Chapter 03

Adjusting Accounts and Preparing

Financial Statements
C1
The Accounting Period

Annually

1 2
Semiannually
1 2 3 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
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C1
Accrual Basis vs. Cash Basis

Accrual Basis Cash Basis

Revenues are Revenues are
recognized when recognized when
earned and expenses cash is received and
are recognized when expenses recorded
incurred. when cash is paid.

Not GAAP
Accounting

3-3
C1
Accrual Basis vs. Cash Basis

On the cash basis the

entire $2,400 would be Insurance Expense 2011
recognized as insurance Jan Feb Mar Apr

expense in 2011. No $ - $ - $ - $ -
May Jun Jul Aug
insurance expense from
this policy would be $ -
Sep
$ -
Oct
$ -
Nov
$ -
Dec
recognized in 2012 or
$ - $ - $ - $ 2,400
2013, periods covered by
the policy.
3-4
C2
Accrual Basis vs. Cash Basis

Insurance Expense 2011

Jan Feb Mar Apr

$ -
May
$ -
Jun
$ -
Jul
$ -
Aug
On the accrual basis
$ - $ - $ - $ - $100 of insurance
$
Sep

- $
Oct

- $
Nov

- $
Dec

100
expense is recognized in
Insurance Expense 2012 2011, $1,200 in 2012,
Jan Feb Mar Apr
$ 100 $ 100 $ 100 $ 100 and $1,100 in 2013. The
May Jun Jul Aug
$ 100 $ 100 $ 100 $ 100 expense is matched with
Sep Oct Nov Dec
$ 100 $ 100 $ 100 $ 100 the periods benefited by
Jan
Insurance Expense 2013
Feb Mar Apr
the insurance coverage.
$ 100 $ 100 $ 100 $ 100
May Jun Jul Aug
$ 100 $ 100 $ 100 $ 100
Sep Oct Nov Dec
$ 100 $ 100 $ 100 $ -
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C2, P1
Adjusting Accounts

An adjusting entry is recorded to bring an asset or

liability account balance to its proper amount.
Framework for Adjustments
Adjustments

Paid (or received) cash before Paid (or received) cash after
expense (or revenue) recognized expense (or revenue) recognized

Prepaid Unearned Accrued Accrued

(Deferred) (Deferred) expenses revenues
expenses* revenues
*including depreciation
3-6
P1
Prepaid (Deferred) Expenses

Here is the check

for my first
Resources paid 6 months’ insurance.
for prior to
receiving the
actual benefits.

Asset Expense
Unadjusted Credit Debit
Balance Adjustment Adjustment

3-7
P1
Supplies

During 2011, Scott Company purchased $15,500 of

supplies. Scott recorded the expenditures as
Supplies. On December 31, a count of the supplies
indicated $2,655 on hand.
What adjustment is required?
Dec. 31 Supplies Expense 12,845
Supplies 12,845
To record supplies used during 2011
Supplies 126 Supplies Expense 652
Bought 15,500 Dec. 31 12,845 Dec. 31 12,845
Bal. 2,655

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P1
Depreciation

Depreciation is the process of allocating

the costs of plant assets over their
expected useful lives.

Straight-Line Asset Cost - Salvage Value

Depreciation =
Expense Useful Life

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P1
Depreciation

On January 1, 2011, Barton, Inc. purchased

equipment for $62,000 cash. The equipment has
an estimated useful life of 5 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, 2011.

2011 $62,000 - $2,000

Depreciation = = $12,000
Expense 5
3-10
P1
Depreciation

On January 1, 2011, Barton, Inc. purchased

equipment for $62,000 cash. The equipment has
an estimated useful life of 5 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, 2011.
Dec. 31 Depreciation Expense 12,000
Accumulated Depreciation - Equipment 12,000
To record equipment depreciation

Accumulated depreciation is
a contra asset account. 3-11
P1
Depreciation

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

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P1
Unearned (Deferred) Revenues

Cash received in
advance of
Buy your season tickets for
providing all home basketball games NOW!
products or
services. “Go Big Blue”

Revenue
Liability
Debit Unadjusted Credit
Adjustment Balance Adjustment

3-13
P1 Unearned (Deferred) Revenues

On October 1, 2011, Ox University sold 1,000

season tickets to its 20 home basketball games for
$100 each. Ox University makes the following entry:

Oct. 1 Cash 100,000

Unearned Revenue 100,000
Basketball revenue received in advance

Unearned Revenue
Oct.1 100,000

3-14
P1
Unearned (Deferred) Revenues

On December 31, Ox University has played 10 of

its regular home games, winning 2 and losing 8.

Dec. 31 Unearned Revenue 50,000

Basketball Revenue 50,000
To recognize 10-games of revenue

Unearned Revenue Basketball Revenue

Dec. 31 50,000 Oct. 1 100,000 Dec. 31 50,000
Bal. 50,000

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P1
Accrued Expenses
We’re about one-half
Costs incurred in a done with this job and
period that are want to be paid for
both unpaid and our work!
unrecorded.

Expense Liability
Debit Credit
Adjustment Adjustment

3-16
P1
Accrued Expenses

Barton, Inc. pays its employees every Friday. Year-end,

12/31/11, falls on a Thursday. As of 12/31/11, the
employees have earned salaries of $47,250 for Monday
through Thursday.

Last pay Next pay

date date
12/25/11

12/1/11 12/31/11 Record adjusting

Year-end journal entry.

3-17
P1
Accrued Expenses

Barton, Inc. pays its employees every Friday. Year-end,

12/31/11, falls on a Thursday. As of 12/31/11, the
employees have earned salaries of $47,250 for Monday
through Thursday.

Dec. 31 Salaries Expense 47,250

Salaries Payable 47,250
To accrue 4-days' salary
Salaries Expense Salaries Payable
Other salaries Dec. 31 47,250
657,500
Dec. 31 47,250
Bal. 704,750

3-18
P1 Accrued Revenues

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, 2011,
the end of the firm’s fiscal year.
Dec. 31 Accounts Receivable 31,200
Service Revenue 31,200
To accrue revenue earned
Accounts Receivable Service Revenue
Other receivables Other revenues
1,325,268 6,589,500
Dec. 31 31,200 Dec. 31 31,200
Bal. 1,356,468 Bal . 6,620,700

3-19
A1
Links to Financial Statements

Summary of Adjustments and Financial Statement Links

Before Adjustment
Income
Balance Sheet Statement
Type Account Account Adjusting Entry
Prepaid Asset Overstated Expense Dr. Expense
Expenses Equity Overstated Understated Cr. Asset
Unearned Liability Overstated Revenue Dr. Liability
Revenues Equity Understated Understated Cr. Revenue
Accrued Liability Understated Expense Dr. Expense
Expenses Equity Overstated Understated Cr. Liability
Accrued Asset Understated Revenue Dr. Asset
Revenues Equity Understated Understated Cr. Revenue

3-20
P2
FastForward – Trial Balance -
December 31, 2011

$
First, the
initial
unadjusted
amounts are
added to the
work sheet.

3-21
P2 FastForward – Recording Adjustments
Trial Balance - December 31, 2011

Next,
FastForward’s
adjustments
are added.

3-22
P2
FastForward – Computing the Adjusted
Trial Balance - December 31, 2011

Finally, the
totals are
determined.

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P3
1. Prepare Income Statement

3-24
P3 2. Prepare Statement of Retained
Earnings

Note that net income from the Income Statement

carries to the Statement of Retained Earnings.

3-25
P3
3. Prepare Balance Sheet

FASTFORWARD
Balance Sheet
December 31, 2011
Assets
Cash $ 3,950
Accounts receivable 1,800
Supplies 8,670
Prepaid insurance 2,300
Equipment 26,000
Less: accum. depr. (375) 25,625
Total assets $ 42,345
Liabilities
Accounts payable $ 6,200
Salaries payable 210
Unearned revenue 2,750
Total liabilities $ 9,160
Equity
Common stock 30,000
Retained earnings 3,185
Total liabilities and equity $ 42,345

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C3 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.”
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P4
Recording Closing Entries

1. Close revenue accounts.

2. Close expense accounts.
3. Close income summary account.
4. Close dividends account.

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P4
Recording Closing Entries

Salaries Expenses Consulting Revenues

$ 18,100 $ 25,000
Examine the
accounts
presented.
Income Summary Retained Earnings

$ 7,000

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P4
Recording Closing Entries

Salaries Expenses Consulting Revenues

$ 18,100 $ 25,000 $ 25,000

Income Summary Close revenues

$ 25,000 with a debit to the
revenue account
and a credit to
Income Summary.

3-30
P4
Recording Closing Entries

Salaries Expenses Consulting Revenues

$ 18,100 $ 18,100 $ 25,000 $ 25,000

Income Summary Close expense

accounts with a
$ 18,100 $ 25,000
credit to expenses
and a debit to
Income Summary.

3-31
P4
Recording Closing Entries

Salaries Expenses Consulting Revenues

$ 18,100 $ 18,100 $ 25,000 $ 25,000

Income Summary
Determine the
$ 18,100 $ 25,000 balance in the
$ 6,900 Income Summary
account.

3-32
P4
Recording Closing Entries

Salaries Expenses Close the Income

$ 18,100 $ 18,100 Summary to
Retained Earnings.

Income Summary Retained Earnings

$ 18,100 $ 25,000 $ 7,000

$ 6,900
$ 6,900 $ 6,900

3-33
P4
Recording Closing Entries

The dividends account is closed to

Retained Earnings.

Dividends Retained Earnings

$ 2,000 $ 2,000 $ 2,000 $ 7,000
6,900

3-34
P4
Recording Closing Entries

The dividends account is closed to

Retained Earnings.

Dividends Retained Earnings

$ 2,000 $ 2,000 $ 2,000 $ 7,000
6,900
$ 11,900
Determine the ending
balance in Retained
Earnings.
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P5
Post-Closing Trial Balance

 Trial balance 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.

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C3
The Accounting Cycle

Start 10. Reverse 9. Prepare

(optional) post-closing
1. Analyze trial balance
transactions
8. Close
2. Journalize
7. Prepare
3. Post statements

4. Prepare 6. Prepare
unadjusted 5. Adjust adjusted
trial balance trial balance
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C4
Classified Balance Sheet

Assets Liabilities and Equity

Current assets Current liabilities
Noncurrent assets: Noncurrent liabilities
Long-term investments Equity
Plant assets
Intangible assets

Current items are those expected to come due

(either collected or owed) within one year or the
company’s operating cycle, whichever is longer.

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C4
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.
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C4
Liabilities

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.

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C4

Classified Balance Sheet

FASTFORWARD
Balance Sheet
Decem ber 31, 2011
Assets
Current Assets
Cash $ 3,950
Accounts receivable 1,800
Supplies 8,670
Prepaid insurance 2,300
Total Current Assets 16,720
Plant Assets
Equipm ent 26,000
Less: accum . depr. (375) 25,625
Total assets $ 42,345
Liabilities
Current Liabilities
Accounts payable $ 6,200
Salaries payable 210
Unearned revenue 2,750
Total liabilities $ 9,160
Equity
Com m on stock 30,000
Retained earnings 3,185
Total liabilities and equity $ 42,345
3-41