Adjusting Accounts & Preparing Financial Statements

1. Adjusting Accounts & Preparing Financial Statements Chapter 3

2. Accounting period • Time principle period • Specific time periods for accounting activities • Fiscal year • Consisting of any 12 months period other than ending on December 31 • Natural year • Ends December 31

3. Accounting basis • Accrual basis • Uses the adjusting process to recognize revenues when earned and to match expenses with revenues • Cash Basis • Recognized revenues when cash is received and records expenses when cash is paid

4. Revenue Recognition • Matching principle • Aims to record expenses in the same accounting period as the revenues that are earned as a result of these expenses

5. Adjustments • Adjusting entries • To correct for transactions and events that extend over more than one period • Deferred – wait till cash is paid • Accrual – • Rule • Debit the expense • Credit the asset or liabilities • For the amount used up

6. Prepaid insurance • Suppose that we purchase $2,400 for insurance for one year on May 1. Record the adjustments on December 31. • $2,400/12 = $200 x 8months = $1,600 • Insurance expense 1600 • Prepaid insurance 1600

7. Supplies • Suppose that supplies account has a balance of $4,000 and inventory shows $1,000. Record the supplies used up. • Balance 4,000 • Inventory1,000 • Used up 3,000

8. Supplies • Supplies expense 3,000 • Supplies 3,000

9. Depreciation • Plant assets/Fixed Assets • Assets which are tanigble and long lived • Building and machinery • Depreciation • The reduction in value of an asset due to its use

10. Depreciation • Depreciation expense • Annual reduction in value of asset • Accumulated depreciation • Contra asset • Increases with a credit • Total reduction in value of an asset

11. Unearned revenues • Refers to cash received in advance of services provided • Suppose that unearned revneue has a balance of $7,000 but records shows only $3,000 is unearned • Balance $7,000 • Should be 3,000 • Earned 4,000

12. Unearned Revenues • Unearned revenues • A liability • If we do not complete the work then we are liable to refund the monies. • Once the work is completed then the liability does not exist • Unearned revenues 4,000 • Fees earned 4000

13. Accrued expenses • Refers to costs that are incurred in a period that are unpaid and unrecorded • Accrued salaries • Salaries owed at the end of the period to be made next period • Suppose year ends on Wed, do we pay on Wed or wait until Friday

14. Salaries • Suppose salaries at year end is $400 • Salaries expense 400 • Salaries payable 400

15. Accrued revenues • Refers to revenues earned in a period that are both unrecorded and not yet received in cash • Unrecorded accounts receivable

16. Trial Balance • Unadjusted trial balance • is a list of account balances before adjustments • Used to make adjusting entries • Adjusted trial balance • Used to prepare financial statements

17. Financial Statements • Four basic financial statements • Income statement • Statement of Retained Earnings • Balance Sheet • Statement of Cash flows

18. Income Statement • Results of operations for a business • Shows revenues minus expenses Rob Co Income Statement For period ending 12/31/04

19. Statement of Retained Earnings Changes in net worth and equity Rob Co Statement of Retained Earnings For period ending 12/31/04 Beginning Retained Earnings $60,000 +Net income 40,000 100,000 -Dividends 20,000 Ending Retained Earnings $80,000

20. Balance sheet Rob Co Balance Sheet December 3, 2004

21. Statement of Cash Flows • Inflows and outflow of cash from • Operations • Investments • Financing

22. Accounting Cycle • Record entries in the journal • Post to ledger • Prepare unadjusted Trial Balance • Record and post adjusting entries • Prepare adjusted trial balance • Prepare financial statements • Record and post closing entries

23. Closing Entries • Temporary accounts • Accumulate data related to one accounting period • Revenue • Expense • Dividends • Income summary

24. Close revenues • Revenues DR • Income summary Cr • Debit whatever revenue accounts you have on the trial balance for their ending balance and the total is credited to income summary

25. Close Expenses • Income summary DR • Expenses CR • Credit each expense account separately for the amount of the balance in the account and debit income summary for the total

26. Close Income Summary • Income Summary DR • Retained earnings CR For the balance in the income summary account Income Summary Debit Credit Total expenses Total revenues Net income

27. Close Dividends • Dividends reduce the equity of the business and the amount retained in the business • Retained earnings DR • Dividends CR • For the amount of the balance in the dividend account

28. Transactions • Fees earned $50,000 • Rent expense 10,000 • Supplies expense 5,000 • Dividends 2,000 • Retained earnings $30,000 • Record the closing entries

29. Close revenues • Fees earned 50,000 • Income summary 50,000

30. Close Expenses • Income Summary $15,000 • Rent expense $10,000 • Supplies expense 5,000

31. Close Income Summary • Income Summary $35,000 • Retained earnings $35,000 Income Summary DR CR $50,000 Expenses $15,000 Revenues $35,000 net income

32. Close Dividends • Retained earnings $2,000 • Dividends $2,000 Retained Earnings CR $30,000 Balance $35,000 net income DR $2,000 Dividends $63,000 ending balance

33. Current assets Expected to be collected in less than one year Cash Accounts receivable Supplies Inventory Plant Asset Long lived tangible assets Factory building Machinery and equipment Classification of Accounts