PowerPoint Authors:

Susan Coomer Galbreath, Ph.D., CPA

Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Winston Kwok, Ph.D., CPA
McGraw-Hill/I rwin Copyright 2011 by The McGraw-Hill Companies, I nc. All rights reserved.
Chapter 3
ADJUSTING ACCOUNTS AND PREPARING
FINANCIAL STATEMENTS
3 - 2
THE ACCOUNTING PERIOD
C 1
3 - 3
ACCRUAL BASIS VERSUS 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 are recorded
when cash is paid.
C 2
3 - 4
Cash Basis
Revenues are
recognized when cash
is received and
expenses are recorded
when cash is paid.
ACCRUAL BASIS VERSUS CASH BASIS
Non-GAAP
C 2
Accrual Basis
Revenues are
recognized when
earned and expenses
are recognized when
incurred.
3 - 5
ACCRUAL BASIS VERSUS CASH BASIS
Example:
FastForward paid $2,400 for a 24-month insurance
policy beginning December 1, 2011.
On the cash basis, the entire $2,400 would be
recognized as insurance expense in 2011. No insurance
expense from this policy would be recognized in 2012
or 2013, periods covered by the policy.
Jan Feb Mar Apr
- $ - $ - $ - $
May Jun Jul Aug
- $ - $ - $ - $
Sep Oct Nov Dec
- $ - $ - $ 2,400 $
Insurance Expense 2009
C 2
3 - 6
ACCRUAL BASIS VERSUS CASH BASIS
Jan Feb Mar Apr
- $ - $ - $ - $
May Jun Jul Aug
- $ - $ - $ - $
Sep Oct Nov Dec
- $ - $ - $ 100 $
Jan Feb Mar Apr
100 $ 100 $ 100 $ 100 $
May Jun Jul Aug
100 $ 100 $ 100 $ 100 $
Sep Oct Nov Dec
100 $ 100 $ 100 $ 100 $
Jan Feb Mar Apr
100 $ 100 $ 100 $ 100 $
May Jun Jul Aug
100 $ 100 $ 100 $ 100 $
Sep Oct Nov Dec
100 $ 100 $ 100 $ - $
Insurance Expense 2009
Insurance Expense 2010
Insurance Expense 2011
On the accrual basis,
$100 of insurance
expense is recognized in
2011, $1,200 in 2012,
and $1,100 in 2013. The
expense is matched with
the periods benefited by
the insurance coverage.
C 2
3 - 7
We have delivered the
product to our customer,
so I think we should record
the revenue earned.
RECOGNIZING REVENUES & EXPENSES
Revenue Recognition Principle
C 2
3 - 8
RECOGNIZING REVENUES & EXPENSES
Revenue Recognition Principle
Matching Principle
Summary
of Expenses
Rent
Gasoline
Advertising
Salaries
Utilities
and . . . .
$1,000
500
2,000
3,000
450
. . . .
Now that we have
recognized the revenue,
lets see what expenses
we incurred to
generate that revenue.
C 2
3 - 9
An adjusting entry is recorded to bring an asset or
liability account balance to its proper amount.
ADJUSTING ACCOUNTS
Prepaid
(Deferred)
expenses*
Unearned
(Deferred)
revenues
Accrued
expense
Accrued
revenues
Framework for Adjustments
*including depreciation
Paid (or received) cash before
expense (or revenue) recognized
Paid (or received) cash after
expense (or revenue) recognized
Adjustments
C 3
3 - 10
Here is the check
for my 24-month
insurance policy.
PREPAID (DEFERRED) EXPENSES
Resources paid
for prior to
receiving the
actual benefits.
P 1
3 - 11
PREPAID INSURANCE
(a) On 12/1/11, FastForward paid $2,400 for insurance for
2-years (24-months, December 2011 through November
2013). FastForward recorded the expenditure as Prepaid
Insurance on 12/31/11.
What adjustment is required?
Dec. 31 Insurance Expense 100
Prepaid Insurance 100
To record first month's expired insurance
Dec. 1 2,400 Dec. 31 100
Bal. 2,300
Prepaid Insurance 637
Dec. 31 100
Insurance Expense
128
P 1
3 - 12
SUPPLIES
(b) During 2011, FastForward purchased $9,720 of supplies.
FastForward recorded the expenditures in the asset account,
Supplies. On December 31, 2011, a count of the supplies
indicated $8,670 on hand, so $1,050 of supplies were used
during December.
What adjustment is required?
Dec. 31 Supplies Expense 1,050
Supplies 1,050
To record supplies used during 2011
Bought 9,720 Dec. 31 1,050
Bal. 8,670
Supplies 126
Dec. 31 1,050
Supplies Expense
652
P 1
3 - 13
OTHER PREPAID EXPENSES
1. Other prepaid expenses, such as Prepaid Rent, are
accounted for exactly as Insurance and Supplies.
2. We should note that some prepaid expenses are both
paid for and fully used up within a single period.
3. For example, a company may pay monthly rent on the
first day of each month. This payment creates a prepaid
expense on the first day of the month that fully expires
by the end of the month.
4. In these special cases, we can record the cash paid with
a debit to the expense account instead of an asset
account.
P 1
3 - 14
Straight-Line
Depreciation
Expense
=
Asset Cost - Residual Value

Useful Life
DEPRECIATION
Depreciation is the process of allocating the
cost of a plant asset over its useful life in a
systematic and rational manner.
P 1
3 - 15
DEPRECIATION
On December 1, 2011, FastForward purchased
equipment for $26,000 cash. The equipment has
an estimated useful life of four years (48 months)
and FastForward expects to sell the equipment at
the end of its life for $8,000 cash.
(c) Lets record depreciation expense for the
month ended December 31, 2011.
Dec. 2011
Depreciation
Expense
=
$26,000 - $8,000

48 months
= $375 per month
P 1
3 - 16
Equipment Depreciation Expense
12/1 26,000 12/31 375
Accumulated Depreciation
12/31 375
Dec. 31 Depreciation Expense 375
Accumulated Depreciation - Equipment 375
To record monthly equipment depreciation
DEPRECIATION
P 1
Contra asset account
3 - 17
FastForward
Partial Balance Sheet
At December 31, 2011
Assets
Cash
.
Equipment 26,000 $
Less: accumulated deprec. (375) 25,625
.
.
Total Assets
Equipment is
shown net of
accumulated
depreciation.
$
DEPRECIATION
P 1
3 - 18
UNEARNED (DEFERRED)
REVENUES
We will apply this cash
you gave us towards
your total consulting fees.
Cash received in
advance of providing
products or services.
P 1
3 - 19
UNEARNED (DEFERRED)
REVENUES
On December 26, 2011, FastForward agrees to provide
consulting services to a client for a fixed fee of
$3,000 for 60 days. On this date, the client pays the
entire consulting fee in advance. FastForward makes
the following entry:
Dec. 26 Cash 3,000
Unearned Revenue 3,000
Consulting fees received in advance
Dec. 26 3,000
Unearned Revenue
P 1
3 - 20
UNEARNED (DEFERRED)
REVENUES
(d) On December 31, FastForward earns 5-days of
consulting fees. Each day that passes results in
consulting fees of $50 ($3,000 60), so
FastForward earned ($50 5 days) $250.
Dec. 31 Unearned Revenue 250
Consulting Revenue 250
To recognize 5-days of consulting fees
Dec 31 250 Dec 26 3,000
Bal 2,750
Unearned Revenue
Dec. 31 250
Consulting Revenue
P 1
3 - 21
Were about one-half
done with this job and
want to be paid for
our work!
Costs incurred in
a period that are
both unpaid and
unrecorded.
ACCRUED EXPENSES
P 1
3 - 22
FastForwards employee earns $70 per day and is paid
every two weeks on Friday. Year-end, 12/31/11, falls on a
Wednesday. The last payday of 2011, is Friday, 12/26/11.
From 12/26 until year-end is three working days. The
employee has earned salaries of $210 for Monday through
Wednesday. They will not be paid until the next Friday.
ACCRUED SALARIES EXPENSES
P 1
3 - 23
Dec. 31 Salaries Expense 210
Salaries Payable 210
To accrue 3 days' salary (3 x $70)
Dec.12 700
Dec.26 700
Dec. 31 210
Bal. 1,610
Salaries Expense
Dec. 31 210
Salaries Payable
(e) FastForwards employee has earned but not been paid
on December 31, 2011, $210.
P 1
ACCRUED SALARIES EXPENSES
3 - 24
FUTURE PAYMENT OF
ACCRUED EXPENSES
On January 9, 2012, FastForward will pay the payroll for
the two weeks from December 26, 2011 through January
9, 2012. Here is the journal entry for the payroll:
Jan 9 Salaries Payable (3 days @ $70) 210
Salaries Expense (7 days @ $70) 490
Cash (10 days @ $70) 700
P aid two-week salary
P 1
3 - 25
Dec. 31 Interest Expense 30
Interest Payable 30
To accrue interest ($6,000 6% 30/360)
Dec. 31 30
Interest Expense
Dec. 31 30
Interest Payable

ACCRUED INTEREST EXPENSES
FastForward borrowed $6,000 from First National Bank on
December 1, 2011. The note bears interest at the annual
rate of 6% and is due to be repaid in one year. Lets
accrue interest for the month ended 12/31/11.
P 1
3 - 26
Yes, Ive completed your
consulting job, but have not
had time to bill you yet.
ACCRUED REVENUES
Revenues earned
in a period that
are both
unrecorded and not
yet received.
P 1
3 - 27
ACCRUED SERVICE REVENUE
(f) On December 12, 2011, FastForward agrees to render
consulting services under a 30-day fixed fee contract for
$2,700 ($90 per day). All services are to be completed by
January 10, 2012, when the client will pay in full.
Dec. 31 Accounts Receivable 1,800
Consulting Revenue 1,800
To accrue revenue (20-days @ $90 per day)
Other receivables
1,900 Receipts 1,900
Dec. 31 1,800
Bal. 1,800
Accounts Receivable
Other revenues
6,050
Dec. 31 1,800
Bal . 7,850
Consulting Revenue
P 1
3 - 28
FUTURE RECEIPT OF
SERVICE REVENUES
On January 10, 2012, FastForward completed its
obligation under the consulting contract. The client was
billed $2,700 and FastForward received $2,700 in cash.
Jan 10 Cash 2,700
Accounts Receivable 1,800
Consulting Revenue 900
T o record completion of contract and cash collection
Revenue in January
10 days @ $90 = $900
P 1
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LINKS TO FINANCIAL STATEMENTS
A 1
3 - 30
FastForward - Trial Balance - December 31, 2011
First, the
initial
unadjusted
amounts are
added to the
worksheet.
P 2
Unadjusted
Trial Balance

Adjustments
Adjusted
Trial Balance
3 - 31
Next,
FastForwards
adjustments
are added.
P 2
FastForward - Trial Balance - December 31, 2011
Unadjusted
Trial Balance

Adjustments
Adjusted
Trial Balance
3 - 32
P 2
FastForward Adjusted Trial Balance - December 31, 2011
Finally, the
totals are
determined.
Unadjusted
Trial Balance

Adjustments
Adjusted
Trial Balance
3 - 33
PREPARING FINANCIAL STATEMENTS
Lets use FastForwards adjusted trial balance to
prepare the companys financial statements.
P 3
3 - 34
FastForward
Income Statement
For the Month Ended December 31, 2011
Revenues:
Consulting revenue 7,850 $
Rental revenue 300
Operating expenses:
Depr. expense - Equip. 375 $
Salaries expense 1,610
Insurance expense 100
Rent expense 1,000
Supplies expense 1,050
Utilities expense 230
Total expenses 4,365
Net income 3,785 $
Dr. Cr.
Cash 4,350 $
Accounts receivable 1,800
Supplies 8,670
Prepaid insurance 2,300
Equipment 26,000
Accum. depr. - Equip. 375 $
Accounts payable 6,200
Salaries payable 210
Unearned revenue 2,750
C. Taylor, Capital 30,000
C. Taylor, Withdrawals 200
Consulting revenue 7,850
Rental revenue 300
Depr. expense 375
Salaries expense 1,610
Insurance expense 100
Rent expense 1,000
Supplies expense 1,050
Utilities expense 230
Totals 47,685 $ 47,685 $
Adjusted
December 31, 2011
Trial Balance
P 3
1. PREPARE THE INCOME STATEMENT
3 - 35
Note: Net Income from the Income
Statement carries to the Statement of
Changes in Equity.
FastForward
Income Statement
For the Month Ended December 31, 2011
Revenues:
Consulting revenue 7,850 $
Rental revenue 300
Operating expenses:
Depr. expense - Equip. 375 $
Salaries expense 1,610
Insurance expense 100
Rent expense 1,000
Supplies expense 1,050
Utilities expense 230
Total expenses 4,365
Net income 3,785 $
FastForward
Statement of Changes in Equity
For the Month Ended December 31, 2011
C. Taylor, Capital 12/1/11 $ -0-
Add: Net income 3,785 $
Investment by owner 30,000 33,785
Total 33,785
Less: Withdrawal by owner 200
C. Taylor, Capital 12/31/11 33,585 $
P 3
2. PREPARE THE STATEMENT
OF CHANGES IN EQUITY
3 - 36
Dr. Cr.
Cash 4,350 $
Accounts receivable 1,800
Supplies 8,670
Prepaid insurance 2,300
Equipment 26,000
Accum. depr. - Equip. 375 $
Accounts payable 6,200
Salaries payable 210
Unearned revenue 2,750
C. Taylor, Capital 30,000
C. Taylor, Withdrawals 200
Adjusted
December 31, 2011
Trial Balance
3. PREPARE THE BALANCE SHEET
FastForward
Balance Sheet
Assets
Cash 4,350 $
Accounts Receivable 1,800
Supplies 8,670
Prepaid Insurance 2,300
Equipment 26,000 $
Accumulated Depreciation 375 25,625
Total assets 42,745 $
Liabilities
Accounts Payable 6,200
Salaries Payable 210
Unearned Revenue 2,750
Total Liabilities 9,160
Equity
C Taylor, Capital 33,585
Total liabilities and Equity 42,745 $
12/31/11
FastForward
Statement of Changes in Equity
For the Month Ended December 31, 2011
C. Taylor, Capital 12/1/11 $ -0-
Add: Net income 3,785 $
Investment by owner 30,000 33,785
Total 33,785
Less: Withdrawal by owner 200
C. Taylor, Capital 12/31/11 33,585 $
P 3
3 - 37
PROFIT MARGIN
The profit margin ratio measures the companys
net income to net sales.
Profit
Margin
Net Income
Net Sales
=
$ in millions 2009 2008 2007 2006
Net income $ 220 $ 718 $ 676 $ 683
Net sales 9,043

10,134

10,671 9,699
Profit margin 2.4% 7.1% 6.3% 7.0%
Industry profit margin 0.3% 1.1% 1.6% 1.5%
A 2
Limited Brands, Inc.
3 - 38
APPENDIX 3A: ALTERNATIVE
ACCOUNTING FOR PREPAYMENTS
P4
An alternative method is to record all prepaid expenses
with debits to expense accounts.
The adjusting entry depends on how the original payment
was recorded.
3 - 39
END OF CHAPTER 3