1. Participation Questions Chap. 3 – due 2/8/15
Which publicly traded Company is used as an example in class for the revenue recognition principle?
Apple Computers, JC Penney, Sears, or Walmart
The second example for the revenue recognition principle discusses Calvin actually taking a cruise in which month?
April 2015, November 2014, March 2015, or May 2015
Which depreciation method did we discuss for the $24,000 in Equipment purchased by Eagle Golf Academy, where the depreciation expense equals $1,000 per month if the useful life of the equipment is 24 months?
Straight-line, Double declining balance, or Activity based depreciation
After all of the adjusting entries were completed for Eagle Golf Academy and the Income statement was prepared, was the income for Golf Eagle positive or negative?
Positive or Negative
The example of Eagle Golf Academy showed that companies can pay dividends even when there is a net loss for the month.
True or False

2. Announcements – 2/3/15
Handout for today–Chapter 3 PowerPoints Pg. 76 & Chapter 1- 3 Review PowerPoints pg. 12 (Also, in the Class Materials under Chapter 3 handout).
Assignments –
Due 2/8/15
Chapter 3 Homework (Connect) – unlimited attempts
Participation questions for Chapter 3 (Webcourses) – 1 attempt
Accounting Cycle Project (Connect) – unlimited attempts.
This assignment will take extra time – 2 to 3 hours, plan accordingly.
Due 2/15/15
SEC Financial Statement Project (Webcourses) – 1 attempt
Exam 1 – February CBA Testing Center BA2 room #104
Learn Smart – 5 points Extra Credit for Block 1 ends February 11th at 11:59 PM
Exam Review session during regular class time on 2/5/14 

3. Questions to be Answered
Overall - What is financial reporting’s role in today’s American society?
Chapter 3 – Once we have all of the transactions aggregated, how do we communicate this information to decision-makers?

4. Debit and Credit Effects on Accounts in the Expanded Accounting Equation – Page 56
Permanent Accounts
Temporary Accounts
Remember that accounts on the left side of the accounting equation (assets) increase with debits or the left side of an account. Accounts on the right side of the accounting equation (liabilities and stockholders’ equity) increase with credits or the right side of an account.
We can expand the basic accounting equation to include the components of stockholders’ equity (common stock and retained earnings) and the components of retained earnings (revenues, expenses, and dividends). Because common stock and retained earnings are part of stockholders’ equity, it follows directly that we increase both with a credit.
Revenues increase retained earnings (“there’s more to keep”). Retained earnings is a credit account, so we increase revenues with a credit. Expenses, on the other hand, decrease retained earnings (“there’s less to keep”). Thus, we do the opposite of what we do with revenues: We increase expenses with a debit. A debit to an expense is essentially a debit to retained earnings, decreasing the account. Similarly, dividends decrease retained earnings, so we also record an increase in dividends with a debit.
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5. Clarification on Rev. Recognition & Coupons - Info Only
Revenue recognition principle - Revenue is recognized when a customer obtains control of a good or service. A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service.
The sales incentives that involve only coupons will be recorded as a reduction of revenue at the time of sale

6. The Financial Reporting Process
Chapter 03
The Financial Reporting Process
PART A - Accrual-Basis Accounting
Chapter 3: The Financial Reporting Process
The chapter is divided into 4 parts.
Part A gives a brief overview of accrual-basis accounting.
Part B describes the measurement process.
Part C specifies the reporting process.
Part D throws light on the closing process.
Lets start with Part A.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc.

7. LO1 Revenue and Expense Reporting
Accrual-basis accounting records revenues when earned (the revenue recognition principle) and expenses with related revenues (the matching principle).
Net income is an essential aspect of good investment decisions. Proper computation of net income requires considerable attention to be paid to the proper measurement of the two primary components of net income – revenues and expenses.
If accounting information is to be useful in making decisions, accountants must measure and report revenues and expenses in a way that clearly reflects the ability of the company to create value for its owners, the stockholders.
To do this, we use accrual-basis accounting, where we record revenues when we earn them (the revenue recognition principle) and expenses with related revenues (the matching principle).
We discuss these principles next.

8. Revenue Recognition Principle
When to record
After revenue is earned:
When good or service has been delivered to customer
Amount to record
Cash value of goods or services transferred to customer
The revenue principle deals with two issues:
1. When to record revenue (make a journal entry)
2. The amount of revenue to record
When should you record revenue? After it has been earned—and not before. In most cases, revenue is earned when the business has delivered a good or service to a customer. It has done everything required to earn the revenue by transferring the good or service to the customer. The amount of revenue to record is the cash value of the goods or services transferred to the customer.
Copyright ©2010 Pearson Education Inc. Publishing as Prentice Hall. 8 8

9. Walmart
Statement of Income

10. Walmart – Revenue Recognition
Sales
Walmart recognizes sales revenue, net of sales taxes and estimated sales returns, at the time it sells merchandise to the customer.
Membership Fee Revenue
Walmart recognizes membership fee revenue both in the United States and internationally over the term of the membership, which is typically 12 months.
Membership fee revenue is included in membership and other income in Walmart's Consolidated Statements of Income. The deferred membership fee is included in accrued liabilities in Walmart's Consolidated Balance Sheets.
Shopping Cards
Customer purchases of shopping cards are not recognized as revenue until the card is redeemed and the customer purchases merchandise using the shopping card
Depreciation allocates the cost of a plant asset to expense over the asset’s useful life. Depreciation is the most common long-term deferral. Many businesses buildings and equipment. As a company uses the assets, it records depreciation for wear-and-tear and obsolescence. The accounting adjustment records Depreciation expense and decreases the asset’s book value over its life. The process is identical to a deferral-type adjustment; the only difference is the type of asset involved. Plant assets are long-lived tangible assets, such as land, buildings, furniture, and equipment. All plant assets but land decline in usefulness, and this decline is an expense. Accountants spread the cost of each plant asset, except land, over its useful life. Depreciation is the process of allocating cost to expense for a long-term plant asset.

11. Revenue Recognition Principle
Recognize revenue when it is earned
Calvin books a cruise with Carnival Cruise Lines, the world’s largest cruise line. He makes reservations and pays for the cruise in November 2014, but the cruise is not scheduled to sail until April 2015.
When does Carnival report revenue from the ticket sale?
The revenue recognition principle states that we should recognize revenue in the period in which we earn it, not necessarily in the period in which we receive cash.
This principle is explained with an example.
Calvin books a cruise with Carnival Cruise Lines, the world’s largest cruise line. He makes reservations and pays for the cruise in November 2012, but the cruise is not scheduled to sail until April 2013.
When does Carnival report revenue from the ticket sale?

12. Revenue Recognition Principle
In November 2014???
No.
Because it has not substantially fulfilled its obligation to Calvin.
In April 2015???
Yes.
Because it is in April 2015 that the cruise occurs.
You may think that the revenue should be recognized in November 2012 since the cash from the sale of tickets is received then. But that is not true.
Carnival cannot recognize revenue in November 2012 as it has not substantially fulfilled its obligation to Calvin.
It can recognize revenue only in April 2013, because it is in April 2013 that the cruise occurs.
Thus it is evident that when the cash is received in advance of services, revenue should be recognized on the date of performance of service rather than the date of receipt of cash.
Now arises the question, when should the revenue be recognized when the services are performed first and the cash is received sometime in the future?
Lets look at an example.

13. Revenue Recognition Principle
Suppose that, anticipating the cruise, Calvin buys a Jimmy Buffet CD from Best Buy. Rather than paying cash, Calvin uses his Best Buy card to buy the CD on account. When does Best Buy recognize revenue?
Suppose that, anticipating the cruise, Calvin buys a Jimmy Buffet CD from Best Buy.
Rather than paying cash, Calvin uses his Best Buy card to buy the CD on account.
When does Best Buy recognize revenue?
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14. Revenue Recognition Principle
Even though Best Buy doesn’t receive cash
immediately from Calvin, it still records the
revenue at the time it sells the CD.
Best Buy records the revenue at the time it sells the CD, even though Best Buy doesn’t receive cash immediately from Calvin.
Thus irrespective of when the cash is received, revenue should be recognized when the sale takes place or the services are performed.
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15. Matching Principle
Recognize expenses in the same period as the revenue they help generate.
There is a cause-and-effect relationship between revenue and expense recognition implicit in this principle.
In a given period, we report revenue as it’s earned, according to the revenue recognition principle. It’s logical, then, that in the same period we should also record all expenses incurred to generate that revenue.
The result is a measure – net income – that matches current period accomplishments (revenues) and sacrifices (expenses).
That’s the matching principle.
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16. Matching Principle Identify expenses incurred Measure the expenses
Match against revenues earned
The matching principle is the basis for recording expenses. Expenses are the costs of assets used up, and of liabilities created, in the earning of revenue. Expenses have no future benefit to the company. The matching principle includes two steps:
1. Identify all the expenses incurred during the accounting period.
2. Measure the expenses, and match expenses against the revenues earned.
To match expenses against revenues means to subtract expenses from revenues to compute net income or net loss.
Prepaid Insurance. Depreciation. Salary Expense. Prepaid rent. Supplies
Copyright ©2010 Pearson Education Inc. Publishing as Prentice Hall. 16 16

17. Considering the previous example about Carnival Cruise Lines, the cost of generating revenue in April (ship supplies, the fuel used, and crew members’ salaries) should be expensed in April even though the cash flows occur in March, April, and May.
The matching principle states that we recognize expenses in the same period as the revenues they help to generate. Expenses include those directly and indirectly related to producing revenues.

18. LO2 Accrual–Basis Compared with Cash–Basis Accounting
There are no receivables or payables in the cash basis of accounting.
Under accrual-basis accounting, we record revenue and expense transactions at the time the earnings-related activities occur.
Under cash-basis accounting, we record revenues at the time we receive cash and expenses at the time we pay cash.
Cash Basis accounting is not a part of GAAP.
Cash-basis accounting is not allowed for financial-reporting purposes.

19. Special Bonus Material
What is an extroverted accountant like?
He’ll look at your shoes while talking to you instead of his own.
Two accountants are in a bank when armed robbers burst in. While several of the robbers take the money from the tellers, others line the customers up against a wall and proceed to take their wallets, watches, and other valuables. In the midst of the chaos, accountant No. 1 jams something in accountant No. 2’s hand. Without looking down, accountant No. 2 whispers, "What is this?" to which accountant number one replies, "It's that $50 I owe you."
Chapter 3: The Financial Reporting Process
The chapter is divided into 4 parts.
Part A gives a brief overview of accrual-basis accounting.
Part B describes the measurement process.
Part C specifies the reporting process.
Part D throws light on the closing process.
Lets start with Part A.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc.

20. The Measurement Process
Part B
The Measurement Process
Part B: Describes the measurement process.

21. LO3 Adjusting Entries Closing Process Reporting Process
The accounting cycle starts with recording of external transactions. We discussed external transactions in chapter 2. In this chapter, we complete the accounting cycle by recording adjusting entries (internal transactions), preparing financial statements, and recording closing entries.
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22. External Transactions of Eagle Golf Academy – Page 43
The best way to understand the impact of a transaction on the accounting equation is to see it demonstrated by a few examples. Let’s return to the Eagle Golf Academy from Chapter 1.
The illustration in the slide summarizes the first five external transactions for Eagle in January, the first month of operations.
Note that business activities usually occur in this same order for a new company—obtain external financing, use those funds to invest in long-term productive assets, and then begin normal operations. We have discussed these business activities in Chapter 1.
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23. Unadjusted Trial Balance of Eagle Golf Academy
Notice that accounts are listed with the debit balances in one column and the credit balances in another column. Asset, expense, and dividend accounts normally have debit balances, while liability, stockholders’ equity, and revenue accounts normally have credit balances.
It may seem unusual that the retained earnings account has a balance of $0. As we explained earlier, retained earnings is a composite of three other types of accounts—revenues, expenses, and dividends. Those three accounts have balances at this point, but those balances haven’t yet been transferred to retained earnings. This transfer is known as the closing process and we will discuss it in Chapter 3. Since this is the first period of the company’s operations, retained earnings will start at $0. As time goes by, the retained earnings balance will be the accumulated net amount of revenues minus expenses and dividends.
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24. Purpose of Adjusting Entries
To record events that have occurred but we have not yet recorded.
To record revenues in the period earned.
To record expenses in the period they are incurred in the generation of those revenues.
Financial statements issued at end of period
Several accounts on unadjusted trial balance need to be brought up-to-date
Adjusting entries are a necessary part of accrual-basis accounting.
We use adjusting entries to record events that have occurred but which have not been recorded.
They help to record revenues in the period earned and expenses in the period they are incurred in the generation of those revenues. Another benefit is that by properly recording revenues and expenses, we correctly state assets and liabilities.
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25. Adjusting Entries - Classifications
Prepayments:
Prepaid expenses – we paid cash (or had an obligation to pay cash) for the purchase of an asset before we incurred the expense.
Depreciation - The process of allocating the cost of plant assets to expense over estimated useful lives
Unearned revenues – we received cash and recorded a liability before we earned the revenue.
Accruals:
Accrued expenses – we paid cash after we incurred the expense and recorded a liability.
Accrued revenues – we received cash after we earned the revenue and recorded an asset.
It is useful to group adjusting entries into the following four categories:
Prepayments:
Prepaid expenses—we paid cash (or had an obligation to pay cash) for the purchase of an asset before we incurred the expense.
Unearned revenues—we received cash and recorded a liability before we earned the revenue.
Accruals:
Accrued expenses—we paid cash after we incurred the expense and recorded a liability.
Accrued revenues—we received cash after we earned the revenue and recorded an asset.
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26. Prepayments - Prepaid Expenses
Costs of assets acquired in one period that will be expensed in a future period.
Business has paid cash first before the asset was used to generate revenue
Examples: Purchase of equipment or supplies, payment of rent in advance, payment of insurance in advance.
Adjusting Entry:
Debit expense account (increase an expense)
Credit asset account (decrease an asset)
Prepaid expenses are costs of assets acquired in one period that will be expensed in a future period. Few examples are Purchase of equipment or supplies, Payment of rent in advance, Payment of insurance in advance.
The adjusting entry for a prepaid expense always includes a debit to an expense account (increase an expense) and a credit to an asset account (decrease an asset).
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27. Prepaid Expenses - Future Benefit
Recorded as assets when purchased
JOURNAL
Date
Accounts and explanation
Debit
Credit
Jan 1
Prepaid rent
6,000
Cash
Jan 6
Supplies
2,300
Prepaid expense is an expense paid in advance. Therefore, prepaid expenses are assets because they provide a future benefit for the owner. Over time, these benefits expire or are used. Examples include prepaid rent and supplies. When these items are purchased, an asset is recorded. The adjustment records an expense for the used portion and decreases the asset. Let’s say a company paid for one year’s rent in advance ($1,000 per month) on June 1. Then, on August 3 purchased $3,500 of supplies. At the time of these purchases, assets are recorded.

28. Example: Prepaid Rent $6,000 Cash paid for prepaid rent Jan. 1 $5,500
Remaining prepaid rent
Jan. 31
Prepaid rent expires
$500
Adjusting
entry
The balance in prepaid rent account on Jan.1 is $6,000. The rent expense for the month of January is $500. As such the balance in prepaid rent account is reduced to $5,500 on Jan. 31.
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29. Supplies used during January
Example: Supplies
$2,300
Cash paid for Supplies
Jan. 6
$1,100
Supplies On-hand
Jan. 31
Supplies used during January
$1,200
Adjusting
entry
The balance in prepaid rent account on Jan.1 is $6,000. The rent expense for the month of January is $500. As such the balance in prepaid rent account is reduced to $5,500 on Jan. 31.
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30. Prepaid Expenses - Benefit Received
Expensed when expired or used
JOURNAL
Date
Accounts and explanation
Debit
Credit
Jan 31
Rent expense
500
Prepaid rent
Supplies expense
1,200
Supplies
Over time, the benefits of a prepaid expense expire and the supplies are used. The adjustment records an expense for the used portion and decreases the asset. For the rent, seven months have expired. Rent expense is recorded for the portion of the rent that has expired. Prepaid rent is reduced by the same amount. For the supplies, only $600 of supplies remain at the end of the year. This means $2,900 were used. Supplies expense is recorded for this amount and the asset account is reduced.
MATCHING PRINCIPLE

31. Prepaid Rent Prepaid rent Rent expense $6,000 $500 $500 $5,500 Jan 1
Amount remaining
Amount expired
Balance Sheet
Income Statement
The T-accounts for Prepaid rent and Rent expense show how the purchased and adjustment of the accounts impacts the financial statements.

32. Supplies Supplies Supplies expense $2,300 $1,200 $1,200 $1,100 Jan 31
Amount on hand
Amount used
Balance Sheet
Income Statement
The T-accounts for Supplies and Supplies expense show how the purchased and adjustment of the accounts impacts the financial statements.

33. Prepayments - Depreciation Expense
As the Asset is used, the cost is transferred to Depreciation Expense – Matching principle
Examples of plant assets:
Buildings, Equipment, Furniture
Depreciation allocates the cost of a plant asset to expense over the asset’s useful life. Depreciation is the most common long-term deferral. Many businesses buildings and equipment. As a company uses the assets, it records depreciation for wear-and-tear and obsolescence. The accounting adjustment records Depreciation expense and decreases the asset’s book value over its life. The process is identical to a deferral-type adjustment; the only difference is the type of asset involved. Plant assets are long-lived tangible assets, such as land, buildings, furniture, and equipment. All plant assets but land decline in usefulness, and this decline is an expense. Accountants spread the cost of each plant asset, except land, over its useful life. Depreciation is the process of allocating cost to expense for a long-term plant asset.

34. Accumulated Depreciation
Sum of all depreciation expense
Increases over plant asset’s life
Contra-asset
Normal credit balance
Always has a companion account
Normal balance is opposite the companion account
Book value
Cost of plant asset less accumulated depreciation
Accumulated depreciation account shows the sum of all depreciation expense from using the asset. Therefore, the balance in the Accumulated depreciation account increases over the asset’s life. Accumulated depreciation is a contra asset account—an asset account with a normal credit balance. A contra account has two distinguishing characteristics:
1. It always has a companion account.
2. Its normal balance is opposite that of the companion account.

35. Apartment Investment & Management (AIV)

36. AIV – Income Statement

37. Depreciation – Equipment has a useful life of 24 months – Straight-line Depreciation
JOURNAL
Date
Accounts and explanation
Debit
Credit
Jan 1
Equipment
24,000
Cash
Jan 31
Depreciation expense
1,000
Accumulated depreciation
To illustrate depreciation, let’s say a company purchased equipment with cash on January 2, 2010 for $50,000. Management estimated the equipment would last five years. At the end of the year, one-fifth of the asset should be depreciated. The entry to record depreciation includes a debit the Depreciation expense and a credit to an account called Accumulated depreciation.

38. Depreciation – Straight Line
Equipment
Depreciation Expense
Jan 31
$1,000
Jan 1
$24,000
Balance Sheet
Income Statement
Accumulated Depreciation
$1,000
Jan 31
The T-accounts for Equipment, Accumulated Depreciation and Depreciation Expense show the impact of the journal entries. Notice the Equipment account is not affected by the adjusting entry.

39. Book Value Balance Sheet January 31, 2012 Equipment $24,000
Less: Accumulated Depreciation
(1,000)
Book value
$23,000
On the balance sheet, plant assets are shown at their book value – the cost of the asset minus the accumulated depreciation.

40. Prepayments - Unearned Revenues
Received cash first from customer before revenue is earned.
Once a company has provided products or services, they can record revenue earned and reduce the obligation to the customer. Recorded as a liability when payment is received
Adjusting entry:
Debit liability account (decrease a liability)
Credit revenue account (increase a revenue)
Unearned revenues occur when a company receives cash in advance from a customer for products or services to be provided in the future.
The adjusting entry for an unearned revenue always includes a debit to a liability account (decrease a liability) and a credit to a revenue account (increase a revenue).
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41. Southwest Airlines Revenue recognition
Tickets sold for Passenger air travel are initially deferred as Air traffic liability. Passenger revenue is recognized and Air traffic liability is reduced when the service is provided (i.e., when the flight takes place). Air traffic liability primarily represents tickets sold for future travel dates and estimated future refunds and exchanges of tickets sold for past travel dates. The balance in Air traffic liability, which includes a portion of the Company’s liability associated with its frequent flyer program, fluctuates throughout the year based on seasonal travel patterns, fare sale activity, and activity associated with the Company’s frequent flyer programs.

42. Unearned Revenue - Cash Received for 10 golf lessons
Receive cash before revenue is earned
Creates a liability
Business owes customer a good or service
Business has to repay cash received from customer if good/service not delivered
JOURNAL
Date
Accounts and explanation
Debit
Credit
Jan 23
Cash
600
Unearned revenue
Some businesses collect cash from customers before earning the revenue. This creates a liability called unearned revenue. Only when the job is completed does the business earn the revenue. For example, suppose an attorney requires her clients to pay in advance before starting work on their cases (often called a retainer). On December 1, a client pays a $1,000 retainer to the attorney. This would create a liability – unearned revenue.
ATTORNEY
KHSS

43. Example: Unearned Training Revenue$?
Unearned revenue remains
Jan. 31
$600
Cash received in advance
Jan. 26
Adjusting
entry
Services provided
2 Lessons
$600 is received in advance from customers who will be given services (that is golf training in this case) in the future.
Service worth $60 is provided to the customers during the month.
Unearned training revenue equals $540 as of Jan. 31.
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44. Unearned Revenue - Good/Service Delivered – (2 golf lessons taken)
When revenue is earned (i.e. good/service delivered)
Liability for unearned revenue is reduced
Revenue is increased
JOURNAL
Date
Accounts and explanation
Debit
Credit
Jan 31
Unearned Revenue
120
Service Revenue
By December 31, the attorney has completed half the work on the client’s case. The adjusting entry would reduce the liability – unearned revenue- and increase revenue. Unearned revenue would now have a balance of $500 representing the remaining half of work that needs to be completed.

45. Adjusting Entries - Classifications
Prepayments:
Prepaid expenses – we paid cash (or had an obligation to pay cash) for the purchase of an asset before we incurred the expense.
Depreciation - The process of allocating the cost of plant assets to expense over estimated useful lives
Unearned revenues – we received cash and recorded a liability before we earned the revenue.
Accruals:
Accrued expenses – we paid cash after we incurred the expense and recorded a liability.
Accrued revenues – we received cash after we earned the revenue and recorded an asset.
It is useful to group adjusting entries into the following four categories:
Prepayments:
Prepaid expenses—we paid cash (or had an obligation to pay cash) for the purchase of an asset before we incurred the expense.
Unearned revenues—we received cash and recorded a liability before we earned the revenue.
Accruals:
Accrued expenses—we paid cash after we incurred the expense and recorded a liability.
Accrued revenues—we received cash after we earned the revenue and recorded an asset.
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46. Accrued Expenses Record before paying cash
When a company has incurred an expense but hasn’t yet paid cash or recorded an obligation to pay, it still should record the expense.
Examples: Accrued salaries, accrued interest.
Adjusting entry:
Debit expense account (increase an expense)
Credit liability account (increase a liability)
When a company has incurred an expense but hasn’t yet paid cash or recorded an obligation to pay, it still should record the expense. This is referred to as an accrued expense. A few examples are accrued salaries, accrued interest, accrued utility costs.
The adjusting entry for an accrued expense always includes a debit to an expense account (increase an expense) and a credit to a liability account (increase a liability).
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47. Accrued Salaries $2,800 weekly salaries $1,120 $1,680 1-29 Monday 1-30
Tuesday
1-31
Wednesday
2-1
Thursday
2-2
Friday
JOURNAL
Date
Accounts and explanation
Debit
Credit
Jan 31
Salaries expense
1,680
Salaries payable
Consider a company that pays its employees each Friday (weekly). Salaries for the week are $15,000. For the year ending 2010, December 31 falls on a Tuesday – two/fifths of the way through the work week. For the adjusting entry, the portion of the salaries expense incurred before the year end is recorded. The credit is to salaries payable. This will increase expenses on the Income Statement and increase liabilities on the Balance Sheet.

48. Example: Accrued Interest Costs
$100
Interest owed
Jan. 31
$100
Cash paid
for Interest
Feb 15
Jan. 1
Interest $100
Adjusting
entry
Bank Loan $10,000
The utilities expense owed on Jan. 31 will be paid on Feb.6. However, the accrued utilities expense should be recorded in the books while preparing the financial statements for the month of January.
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49. Interest Calculation – Pg 90
An adjusting entry will be recorded on Jan. 31 debiting accounts receivable and crediting training revenue.
The adjusting entry would result in an increase in assets, accounts receivable, and in revenues and stockholders’ equity.
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50. Example: Accrued Interest Costs
JOURNAL
Date
Accounts and explanation
Debit
Credit
Jan 31
Interest Expense
100
Interest Payable
An adjusting entry is recorded on Jan. 31 debiting the utilities expense and crediting utilities payable account.
The adjusting entry increases liability ( utilities payable) by $960. It also increases expenses by $960. As a result there will be decrease in net income and stockholders equity by $960.
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51. Accrued Revenues
When a company has earned revenue but hasn’t yet received cash or recorded an amount receivable, it still should record the revenue. This is referred to as an accrued revenue.
Examples: Interest receivable,
Adjusting entry:
Debit asset account (increase an asset)
Credit revenue account (increase a revenue)
When a company has earned revenue but hasn’t yet received cash or recorded an amount receivable, it still should record the revenue. This is referred to as an accrued revenue. A few examples include interest receivable, accounts receivable.
The adjusting entry for an accrued revenue always includes a debit to an asset account (increase an asset) and a credit to a revenue account (increase a revenue).
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52. Summary of the Adjusting Process
Two purposes of adjusting process
Measure income (Revenues and Expenses)
Update balance sheet
Every adjusting entry affects at least one:
Revenue or expense
Asset or liability
Two purposes of the adjusting process are to (1) measure income, and (2) update the balance sheet. Therefore, every adjusting entry affects at least one Revenue or expense—to measure income, and one Asset or liability—to update the balance sheet.

53. Prepaids and Accruals -
PREPAIDS –CASH FIRST
FIRST
LATER
Prepaid expenses
Prepaid expense
Expense
Cash
Unearned revenues
Unearned revenue
Revenue
ACCRUALS – CASH LATER
Accrued expenses
Payable
Accrued revenues
Receivable
This table diagrams the distinctive timing of prepaids and accruals. With prepaids the cash comes first. Then an adjusting entry is needed to update the accounts. Accruals start with an adjusting entry. Then, the cash transaction comes later.

54. Summary of Adjusting Entries
Recording the Adjustment
Category of Adjustment
Debit
Credit
Prepaid expense
Expense
Asset
Depreciation
Contra asset
Accrued expense
Liability
Accrued revenue
Revenue
Unearned revenue
Each category of adjustment has its own pattern. Notice that each involves a balance sheet account and an income statement account .

55. Unadjusted Trial Balance of Eagle Golf Academy
Notice that accounts are listed with the debit balances in one column and the credit balances in another column. Asset, expense, and dividend accounts normally have debit balances, while liability, stockholders’ equity, and revenue accounts normally have credit balances.
It may seem unusual that the retained earnings account has a balance of $0. As we explained earlier, retained earnings is a composite of three other types of accounts—revenues, expenses, and dividends. Those three accounts have balances at this point, but those balances haven’t yet been transferred to retained earnings. This transfer is known as the closing process and we will discuss it in Chapter 3. Since this is the first period of the company’s operations, retained earnings will start at $0. As time goes by, the retained earnings balance will be the accumulated net amount of revenues minus expenses and dividends.
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56. LO4 Post Adjusting Entries
Post adjusting entries to the T-accounts in the general ledger to update the account balances.
Prepare an adjusted trial balance.
An adjusted trial balance is a list of all accounts and their balances after we have updated account balances for adjusting entries.
To complete the measurement process, we need to update balances of assets, liabilities, revenues, and expenses for adjusting entries.
An adjusted trial balance is then prepared with updated balances. An adjusted trial balance is a list of all accounts and their balances at a particular date after we have updated account balances for adjusting entries.
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58. LO5 Financial Statements
Once the adjusted trial balance is complete, we prepare financial statements.
Revenue and expense accounts are reported in the income statement. The difference between total revenues and total expenses equals net income.
All asset, liability, and stockholders’ equity accounts are reported in the balance sheet which confirms the equality of the basic accounting equation.
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59. Part C
The Reporting Process
Part C: Specifies the reporting process.

60. LO5 Financial Statements
Once the adjusted trial balance is complete, we prepare financial statements.
Revenue and expense accounts are reported in the income statement. The difference between total revenues and total expenses equals net income.
All asset, liability, and stockholders’ equity accounts are reported in the balance sheet which confirms the equality of the basic accounting equation.
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61. Income Statement
The income statement demonstrates that Eagle Golf Academy earned a profit of $500 in the month of January. The revenues earned from providing service to customers exceed the costs of providing that service.
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62. Statement of Stockholders’ Equity
The statement of stockholders’ equity summarizes the changes in each stockholders’ equity account as well as in total stockholders’ equity and the accounting value of the company to stockholders (owners). It also reflects the retained earnings of the company.
Retained earnings has three components: revenues, expenses, and dividends. In the adjusted trial balance, the balance of the retained earnings account equals its balance before all revenue, expense, and dividend transactions, which is the balance of retained earnings at the beginning of the accounting period. For Eagle Golf Academy, the beginning balance of retained earnings equals $0 since this is the first month of operations.
Total stockholders’ equity increases from $0 at the beginning of January to $25,300 by the end of January. The increase occurs as a result of a $25,000 investment by the owners (stockholders) when they bought common stock plus an increase of $300 when the company earned a profit of $500 on behalf of its stockholders and after distributing $200 of dividends, retained $300 in the business.
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63. Classifying Assets & Liabilities
Classified as current or long-term term based on liquidity (assets) or order of liquidation (liabilities)
How quickly an item can be converted to cash (assets) or liquidated using cash (liabilities)
Cash
Most liquid
Accounts receivable
Very liquid
Inventory
Somewhat liquid
Plant assets
Not liquid
On the balance sheet, assets and liabilities are classified as current or long term to indicate their relative liquidity. Liquidity measures how quickly an item can be converted to cash. Cash is the most liquid asset. Accounts receivable are relatively liquid because cash collections usually follow quickly. Inventory is less liquid than accounts receivable because the company must first sell the goods. Equipment and buildings are even less liquid because these assets are held for use and not for sale. A balance sheet lists assets and liabilities in the order of relative liquidity.
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64. Long-term liabilities
Converted to cash, sold or consumed in the next year
Current assets
Held for longer than one year
Includes plant assets
Long-term assets
Must be paid within one year
Current liabilities
Due date more than one year from balance sheet date
Long-term liabilities
Current assets are the most liquid assets. They will be converted to cash, sold, or consumed during the next 12 months or within the business’s normal operating cycle if longer than a year. The operating cycle is the time span during which cash is paid for goods and services and these goods and services are sold to bring in cash. For most businesses, the operating cycle is a few months. Cash, Short-term investments, Accounts receivable, Merchandise inventory, and Prepaid expenses are the current assets.
Long-term assets are all assets not classified as current assets. One category of long-term assets is plant assets, often labeled Property, plant, and equipment or Fixed assets. Land, Buildings, Furniture and fixtures, and Equipment are plant assets. Long-term investments, Intangible assets, and Other assets (a catchall category for assets that are not classified more precisely) are also long-term.
Current liabilities are debts that must be paid within 1 year or within the entity’s operating cycle if longer than a year. Accounts payable, Notes payable due within 1 year, Salary payable, Unearned revenue, Interest payable, and Income tax payable are current liabilities. Bankers and other lenders are interested in the due dates of an entity’s liabilities. The sooner a liability must be paid, the more pressure it creates. Therefore, the balance sheet lists liabilities in the order in which they must be paid.
All liabilities that are not current are classified as long-term liabilities. Many notes payable are long term. Some notes payable are paid in installments, with the first installment due within 1 year, the second installment due the second year, and so on. The first installment is a current liability and the remainder is long term.
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65. Classified Balance Sheet
Categorizes and subtotals assets and liabilities by current and long-term
Assets
Liabilities
Current assets
Current liabilities
Long-term investments
Long-term liabilities
Property, plant and equipment
Other assets
A classified balance sheet separates current assets from long-term assets and current liabilities from long-term liabilities.
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66. Classified Balance SheetSheet January 31
EAGLE GOLF ACADEMY
Classified Balance
Assets
Liabilities
Current assets:
Current liabilities:
Cash
$6,200
Accounts payable
$2,300
Accounts receivable
2,700
Unearned revenue
480
Supplies
1,100
Salaries payable
1680
Prepaid rent
5,500
Utilities payable
960
Total current assets
15,500
Interest payable
100
Total current liabilities
$5,520
Long-term assets:
Equipment
24,000
Long-term liabilities:
Less: Accum. depr., equip.
(1,000)
Notes payable
10,000
Total long-term assets
23,000
Total liabilities
$15,520
Stockholders’ Equity
Common stock
25,000
Retained earnings
(2,020)
Total stockholders’ equity
$22,980
Total assets
$38,500
Total liabilities and stockholders’ equity
The balance sheet includes all asset, liability, and permanent stockholders’ equity accounts. We can separate assets into those that provide a benefit over the next year (current assets) and those that provide a benefit for more than one year (long-term assets). Similarly, we can divide liabilities into those due over the next year (current liabilities) and those due in more than one year (long-term liabilities).
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67. Part D The Closing Process
Part D: Throws light on the closing process.

68. LO6 Closing Entries Prepares the accounts for next period
Temporary accounts are set to zero and closed into Retained earnings
Increase the retained earnings account by the amount of revenues and decrease retained earnings by the amount of expenses and dividends.
Does not affect the balances of permanent accounts other than retained earnings.
The closing process will have the following effects:
1) Transfer of balance of all revenue, expense, and dividend accounts to the balance of retained earnings.
2) Increase in retained earnings account by the amount of revenues and decrease in retained earnings by the amount of expenses and dividends.
3) The balance of each revenue, expense, and dividend account will be reduced to zero.
4) Closing entries do not affect the balances of permanent accounts other than retained earnings.

69. Closing Entries (Zero out temporary accounts)
Close Revenues
Debit each revenue account
Credit Retained earnings
Close Expenses
Debit Retained earnings
Credit each expense account
Close Dividends
Credit Dividends
Closing entries transfer the revenue, expense, and dividends balances to Retained Earnings. Here are the steps to close the books of a company:
Debit each revenue account for the amount of its credit balance. Credit Retained earnings for the sum of the revenues. Now the sum of the revenues is in Retained earnings.
Credit each expense account for the amount of its debit balance. Debit Retained earnings for the sum of the expenses. The sum of the expenses is now in Retained earnings.
3) Credit the Dividends account for the amount of its debit balance. Debit Retained earnings. This entry places the dividends amount in the debit side of Retained earnings. Remember that dividends are not expenses. Dividends never affect net income.
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70. Accounts and explanation Debit Credit Sales revenue 6,420
JOURNAL
Date
Accounts and explanation
Debit
Credit
Sales revenue
6,420
Retained earnings
8,240
Supplies Expense
1,200
Rent expense
500
Depreciation expense
1,000
Salaries expense
4,480
Utilities expense
960
Interest expense
100
Problem 3-75A requires the preparation of closing entries. The first closing entry is to zero out revenue accounts. This company only has one revenue account – Sales revenue. It should be debited for its balance. Retained earnings is credited. The second entry is to close all expense accounts. Each expense account is credited for its balance. Retained earnings is debited for the total.
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71. Accounts and explanation Debit Credit Retained earnings 200 Dividends
JOURNAL
Date
Accounts and explanation
Debit
Credit
Retained earnings
200
Dividends
In Problem 3-75A, the last closing entry is to zero out Dividends. Retained earnings is debited and Dividends is credited for its balance.
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72. Close to Retained Earnings
The ending balance of retained earnings now includes all transactions affecting the components of the account. The ending balance of $300 represents all revenues and expenses over the life of the company (just the first month of operations in this example) less dividends.
The ending balance of retained earnings in January will be its beginning balance in February. Then we’ll close February’s revenues, expenses, and dividends to retained earnings, and this cycle will continue each period
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73. LO7 Post–Closing Trial Balance (Information Purposes Only)
The first and foremost step in closing process is to post, closing entries that transfer the balances of all temporary accounts (revenues, expenses, and dividends) to the balance of the retained earnings account. After we post the closing entries to the ledger accounts, we can prepare a post-closing trial balance.
The post-closing trial balance is a list of all accounts and their balances at a particular date after we have updated account balances for closing entries.
Notice that the post-closing trial balance does not include any revenues, expenses, or dividends, because these accounts all have zero balances after closing entries. The balance of retained earnings has been updated from the adjusted trial balance to include all revenues, expenses, and dividends for the period.
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75. Statement of Retained Earnings Balance Sheet Statement of Cash Flows
Income Statement
Statement of Retained Earnings
Balance Sheet
Statement of Cash Flows
Accounting Equation: Assets = Liabilities + Owners Equity
GAAP (Rules) formulated by FASB
Principles
Revenue Recognition
Matching Principle
Entity – any organization stand apart as a separate economic unit.
HC – assets should be recorded at cost.
Cannot count revenue twice for two entities – even if it is a subsidiary that sells to the parent company.
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