Adjusting Accounts and Preparing Financial Statements Chapter 5 Adjusting Accounts and Preparing Financial Statements

LO1 Learning Objective 1 Explain accrual accounting and how it improves financial statements. Accrual basis accounting uses the adjusting process to recognize revenues when earned and expenses when incurred. Cash basis accounting recognizes revenue when cash is received and records expenses when cash is paid. It is commonly held that accrual accounting better reflects business performance than cash basis accounting. As an example, consider FastForward’s Prepaid Insurance account. FastForward paid $2,400 for 24 months of insurance coverage beginning December 1, 2010. Accrual accounting requires that $100 of insurance expense be reported on December 2010’s income statement keeping the accounts more accurate.

LO2 Learning Objective 2 Identify the types of accounting adjustments and their purpose. Reflects unearned revenues and prepaid expenses. Reflect s transactions when cash is paid or received after a related expense or revenue is recognized. Adjustments Work before cash (Accruals) Cash before work (Deferrals) Unearned (Deferred) revenues Prepaid (deferred) expenses Accrued revenues Accrued expenses

Learning Objective 3 Prepare and explain adjusting entries. LO3 Learning Objective 3 Prepare and explain adjusting entries. An adjusting entry is recorded to bring an asset or liability account balance to its proper amount. This entry also updates a related expense or revenue account. Three-step Process Determine the current account balance. Determine what the current account balance should be. Record the adjusting journal entry to get from step 1 to step 2.

Resources paid for prior to receiving the actual benefits. LO3 Prepaid Expenses Remember that a prepaid expense is an asset that results from the payment of cash before the expense is recognized. Resources paid for prior to receiving the actual benefits. Asset Expense Unadjusted Balance Credit Adjustment Debit

What adjustment is required? LO3 Prepaid Insurance On December 1, 2010, FastForward paid $4,800 for insurance for 24 months. FastForward recorded the expenditure as Prepaid Insurance on December 1. What adjustment is required? 637 128

LO3 Supplies During December, FastForward purchased $9,720 of supplies. FastForward recorded the expenditures with a debit to Supplies. On December 31, a count of the supplies indicated $8,670 on hand. 126 652

Asset Cost - Salvage Value LO3 Depreciation Depreciation is the process of spreading the costs of plant and equipment over their expected useful lives. Straight-Line Depreciation Expense = Asset Cost - Salvage Value Useful Life

Accumulated depreciation is LO3 Depreciation FastForward purchased equipment for $20,000 in early December. The equipment is expected to have a useful life of four years and a salvage value of $8,000. Monthly Depreciation Expense = $20,000 - $8,000 48 months $250 Accumulated depreciation is a contra asset account.

Equipment is shown net of accumulated depreciation. LO3 Depreciation Notice the contra-account, accumulated depreciation, will be shown as a reduction in the cost of the asset Equipment is shown net of accumulated depreciation.

Accrued Salaries Expense LO3 Accrued Salaries Expense FastForward’s employee earns $70 per day, or $350 for a five-day workweek beginning on Monday and ending on Friday. This employee is paid every two weeks on Friday. On December 12 and 26, the wages are paid, recorded in the journal, and posted to the ledger. At December 31, the employee has worked for three days for FastForward and will be paid on January 9, 2011. 12/31/10 Year end Last pay date 12/26/10 Next pay 1/9/11 Record adjusting journal entry.

Learning Objective 4 Explain and prepare an adjusted trial balance. LO4 Learning Objective 4 Explain and prepare an adjusted trial balance. An adjusted trial balance is a list of accounts and balances prepared after adjusting entries have been recorded and posted to the ledger.

LO5 Learning Objective 5 Prepare financial statements from an adjusted trial balance. Notice how we took the information directly from the worksheet and prepared the income statement.

Preparing Financial Statements LO5 Preparing Financial Statements Note: Investment by owner and withdrawals by owner come from the adjusted trial balance.

Preparing Financial Statements LO5 Preparing Financial Statements Notice assets and liabilities balances are transferred over from the adjusted trial balance to the Balance Sheet.

End of Chapter 5