ADJUSTING ENTRIES p.106

ADJUSTING ENTRIESp.106 • Adjusting entries make the revenue recognition and matching principles • Why do you adjust accounts HAPPEN!

ADJUSTING ENTRIES p.106 • Adjusting entriesare required each time financial statements are prepared. • Adjusting entries can be classified as 1.prepayments 2.accruals 3. estimates

TYPES OF ADJUSTING ENTRIES Prepayments • Prepaid Expenses— Expenses paid in cash and recorded as assets before they are used or consumed. ex: 2. Unearned Revenues— Revenues received in cash and recorded as liabilities before they are earned. ex:

PREPAYMENTSexamples • At the end of the accounting period the trial balance indicates there are $5000 of supplies; a physical inventory indicates that there are actually only $1000 of supplies

PREPAYMENTSexamples 2. On Sept 1, ABC Co. paid $2400 for a one year fire insurance policy. What is the adjustment at the end of the calendar year (Dec. 31)?

PREPAID EXPENSES • Prepaid expensesare expenses paid in cash and recorded as assets before they are used or consumed.  • Prepaid expenses ________ with the passage of time or through ____________________ . • Anasset-expenseaccount relationshipexists with prepaid expenses.

UNEARNED REVENUEexample 3. Cubana Airlines sells Mr. S an all-inclusive Cuban holiday for March break. Mr. S pays $3500 on Dec 15th; Record both the original transaction and the adjustment made by Cubana when Mr. S flys to Cuba March 12.

UNEARNED REVENUES • Unearned revenuesare revenues received and recorded as ___________ before they are earned. • Unearned revenues are subsequently earned by performing a service or providing a good to a customer. • A ________________account relationship exists with unearned revenues.

TYPES OF ADJUSTING ENTRIES Accruals think  1. Accrued Revenues— Revenues earned but not yet received in cash or recorded. 2. Accrued Expenses— Expenses incurred but not yet paid in cash or recorded.

ACCRUALS • A different type of adjusting entry is accruals. • Adjusting entries for accruals are required to record revenues earned and expenses incurred in the current period. • The adjusting entry for accruals will

JB pharma contracts to produce Life brand energy bars for Shoppers on August 10th. JB purchases $400 K of ingredients on account August 24 JB manufactures $1 mm of energy bars in Sept, and ships them to Shoppers, Sept. 22. JB incurs $200 of overhead and production costs for the energy bars Shoppers pays JB December 23. ACCRUAL EXAMPLE: Revenue Recognition and Matching Principal

INTEREST ADJUSTMENT P. 113 On Oct 1. Pioneer Advertising signed a $5000 three month note payable due January 1. Pioneer’s Interest Adjustment, Oct. 31: Oct 31: Face Value of Note Annual Interest Rate Time (in Terms of One Year) Interest x x = $5,000 x 6% x 1/12 = $25

ACCRUED EXPENSES • Accrued expensesare expenses incurred but not yet paid. • A liability-expense account relationship exists. • Prior to adjustment, __________ and ________ are ___________. • The adjusting entry results in a _____ to an expense account and a _______ to a liability account. • Examples of accrued expenses include: accounts payable, rent payable, salaries payable, and interest payable.

Adjusting Entries Accrued Revenues Asset Revenue Debit Adjusting Entry (+) Credit Adjusting Entry (+) Accrued Expenses Expense Liability Debit Adjusting Entry (+) Credit Adjusting Entry (+) ILLUSTRATION 3-5ADJUSTING ENTRIES FOR ACCRUALS

TYPES OF ADJUSTING ENTRIES Estimates 1. Amortization=

AMORTIZATION • Amortizationis the process of allocating the cost of certain capital assets to expense over their useful life in a rational and systematic manner. • Amortization attempts to ______ the cost of a long-term, capital asset to the revenue it generates each period.

AMORTIZATION • Amortization is an _________ rather than a factual measurement of the cost that has expired. We’re not attempting to reflect the actual change in value of an asset! Depreciation DOES NOT represent the market value of the asset!

Depreciation (Amortization) Straight Line Example • Moe purchased a mechanical bull was purchased on September 1, 2006 for $2,000 with an estimated life of five years and an expected salvage value of $200. Calculate the Depreciation for both 2006 (1/2 year rule) and 2007 Dec 31, 2006 Dec 31, 2006

Depreciation (Amortization) Declining Balance Example Moe moved his business into the new building on August 31, 2006. The building cost $50,000 amortized at 10% over 25 years with no expected salvage value. Calculate the Depreciation for both 2006 (1/2 year rule) and 2007 Dec 31, 2006 Dec 31, 2006

AMORTIZATION • In recording amortization, Amortization Expenseis _______ and a contra asset account, Accumulated Amortization, is ___________. • The difference between the cost of the asset and its related accumulated amortization is referred to as the _________________of the asset. xxx xxx Accumulated Amortization Amortization Expense

Estimate AMORTIZATION Balance Sheet Presentation Office equipment $5,000 Less: Accumulated amortization 83 Net book value $4,917

ILLUSTRATION 3-8SUMMARY OF ADJUSTING ENTRIES Account Accounts before Adjusting Type of Relationship Adjustment Entry 1.Prepaid Assets and Assets overstated Dr. Expenses expenses expenses Expenses understated Cr. Assets 2.Unearned Liabilities and Liabilities overstated Dr. Liabilities revenues revenues Revenues understated Cr. Revenues 3.Accrued Assets and Assets understated Dr. Assets revenues revenues Revenues understated Cr. Revenues 4.Accrued Expenses and Expenses understated Dr. Expenses expenses liabilities Liabilities understated Cr. Liabilities 5.Amortization Expense and Expenses understated Dr. Amort. Exp contra asset Assets overstated Cr. Accum. Amortization Adjustment

ADJUSTED TRIAL BALANCE • An Adjusted Trial Balanceis prepared after all adjusting entries have been journalized and posted. • It shows the balances of all accounts at the end of the accounting period and the effects of all financial events that have occurred during the period. • It proves the equality of the total debit and credit balances in the ledger after all adjustments have been made. • Financial statements can be prepared directly from the adjusted trial balance.

ILLUSTRATION 3-11TRIAL BALANCE AND ADJUSTED TRIAL BALANCE COMPARED

PREPARING FINANCIAL STATEMENTS Financial statementscan be prepared directly from an adjusted trial balance. 1. The income statement is prepared from the revenue and expense accounts. 2. The statement of owner’s equity is derived from the owner’s capital and drawings accounts and the net income (or net loss) shown in the income statement. 3. The balance sheet is then prepared from the asset and liability accounts and the ending owner’s capital balance as reported in the statement of owner’s equity.

ILLUSTRATION 3-12PREPARATION OF THE INCOME STATEMENT AND THE STATEMENT OF OWNER’S EQUITY FROM THE ADJUSTED TRIAL BALANCE

From Statement of Owner’s Equity ILLUSTRATION 3-13PREPARATION OF THE BALANCE SHEET FROM THE ADJUSTED TRIAL BALANCE

STEPS IN THE ACCOUNTING CYCLE 1. Analyse transactions 2. Journalize the transactions 9. Coming next chapter 3. Post to ledger accounts 8. Coming next chapter 4. Prepare a trial balance 7. Prepare financial statements 5. Journalize and post adjusting entries 6. Prepare adjusted trial balance

ADJUSTING ENTRIES p.106