Dr. Mohamed A. Hamada Lecturer of Accounting Information Systems 1-1 Chapter 6 Adjusting the Accounts

1.Explain the time period assumption. 2.Explain the accrual basis of accounting. 3.Explain the reasons for adjusting entries. 4.Identify the major types of adjusting entries. 5.Prepare adjusting entries for deferrals. 6.Prepare adjusting entries for accruals. 7.Describe the nature and purpose of an adjusted trial balance. Study Objectives

Practical case 1 The following accounts come from the ledger of SnowGo Company at December 31, Prepare a trial balance in good form. 3

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Practical case 2 B- Jan Nab is the sole owner of Deer Park, a public camping ground. Jan has compiled the following financial information as of December 31, Revenues during 2010—camping fees $140,000 - Value of equipments $105,500 Revenues during 2010—general store 50,000 - Notes payable 60,000 Accounts payable 11,000 - Expenses during ,000 Cash on hand 23,000 - Supplies on hand 2,500 - Required : (a) Determine Jan Nab’s net income for (b) Prepare a balance sheet for Deer Park as of December 31,

6 Deer Park Balance sheet December 31, 2010 Net income

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

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). Jan.Feb.Mar.Apr.Dec......

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

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

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

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 of accounting is in accord with generally accepted accounting principles. d.Revenue is recorded only when cash is received, and expenses are recorded only when cash is paid. Review Timing Issues

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

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

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

Types of Adjusting Entries 1.Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed. Deferrals 3. Accrued Revenues. Revenues earned but not yet received in cash or recorded. 4. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded. 2. Unearned Revenues. Revenues received in cash and recorded as liabilities before they are earned. Accruals

Trial Balance Trial Balance – Each account is analyzed to determine whether it is complete and up-to-date. Illustration 3-3 Trial Balance

Deferrals are either: Prepaid expenses OR Unearned revenues. Adjusting Entries for Deferrals

Payment of cash that is recorded as an asset because service or benefit will be received in the future. Adjusting Entries for “Prepaid Expenses” insurancesuppliesadvertising Cash Payment Expense Recorded BEFORE rent maintenance on equipment fixed assets (depreciation) Prepayments often occur in regard to:

Adjusting Entries for “Prepaid Expenses” Adjusting entries for prepaid expenses Increases (debits) an expense account and Decreases (credits) an asset account. Illustration 3-4

GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit Prepaid Expenses Example On September 1, 1998, Bob’s Bait Shop prepaid its rent for the next twelve months. Rent is $200 per month. Prepare the proper initial journal entry.

On September 1, 1998, Bob’s Bait Shop prepaid its rent for the next twelve months. Rent is $200 per month. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-SepPrepaid Rent2,400 Cash2,400 to record prepayment of twelve months of rent Prepaid Expenses Example

GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit Prepaid Expenses Example Bob’s fiscal year-end is December 31. Record the adjustment necessary on December 31 for the prepaid rent. Prepare the proper adjusting journal entry.

Bob’s fiscal year-end is December 31. Record the adjustment necessary on December 31 for the prepaid rent. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 31-DecRent Expense800 Prepaid Rent800 to record recognition of four months of rent expense $200  x 4 months = $800 Prepaid Expenses Example

Illustration: Pioneer Advertising Agency purchased advertising supplies costing $2,500 on October 5. This account shows a balance of $2,500 in the October 31 trial balance. An inventory count at the close of business on October 31 reveals that $1,000 of supplies are still on hand. Advertising supplies1,500 Advertising supplies expense1,500Oct. 31 Adjusting Entries for “Prepaid Expenses”

Supplies For example: the general ledger shows a balance in the supplies account of $2,000. Inventory shows $500 of supplies still on hand Supplies Balance $2,000 Inventory 500 Used up 1,500 Adjusting Entries Supplies expense $1500 Supplies $1500

Example 1 the general ledger shows that the balance in the supplies account is $4,000. An inventory is conducted of supplies and it is found that only $2,500 of supplies is still on hand. Record the adjusting entry for the use of supplies.

Prepaid insurance The G/L shows the balance are $6,000. The policy was purchased on May 1 st for 12 months. Record the adjusting entry on Dec 31 for insurance expired. $6,000/12 = 500 per month May to Dec = 8 months x $500 = $4,000 is expired

Prepaid insurance Adjusting entry Insurance exp $4,000 Prepaid insurance $4,000

Example 2: the general ledger shows that the balance in the prepaid insurance account is $ The policy was purchased on Aug 1st for 12 months. Record the adjusting entry for the insurance expired.

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”

Illustration: Pioneer Advertising estimates depreciation on the office equipment to be $480 a year, or $40 per month. Accumulated depreciation40 Depreciation expense40Oct. 31 Adjusting Entries for “Prepaid Expenses”

Depreciation (Statement Presentation) Accumulated Depreciation is a contra asset account. Appears just after the account it offsets (Equipment) on the balance sheet. Illustration 3-8 Adjusting Entries for “Prepaid Expenses”

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