The Adjusting Process

1. The Adjusting Process Chapter 3

2. Accrual Accounting Versus Cash-Basis Accounting • Accrual Basis • Revenues recognized when earned • Expenses recognized when incurred • Cash Basis • Revenues recognized when cash received • Expensesrecorded when cash paid Not GAAP

3. Accrual vs. Cash-Basis: Revenue Accrual basis revenue transactions Cash-basis revenue transactions

4. Accrual vs. Cash-Basis Accounting Accrual basis Cash-basis

5. Define and apply the accounting period concept, revenue, and matching principles 2

6. Accounting Period Concept • Businesses prepare financial statements for specific periods to evaluate performance • Basic accounting period = one year • Calendar year • Fiscal year • Interim periods • Financial statements of less than one year • Monthly • Quarterly • Semi-annually

7. Revenue Recognition Principle • When to record revenue? • When it is earned • When service is provided • When the product delivered • When the earnings process is complete • Not when cash is received, accrual method • The amount of revenue to recorded? • Value of item or service transferred to customer

8. The Matching Principle • Measure all expenses incurred during the period • Match the expenses against the revenues earned during the same period

9. The Time-Period Concept • Requires that accounting information be reported at regular intervals • Accounts are updated at the end of each accounting period

10. Adjusting Entries

11. Adjusting Entries • Prepared at end of an accounting period • Assigns: • Revenues to the period when earned • Expenses to the period when incurred • Update asset and liability accounts • Need to properly match revenues and expenses to measure: • Net income • Assets and Liabilities

12. Adjusting Entry Rules

13. Types of Adjusting Entries

14. Prepaid Expenses • Advance payments of expenses • Examples: • Rent • Insurance • Supplies • Recorded as an asset • Adjusting entry records amount used as an expense

16. Prepaid Expense: Rent At May 31st, this amount is too high. One month has been used.

18. Supplies Expense At May 31st, we determine that $100 of supplies has been used.

20. Depreciation • Plant assets • Long-lived tangible assets used in business operations • Examples: • Land, buildings, equipment, and furniture • Depreciation • Allocation of a plant asset’s cost to expense over its useful life • Land is not depreciated

21. Depreciation Entry Note; A similar entry would have to be done to record depreciation on the building Contra asset account Amount calculated based on depreciation method

22. Accumulated Depreciation • Contra asset • Normal credit balance • Always paired with related account • Holds sum of all depreciation recorded on a plant asset • Book value: • Cost minus accumulated depreciation

23. Note; A similar entry would have to be done to record depreciation on the building Depreciation Posting Furniture book value is 18,000 – 300 = 17,700

24. Accrued Expenses • Expenses incurred before payment is made • Results in a liability • Opposite of a prepaid expense • Examples: • Salaries • Interest

26. Accrued Expense Entries

28. Accrued Revenues • Revenue earned before cash is received • Results in a receivable

29. Unearned Revenue • Cash is collected before revenue is earned • Results in a liability • Owes a product or service or refund • Also called deferred revenue BEFORE

31. Unearned Revenue Entries

32. Summary of Adjusting Entries • To properly measure net income for the period • The entry affects a revenue or an expense • To update the balance sheet • The entry affects an asset or a liability

33. Summary of Adjusting Entries

34. Adjusted Trial Balance • Prepared after adjusting entries are posted • Useful step in preparing financial statements • Often appears on a work sheet • Tool accountants use at end of period

39. 6 Prepare the financial statements from the adjusted trial balance

40. The Balance Sheet is prepared last. A = L + E Statement of Retained Earnings /Owners Equity is second Income Statement is prepared first. Revenue - Expenses

41. Income Statement Net Income to the Owners Equity Stmt

42. Statement of Retained Earnings Owners Equity Ending Capital Balance to the Balance Sheet

43. Balance Sheet