1. Financial and Managerial Accounting
Wild, Shaw, and Chiappetta
Fifth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. 1

2. Adjusting Accounts and Preparing Financial Statements
Chapter 3
Adjusting Accounts and Preparing Financial Statements

3. Conceptual Chapter Objectives
C1: Explain the importance of periodic reporting and the time period assumption.
C2: Explain accrual accounting and how it improves financial statements.
C3: Identify steps in the accounting cycle.
C4: Explain and prepare a classified balance sheet.
3-3

4. Analytical Chapter Objectives
A1: Explain how accounting adjustments link to financial statements.
A2: Compute profit margin and describe its use in analyzing company performance.
A3: Compute the current ratio and describe what it reveals about a company’s financial condition.
3-4

5. Procedural Chapter Objectives
P1: Prepare and explain adjusting entries.
P2: Explain and prepare an adjusted trial balance.
P3: Prepare financial statements from an adjusted trial balance.
P4: Describe and prepare closing entries.
P5: Explain and prepare a post-closing trial balance.
3-5

6. Procedural Chapter Objectives (Continued)
P6: Appendix 3A – Explain the alternatives in accounting for prepaids (see text for details).
P7: Appendix 3B – Prepare a work sheet and explain its usefulness (see text for details).
P8: Appendix 3C – Prepare reversing entries and explain their purpose (see text for details).
3-6

7. The Accounting Period Annually Semiannually Quarterly Monthly 1 2 1 23 4
Quarterly 1 2 3 4 5 6 7 8 9 10 11 12
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Monthly
3-7

8. Accrual Basis vs. Cash Basis
Revenues are recognized when earned and expenses are recognized when incurred.
Cash Basis
Revenues are recognized when cash is received and expenses recorded when cash is paid.
When should we recognize
revenues and expenses?
Not GAAP
3-8

9. Accrual Basis vs. Cash Basis
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.
3-9

10. Accrual Basis vs. 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.
3-10

11. Framework for Adjustments
Adjusting Accounts
C2, P1
An adjusting entry is recorded to bring an asset or liability account balance to its proper amount as well as update any related revenue or expense account.
Framework for Adjustments
Adjustments
Paid (or received) cash before expense (or revenue) recognized
Paid (or received) cash after expense (or revenue) recognized
Prepaid (Deferred) expenses*
Unearned (Deferred) revenues
Accrued expenses
Accrued revenues
*including depreciation
3-11

12. Prepaid (Deferred) Expenses
Here is the check
for my first
24-months’ insurance.
Resources paid for prior to receiving the actual benefits.
Asset
Expense
Unadjusted
Balance
$2,400
Credit
Adjustment
$100
Debit
Adjustment
$100
3-12

13. What adjustment is required?
Supplies P1
During 2013, Scott Company purchased $9,720 of supplies. Scott recorded the expenditures as Supplies. On December 31, a count of the supplies indicated $8,670 on hand.
What adjustment is required?
Dec 31 Supplies Expense , Supplies , (To record supplies used for the year)
126
652
3-13

14. Asset Cost - Salvage Value
Depreciation P1
Depreciation is the process of allocating the costs of plant assets over their expected useful lives.
Straight-Line
Depreciation
Expense =
Asset Cost - Salvage Value
Useful Life
3-14

15. Depreciation P1
On January 1, 2013, Barton, Inc. purchased equipment for $62,000 cash. The equipment has an estimated useful life of five years, and Barton expects to sell the equipment at the end of its life for $2,000 cash.
Let’s record depreciation expense for the year ended December 31, 2013.
2013
Depreciation
expense =
$62, $2,000 5
$12,000
3-15

16. Accumulated depreciation is
On January 1, 2013, Barton, Inc. purchased equipment for $62,000 cash. The equipment has an estimated useful life of five years, and Barton expects to sell the equipment at the end of its life for $2,000 cash.
Let’s record depreciation expense for the year ended December 31, 2013.
Accumulated depreciation is
a contra asset account.
3-16

17. Depreciation P1
Equipment is shown net of accumulated depreciation. This amount is referred to as the asset’s book value. $
3-17

18. Unearned (Deferred) RevenuesP1
Cash received in advance of providing products or services.
Buy your season tickets for
all home basketball games NOW!
“Go Big Blue”
Liability
Revenue
Debit
Adjustment
Unadjusted
Balance
Credit
Adjustment
3-18

19. Unearned (Deferred) RevenuesP1
On October 1, 2013, Ox University sold 1,000 season tickets to its 20 home basketball games for $100 each. Ox University makes the following entry:
Unearned Revenue is a liability account
3-19

20. Unearned (Deferred) RevenuesP1
On December 31, Ox University has played 10 of its regular home games, winning 2 and losing 8.
3-20

21. want to be paid for our work!
Accrued Expenses P1
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.
Expense
Liability
Debit
Adjustment
Credit
Adjustment
3-21

22. Accrued Expenses P1
Barton, Inc. pays its employees every Friday. Year-end, 12/31/13, falls on a Thursday. As of 12/31/13, the employees have earned salaries of $47,250 for Monday through Thursday.
12/1/13
12/31/13
Year-end
Last pay
date
12/25/13
Next pay
Jan 1, 2014
Record adjusting
journal entry.
3-22

23. Accrued Expenses P1
Barton, Inc. pays its employees every Friday. Year-end, 12/31/13, falls on a Thursday. As of 12/31/13, the employees have earned salaries of $47,250 for Monday through Thursday.
3-23

24. Accrued Revenues P1
Smith & Jones, CPAs, had $31,200 of work completed but not yet billed to clients. Let’s make the adjusting entry necessary on December 31, 2013, the end of the firm’s fiscal year.
3-24

25. Links to Financial Statements
3-25

26. First, the initial unadjusted amounts are added to the work sheet.
FastForward – Trial Balance - December 31, 2013 P2
First, the initial unadjusted amounts are added to the work sheet.
3-26

27. FastForward – Recording Adjustments Trial Balance - December 31, 2013P2
FastForward – Recording Adjustments
Trial Balance - December 31, 2013
Next, FastForward’s adjustments are added.
Key each adjustment with a letter. The letter c was used here.
3-27

28. FastForward - Computing the Adjusted Trial Balance - December 31, 2013
The adjusted trial balance combines the unadjusted trial balance account balances with the adjustments we make.
3-28

29. Prepare Income Statement
3-29

30. Prepare Statement of Retained Earnings
Note that net income from the Income Statement carries to the Statement of Retained Earnings.
3-30

31. P3
Prepare Balance Sheet
3-31

32. The Closing Process: Temporary and Permanent Accounts
C3, P4
The Closing Process: Temporary and Permanent Accounts
Temporary (nominal) accounts accumulate data related to one accounting period. They include all income statement accounts, the dividends account, and the Income Summary account. These accounts are “closed” at the end of the period to get ready for the next accounting period.
Permanent (real) accounts report activities related to one or more future accounting periods. They carry ending balances to the next accounting period and are not “closed.”
3-32

33. Recording Closing EntriesP4
Close revenue accounts.
Close expense accounts.
Close income summary account.
Close dividends account.
3-33

34. Examine the accounts presented.
Recording Closing Entries P4
Salaries Expense
Consulting Revenue
18,100
Examine the accounts presented.
25,000
Income Summary
Retained Earnings
7,000
3-34

35. Recording Closing EntriesP4
Salaries Expense
Consulting Revenue
18,100
25,000
$ 25,000
25,000
Income Summary
Close revenues with a debit to each revenue account and a credit to Income Summary for the total.
3-35

36. Recording Closing EntriesP4
Salaries Expense
Consulting Revenue
18,100
18,100
25,000
25,000
Close expense accounts with a credit to each expense account and a debit to Income Summary for the total.
Income Summary
25,000
3-36

37. Determine the balance in the Income Summary account.
Recording Closing Entries P4
Salaries Expense
Consulting Revenue
18,100
18,100
25,000
25,000
Income Summary
Determine the balance in the Income Summary account.
18,100
25,000
6,900
3-37

38. Close the Income Summary to Retained Earnings.
Recording Closing Entries P4
Salaries Expense
Close the Income Summary to Retained Earnings.
18,100
18,100
Income Summary
Retained Earnings
18,100
25,000
7,000
6,900
6,900
3-38

39. The dividends account is closed to Retained Earnings.
Recording Closing Entries P4
The dividends account is closed to Retained Earnings.
Retained Earnings
Dividends
2,000
2,000
7,000
6,900
3-39

40. Determine the ending balance in Retained Earnings.
Recording Closing Entries P4
After closing, the Retained Earnings account will have a new ending balance…
Retained Earnings
2,000
7,000
6,900
Determine the ending balance in Retained Earnings.
11,900
3-40

41. Post-Closing Trial Balance
The trial balance is prepared after the closing entries have been posted.
The purpose is to ensure that all nominal or temporary accounts have been closed.
The only accounts on this trial balance should be assets, liabilities, and equity accounts.
3-41

42. The Accounting Cycle 9. Prepare post-closing trial balance 10. Reverse
Start
10. Reverse
(optional)
1. Analyze transactions
8. Close
2. Journalize
7. Prepare statements
3. Post
4. Prepare unadjusted trial balance
6. Prepare adjusted trial balance
5. Adjust
3-42

43. Classified Balance Sheet
Current items are those expected to come due (either collected or owed) within one year or the company’s operating cycle, whichever is longer.
3-43

44. Classified Balance Sheet
Plant Assets
Tangible assets that are both long-lived and used to produce or sell products or services. Examples include equipment, machinery, buildings, and land that are used to produce or sell products and services.
Intangible Assets
Long-term resources that benefit business operations. They usually lack physical form and have uncertain benefits. Examples include patents, trademarks, copyrights, franchises, and goodwill.
3-44

45. Long-Term LiabilitiesC4
Current Liabilities
Obligations due to be paid or settled within one year or the operating cycle, whichever is longer.
Long-Term Liabilities
Obligations not due within one year or the operating cycle, whichever is longer.
3-45

46. Classified Balance Sheet
3-46

47. Profit Margin A2
The profit margin ratio measures the company’s net income to net sales.
Profit
margin
Net income
Net sales =
3-47

48. Current Ratio A3
This ratio is an important measure of a company’s ability to pay its short-term obligations.
Current
ratio
Current assets
Current liabilities =
3-48

49. End of Chapter 3
3-49