3 - 1 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Adjusting Accounts and Preparing Financial Statements Chapter 3

3 - 2 The Accounting Period C 1

3 - 3 Accounting Accrual Basis versus Cash Basis Accrual Basis Revenues are recognized when earned and expenses are recognized when incurred. Cash Basis Revenues are recognized when cash is received and expenses are recorded when cash is paid. C 2

3 - 4 Cash Basis Revenues are recognized when cash is received and expenses are recorded when cash is paid. Accounting Accrual Basis versus Cash Basis Non-GAAPNon-GAAP C 2 Accrual Basis Revenues are recognized when earned and expenses are recognized when incurred.

3 - 5 Accrual Basis versus Cash Basis On December 1, 2013, FastForward paid $2,400 cash for a twenty-four month business insurance policy. Using the cash basis, the entire $2,400 would be recognized as insurance expense in No insurance expense from this policy would be recognized in 2014 or 2015, periods covered by the policy. C 2

3 - 6 Accrual Basis versus Cash Basis On the accrual basis, $100 of insurance expense is recognized in 2013, $1,200 in 2014, and $1,100 in The expense is matched with the periods benefited by the insurance coverage. C 2

3 - 7 We have delivered the product to our customer, so I think we should record the revenue earned. We have delivered the product to our customer, so I think we should record the revenue earned. Recognizing Revenues and Expenses C 2 The revenue recognition principle states that we recognize revenue when the product or service is delivered to our customer.

3 - 8 Recognizing Revenues and Expenses The expense recognition (or matching) principle aims to record expenses in the same accounting period as the revenues that are earned as a result of those expenses. This matching of expenses with the revenue benefits is a major part of the adjusting process. Summary of Expenses Rent Gasoline Advertising Salaries Utilities and.... $1, ,000 3, Now that we have recognized the revenue, let’s see what expenses we incurred to generate that revenue. Now that we have recognized the revenue, let’s see what expenses we incurred to generate that revenue. C 2

3 - 9 An adjusting entry is recorded to bring an asset or liability account balance to its proper amount. Framework for Adjustments C 3

Here is the check for my 24-month insurance policy. Here is the check for my 24-month insurance policy. Prepaid (Deferred) Expenses Resources paid for prior to receiving the actual benefits. P 1

Prepaid Insurance (a) On 12/1/13, FastForward paid $2,400 for insurance for 2- years (24-months, December 2013 through November 2015). FastForward recorded the expenditure as Prepaid Insurance on 12/1/13. What adjustment is required? (a) On 12/1/13, FastForward paid $2,400 for insurance for 2- years (24-months, December 2013 through November 2015). FastForward recorded the expenditure as Prepaid Insurance on 12/1/13. What adjustment is required? P 1

Supplies (b) During 2013, FastForward purchased $9,720 of supplies. FastForward recorded the expenditures in the asset account, “Supplies.” On December 31, 2013, a count of the supplies indicated $8,670 on hand, so $1,050 of supplies were used during December. What adjustment is required? P 1

Other Prepaid Expenses 1.Other prepaid expenses, such as Prepaid Rent, are accounted for exactly as Insurance and Supplies. 2.We should note that some prepaid expenses are both paid for and fully used up within a single period. 3.For example, a company may pay monthly rent on the first day of each month. This payment creates a prepaid expense on the first day of the month that fully expires by the end of the month. 4.In these special cases, we can record the cash paid with a debit to the expense account instead of an asset account. 1.Other prepaid expenses, such as Prepaid Rent, are accounted for exactly as Insurance and Supplies. 2.We should note that some prepaid expenses are both paid for and fully used up within a single period. 3.For example, a company may pay monthly rent on the first day of each month. This payment creates a prepaid expense on the first day of the month that fully expires by the end of the month. 4.In these special cases, we can record the cash paid with a debit to the expense account instead of an asset account. P 1

Straight-Line Depreciation Expense = Asset Cost - Salvage Value Useful Life Depreciation Depreciation is the process of allocating the cost of a plant asset over its useful life in a systematic and rational manner. P 1

Depreciation On December 1, 2013, FastForward purchased equipment for $26,000 cash. The equipment has an estimated useful life of four years (48 months) and FastForward expects to sell the equipment at the end of its life for $8,000 cash. (c) Let’s record depreciation expense for the month ended December 31, P 1

Equipment Depreciation Expense 12/1 26,000 12/ Accumulated Depreciation 12/ Depreciation P 1 Contra asset account

Equipment is shown net of accumulated depreciation. $ Depreciation P 1

Unearned (Deferred) Revenues We will apply this cash you gave us towards your total consulting fees. We will apply this cash you gave us towards your total consulting fees. Cash received in advance of providing products or services. P 1

Unearned (Deferred) Revenues On December 26, 2013, FastForward agrees to provide consulting services to a client for a fixed fee of $3,000 for 60 days. On this date, the client pays the entire consulting fee in advance. FastForward makes the following entry: P 1

Unearned (Deferred) Revenues (d) On December 31, FastForward earns 5-days of consulting fees. Each day that passes results in consulting fees of $50 ($3,000 ÷ 60), so FastForward earned ($50 × 5 days) $250. P 1

We’re about one-half done with this job and want to be paid for our work! We’re about one-half done with this job and want to be paid for our work! Costs incurred in a period that are both unpaid and unrecorded. Costs incurred in a period that are both unpaid and unrecorded. Accrued Expenses P 1

FastForward’s employee earns $70 per day and is paid every two weeks on Friday. Year-end, 12/31/13, falls on a Wednesday. The last payday of 2013 is Friday, 12/26/13. From 12/26 until year- end is three working days. The employee has earned $210 for Monday through Wednesday. He will not be paid until Friday 1/9/14. Accrued Salaries Expenses P 1

(e) FastForward’s employee has earned but not been paid on December 31, 2013, $210. P 1 Accrued Salaries Expenses

Future Payment of Accrued Expenses On January 9, 2014, FastForward will pay the payroll for the two weeks from December 26, 2013 through January 9, Here is the journal entry for the payroll: P 1

Accrued Interest Expenses FastForward borrowed $6,000 from First National Bank on December 1, The note bears interest at the annual rate of 6% and is due to be repaid in one year. Let’s accrue interest for the month ended December 31, P 1

Yes, I’ve completed your consulting job, but have not had time to bill you. Yes, I’ve completed your consulting job, but have not had time to bill you. Accrued Revenues Revenues earned in a period that are both unrecorded and not yet received. Revenues earned in a period that are both unrecorded and not yet received. P 1

Accrued Service Revenue (f) On December 12, 2013, FastForward agrees to render consulting services under a 30-day fixed fee contract for $2,700 ($90 per day). All services are to be completed by January 10, 2014, when the client will pay in full. P 1

Future Receipt of Service Revenues On January 10, 2014, FastForward completed its obligation under the consulting contract. The client was billed $2,700 and FastForward received $2,700 in cash. Revenue in January 10 $90 = $900 Revenue in January 10 $90 = $900 P 1

Links to Financial Statements A 1

P 2

Preparing Financial Statements Let’s use FastForward’s adjusted trial balance to prepare the company’s financial statements. P 3

P 3 1. Prepare the Income Statement

Note: Net Income from the Income Statement carries to the Statement of Changes in Owner’s Equity. P 3 2. Prepare the Statement of Owner’s Equity a

Prepare The Balance Sheet P 3

Global View Both U.S. GAAP and IFRS include similar guidance for adjusting accounts. Although some variations exist in revenue and expense recognition.

Profit Margin The profit margin ratio measures the company’s net income to net sales. Profit Margin = A 2 Limited Brands, Inc. Net Income Net Sales

Appendix 3A: Alternative Accounting for Prepayments P4 An alternative method is to record all prepaid expenses with debits to expense accounts. The adjusting entry depends on how the original payment was recorded.

Appendix 3A: Alternative Accounting for Prepayments P4

Appendix 3A: Alternative Accounting for Revenues P4 An alternative method is to record all revenues to a liability account or a revenue account. The adjusting entry depends on how the original receipt was recorded.

Appendix 3A: Alternative Accounting for Revenues P4

End of Chapter 3