Adjusting the Accounts

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Presentation transcript:

Adjusting the Accounts Chapter 4 Adjusting the Accounts

Describe the nature of the adjusting process.

Under the accrual basis of accounting, revenues are reported in the income statement in the period in which they are earned.

4-1 Guidelines to Report Revenue and Expenses Time Period Assumption Economic life of business can be divided into artificial time periods Revenue Recognition Principle Revenue recognized in the accounting period in which it is earned Matching Principle Expenses matched with revenues in the period when efforts are expended to generate revenues

The accounting concept that supports this approach to reporting of revenues is called the revenue recognition concept.

The accounting concept that supports reporting revenues and related expenses in the same period is called the matching concept, or matching principle.

Under the cash basis of accounting, revenues and expenses are reported in the income statement in the period in which cash is received or paid.

The Adjusting Process The analysis and updating of accounts at the end of the period before the financial statements are prepared is called the adjusting process.

Adjusting Entries The journal entries that bring the accounts up to date at the end of the accounting period are called adjusting entries.

Adjusting entries-- allow revenues and expenses to be recorded in the correct time period. are dated the last day of the period. always involved at least one balance sheet and at least one income statement account. never involves the Cash account.

Accounts Requiring Adjustment Prepaid expenses, sometimes referred to as deferred expenses, are items that have been initially recorded as assets but are expected to become expenses over time or through the normal operations of the business.

Accounts Requiring Adjustment Unearned revenues, sometimes referred to as deferred revenues, are items that have been initially recorded as liabilities but are expected to become revenues over time or through the normal operations of the business.

Accounts Requiring Adjusting Accrued revenues, sometimes referred to as accrued assets (accrued means unpaid), are revenues that have been earned but have not been recorded in the accounts.

Accrued expenses, sometimes referred to as accrued liabilities, are expenses that have been incurred but have not been recorded in the accounts. Adjusting the Accounts http://www.youtube.com/watch?v=F2gBvmbNAD4(9:06)

Journalize entries for accounts requiring adjustment.

Unadjusted Trial Balance for ABC Restaurant

Adjusting Process for Prepaid Expenses ABC Restaurant’ Supplies account has a balance of $2,000 in the unadjusted trial balance. Some of these supplies have been used. On December 31, a count reveals that $760 of supplies are on hand.

Supplies (balance on trial balance) $2,000 Supplies on hand, December 31 – 760 Supplies used $1,240

Supplies Supplies Expense Bal. 2,000 Dec. 31 1,240 Bal. 800 Dec. 31 Supplies Expense 1 240 00 2007 55 Supplies 1 240 00 14 Supplies used ($2,000 – $760) Supplies Supplies Expense 14 55 Bal. 2,000 Dec. 31 1,240 Bal. 800 Dec. 31 1,240 760 2,040 23

The debit balance of $2,400 in ABC Restaurant’ Prepaid Insurance account represents the December 1 prepayment of insurance for 12 months.

31 Insurance Expense 200 00 56 Prepaid Insurance 200 00 15 Insurance expired ($2,400/12). Prepaid Insurance 15 Insurance Expense 56 Bal. 2,400 Dec. 31 200 Dec. 31 200 2,200 25

On December 1, the tenant prepaid three months’ rent for use of an office building owned by ABC Restaurant. As of December 31, only $120 has been earned.

31 Unearned Rent 120 00 23 Rent Revenue 120 00 42 Rent earned ($360/3 months) Unearned Rent 23 Rent Revenue 42 Dec. 31 120 Bal. 360 Dec. 31 120 240 Bal.

ABC Restaurant provided $500 in services during December for which the customer has not been billed.

31 Accounts Receivable 500 00 12 Fees Earned 500 00 41 Accrued fees (25 hrs. x $20) Accounts Receivable 12 Fees Earned 41 Bal. 2,220 Bal. 16,340 Dec. 31 500 Dec. 31 500 2,720 Bal. 16,840 Bal.

At the end of December, accrued wages amounted to $250. Without this adjusting entry, Wages Expense is understated.

31 Wages Expense 250 00 51 Wages Payable 250 00 22 Accrued wages. Wages Payable Wages Expense 51 22 Dec. 31 250 Bal. 4,275 Dec. 31 250 Bal. 4,525

Wages Payable 22 Wages Expense 51 Dec. 31 250 Bal. 4,275 Dec. 31 250 Bal. 4,525 Closing entries will be discussed in a later chapter. For now, just be aware that Wages Expense is closed after financial statements are prepared and its balance rolled back to zero.

The payment of January 10 wages totaling $1,275 is shown below. The payment of January 10 wages totaling $1,275 is shown below. Jan. 10 Wages Expense 1 025 00 Wages Payable 250 00 Cash 1 275 00 Paid wages.

Dec. 31 250 Wages Payable Bal. 4,275 Wages Expense 22 51 Bal. 4,525 Jan. 10 1,025 Jan. 10 250 The liability is cancelled. An expense for wages of $1,025 is recorded in the new fiscal year.

4-5 Types of Adjusting Entries Type of Adjustment Reason for Adjustment Account Balances Before Adjustment Adjusting Entry 1. Prepaid Expenses (a) Prepaid expenses originally recorded in asset accounts have been used Assets Overstated Expenses Understated Dr. Expenses Cr. Assets 2. Unearned Revenues (b) Unearned revenues initially recorded in liability accounts have been earned Liabilities Overstated Revenues Understated Dr. Liabilities Cr. Revenues 3. Accrued Revenues (c) Revenues earned but not yet received in cash or recorded Assets Understated Dr. Assets 4. Accrued Expenses (d) Expenses incurred but not yet paid in cash or recorded Liabilities Understated Cr. Liabilities Each adjusting entry affects a balance sheet account and an income statement account.

Adjusting Entries (Part 1): Prepaids (9:26) http://www.youtube.com/watch?v=3n4SG2cxlh0&feature=related Adjusting Entries (Part 2): Supplies (4:44) http://www.youtube.com/watch?v=3vEyr8yl6go&feature=fvwrel

Physical resources that are owned and used by a business and are permanent or have a long life are called fixed assets or plant assets.

As time passes, a fixed asset loses its ability to provide useful services. This decrease in usefulness is called depreciation.

Definition of 'Depreciation' Definition of 'Depreciation' Depreciation is used in accounting to try to match the expense of an asset to the asset's income. For example, if a company buys a piece of equipment for $1 million and expects it to have a useful life of 10 years, it will be depreciated over 10 years.

Every accounting year, the company will expense $100,000 (assuming straight-line depreciation, $1 million/10), which will be matched with the money that the equipment helps to make each year. Depreciation(5:45) http://www.youtube.com/watch?v=laPtTeDgzeQ

Normal Titles and Related Contra Asset Accounts Normal titles for fixed asset accounts and their related contra asset accounts are as follows: Fixed Asset Contra Asset Land None—Land is not depreciated Buildings Accumulated Depreciation— Buildings Store Equipment Accumulate Depreciation— Store Equipment Office Equipment Accumulated Depreciation— Office Equipment

4-2 Depreciation Entry: PREPAYMENT ASSET EXPENSE Cost of Truck $15,000 2008 2009 2010 1/1/08 12/31/08 12/31/09 12/31/10 Entry: Truck 15,000 Cash 15,000 Depreciation Expense 5,000 ASSET Accumulated Depreciation 5,000 Depreciation Expense 5,000 EXPENSE Accumulated Depreciation 10,000 CONTRA ASSET Depreciation Expense 5,000 Statement Presentation: Balance Sheet Asset Truck $15,000 Contra Asset Less: Accum. Depr. 5,000 10,000 15,000 Book Value $10,000 $ 5,000 $ -0- Accumulated Depreciation 15,000

ABC Restaurant estimates the depreciation on its office equipment to be $50 for the month of December.

31 Depreciation Expense 50 00 53 Accum. Depreciation— Office Equipment 50 00 19 Depreciation Expense 53 Accum. Depr.—Office Equip. 19 Dec. 31 50 Dec. 31 50

ABC Restaurant’ balance sheet would show the office equipment at cost, less the accumulated depreciation. Office equipment $1,800 Less accumulated depreciation 50 $1,750 Book value

Prepare an adjusted trial balance.

Adjusted Trial Balance The purpose of the adjusted trial balance is to verify the equality of the total debit balances and total credit balances before the financial statements are prepared.

Adjusted Trial Balance

4-8 Review Chapter Concepts Topic Applied Results Justification 1. Time Period Assumption Economic life of business is divided into time periods. To provide information to prepare financial statements and tax return 2. Revenue Recognition Revenue is recorded in period earned. Requires adjusting entries. To record assets or decreases in liabilities and proper reporting of revenue earned. 3. Matching Principle Record expenses in the period they occur. Requires adjusting entries. To record liabilities or use of assets and expenses incurred in earning revenues. 4. Accrual Basis Accounting Applies revenue recognition principle, matching principle, and time period assumption. To record revenue when earned and expenses when incurred.