Chapter Four

1. Chapter Four Adjusting Entries and the Work Sheet

2. Performance Objectives • Define: • Fiscal period • Fiscal year • Accounting cycle • Adjustments • Worksheet • Complete a work sheet for a service enterprise, involving adjustments for expired insurance, depreciation, and accrued wages • Prepare an income statement, a statement of owner’s equity, and a balance sheet for a service business directly from the work sheet Accounting Is Fun!

3. Performance Objectives • Journalize and post adjusting entries • Prepare financial statements • An income statement involving more than one revenue account and a net loss • A statement of owner’s equity with an additional investment and either a net income or a net loss • An income statement and a balance sheet for a business having more than one accumulated depreciation account • A balance sheet containing the statement of owner’s equity information Accounting Is Fun!

4. Define: • Fiscal Period • Any period of time covering a complete accounting cycle • Generally consisting of twelve consecutive months • The period could be: • One month • One quarter • One year • Fiscal Year • A fiscal period consisting of twelve consecutive months Accounting Is Fun!

5. Accounting Cycle • The sequence of steps in the accounting process completed during the fiscal period Accounting Is Fun!

6. List The Steps In The Accounting Cycle • Analyze source documents & record business transactions in a journal • Post journal entries to the ledger accounts • Prepare a trial balance • Gather adjustment data and record adjustments in the work sheet • Complete the work sheet • Create financial reports from data in work sheet • Journalize and post the adjusting entries • Journalize and post the closing entries • Prepare the post-closing trial balance Chapter 3 Chapter 4 Chapter 5 Accounting Is Fun!

7. What Are Adjustments? • Are all the accounts up to date? • Example: • What about prepaid Insurance? • Adjustments: • Internal transactions that bring ledger accounts up to date as a planned part of the accounting procedure Accounting Is Fun!

8. Work Sheet • A multicolumn working paper used by accountants to record necessary adjustments and provide up-to-date account balances needed to prepare the financial statements • A TOOL used by accountants to bring all the account information together to prepare financial statements Accounting Is Fun!

9. Accounting Is Fun!

10. Performance Objective 3 Complete a work sheet for a service enterprise, involving adjustments for expired insurance, depreciation, and accrued wages Accounting Is Fun!

11. Adjustments • Internal transactions that make the financial statements more accurate and bring ledger accounts up to date as a planned part of the accounting procedure • 1st: • Recorded in the Adjustments columns of the work sheet (makes the financial statements more accurate) • 2nd: • Record the adjustments in the journal, then post to the ledger accounts (brings the books up to date) • Each adjustment directly affect accounts on the • Income statement • Balance sheet Accounting Is Fun!

12. Adjustments Accounting Is Fun!

13. Matching Principle The principle that the revenue for one time period is matched up or compared with the related expenses for the same time period • To get an more accurate net income number (and resultant balance sheet accounts), we always want to match all the expenses of one period to the all the revenues of that same period • Match does not mean: • Match.Com (joke) • “Equals” Accounting Is Fun!

14. Accruals • Accrual • Recognition of an expense or a revenue that has been incurred or earned but has not yet been recorded • Expense meaning of accrual: • Record (recognize) an expense when it has been incurred but not yet recorded in the books • Regardless of when the cash is paid • Revenue meaning of accrual: • Record (recognize) a revenue when it has been earned but not yet recorded in the books • Regardless of when the cash is received • Accrued earnings are a better financial measurement for the economic activity for the accounting period Define incur: To come in existence; To bring upon oneself Accounting Is Fun!

15. Adjustment for Prepaid Insurance • The asset insurance paid for in advance partly or completely expires with the passage of time • The asset portion must be reduced and the corresponding expense increased Accounting Is Fun!

16. Adjustment for Prepaid Insurance Recorded in Work Sheet Accounting Is Fun!

17. Adjustments - Depreciation • Originally we bought equipment for $49,720 • We paid the cash or incurred debt for it, so why can’t we just record it as an expense? • Because the income statement would show expenses that are too large • Because the equipment will probably be around for many more years! • The Equipment will probably help to generate revenue for many more years to come • As a result, we must chop the original cost up into pieces and spread the pieces out over the useful life of the asset • This is called depreciation Accounting Is Fun!

18. Depreciation • Systematically spreads out the cost of these assets over their useful lives • Matches the expenses for one period to the revenue generated for that same period (Matching Principle) Accounting Is Fun!

19. Depreciation • An expense based on the expectation that an asset will gradually decline in usefulness due to time, wear and tear, or obsolescence; the cost of the asset is therefore spread out over its estimated useful life • A portion of depreciation expense is allotted to each fiscal period Accounting Is Fun!

20. Straight-line Depreciation • A means of calculating depreciation in which the cost of an asset, less any trade-in value, is allocated evenly over the useful life of the asset • (Cost - Trade-in Value)/(Useful Life in Years) Accounting Is Fun!

21. Adjustment for Depreciation of Equipment • We have calculated the depreciation expense • Expenses are debits • But what is the credit entry? • Equipment? • No: The historical cost principle says that we must keep the original cost on the books! • We cannot credit the Equipment account • We credit the contra account: Accumulated Depreciation Accounting Is Fun!

22. Definitions • Contra Account • An account that is contrary to, or a deduction from, another account; for example, Accumulated Depreciation is listed as a deduction from Equipment • Contra accounts are always “attached” to another account • Contra accounts are always a subtraction from the account it is attached to Accounting Is Fun!

23. Accumulated Depreciation • Accumulated depreciation is a contra asset account • It is “connected” to the related asset account • The debits & credits are the same as the asset account • But the plus and minus signs are reversed • Because it is subtracted from the related asset account! • When depreciation is recorded, we do not directly subtract (credit) the related asset, such as equipment • The amount of depreciation should be recorded in the account: accumulated depreciation Accounting Is Fun!

24. Accumulated Depreciation Accounting Is Fun!

25. Book Value or Carrying Value • The cost of an asset minus the accumulated depreciation • Listed on the balance sheet Accounting Is Fun!

26. Adjustment for Depreciation Recorded in Work Sheet Accounting Is Fun!

27. Depreciation and Land • Why don’t we depreciate land? • Land supposedly lasts forever • It does not get “used up over time” • It can help to generate revenue for a very long time Accounting Is Fun!

28. Adjustment for Wages Expense • Why necessary? • The end of the pay period rarely falls on the same day as the end of the fiscal period • Accrued wages • The amount of unpaid wages owed to employees for the time between the end of the last pay period and the end of the fiscal period • Accounts used: • Wages Expense (DR) • Wages Payable (CR) Accounting Is Fun!

29. Adjustment for Wages Expense Accounting Is Fun!

30. Adjustment for Wages Expense Accounting Is Fun!

31. Adjustment for Wages Expense Accounting Is Fun!

32. Adjustment for Wages Expense for Arch Copy Co. Accounting Is Fun!

33. Adjustment for Wages Expense Recorded in Work Sheet Accounting Is Fun!

34. Complete a Work Sheet for a Service Enterprise Accounting Is Fun!

35. Steps to Complete Worksheet • Complete Trial Balance columns, total, and rule (DR = CR) • Complete Adjustments columns, total, and rule (DR = CR) • Label entries with letter references: (a), (b) • Complete Adjusted Trial Balance columns, total, and rule (DR = CR) • Record balances in Income Statement and Balance Sheet columns and total each column (DR ≠ CR) Accounting Is Fun!

36. Steps to Complete Worksheet • Record net income or net loss • Subtract the smaller of the Income Statement columns from the larger; add the difference to the smaller side, total, and rule • If there is a net income, the credit side of the columns will be larger and you will place net income on the debit side • If there is a net loss, the debit side of the columns will be larger and you will place net loss on the credit side Accounting Is Fun!

37. Steps to Complete Worksheet • Record net income or net loss in the Balance Sheet columns • Subtract the smaller side from the larger side; add the difference to the smaller side, total, and rule • The amount should equal the difference between the Income Statement columns Accounting Is Fun!

38. Complete the Trial Balance Columns Accounting Is Fun!

39. Complete the Adjustments Columns Accounting Is Fun!

40. Complete the Adjusted Trial Balance Columns Accounting Is Fun!

41. Carry the Amounts to Either the Income Statement or Balance Sheet Columns Accounting Is Fun!

42. Worksheets with Two Pages • Totals at the bottom of the first page of the work sheet may not be equal • DR must equal CR at the bottom of the second or last page Accounting Is Fun!

43. Finding Errors in Income Statement and Balance Sheet Columns • Is all the addition across to the Adjusted Trial Balance columns correct? • Are the adjusted trial balance amounts moved to the correct column? • Revenues and expenses to Income Statement columns? • Everything else to Balance Sheet columns? • Is the addition for totals and footings correct? • Is net income or net loss placed in the correct columns? Accounting Is Fun!

44. Performance Objective 4 Prepare an income statement, a statement of owner’s equity, and a balance sheet for a service business directly from the work sheet Accounting Is Fun!

45. Income Statement • Copy all revenue and expenses from the Income Statement columns straight over to the income statement • Date is for the whole period Accounting Is Fun!

46. Income Statement Accounting Is Fun!

47. Statement of Owner’s Equity • Always check the beginning balance of Capital • Is there any additional investment? • Record net income or net loss • Are there any withdrawals? • Date is for the whole period • Remember: • Since we list the Capital account twice, the appropriate date must be included with the account title Accounting Is Fun!

48. Statement of Owner’s Equity Accounting Is Fun!

49. Balance Sheet • Create new accounts for accumulated depreciation • Copy all assets and liabilities to balance sheet • Use ending Capital from statement of owner’s equity • Date is just one day • “Snapshot in time!” Accounting Is Fun!

50. Balance Sheet Accounting Is Fun!