1. ©2009 The McGraw-Hill Companies, Inc. Chapter 3 The Financial Reporting Process

2. ©2009 The McGraw-Hill Companies, Inc. Part A Accrual-Basis Accounting

3. 3-3 LO1 Revenue and Expense Reporting  Accounting information – necessary for decision making.  To be useful in decision making – accountants must report revenues and expenses in a way that reflects the ability of the company to create value for its owners.  Accrual-basis accounting records revenues when earned (the revenue recognition principle) and expenses with related revenues (the matching principle).

4. 3-4 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 2010, but the cruise is not scheduled to sail until April 2011. When does Carnival report revenue from the ticket sale?

5. 3-5 Revenue Recognition Principle In November 2010??? No. Because it has not substantially fulfilled its obligation to Calvin. In April 2011??? Yes. Because it is in April 2011 that the cruise occurs.

6. 3-6 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?

7. 3-7 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.

8. 3-8 Matching Principle

9. 3-9

10. 3-10 LO2 Accrual–Basis Compared with Cash–Basis Accounting

11. 3-11 Accrual–Basis Compared with Cash– Basis Accounting Recognize Revenue? Accrual- Cash- Basis May Company provides services to customers on account. YesNo June Company receives cash from customers for services provided NoYes in May.

12. 3-12 Accrual–Basis Compared with Cash– Basis Accounting Recognize Expense? Accrual- Cash- BasisBasis May Company purchases supplies on account Yes No and uses them. June Company pays cash No Yes for supplies purchased in May.

13. ©2009 The McGraw-Hill Companies, Inc. Part B The Measurement Process

14. 3-14 Closing Process LO3 Adjusting Entries Reporting Process

15. 3-15 Purpose of Adjusting Entries  To record events that have occurred but which have not been recorded.  To record revenues in the period earned.  To record expenses in the period they are incurred in the generation of those revenues.  To correctly state assets and liabilities in the balance sheet.

16. 3-16 Grouping Adjusting Entries 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.

17. 3-17 Prepaid Expenses Costs of assets acquired in one period that will be expensed in a future period. Examples: Purchase of supplies, payment of rent in advance, payment of insurance in advance. Adjusting Entry: Debit expense account Credit asset account

18. 3-18 Example: Prepaid Rent Prepaid rent expires $500 Adjusting entry $5,500 Remaining prepaid rent Jan. 31 $6,000 Cash paid for prepaid rent Jan. 1

19. 3-19 Example: Prepaid Rent

20. 3-20 Unearned Revenues Company receives cash in advance from a customer for products or services to be provided in the future. Adjusting entry: Debit liability account Credit revenue account

21. 3-21 Example: Unearned Training Revenue Adjusting entry $540 Unearned revenue remains Jan. 31 $600 Cash received in advance Jan. 26 Services provided $60

22. 3-22 Example: Prepaid Rent

23. 3-23 Accrued Expenses 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, accrued utility costs. Adjusting entry: Debit expense account Credit liability account

24. 3-24 Example: Accrued Utility Costs At the end of January, Woods receives a utility bill for $960 associated with operations in January. Woods plans to pay the bill on February 6. Even though it won’t pay the cash until February, Woods must record the utility costs for January as an expense in January.

25. 3-25 Example: Accrued Utility Costs Adjusting entry $960 Utilities owed Jan. 31 $960 Cash paid for utilities Feb. 6 Utilities used $960 Jan. 1

26. 3-26 Example: Accrued Utility Costs

27. 3-27 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, accounts receivable Adjusting entry: Debit asset account Credit revenue account

28. 3-28 Example: Accounts Receivable Suppose, Woods provides $200 of golf training to customers from January 28 to January 31. However, it usually takes Woods one week to mail bills to customers and another week for customers to pay. Therefore, Woods expects to receive cash from these customers during February 8-14. Irrespective of when cash will be received, the revenue should be recognized in January.

29. 3-29 Example: Accounts Receivable Adjusting entry $200 Owed from customers Jan. 31 $200 Cash received from customers Feb. 8-14 Revenues earned $200 Jan. 28

30. 3-30 Example: Accounts Receivable

31. 3-31 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.

32. 3-32 Trial Balance and Adjusted Trial Balance of Woods Golf Academy

33. ©2009 The McGraw-Hill Companies, Inc. Part C The Reporting Process

34. 3-34 LO5 Financial Statements

35. 3-35 Income Statement Woods Golf Academy Income Statement For the month ended January 31 Revenues: Training revenue$6,360 Expenses: Salaries expense$3,100 Rent expense500 Supplies expense800 Depreciation expense400 Interest expense100 Utilities expense960 Total expenses5,860 Net income$ 500

36. 3-36 Statement of Stockholders’ Equity

37. 3-37 Classified Balance Sheet Woods Golf Academy Classified Balance Sheet January 31 AssetsLiabilities Current assets:Current liabilities: Cash$ 6,200Accounts payable$ 2,300 Accounts receivable2,700Unearned revenue540 Supplies1,500Salaries payable300 Prepaid rent5,500Utilities payable960 Total current assets15,900Interest payable100 Total current liabilities4,200 Long-term assets: Equipment24,000Long-term liabilities: Accum. depr., equip. (400)Notes payable10,000 Total liabilities$ 14,200 Total long-term assets23,600 Stockholders’ Equity Common stock25,000 Retained earnings300 Total stockholders’ equity $ 25,300 Total liabilities and stockholders’ equity $ 39,500 Total assets$ 39,500 Total assets equal current plus long-term assets. Total liabilities equal current plus long-term liabilities. Total stockholders’ equity includes common stock and retained earnings from the statement of stockholders’ equity. Total assets must equal total liabilities plus stockholders’ equity. Total assets equal current plus long-term assets. Total liabilities equal current plus long-term liabilities. Total stockholders’ equity includes common stock and retained earnings from the statement of stockholders’ equity. Total assets must equal total liabilities plus stockholders’ equity.

38. ©2009 The McGraw-Hill Companies, Inc. Part D The Closing Process

39. 3-39 LO6 Closing Entries  Transfer the balance of all revenue, expense, and dividend accounts to the balance of retained earnings.  Increase the retained earnings account by the amount of revenues and decrease retained earnings by the amount of expenses and dividends.  The balance of each revenue, expense, and dividend account equals zero after closing entries.  Do not affect the balances of permanent accounts other than retained earnings.

40. 3-40 Closing Entries for Woods Golf Academy

41. 3-41 Close to Retained Earnings

42. 3-42 LO7 Post Closing Entries and Prepare Post–Closing Trial Balance

43. ©2009 The McGraw-Hill Companies, Inc. End of Chapter 3