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 © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 3 ADJUSTING ACCOUNTS AND PREPARING FINANCIAL STATEMENTS

3 - 2 T HE A CCOUNTING P ERIOD C 1

3 - 3 Accounting A CCRUAL B ASIS VERSUS C ASH B ASIS 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 A CCRUAL B ASIS VERSUS C ASH B ASIS Non-GAAPNon-GAAP C 2 Accrual Basis Revenues are recognized when earned and expenses are recognized when incurred.

3 - 5 A CCRUAL B ASIS VERSUS C ASH B ASIS On the cash basis, the entire $2,400 would be recognized as insurance expense in No insurance expense from this policy would be recognized in 2012 or 2013, periods covered by the policy. C 2

3 - 6 A CCRUAL B ASIS VERSUS C ASH B ASIS On the accrual basis, $100 of insurance expense is recognized in 2011, $1,200 in 2012, 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. R ECOGNIZING R EVENUES & E XPENSES Revenue Recognition Principle C 2

3 - 8 R ECOGNIZING R EVENUES & E XPENSES Revenue Recognition Principle Matching Principle 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. A DJUSTING A CCOUNTS Prepaid (Deferred) expenses* Unearned (Deferred) revenues Accrued expense Accrued revenues Framework for Adjustments * including depreciation Paid (or received) cash before expense (or revenue) recognized Paid (or received) cash after expense (or revenue) recognized Adjustments C 3

Here is the check for my 24-month insurance policy. Here is the check for my 24-month insurance policy. P REPAID (D EFERRED ) E XPENSES Resources paid for prior to receiving the actual benefits. P 1

P REPAID I NSURANCE (a) On 12/1/11, FastForward paid $2,400 for insurance for 2-years (24-months, December 2011 through November 2013). FastForward recorded the expenditure as Prepaid Insurance on 12/31/11. What adjustment is required? (a) On 12/1/11, FastForward paid $2,400 for insurance for 2-years (24-months, December 2011 through November 2013). FastForward recorded the expenditure as Prepaid Insurance on 12/31/11. What adjustment is required? P 1

S UPPLIES (b) During 2011, FastForward purchased $9,720 of supplies. FastForward recorded the expenditures in the asset account, “Supplies.” On December 31, 2011, 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

O THER P REPAID E XPENSES 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 D EPRECIATION Depreciation is the process of allocating the cost of a plant asset over its useful life in a systematic and rational manner. P 1

E ND OF C HAPTER 3