Expenses</p> <p>Supplies</p> <p>Businesses use various types of supplies such as paper, envelopes and printer cartridges. Though in the course of operations, supplies are used but they postpone recognizing their use until the adjustment process.</p> <p>Adjusting Entries for SuppliesADJUSTMENT JOURNAL ENTRYDate Oct. 31 Account Titles and Explanation Advertising Supplies Expense Advertising Supplies (To record supplies used) Debit Credit 1,500 1,500October 31, an inventory count reveals that $1,000 of $2,500 of supplies are still on hand.</p> <p>POSTINGAdvertising Supplies Oct. 5 2,500 Oct. 31 31 1,000 1,500Advertising Supplies Expense Oct. 31 1,500</p> <p>Insurance</p> <p>Insurance must be paid in advance.Insurance premium (payments) normally are recorded as an increase to the asset account Prepaid Insurance. At the financial statement date companies increase insurance expense decrease prepaid insurance for the cost that has expired during the period.</p> <p>Adjustment Entries for Prepaid InsuranceADJUSTMENT JOURNAL ENTRYDate Oct. 31</p> <p>October 31, an analysis of the policy reveals that $50 of insurance expires each month.Debit Credit 50 50</p> <p>Account Titles and Explanation Insurance Expense Prepaid Insurance (To record insurance expired)</p> <p>POSTINGPrepaid InsuranceOct. 4 31 600 Oct. 31 550 10 50</p> <p>Insurance Expense Oct. 31 50</p> <p>63</p> <p>Depreciation</p> <p>depreciation is the process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner. Long-lived assets (equipments or buildings) is essentially a long-term prepayment for services. Allocated in the same manner as other prepaid expenses. Depreciation is an estimate rather than a factual measurement of expired cost.</p> <p>Depreciation</p> <p>Recording depreciation Debit Depreciation Expense Credit Accumulated Depreciation (contra asset)</p> <p>An account offset against an asset account on the balance sheet is known as contra asset account.Depreciation ExpenseXXX</p> <p>Accumulated DepreciationXXX</p> <p>DepreciationStatement Presentation:</p> <p>Balance Sheet Accumulated Depreciation is offset against the asset account Book Value difference between the cost of any depreciable asset and its related accumulated depreciation is the book value of the asset</p> <p>Adjustment Entries for DepreciationADJUSTMENTOctober 31, depreciation on the office equipment is estimated to be $480 a year, or $40 per month.</p> <p>JOURNAL ENTRYDate Oct. 31 Account Titles and Explanation Depreciation Expense Accumulated Depreciation - Office Equipment (To record monthly depreciation) Debit Credit 40 40</p> <p>POSTINGAccumulated Depreciation Office Equipment Oct. 31 40</p> <p>Depreciation Expense Oct. 31 40</p> <p>Adjusting Entries for DeferralsUnearned Revenues: Companies record cash received before revenue is earned by increasing a liability account called unearned revenues. Opposite of Prepaid Expenses. Unearned revenues are earned by rendering a service to a customer. A liability-revenue account relationship exists with unearned revenues.</p> <p>Adjusting Entries for Unearned Revenues</p> <p>Prior to adjustment liabilities are overstated and revenues are understated. An adjusting entry for unearned revenues results in a decrease (debit) to a liability account and an increase (credit) to a revenue account. For example : rent, magazine subscriptions and customer deposits for future services.</p> <p>Adjusting Entries for Unearned Revenues</p> <p>Unearned revenue is sometimes referred to as deferred revenue.</p> <p>Adjusting Entries for Unearned RevenuesADJUSTMENT JOURNAL ENTRYDate Oct. 31</p> <p>October 31, analysis reveals that, of $1,200 in fees, $400 has been earned in October.Debit Credit 400 400</p> <p>Account Titles and Explanation Unearned Revenue Service Revenue (To record revenue for services provided)</p> <p>POSTINGUnearned Revenue Oct. 31 400 Oct. 2 31 1,200 800</p> <p>Service Revenue Oct. 31 31</p> <p>10,000 400</p> <p>Adjusting Entries for AccrualsCompanies make adjusting entries for accruals to record revenues earned and expenses incurred in the current accounting period that have not been recognized through daily entries. Accrued Revenues: Revenues earned but not yet recorded at the statement date. Accrued revenues may accumulate (accrue) with the passing of time - interest revenue or rent revenue.</p> <p>Adjusting Entries for Accruals Accrued revenues may also result from services that have been performed but are neither billed or collected. Adjusting entry for accrued revenue shows us: receivables that exits at the balance sheet date, revenues earned during the period. An adjusting entry for accrued revenues increases (debits) an asset and increases (credits) a revenue account. An asset-revenue account relationship exists Prior to adjustment, assets and revenues are understated.</p> <p>Adjusting Entries for Accrued Revenues</p> <p>Adjusting Entries for Accrued RevenueADJUSTMENT JOURNAL ENTRYDate Oct. 31</p> <p>October 31, the agency earned $200 for advertising services that were not billed to clients before October 31.Debit Credit 200 200</p> <p>Account Titles and Explanation Accounts Receivable Service Revenue (To accrue revenue for services provided)</p> <p>POSTINGAccounts Receivable Oct. 31 200</p> <p>Service Revenue Oct. 31 31 31 31</p> <p>10,000 400 200 10,600</p> <p>Adjusting Entries for AccrualsAccrued Expenses: Expenses incurred but not paid yet or recorded at the statement date. Interest, rent, taxes and salaries are typical accrued expenses. A liability-expense account relationship exists. Prior to adjustment, liabilities and expenses are understated</p> <p>Adjusting Entries for Accruals Adjusting entry for accrued expenses shows us:the obligations that exist at the balance sheet date &amp; the expenses of the current accounting period.</p> <p> Adjusting Entry for accrued expenses increases (debits) an expense account and increases (credits) a liability account.</p> <p>Adjusting Entries for Accrued Expenses</p> <p>Adjusting Entries for Accrued Expenses (Accrued Interest)ADJUSTMENT JOURNAL ENTRYDate Oct. 31 Account Titles and Explanation Interest Expense Interest Payable (To accrue interest on notes payable) Debit Credit 50 50</p> <p>October 31, the portion of the interest to be accrued on a 3-month note payable is calculated to be $50.</p> <p>POSTINGInterest Expense Oct. 31 50Interest Payable Oct. 31 50</p> <p>Adjusting Entries for Accrued Expenses (Accrued Interest)ADJUSTMENT JOURNAL ENTRYDate Oct. 31 Account Titles and Explanation Salaries Expense Salaries Payable (To record accrued salaries) Debit Credit 1,200 1,200</p> <p>October 31, accrued salaries are calculated to be $1,200.</p> <p>POSTINGSalaries Expense Oct. 26 4,000 31 1,200 31 5,200</p> <p>Salaries Payable Oct. 31</p> <p>1,200</p> <p>The Adjusted Trial Balance and Financial Statements</p> <p>Adjusted Trial Balance</p> <p>prepared after all adjusting entries have been journalized and posted. purpose is to prove equality of the total debit and credit balances in the ledger after adjustments. prepared directly from the adjusted trial balance.</p> <p>Financial statements</p> <p>Trial Balance vs. Adjusted Trial BalancePIONEER ADVERTISING AGENCY Adjusted Trial Balance October 31, 2010Before Adjustment Debit Credit $ 15,200 2,500 600 5,000 $ 5,000 2,500 1,200 10,000 500 10,000 4,000 After Adjustment Debit Credit $ 15,200 200 1,000 550 5,000 $ 40 5,000 2,500 50 800 1,200 10,000 500 10,600 5,200 1,500 900 50 50 40 $ 30,190 $ 30,190</p> <p>Cash Accounts Receivable Advertising Supplies Prepaid Insurance Office Equipment Accumulated Depreciation - Office Equipment Notes Payable Accounts Payable Interest Payable Unearned Revenue Salaries Payable C. R. Byrd, Capital C. R. Byrd, Drawing Service Revenue Salaries Expense Advertising Supplies Expense Rent Expense Insurance Expense Interest Expense Depreciation Expense</p> <p>900</p> <p>$ 28,700</p> <p>$ 28,700</p>


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