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The Adjusting Process

The Adjusting Process. Chapter 3. Objective 1. Distinguish accrual accounting from cash-basis accounting. Not GAAP. Accrual Basis Vs. Cash Basis. Accrual Basis Revenues are recognized when earned and expenses are recognized when incurred. Cash Basis

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The Adjusting Process

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  1. The Adjusting Process Chapter 3

  2. Objective 1 Distinguish accrual accounting from cash-basis accounting

  3. Not GAAP Accrual Basis Vs. Cash Basis Accrual Basis Revenues are recognized when earned and expenses are recognized when incurred. Cash Basis Revenues are recognized when cash is received and expenses recorded when cash is paid.

  4. S3-1 • Service revenue: • Cash basis $600 • Accrual basis (600+500) $1,100

  5. Interim Statements Accounting Period • Managers adopt an artificial period of time to evaluate performance • Monthly • Quarterly • Semiannually • Annually

  6. Recognizing Revenues and Expenses Three new basic accounting principles • Revenue Recognition • Matching • Time Period

  7. Objective 2 Apply the revenue and matching principles

  8. Revenue Principle • When is revenue recognized? • When it is earned • Not necessarily when cash is received • How much revenue should be recognized? • Cash value of item transferred to customer

  9. S3-3 • When should revenue be recorded?When the magazines are mailed to customers • How much revenue should be recorded?As of March, three month’s revenue should be recognized

  10. The Matching Principle • Measure all expenses incurred during the accounting period • When are expenses recognized? • Match the expenses against the revenues earned during the period

  11. Adjusting Entries • At the end of an accounting period, ask yourself these questions: • Have I recorded all revenues earned during this accounting period? • Have I recognized all expenses incurred during this accounting period? • If the answer is “No”, you need to prepare an adjusting entry

  12. S3-4 Prepaid rent is an asset – this will benefit the company in the future. Since you have not occupied the apartment yet, it is not an expense yet Jan 1 – Paid rent for the entire year Jan 1 Prepaid Rent 3,600 Cash 3,600 Prepaid rent for 1 year

  13. S3-4 Each month, we’ll recognize rent expense; and each month, we’ll reduce the prepaid account until the year is over Prepaid Rent Rent Expense Jan 1 3,600 300 Jan 31 300 300 Feb 28 300 300 Mar 31 300 300 Apr 30 300 300 May 31 300 300 Jun 30 300 300 Jul 31 300 300 Aug 31 300 300 Sep 30 300 Bal 900 Bal 2,700

  14. The Time Period Concept • Requires that accounting information be reported at regular intervals

  15. Adjusting Entries • Prepared at end of an accounting period • Recorded to bring an asset or liability account balance to its proper amount • Recognize all revenues when earned • Recognize all expenses incurred

  16. Objective 3 Make adjusting entries

  17. Adjusting Entries At the end of an accounting period, ask yourself these questions: • Have I recognized all revenues earned this period? • Have I recorded all expenses incurred this period? If the answer is “No”, you need to prepare an adjusting entry

  18. Adjusting Entries Five categories • Prepaid expenses • Depreciation • Accrued revenues • Accrued expenses • Unearned revenues

  19. Resources paid for prior to receiving the actual benefits Adjusting Prepaid Expenses

  20. Prepaid Rent S3-5 Apr 1 Prepaid Rent 3,000 Cash 3,000 Prepaid rent for 6 months 4/1 3,000

  21. Prepaid Rent S3-5 Rent is $500 per month ($3,000/6) Apr 30 Rent Expense 500 Prepaid Rent 500 To record rent for April Rent Expense 4/1 3,000 4/30 500 4/30 500 Bal 2,500

  22. Straight-Line Depreciation Expense Asset Cost Useful Life = Adjusting for Depreciation Long term plant assets except for land are depreciated Depreciation - process of allocating the cost of a plant asset to expense over its expected useful life

  23. S3-6 May 1 Computer Equipment 36,000 Cash 36,000 Purchased computer Computer Equipment 5/1 36,000

  24. Depreciation • Depreciation, for accounting purposes, is not an attempt to assign a market value to assets • It is merely a systematic way of allocating some of the cost of the asset to each period that asset helps the company earn revenue • Accumulated Depreciation • A contra asset account • Represents the amount of depreciation that has been taken over the life of the asset to date

  25. S3-6 Income Statement Account May 31 Depreciation Expense, Computer Equipment 1,000 Accumulated Depreciation, Computer Equipment 1,000 To record depreciation for May Balance Sheet Account Accumulated depreciation is a contra asset account

  26. S3-6 Computer Equipment 5/1 36,000 Depreciation Expense, Computer Equipment Accumulated Depreciation, Computer Equipment 5/31 1,000 5/31 1,000 Bal 1,000 Bal 1,000

  27. Book Value • Reported on balance sheet • Cost minus accumulated depreciation

  28. S3-6 Your Company Balance Sheet May 31, 20XX Assets Cash $XXXX . . . Computer Equipment $ 36,000 Less: Accumulated Depreciation (1,000) 35,000 Total Assets $XXXX Book Value

  29. Notice: accumulated depreciation increases each accounting period. The book value gradually gets smaller S3-6 Your Company Balance Sheet June 30, 20XX Assets Cash $XXXX . . . Computer Equipment $ 36,000 Less: Accumulated Depreciation (2,000) 34,000 Total Assets $XXXX Book Value

  30. Accrued Expenses Costs incurred in a period that are both unpaid and unrecorded

  31. S3-8 Dec 31 Interest Expense 700 Interest Payable 700 To record accrued interest When you borrow money, interest expense is accumulating everyday. At the end of an accounting period, you need to figure out how much interest has accrued and recognize the expense. You also have to recognize that you must pay that money sometime in the future. Interest Expense Interest Payable 12/31 700 700 12/31

  32. Accrued Revenues Revenues earned in a period that are both unrecorded and not yet received

  33. Accrued Revenues • Your lawn maintenance company agrees to provide 30 hours of work at $60 per hour for Company A. It is also agreed that you will bill them when the work had been completed • As of May 31, you have worked 20 hours on this contract. The 20 hours’ worth of revenues earned in May, must be recorded in May, even though you haven’t billed your customer yet

  34. Accrued Revenues How much revenue was earned in May? $60 x 20 = $1200 May 31 Accounts Receivable 1,200 Service Revenue 1,200 To record accrued revenues Accounts Receivable Service Revenue 5/31 1,200 1,200 5/31

  35. Unearned Revenue Cash received in advance of providing products or services

  36. When the money is received, the company debits cash and credits Unearned Revenue (a liability recognizing that the company owes their customer a service or product) S 3-9 Dec 31 Unearned Subscription Revenue 5,000 Subscription Revenue 5,000 To record revenue earned At the end of an accounting period, you must determine how much of that unearned revenue has actually been earned

  37. Tips • An adjusting entry will NEVER involve a debit or credit to Cash • Each adjusting entry will affect at least one balance sheet account and one income statement account

  38. Summary Debit Expense Credit Asset (Prepaid) Prepaid expenses Depreciation Accrued revenues Debit Depreciation Expense Credit Accumulated Depreciation Debit Receivable Credit Revenue

  39. Summary Debit Expense Credit Liability Accrued expenses Unearned revenues Debit Liability (Unearned) Credit Revenue

  40. E3-19 a This is an example of unearned revenues: $4,000 /12 = $333.33 per month 3 months have expired. $333.33 x 3 = $1,000 Dec 31 Unearned Rent Revenue 1,000 Rent Revenue 1,000 To record revenue earned Unearned Rent Revenue Rent Revenue 10/1 4,000 12/31 1,000 12/31 1,000 Bal. 3,000

  41. This is an example of accrued expenses. The company owes employees salaries for two days’ work – Monday and Tuesday E3-19 b Dec 31 Salary Expense 3,000 Salary Payable 3,000 To record accrued salaries Salaries Expense Salaries Payable 12/31 3,000 12/31 3,000

  42. E3-19c How much of the supplies have been used up? We stared with $3,100 and ended up with $1,200. The rest was used up Dec 31 Supplies Expense 1,900 Supplies 1,900 To record supplies used Supplies Supplies Expense 3,100 12/31 1,900 12/31 1,900 Bal. 1,200

  43. E3-19d Dec 31 Depreciation Expense, Equipment 2,500 Accumulated Depreciation, Equipment 2,500 To record depreciation Accumulated Depreciation Depreciation Expense 12/31 2,500 12/31 2,500

  44. E3-19f Dec 31 Insurance Expense 200 Prepaid Insurance 200 To record insurance expired Prepaid Insurance Insurance Expense Bal 1,200 12/31 200 12/31 200 Bal. 1,000

  45. Objective 4 Prepare an adjusted trial balance

  46. S 3-10 400 200 17,000 4,000 500 1,000 200 23,300 a. 500 2,000 200 100 3,000 6,000 12,000 23,300 b. 1,000 c. 100 a. 500 b. 1,000 c. 100 1,600 1,600

  47. 400 200 17,000 4,000 500 1,000 200 23,300 2,000 200 100 3,000 6,000 12,000 23,300 S3-11 Net Income $6,300

  48. 400 200 17,000 4,000 500 1,000 200 23,300 2,000 200 100 3,000 6,000 12,000 23,300 S3-12 Total Assets = $15,600

  49. 400 200 17,000 4,000 500 1,000 200 23,300 2,000 200 100 3,000 6,000 12,000 23,300 Balance Sheet Accounts Income Statement Accounts

  50. Objective 5 Prepare the financial statements from the adjusted trial balance

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