Adjustments, Financial

Statements, and the Quality of

Earnings
Chapter 4

McGraw-Hill/Irwin

2009 The McGraw-Hill Companies, Inc.

Accounting Cycle
Start of Period

During
During the
the period:
period:

Analyze
Analyze transactions.
transactions.

Record
Record journal
journal entries.
entries.

Post
Post amounts
amounts to
to general
general
ledger.
ledger.

At
At the
the end
end of
of the
the period:
period:

Adjust
Adjust revenues
revenues and
and
expenses.
expenses.

Close
Close revenues,
revenues,
gains,
gains, expenses,
expenses, and
and
losses
losses to
to Retained
Retained
Earnings.
Earnings.

Prepare
Prepare financial
financial
statements.
statements.
Disseminate
Disseminate
statements
statements to
to
users.
users.

Types of Adjustments
There are four types of adjustments.
Revenues
Revenues
1.
1. Unearned
Unearned
Revenues.
Revenues.

Expenses
Expenses
3.
3. Prepaid
Prepaid
Expenses.
Expenses.

2.
2. Accrued
Accrued
Revenues.
Revenues.

4.
4. Accrued
Accrued
Expenses.
Expenses.

McGraw-Hill/Irwin

Slide 3

Unearned Revenues
End of
accounting period.

Cash received.

Revenues earned.

Example
Example includes
includes rent
rent received
received in
in
advance
advance (an
(an unearned
unearned revenue).
revenue).

McGraw-Hill/Irwin

Slide 4

Accrued Revenue
End of
accounting period.

Revenues earned

Cash received

Example
Example includes
includes interest
interest earned
earned
during
during the
the period
period (accrued
(accrued revenue).
revenue).

McGraw-Hill/Irwin

Slide 5

Prepaid Expenses
End of
accounting period.

Cash paid.

Expense incurred.

Examples
Examples include
include prepaid
prepaid rent,
rent,
advertising,
advertising, and
and insurance.
insurance.

McGraw-Hill/Irwin

Slide 6

Accrued Expenses
As of 12/27/09, Denton, Inc. had already paid
$1,900,000 in wages for the year. Denton pays its
employees every Friday. Year-end, 12/31/09, falls on a
Wednesday. The employees have earned total wages of
$50,000 for Monday through Wednesday of the week
ending 1/02/10.

McGraw-Hill/Irwin

Slide 7

Accrued Expenses Involving Estimates

Certain
Certain circumstances
circumstances require
require

adjusting
adjusting entries
entries to
to record
record
accounting
accounting estimates.
estimates.

Examples
Examples include
include .. .. ..

Depreciation
Depreciation

Bad
Bad debts
debts

Income
Income taxes
taxes

The
The income
income
statement
statement
contains
contains
revenues
revenues and
and
expenses.
expenses.
Earnings
Earnings Per
Per
Share
Share (EPS)
(EPS) must
must
be
be reported
reported on
on
the
the income
income
statement.
statement.

Statement of Stockholders Equity

Net income appears on the statement of stockholders
equity as an increase in Retained Earnings.

From the
Income
Statement

McGraw-Hill/Irwin

Slide 10

Balance Sheet Liabilities &

Stockholders Equity
From
From the
the
Statement
Statement of
of
Stockholders
Stockholders
Equity.
Equity.

McGraw-Hill/Irwin

Slide 11

Closing the Books

Closing
entries:
Closing
entries:
Even though the
1.
Transfer
net
income
(or
1.
Transfer
net
income
(or
balance sheet
loss)
loss) to
to Retained
Retained
account balances
Earnings.
Earnings.
carry forward from
2.
2. Establish
Establish aa zero
zero balance
balance
period to period,
in
in each
each of
of the
the
the income
temporary
temporary accounts
accounts to
to
statement accounts
start
start the
the next
next accounting
accounting
do not.
period.
period.

McGraw-Hill/Irwin

Slide 12

Closing the Books

Two steps are used in the

closing process . . .
1. Close revenues and gains
to Retained Earnings.
2. Close expenses and losses
to Retained Earnings.

McGraw-Hill/Irwin

Slide 13

Post-Closing Trial Balance

After all temporary accounts have been closed, we
prepare a post-closing trial balance. Only assets,
liabilities, and stockholders equity accounts will appear. All
revenue, expense, gain and loss accounts will have a zero
balance.

McGraw-Hill/Irwin

Slide 14

End of Chapter 4

2008 The McGraw-Hill Companies, Inc.