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STUDY OBJECTIVES After studying this chapter, you should understand:

ACCRUALS AND DEFERRALS. STUDY OBJECTIVES After studying this chapter, you should understand:. STUDY OBJECTIVE 1 TIME PERIOD ASSUMPTION. The time period assumption assumes that the economic life of a business can be divided into artificial time periods.

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STUDY OBJECTIVES After studying this chapter, you should understand:

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  1. ACCRUALS AND DEFERRALS STUDY OBJECTIVES After studying this chapter, you should understand:

  2. STUDY OBJECTIVE 1 TIME PERIOD ASSUMPTION • Thetime period assumptionassumes that the economic life of a business can be divided into artificial time periods. • Accounting time periods are generally a month, a quarter, or a year (fiscal year)

  3. STUDY OBJECTIVE 2 ACCRUAL vs. CASH-BASIS ACCOUNTING Accrual Basis Revenue recognized when earned Expenses are matched against revenues Required by GAAP Cash-Basis Revenues and expenses recorded when cash is paid or received Not GAAP

  4. REVENUE RECOGNITION PRINCIPLE • The revenue recognition principledictates that revenue be recognized in the accounting period in which it is earned. • In a service business, revenue is considered to be earned when the service is performed.

  5. MATCHING PRINCIPLE • The practice of expense recognition is referred to as thematching principle. • Thematching principledictates that efforts (expenses) be matched with accomplishments (revenues). Revenues earned this month expenses incurred in earning the revenue are offset against....

  6. Time-Period Assumption Economic life of business can be divided into artificial time periods Revenue-Recognition Principle Matching Principle Revenue recognized in the accounting period in which it is earned Expenses matched with revenues in the same period when efforts are expended to generate revenues GAAP RELATIONSHIPS IN REVENUE & EXPENSE RECOGNITION

  7. STUDY OBJECTIVE 3 WHY ADJUSTING ENTRIES ARE NECESSARY Adjusting entriesare needed to ensure that revenue recognition and matching principles are followed 1 Revenues are recorded in the period earned, and...... 2 Expenses are recognized in the period incurred.

  8. STUDY OBJECTIVE 4 TYPES OF ADJUSTING ENTRIES Adjusting entries are required each time financial statements are prepared. Two main categories of adjustments are: PREPAYMENTS ACCRUALS

  9. ADJUSTING ENTRIES: PREPAYMENTS Prepaid Expenses Expenses are paid and recorded as assets before they are used or consumed Example: Prepaid Insurance Unearned Revenues Cash received and recorded as liabilities before revenue is earned Example: Cash received for services provided in future

  10. ADJUSTING ENTRIES: ACCRUALS Accrued Revenues Revenues earned but Not yet received In cash or recorded Example: Sales of merchandise On account Accrued Expenses Expenses incurred but not yet paid in cash or recorded Example: Utilities used but not yet paid for

  11. PIONEER ADVERTISING AGENCY Trial Balance October 31, 2006 Debit Credit Cash $ 15,200 Advertising Supplies 2,500 Prepaid Insurance 600 Office Equipment 5,000 Notes Payable $ 5,000 Accounts Payable 2,500 Unearned Revenue 1,200 Common Stock 10,000 Retained Earnings 0 Dividends 500 Service Revenue 10,000 Salaries Expense 4,000 Rent Expense 900 $ 28,700 TRIAL BALANCE The Trial Balance is the starting place for adjusting entries. $ 28,700

  12. STUDY OBJECTIVE 5 ADJUSTING ENTRIES FOR PREPAYMENTS Adjusting entries for prepayments are required to record the portion of the prepayment representing: 1 the expense incurred,or 2 the revenue earnedin the current period.

  13. Adjusting Entries Asset Expense Unadjusted Balance Credit Adjusting Entry (-) Debit Adjusting Entry (+) Liability Revenue Debit Adjusting Entry (-) Unadjusted Balance Credit Adjusting Entry (+) ADJUSTING ENTRIES FOR PREPAYMENTS Prepaid Expenses Unearned Revenues

  14. ADJUSTING ENTRIES FOR PREPAYMENTS SUPPLIES October 31, an inventory count reveals that $1,000 of $2,500 of supplies are still on hand. ADJUSTMENT JOURNAL ENTRY Date Account Titles and Explanation Debit Credit Oct. 31 Advertising Supplies Expense 1,500 Advertising Supplies 1,500 (To record supplies used) POSTING Advertising Supplies Advertising Supplies Expense Oct. 5 2,500 Oct. 31 1,500 Oct. 31 1,500 31 1,000

  15. ADJUSTING ENTRIES FOR PREPAYMENTS INSURANCE October 31, an analysis of the policy reveals that $50 of insurance expires each month. ADJUSTMENT JOURNAL ENTRY Date Account Titles and Explanation Debit Credit Oct. 31 Insurance Expense 50 Prepaid Insurance 50 (To record insurance expired) POSTING Prepaid Insurance 10 Insurance Expense 63 Oct. 4 600 Oct. 31 50 Oct. 31 50 31 550

  16. REVIEW QUESTION ADJUSTING ENTRY-SUPPLIES The trial balance shows supplies of $1,350 and supplies expense of $0. If $750 of supplies are on hand at the end of the period, what is the adjusting entry? Account Debit Credit Supplies Expense $600 Supplies $600 The balance in supplies after adjustment is $750, the amount remaining unused. The amount used is transferred to expense.

  17. ADJUSTING ENTRIES FOR PREPAYMENTS DEPRECIATION • Depreciation is the allocation of the cost of an asset to expense over its useful life. • Depreciation is an estimate of expired cost. • Depreciation Expense is debited and a contra-assetaccount, Accumulated Depreciation, is credited • Cost – accumulated depreciation = Book value Accumulated Depreciation Depreciation Expense XXX XXX

  18. ADJUSTING ENTRIES FOR PREPAYMENTS DEPRECIATION October 31, depreciation on the office equipment is estimated to be $480 a year, or $40 per month. ADJUSTMENT JOURNAL ENTRY Date Account Titles and Explanation Debit Credit Oct. 31 Depreciation Expense 40 Accumulated Depreciation - Office Equipment 40 (To record monthly depreciation) POSTING Accumulated Depreciation - Depreciation Expense Office Equipment Oct. 31 40 Oct. 31 40

  19. ADJUSTING ENTRIES FOR PREPAYMENTS UNEARNED REVENUES October 31, analysis reveals that, of $1,200 in fees received in advance of performance, $400 has been earned in October. ADJUSTMENT JOURNAL ENTRY Date Account Titles and Explanation Debit Credit Oct. 31 Unearned Revenue 400 Service Revenue 400 (To record revenue for services provided) POSTING Service Revenue Unearned Revenue Oct. 31 400 Oct. 2 1,200 Oct. 31 10,000 31 800 31 400

  20. STUDY OBJECTIVE 6 ADJUSTING ENTRIES FOR ACCRUALS • Adjusting entries for accruals are required to record revenues earned and expenses incurred in the current period. • The adjusting entry for accruals will increase both a balance sheet and an income statement account.

  21. Adjusting Entries Asset Revenue Debit Adjusting Entry (+) Credit Adjusting Entry (+) Expense Liability Debit Adjusting Entry (+) Credit Adjusting Entry (+) ADJUSTING ENTRIES FOR ACCRUALS Accrued Revenues Accrued Expenses

  22. ADJUSTING ENTRIES FOR ACCRUALS ACCRUED REVENUE October 31, the agency earned $200 for advertising services that were not billed to clients before October 31. ADJUSTMENT JOURNAL ENTRY Date Account Titles and Explanation Debit Credit Oct. 31 Accounts Receivable 200 Service Revenue 200 (To accrue revenue for services provided) POSTING Accounts Receivable Service Revenue Oct. 31 200 Oct. 31 10,000 31 400 31 200 31 10,600

  23. ADJUSTING ENTRIES FOR ACCRUALS ACCRUED INTEREST October 31, the portion of the interest to be accrued on a 3-month note payable is calculated to be $50. ADJUSTMENT JOURNAL ENTRY Date Account Titles and Explanation Debit Credit Oct. 31 Interest Expense 50 Interest Payable 50 (To accrue interest on notes payable) POSTING Interest Expense Interest Payable Oct. 31 50 Oct. 31 50

  24. ADJUSTING ENTRIES FOR ACCRUALS ACCRUED SALARIES October 31, accrued salaries are calculated to be $1,200. ADJUSTMENT JOURNAL ENTRY Date Account Titles and Explanation Debit Credit Oct. 31 Salaries Expense 1,200 Salaries Payable 1,200 (To record accrued salaries) POSTING Salaries Expense Salaries Payable Oct. 31 1,200 Oct. 26 4,000 31 1,200 31 5,200

  25. REVIEW QUESTION ADJUSTING ENTRY-SALARIES Kathy Siska earned a salary of $400 for the last week of September. She will be paid on October 1. What is the required adjusting entry? Account Debit Credit Salaries Expense $400 Salaries Payable $400 This entry recognizes an expense for the salary earned by Kathy in the last week of September, and a liability for the amount due to Kathy at September 30th.

  26. STUDY OBJECTIVE 7 ADJUSTED TRIAL BALANCE • An Adjusted Trial Balanceis prepared after all adjusting entries have been journalized and posted. • Its purpose is to prove 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.

  27. PIONEER ADVERTISING AGENCY Adjusted Trial Balance October 31, 2006 Debit Credit Cash $ 15,200 Accounts Receivable 200 Advertising Supplies 1,000 Prepaid Insurance 550 Office Equipment 5,000 Accumulated Depreciation - Office Equpment $ 40 Notes Payable 5,000 Accounts Payable 2,500 Interest Payable 50 Unearned Revenue 800 Salaries Payable 1,200 Common Stock 10,000 Retained Earnings 0 Dividends 500 PREPARING THE INCOME STATEMENT FROM THE ADJUSTED TRIAL BALANCE INCOME STATEMENT ACCOUNTS Service Revenue 10,600 Salaries Expense 5,200 Ad vertising Supplies Expense 1,500 Rent Expense 900 Insurance Expense 50 Interest Expense 50 Depreciation Expense 40 $ 30,190 $ 30,190

  28. INCOME STATEMENT The income statement is prepared from the revenue and expense accounts. PIONEER ADVERTISING AGENCY Income Statement For the Month Ended October 31, 200 6 Revenues Fees earned $ 10,600 Expenses Salaries expense $ 5,200 Advertising supplies expense 1,500 Rent expense 900 Insurance expense 50 Interest expense 50 Depreciation expense 40 Total expenses 7,740 Net income $ 2,860

  29. PIONEER ADVERTISING AGENCY Adjusted Trial Balance October 31, 2006 Debit Credit Cash $ 15,200 Accounts Receivable 200 Advertising Supplies 1,000 Prepaid Insurance 550 Office Equipment 5,000 Accumulated Depreciation - Office Equpt. $ 40 Notes Payable 5,000 Accounts Payable 2,500 Interest Payable 50 Unearned Revenue 800 Salaries Payable 1,200 C.ommon Stock 10,000 Retained Earnings 0 Dividends 500 PREPARING THE RETAINED EARNINGS STATEMENT FROM THE ADJUSTED TRIAL BALANCE BALANCE SHEET ACCOUNTS RETAINED EARNINGS STATEMENT ACCOUNTS Service Revenue 10,600 Salaries Expense 5,200 A dvertising Supplies Expense 1,500 Rent Expense 900 Insurance Expense 50 Interest Expense 50 Depreciation Expense 40 $ 30,190 $ 30,190

  30. PIONEER ADVERTISING AGENCY Retained Earnings Statement For the Month Ended October 31, 2006 Retained earnings, October 1 $ - 0 - Add: Net income 2,860 2,860 2,860 Less: Dividends 500 Retained earnings, October 31 $ 2,360 RETAINED EARNINGS STATEMENT The retained earnings statement is prepared from the revenue, expense, dividends, and retained earnings accounts.

  31. PIONEER ADVERTISING AGENCY Balance Sheet October 31, 2006 Assets Liabilities and Stockholders’ Equity Cash $ 15,200 Liabilities Accounts receivable 200 Notes payable $ 5,000 Advertising supplies 1,000 Accounts payable 2,500 Prepaid insurance 550 Interest payable 50 Office equipment $ 5,000 Unearned fees 800 Less: Accumulated Salaries payable 1,200 depreciation 40 4,960 Total liabilities 9,550 BALANCE SHEET The balance sheet is prepared from asset and liability and stockholders equity accounts. Stockholders’ Equity Common Stock 10,000 Retained Earnings 2,360 Total liabilities and owner’s Total assets $ 21,910 equity $ 21,910

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