Accrual Accounting and Financial Statements

1. 4 Accrual Accounting and Financial Statements

2. Annual 1 2 Semiannual 1 2 3 4 Quarter 1 2 3 4 5 6 7 8 9 10 11 12 Month Exh. 4.1 The Accounting Period

3. Transactions and Events Exchanges of economic consideration between two parties. External Transactions occur between the organization and an outside party. Internal Transactions occur within the organization.

4. Recognizing Revenues and Expenses • Revenue Recognition We have delivered the product to our customer, so I think we should record the revenue earned.

5. Summary of Expenses Rent Gasoline Advertising Salaries Utilities and . . . . $1,000 500 2,000 3,000 450 . . . . Recognizing Revenues and Expenses • Revenue Recognition • Matching Now that we have recognized the revenue, let’s see what expenses we incurred to generate that revenue.

6. Not GAAP Accounting 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.

7. Exh. 4.4 Adjusting Accounts An adjusting entry is recorded to bring an asset or liability account balance to its proper amount. Transactions where cash is paid or received beforea related expense or revenue is recognized. Transactions where cash is paid or received after a related expense or revenue is recognized.

8. Expense Asset Unadjusted Balance Credit Adjustment Debit Adjustment Adjusting Prepaid Expenses Here is the check for my first 6 months’ rent. Resources paid for prior to receiving the actual benefits.

9. Adjusting Prepaid Expenses On December 1, 2001, Scott Company paid $12,000 to cover rent for December 2001 through May 2002. Let’s look at the adjusting journal entry needed on December 31, 2001.

10. Prepaid Rent Rent Expense 12/1 $12,000 12/31 $2,000 12/31 $2,000 Adjusting Prepaid Expenses After posting, the accounts involved look like this:

11. Straight-Line Depreciation Expense Asset Cost - Salvage Value Useful Life = Adjusting for Depreciation Depreciation is the process of computing expense from allocating the cost of plant and equipment over their expected useful lives.

12. 2002 Depreciation Expense $62,000 - $2,000 5 = = $12,000 Adjusting for Depreciation On January 1, 2002, Monroe, Inc. purchased oil pumping equipment for $62,000 cash. The equipment has an estimated useful life of 5 years and Monroe expects to sell the equipment at the end of its life for $2,000 cash. Let’s record depreciation expense for the year ended December 31, 2002.

13. Adjusting for Depreciation On January 1, 2002, Monroe, Inc. purchased oil pumping equipment for $62,000 cash. The equipment has an estimated useful life of 5 years and Monroe expects to sell the equipment at the end of its life for $2,000 cash. Prepare the Journal Entry Accumulated depreciation is a contra asset account.

14. Equipment Depreciation Expense 1/1 $62,000 12/31 $12,000 Accumulated Depreciation 12/31 $12,000 Adjusting for Depreciation After posting, the accounts involved look like this:

15. Adjusting for Depreciation The equipment account is shown on the balance sheet like this.

16. Buy your season tickets for all home basketball games NOW! “Go Big Blue” Revenue Liability Debit Adjustment Unadjusted Balance Credit Adjustment Adjusting Unearned Revenue Cash received in advance of providing products or services.

17. Adjusting Unearned Revenue On October 1, 2002, Ox University sold 1,000 season tickets to its 20 home basketball games for $100 each. OxU makes the following entry:

18. Prepare the appropriate Adjusting Entry on December 31 Adjusting Unearned Revenue On December 31, OxU has played 10 of its regular home games, winning 2 and losing 8.

19. Adjusting Unearned Revenue On December 31, OxU has played 10 of its regular home games, winning 2 and losing 8.

20. Unearned BasketballRevenue Basketball Revenue 12/31 $50,000 10/1 $100,000 12/31 $50,000 Adjusting Unearned Revenue After posting, the accounts involvedwill look like this . . .

21. Liability Expense Debit Adjustment Credit Adjustment Adjusting for Accrued Expenses We’re about one-half done with this job and want to be paid! Costs incurred in a period that are both unpaid and unrecorded.

22. Last pay date 12/26/02 Next pay date 1/2/03 12/1/02 12/31/02 Year end Adjusting for Accrued Expenses Denton, Inc. pays its employees every Friday. Year-end, 12/31/02, falls on a Wednesday. As of 12/31/02, the employees have earned salaries of $47,250 for Monday through Wednesday of the week ended 1/02/03. Record adjusting journal entry.

23. Prepare the appropriate Adjusting Entry on December 31 Adjusting for Accrued Expenses Denton, Inc. pays its employees every Friday. Year-end, 12/31/02, falls on a Wednesday. As of 12/31/02, the employees have earned salaries of $47,250 for Monday through Wednesday of the week ended 1/02/03.

24. Adjusting for Accrued Expenses Denton, Inc. pays its employees every Friday. Year-end, 12/31/02, falls on a Wednesday. As of 12/31/02, the employees have earned salaries of $47,250 for Monday through Wednesday of the week ended 1/02/03.

25. Salaries Expense Salaries Payable 12/31 $47,250 12/31 $47,250 Adjusting for Accrued Expenses After posting, the accounts involvedwill look like this . . .

26. Revenue Asset Debit Adjustment Credit Adjustment Adjusting for Accrued Revenues Yes, you can pay me for your tax return when I finish the work. Revenues earned in a period that are both unrecorded and not yet received.

27. Prepare the appropriate Adjusting Entry on December 31 Adjusting for Accrued Revenues Smith & Jones, CPAs, had $31,200 of work completed but not yet billed to clients. Let’s make the adjusting entry necessary on December 31, 2002, the end of the company’s fiscal year.

28. Adjusting for Accrued Revenues Smith & Jones, CPAs, had $31,200 of work completed but not yet billed to clients. Let’s make the adjusting entry necessary on December 31, 2002, the end of the company’s fiscal year.

29. Accounts Receivable Service Revenue 12/31 $31,200 12/31 $31,200 Adjusting for Accrued Revenues

30. Exh. 4.18 Adjustments and Financial Statements Four major types of transactions requiring adjustment.

31. FastForwardTrial Balance December 31, 2001 Exh. 4.20 First, the initial unadjusted amounts are added to the worksheet.

32. FastForwardTrial Balance December 31, 2001 Exh. 4.20 Next, FastForward’s adjustments are added.

33. FastForwardTrial Balance December 31, 2001 Exh. 4.20 Finally, the totals are determined.

34. Preparing Financial Statements Let’s use FastForward’s adjusted trial balance to prepare the company’s financial statements.

35. Exh. 4.21 Step One: Prepare the Income Statement.

36. Exh. 4.21 Step Two: Prepare the Statement of Changes in Owner’s Equity. Note that the Net Income from the Income Statement carries to the Statement of Changes in Owner’s Equity.

37. Exh. 4.22 Step Three: Prepare the Balance Sheet.

38. Accrual Adjustments in Later Periods Accrued revenues at the end of one accounting period often result in cash receipts from customers in the next period. Here is the money I owe you for completing my tax return. Make sure your books show that I paid you.

39. Accrual Adjustments in Later Periods Here is the 2002 adjusting entry we made for Smith & Jones, CPAs, to record revenue earned by not yet received. In 2003, we collect the cash from our customers.

40. The profit margin ratio measures the company’s net income to sales. Profit Margin Net Income Revenues = Using the InformationProfit Margin

41. End of Chapter 4