Adjustments, Financial Statements, and the Quality of Earnings Chapter 4 McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.

Accounting Cycle l Prepare financial statements. l Disseminate statements to users. l Prepare financial statements. l Disseminate statements to users. l Close revenues, gains, expenses, and losses to Retained Earnings. During the period: l Analyze transactions. l Record journal entries. l Post amounts to general ledger. During the period: l Analyze transactions. l Record journal entries. l Post amounts to general ledger. At the end of the period: l Adjust revenues and expenses. At the end of the period: l Adjust revenues and expenses. Start of Period

McGraw-Hill/Irwin Slide 3 Types of Adjustments There are four types of adjustments.ExpensesExpenses 3.Prepaid Expenses. 4.Accrued Expenses. 3.Prepaid Expenses. 4.Accrued Expenses.RevenuesRevenues 1.Unearned Revenues. 2.Accrued Revenues. 1.Unearned Revenues. 2.Accrued Revenues.

McGraw-Hill/Irwin Slide 4 End of accounting period. Cash received.Revenues earned. Example includes rent received in advance (an unearned revenue). Unearned Revenues

McGraw-Hill/Irwin Slide 5 End of accounting period. Cash receivedRevenues earned Example includes interest earned during the period (accrued revenue). Accrued Revenue

McGraw-Hill/Irwin Slide 6 End of accounting period. Cash paid. Examples include prepaid rent, advertising, and insurance. Prepaid Expenses Expense incurred.

McGraw-Hill/Irwin Slide 7 Accrued Expenses As of 12/27/09, Denton, Inc. had already paid $1,900,000 in wages for the year. Denton pays its employees every Friday. Year-end, 12/31/09, falls on a Wednesday. The employees have earned total wages of $50,000 for Monday through Wednesday of the week ending 1/02/10.

 Certain circumstances require adjusting entries to record accounting estimates.  Examples include...  Depreciation  Bad debts  Income taxes  Certain circumstances require adjusting entries to record accounting estimates.  Examples include...  Depreciation  Bad debts  Income taxes Accrued Expenses Involving Estimates

The income statement contains revenues and expenses. Earnings Per Share (EPS) must be reported on the income statement.

McGraw-Hill/Irwin Slide 10 Statement of Stockholders’ Equity Net income appears on the statement of stockholders’ equity as an increase in Retained Earnings. From the Income Statement

McGraw-Hill/Irwin Slide 11 Balance Sheet – Liabilities & Stockholders’ Equity From the Statement of Stockholders’ Equity.

McGraw-Hill/Irwin Slide 12 Closing the Books Even though the balance sheet account balances carry forward from period to period, the income statement accounts do not. Closing entries: 1.Transfer net income (or loss) to Retained Earnings. 2.Establish a zero balance in each of the temporary accounts to start the next accounting period. Closing entries: 1.Transfer net income (or loss) to Retained Earnings. 2.Establish a zero balance in each of the temporary accounts to start the next accounting period.

McGraw-Hill/Irwin Slide 13 Closing the Books Two steps are used in the closing process Close revenues and gains to Retained Earnings. 2. Close expenses and losses to Retained Earnings.

McGraw-Hill/Irwin Slide 14 Post-Closing Trial Balance After all temporary accounts have been closed, we prepare a post-closing trial balance. Only assets, liabilities, and stockholders’ equity accounts will appear. All revenue, expense, gain and loss accounts will have a zero balance.