1. 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 Adjustments, Financial Statements, and the Quality of Earnings Chapter 4

2. 4-2 Understanding the Business Management is responsible for preparing...... useful to investors and creditors. High Quality = Relevance + Reliability Financial Statements

3. 4-3 Accounting Cycle  Prepare financial statements.  Disseminate statements to users.  Prepare financial statements.  Disseminate statements to users.  Close revenues, gains, expenses, and losses to Retained Earnings. During the period:  Analyze transactions.  Record journal entries.  Post amounts to general ledger. During the period:  Analyze transactions.  Record journal entries.  Post amounts to general ledger. Start of Period At the end of the period:  Adjust revenues and expenses. At the end of the period:  Adjust revenues and expenses.

4. 4-4 Unadjusted Trial Balance A listing of individual accounts, usually in financial statement order. A listing of individual accounts, usually in financial statement order. Ending debit or credit balances are listed in two separate columns. Ending debit or credit balances are listed in two separate columns. Total debit account balances should equal total credit account balances. Total debit account balances should equal total credit account balances. A listing of individual accounts, usually in financial statement order. A listing of individual accounts, usually in financial statement order. Ending debit or credit balances are listed in two separate columns. Ending debit or credit balances are listed in two separate columns. Total debit account balances should equal total credit account balances. Total debit account balances should equal total credit account balances.

5. 4-5 Partial Trial Balance

6. 4-6 Partial Trial Balance

7. 4-7 Purpose of Adjustments Revenues are recorded when earned. Expenses are recorded when incurred. Because transactions occur over time, ADJUSTMENTS are required at the end of each fiscal period to get the revenues and expenses into the “right” period. Matching Principle

8. 4-8 Types of Adjustments There are four types of adjustments. Two types of adjustments increase Revenue and two types of adjustments increase Expenses.

9. 4-9 Types of Adjustments

10. 4-10 Adjustment Process

11. 4-11 Prepaid Expenses Property and equipment are assets that have a normal debit balance. Depreciation is the allocation of the cost of an asset over its estimated useful life to the company. Depreciation is an expense with a normal debit balance. When we record depreciation we credit a “contra asset account” called Accumulated Depreciation. Contra-accounts are accounts that are directly linked to another account, but with an opposite balance. We subtract accumulated depreciation from the cost of our property and equipment to arrive at net book value.

12. 4-12 Ethics and Adjusting Entries

13. 4-13 Preparing Financial Statements Before we prepare a complete set of financial statements, let’s update the trial balance to reflect the adjustments and provide us with adjusted balances for the statements. 1.Income statement, 2.Statement of stockholders’ equity, 3.Balance sheet, and 4.Statement of cash flows. Before we prepare a complete set of financial statements, let’s update the trial balance to reflect the adjustments and provide us with adjusted balances for the statements. 1.Income statement, 2.Statement of stockholders’ equity, 3.Balance sheet, and 4.Statement of cash flows.

14. 4-14

15. 4-15 Financial Statement Relationships

16. 4-16 Income Statement This is the income statement drawn from the adjusted trial balance. Refer back to the adjusted trial balance and trace the income statement numbers forward. Notice that gains and losses are reported in the Other Items section of the statement.

17. 4-17 Here is an example of the closing process using an illustration with just a few accounts. Closing the Books

18. 4-18 End of Chapter 4