1. Slide 3-1

2. Slide 3-2 Adjusting the Accounts Financial Accounting, Seventh Edition

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

4. Slide 3-4 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

5. Slide 3-5 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). SO 1 Explain the time period assumption. Jan.Feb.Mar.Apr.Dec......

6. Slide 3-6 The time period assumption states that: 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 SO 1 Explain the time period assumption. 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. Solution on notes page

7. Slide 3-7 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 SO 2 Explain the accrual basis of accounting.

8. Slide 3-8 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 SO 2 Explain the accrual basis of accounting.

9. Slide 3-9 Revenue Recognition Principle Timing Issues Recognizing Revenues and Expenses SO 2 Explain the accrual basis of accounting. Companies recognize revenue in the accounting period in which it is earned. In a service enterprise, revenue is considered to be earned at the time the service is performed.

10. Slide 3-10 Expense Recognition Principle – (Matching Principle) Timing Issues Recognizing Revenues and Expenses SO 2 Explain the accrual basis of accounting. Match expenses with revenues in the period when the company makes efforts to generate those revenues. “Let the expenses follow the revenues.”

11. Slide 3-11 Timing Issues SO 2 Explain the accrual basis of accounting. GAAP relationships in revenue and expense recognition Illustration 3-1

12. Slide 3-12 SO 2

13. Slide 3-13 Match the description of the concept to the concept. Solution on notes page Timing Issues SO 2 Explain the accrual basis of accounting. g f c b

14. Slide 3-14 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 SO 2 Explain the accrual basis of accounting. Solution on notes page 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.

15. Slide 3-15 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 SO 3 Explain the reasons for adjusting entries.

16. Slide 3-16 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 SO 3 Explain the reasons for adjusting entries.

17. Slide 3-17 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 SO 3 Explain the reasons for adjusting entries. The Basics of Adjusting Entries

18. Slide 3-18 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 SO 4 Identify the major types of adjusting entries. Illustration 3-2 Categories of adjusting entries Types of Adjusting Entries

19. Slide 3-19 SO 4 Identify the major types of adjusting entries. Trial Balance Trial Balance – Illustrations are based on the January 31, trial balance of Phoenix Consulting. Types of Adjusting Entries

20. Slide 3-20 Deferrals are either: Prepaid expenses OR Unearned revenues. SO 5 Prepare adjusting entries for deferrals. Types of Adjusting Entries Adjusting Entries for Deferrals

21. Slide 3-21 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 SO 5 Prepare adjusting entries for deferrals. rent maintenance on equipment fixed assets (depreciation) Prepayments often occur in regard to:

22. Slide 3-22 Prepaid Expenses Costs that expire either with the passage of time or through use. Adjusting entries (1) to record the expenses that apply to the current accounting period, and (2) to show the unexpired costs in the asset accounts. Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.

23. Slide 3-23 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals. Adjusting entries for prepaid expenses Increases (debits) an expense account and Decreases (credits) an asset account. Illustration 3-4

24. Slide 3-24 Illustration (Insurance):On Jan. 1 st, Phoenix Consulting paid $12,000 for 12 months of insurance coverage. Show the journal entry to record the payment on Jan. 1 st. Illustration (Insurance): On Jan. 1 st, Phoenix Consulting paid $12,000 for 12 months of insurance coverage. Show the journal entry to record the payment on Jan. 1 st. Cash12,000 Prepaid Insurance12,000Jan. 1 DebitCredit Prepaid Insurance 12,00012,000 DebitCredit Cash Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.

25. Slide 3-25 Illustration (Insurance): On Jan. 1 st, Phoenix Consulting paid $12,000 for 12 months of insurance coverage. Show the adjusting journal entry required at Jan. 31 st. Prepaid Insurance1,000 Insurance Expense1,000Jan. 31 DebitCredit Prepaid Insurance 12,0001,000 DebitCredit Insurance Expense 1,000 11,000 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.

26. Slide 3-26 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” SO 5 Prepare adjusting entries for deferrals.

27. Slide 3-27 Illustration (Depreciation): On Jan. 1 st, Phoenix Consulting paid $24,000 for equipment that has an estimated useful life of 20 years. Show the journal entry to record the purchase of the equipment on Jan. 1 st. Cash24,000 Equipment24,000Jan. 1 DebitCredit Equipment 24,00024,000 DebitCredit Cash Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.

28. Slide 3-28 Illustration (Depreciation): On Jan. 1 st, Phoenix Consulting paid $24,000 for equipment that has an estimated useful life of 20 years. Show the adjusting journal entry required at Jan. 31 st. ($24,000 / 20 yrs. / 12 months = $100) Accumulated Depreciation100 Depreciation Expense100Jan. 31 DebitCredit Depreciation Expense 100100 DebitCredit Accumulated Depreciation Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.

29. Slide 3-29 Depreciation (Statement Presentation) Accumulated Depreciation is a contra asset account. Appears just after the account it offsets (Equipment) on the balance sheet. Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.

30. Slide 3-30 Summary Illustration 3-9 Adjusting Entries for “Prepaid Expenses” SO 5 Prepare adjusting entries for deferrals.

31. Slide 3-31 Receipt of cash that is recorded as a liability because the revenue has not been earned. Adjusting Entries for “Unearned Revenues” rent airline tickets school tuition Cash Receipt Revenue Recorded BEFORE magazine subscriptions customer deposits Unearned revenues often occur in regard to: SO 5 Prepare adjusting entries for deferrals.

32. Slide 3-32 Unearned Revenues Company makes an adjusting entry to record the revenue that has been earned and to show the liability that remains. The adjusting entry for unearned revenues results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account. SO 5 Prepare adjusting entries for deferrals. Adjusting Entries for “Unearned Revenues”

33. Slide 3-33 SO 5 Prepare adjusting entries for deferrals. Adjusting entries for unearned revenues Decrease (a debit) to a liability account and Increase (a credit) to a revenue account. Adjusting Entries for “Unearned Revenues” Illustration 3-10

34. Slide 3-34 Illustration:On Jan. 1 st, Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. Show the journal entry to record the receipt on Jan. 1 st. Illustration: On Jan. 1 st, Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. Show the journal entry to record the receipt on Jan. 1 st. Unearned Rent Revenue24,000 Cash24,000Jan. 1 DebitCredit Cash 24,00024,000 DebitCredit Unearned Rent Revenue Adjusting Entries for “Unearned Revenues” SO 5 Prepare adjusting entries for deferrals.

35. Slide 3-35 Illustration:On Jan. 1 st, Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. Show the adjusting journal entry required on Jan. 31 st. Illustration: On Jan. 1 st, Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. Show the adjusting journal entry required on Jan. 31 st. Rent Revenue8,000 Unearned Rent Revenue8,000Jan. 31 DebitCredit Rent Revenue 8,00024,000 DebitCredit Unearned Rent Revenue 8,000 16,000 Adjusting Entries for “Unearned Revenues” SO 5 Prepare adjusting entries for deferrals.

36. Slide 3-36 Summary Adjusting Entries for “Unearned Revenues” Illustration 3-12 SO 5 Prepare adjusting entries for deferrals.

37. Slide 3-37 SO 5

38. Slide 3-38 Made to record: Revenues earned and OR Expenses incurred in the current accounting period that have not been recognized through daily entries. SO 6 Prepare adjusting entries for accruals. Types of Adjusting Entries Adjusting Entries for Accruals

39. Slide 3-39 Revenues earned but not yet received in cash or recorded. Adjusting Entries for “Accrued Revenues” rentinterest services performed BEFORE Accrued revenues often occur in regard to: Cash Receipt Revenue Recorded Adjusting entry results in: SO 6 Prepare adjusting entries for accruals.

40. Slide 3-40 Accrued Revenues An adjusting entry serves two purposes: (1) It shows the receivable that exists, and (2) It records the revenues earned. Adjusting Entries for “Accrued Revenues” SO 6 Prepare adjusting entries for accruals.

41. Slide 3-41 Adjusting entries for accrued revenues Increases (debits) an asset account and Increases (credits) a revenue account. SO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Revenues” Illustration 3-13

42. Slide 3-42 Illustration:On Jan. 1 st, Phoenix Consulting invested $300,000 in securities that return 5% interest per year. Show the journal entry to record the investment on Jan. 1 st. Illustration: On Jan. 1 st, Phoenix Consulting invested $300,000 in securities that return 5% interest per year. Show the journal entry to record the investment on Jan. 1 st. Cash300,000 Investments300,000Jan. 1 SO 6 Prepare adjusting entries for accruals. DebitCredit Investments 300,000300,000 DebitCredit Cash Adjusting Entries for “Accrued Revenues”

43. Slide 3-43 Illustration:On Jan. 1 st, Phoenix Consulting invested $300,000 in securities that return 5% interest per year. Show the adjusting journal entry required on Jan. 31 st. ($300,000 x 5% / 12 months = $1,250) Illustration: On Jan. 1 st, Phoenix Consulting invested $300,000 in securities that return 5% interest per year. Show the adjusting journal entry required on Jan. 31 st. ($300,000 x 5% / 12 months = $1,250) Interest Revenue1,250 Interest Receivable1,250Jan. 31 DebitCredit Interest Receivable 1,2501,250 DebitCredit Interest Revenue Adjusting Entries for “Accrued Revenues” SO 6 Prepare adjusting entries for accruals.

44. Slide 3-44 Summary Illustration 3-15 Adjusting Entries for “Accrued Revenues” SO 6 Prepare adjusting entries for accruals.

45. Slide 3-45 Expenses incurred but not yet paid in cash or recorded. Adjusting Entries for “Accrued Expenses” rentinterest BEFORE Accrued expenses often occur in regard to: Cash Payment Expense Recorded taxessalaries Adjusting entry results in: SO 6 Prepare adjusting entries for accruals.

46. Slide 3-46 Accrued Expenses An adjusting entry serves two purposes: (1) It records the obligations, and (2) It recognizes the expenses. Adjusting Entries for “Accrued Expenses” SO 6 Prepare adjusting entries for accruals.

47. Slide 3-47 Adjusting entries for accrued expenses Increases (debits) an expense account and Increases (credits) a liability account. SO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Expenses” Illustration 3-16

48. Slide 3-48 Notes Payable200,000 Cash200,000Jan. 2 DebitCredit Cash 200,000200,000 DebitCredit Notes Payable Illustration:On Jan. 2 nd, Phoenix Consulting borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the journal entry to record the borrowing on Jan. 2 nd. Illustration: On Jan. 2 nd, Phoenix Consulting borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the journal entry to record the borrowing on Jan. 2 nd. Adjusting Entries for “Accrued Expenses” SO 6 Prepare adjusting entries for accruals.

49. Slide 3-49 Illustration:On Jan. 2 nd, Phoenix Consulting borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the adjusting journal entry required on Jan. 31 st. ($200,000 x 9% / 12 months = $1,500) Illustration: On Jan. 2 nd, Phoenix Consulting borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the adjusting journal entry required on Jan. 31 st. ($200,000 x 9% / 12 months = $1,500) Interest Payable1,500 Interest Expense1,500Jan. 31 DebitCredit Interest Expense 1,5001,500 DebitCredit Interest Payable Adjusting Entries for “Accrued Expenses” SO 6 Prepare adjusting entries for accruals.

50. Slide 3-50 Summary Illustration 3-21 SO 6 Prepare adjusting entries for accruals. Adjusting Entries for “Accrued Expenses”

51. Slide 3-51 The Adjusted Trial Balance SO 7 After all adjusting entries are journalized and posted the company prepares another trial balance from the ledger accounts (Adjusted Trial Balance). Its purpose is to prove the equality of debit balances and credit balances in the ledger.

52. Slide 3-52 Which of the following statements is incorrect concerning the adjusted trial balance? a.An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger after all adjustments are made. b.The adjusted trial balance provides the primary basis for the preparation of financial statements. c.The adjusted trial balance lists the account balances segregated by assets and liabilities. d.The adjusted trial balance is prepared after the adjusting entries have been journalized and posted. Review Question SO 7 Describe the nature and purpose of an adjusted trial balance. The Adjusted Trial Balance Which of the following statements is incorrect concerning the adjusted trial balance? a.An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger after all adjustments are made. b.The adjusted trial balance provides the primary basis for the preparation of financial statements. c.The adjusted trial balance lists the account balances segregated by assets and liabilities. d.The adjusted trial balance is prepared after the adjusting entries have been journalized and posted.

53. Slide 3-53 Financial Statements are prepared directly from the Adjusted Trial Balance. Balance Sheet Income Statement Retained Earnings Statement Preparing Financial Statements SO 7 Describe the nature and purpose of an adjusted trial balance.

54. Slide 3-54 Preparing Financial Statements SO 7

55. Slide 3-55 SO 7 Describe the nature and purpose of an adjusted trial balance. Preparing Financial Statements

56. Slide 3-56  California adds $6 to $10 of sales tax to the cost of computers and televisions to fund recycling programs.  Each cathode ray tube (CRT) monitor contains 4 – 6 pounds of lead. Consumer electronic products account for about 40% of the lead found in landfills.  Environmental groups put a resolution on a recent Apple Computer ’ s shareholder meeting agenda requiring the company to study how it can increase recycling.  The average household has two to three old computers in its garage or storage area. Is Your Old Computer a Liability?

57. Slide 3-57

58. Slide 3-58 Should companies accrue for environmental cleanup costs as liabilities on their financial statements? YES: As more states impose laws holding companies responsible, and as more courts levy pollution-related fines, it becomes increasingly likely that companies will have to pay large amounts in the future. NO: The amounts still are too difficult to estimate. Putting inaccurate estimates on the financial statements reduces their usefulness. Instead, why not charge the costs later, when the actual environmental cleanup or disposal occurs, at which time the company knows the actual cost?

59. Slide 3-59 Some companies use an alternative treatment for prepaid expenses and unearned revenues. When a company prepays an expense, it debits that amount to an expense account. When a company receives payment for future services, it credits the amount to a revenue account. Alternative Treatment of Prepaid Expenses and Unearned Revenues SO 8 Prepare adjusting entries for the alternative treatment of deferrals. APPENDIX

60. Slide 3-60 Illustration (Insurance): On Dec. 1 st, Phoenix Consulting paid $12,000 for 12 months of insurance coverage. Show the journal entry to record the payment on Dec. 1 st. Cash12,000 Insurance Expense12,000Dec. 1 DebitCredit Insurance Expense 12,00012,000 DebitCredit Cash Alternative Treatment for “Prepaid Expenses” SO 8 Prepare adjusting entries for the alternative treatment of deferrals.

61. Slide 3-61 Illustration (Insurance): On Dec. 1 st, Phoenix Consulting paid $12,000 for 12 months of insurance coverage. Show the adjusting journal entry required at Dec. 31 st. Insurance Expense11,000 Prepaid Insurance11,000Dec. 31 DebitCredit Insurance Expense 12,00011,000 DebitCredit Prepaid Insurance Alternative Treatment for “Prepaid Expenses” 11,000 1,000 SO 8 Prepare adjusting entries for the alternative treatment of deferrals.

62. Slide 3-62 Illustration:On Dec. 1 st, Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. Show the journal entry to record the receipt on Dec. 1 st. Illustration: On Dec. 1 st, Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. Show the journal entry to record the receipt on Dec. 1 st. Rent Revenue24,000 Cash24,000Dec. 1 DebitCredit Cash 24,00024,000 DebitCredit Rent Revenue SO 8 Prepare adjusting entries for the alternative treatment of deferrals. Alternative Treatment for “Unearned Revenues”

63. Slide 3-63 Illustration:On Dec. 1 st, Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. Show the adjusting journal entry required on Dec. 31 st. Illustration: On Dec. 1 st, Phoenix Consulting received $24,000 from Arcadia High School for 3 months rent in advance. Show the adjusting journal entry required on Dec. 31 st. Unearned Rent Revenue16,000 Rent Revenue16,000Dec. 31 DebitCredit Unearned Rent Revenue 16,00024,000 DebitCredit Rent Revenue 16,000 8,000 SO 8 Prepare adjusting entries for the alternative treatment of deferrals. Alternative Treatment for “Unearned Revenues”

64. Slide 3-64 SO 8 Prepare adjusting entries for the alternative treatment of deferrals. Summary of Additional Adjustment Relationships Illustration 3A-7

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