You are on page 1of 49

Financial and Managerial

Accounting

John J. Wild
Third Edition
McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

Chapter 3
Adjusting Accounts and
Preparing Financial
Statements

Conceptual Chapter Objectives


C1: Explain the importance of periodic
reporting and the time period
principle.
C2: Explain accrual accounting and how
it improves financial statements.
C3: Identify steps in the accounting cycle.
C4: Explain and prepare a classified
balance sheet.
3-3

Analytical Chapter Objectives


A1: Explain how accounting adjustments
link to financial statements.
A2: Compute profit margin and describe
its use in analyzing company
performance.
A3: Compute the current ratio and
describe what it reveals about a
companys financial condition.
3-4

Procedural Chapter Objectives


P1: Prepare and explain adjusting entries.
P2: Explain and prepare an adjusted trial
balance.
P3: Prepare financial statements from an
adjusted trial balance.
P4: Describe and prepare closing entries.
P5: Explain and prepare a post-closing trial
balance.
3-5

Procedural Chapter Objectives


(Continued)
P6: Appendix 3A: Explain the
alternatives in accounting for
prepaids.
P7: Appendix 3B: Prepare a work sheet
and explain its usefulness.

3-6

C1

The Accounting Period


Annually
1

Semiannually
1

Quarterly
1

Jan

Feb

Mar

Apr

May Jun Jul

10

Aug Sep Oct

Monthly

11

12

Nov Dec

3-7

C1

Accrual Basis vs. Cash Basis


Accrual Basis

Cash Basis

Revenues are
recognized when
earned and expenses
are recognized when
incurred.

Revenues are
recognized when
cash is received and
expenses recorded
when cash is paid.

Accounting

Not GAAP

3-8

C1

Accrual Basis vs. Cash Basis

On the cash basis the entire $2,400 would be


recognized as insurance expense in 2009. No insurance
expense from this policy would be recognized in 2010 or
2011, periods covered by the policy.

3-9

C2

Accrual Basis vs. Cash Basis


On the accrual basis
$100 of insurance
expense is recognized in
2009, $1,200 in 2010,
and $1,100 in 2011. The
expense is matched with
the periods benefited by
the insurance coverage.

3-10

C2, P1

Adjusting Accounts
An adjusting entry is recorded to bring an asset or
liability account balance to its proper amount.

Framework for Adjustments


Adjustments
Paid
Paid (or
(or received)
received) cash
cash before
before
expense
expense (or
(or revenue)
revenue) recognized
recognized

Prepaid
Unearned
Prepaid
Unearned
(Deferred)
(Deferred)
(Deferred)
(Deferred)
expenses*
revenues
expenses*
revenues
*including depreciation

Paid
Paid (or
(or received)
received) cash
cash after
after
expense
expense (or
(or revenue)
revenue) recognized
recognized

Accrued
Accrued
expenses
expenses

Accrued
Accrued
revenues
revenues

3-11

P1

Prepaid (Deferred) Expenses


Resources paid
for prior to
receiving the
actual benefits.
Asset
Unadjusted
Balance

Credit
Adjustment

Here is the check


for my first
6 months insurance.

Expense
Debit
Adjustment

3-12

P1

Supplies
During 2009, Scott Company purchased $15,500 of
supplies. Scott recorded the expenditures as
Supplies. On December 31, a count of the supplies
indicated $2,655 on hand.
What adjustment is required?

126

652

3-13

P1

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

3-14

P1

Depreciation
On January 1, 2009, Barton, Inc. purchased
equipment for $62,000 cash. The equipment
has an estimated useful life of 5 years and
Barton expects to sell the equipment at the end
of its life for $2,000 cash.
Lets record depreciation expense for the year
ended December 31, 2009.
2009
$62,000 - $2,000
Depreciation =
=
Expense
5

$12,000
3-15

P1

Depreciation
On January 1, 2009, Barton, Inc. purchased
equipment for $62,000 cash. The equipment
has an estimated useful life of 5 years and
Barton expects to sell the equipment at the end
of its life for $2,000 cash.
Lets record depreciation expense for the year
ended December 31, 2009.

Accumulated
Accumulated depreciation
depreciation is
is
aa contra
contra asset
asset account.
account.

3-16

P1

Depreciation

Equipment is
shown net of
accumulated
depreciation.
This amount is
referred to as the
assets book
value

3-17

P1

Unearned (Deferred) Revenues


Cash
Cash received
received in
in
advance
advance of
of
providing
providing
products
products or
or
services.
services.

Liability
Debit
Adjustment

Unadjusted
Balance

Buy your season tickets for


all home basketball games NOW!

Go Big Blue

Revenue
Credit
Adjustment

3-18

P1

Unearned (Deferred) Revenues


On October 1, 2009, Ox University sold 1,000
season tickets to its 20 home basketball games for
$100 each. Ox University makes the following entry:

3-19

P1

Unearned (Deferred) Revenues


On December 31, Ox University has played 10 of
its regular home games, winning 2 and losing 8.

3-20

Accrued Expenses

P1

Costs
Costs incurred
incurred in
in aa
period
period that
that are
are
both
both unpaid
unpaid and
and
unrecorded.
unrecorded.

Expense
Debit
Adjustment

Were about one-half


done with this job and
want to be paid for
our work!

Liability
Credit
Adjustment

3-21

Accrued Expenses

P1

Barton,
Barton, Inc.
Inc. pays
pays its
its employees
employees every
every Friday.
Friday. Year-end,
Year-end,
12/31/09,
12/31/09, falls
falls on
on aa Wednesday.
Wednesday. As
As of
of 12/31/09,
12/31/09, the
the
employees
employees have
have earned
earned salaries
salaries of
of $47,250
$47,250 for
for Monday
Monday
through
through Wednesday.
Wednesday.

Last pay
date
12/26/09
12/1/09

Next pay
date

12/31/09
Year end

Record
Record adjusting
adjusting
journal
journal entry.
entry.
3-22

P1

Accrued Expenses
Barton,
Barton, Inc.
Inc. pays
pays its
its employees
employees every
every Friday.
Friday. Year-end,
Year-end,
12/31/09,
12/31/09, falls
falls on
on aa Wednesday.
Wednesday. As
As of
of 12/31/09,
12/31/09, the
the
employees
employees have
have earned
earned salaries
salaries of
of $47,250
$47,250 for
for Monday
Monday
through
through Wednesday.
Wednesday.

3-23

P1

Accrued Revenues
Smith
Smith &
& Jones,
Jones, CPAs,
CPAs, had
had $31,200
$31,200 of
of work
work
completed
completed but
but not
not yet
yet billed
billed to
to clients.
clients. Lets
Lets make
make
the
the adjusting
adjusting entry
entry necessary
necessary on
on December
December 31,
31, 2009,
2009,
the
the end
end of
of the
the companys
companys fiscal
fiscal year.
year.

3-24

A1

Links to Financial Statements

3-25

P2

FastForward - Trial Balance December 31, 2009

First, the
initial
unadjusted
amounts are
added to the
work sheet.

3-26

P2

FastForward - Recording Adjustments


Trial Balance - December 31, 2009

Next,
FastForwards
adjustments
are added.

3-27

P2

FastForward Computing the Adjusted


Trial Balance - December 31, 2009

Finally, the
totals are
determined.

3-28

P3

1. Prepare the Income


Statement

3-29

P3

2. Prepare Statement of Retained


Earnings
Note: Net Income from the Income
Statement carries to the Statement
of Retained Earnings.

3-30

P3

3. Prepare Balance Sheet

3-31

C3

The Closing Process: Temporary and


Permanent Accounts
Temporary (nominal) accounts accumulate data related to
one accounting period. They include all income statement
accounts, the dividends account, and the Income Summary
account. These accounts are closed at the end of the period
to get ready for the next accounting period.

Permanent (real) accounts report activities related to one or


more future accounting periods. They carry ending balances
to the next accounting period and are not closed.
3-32

P4

Recording Closing Entries


1.
2.
3.
4.

Close revenue accounts.


Close expense accounts.
Close the income summary account.
Close dividends account.

3-33

P4

Recording Closing Entries


Salaries Expenses
$ 18,100

Consulting Revenues

Examine the
accounts
presented.

Income Summary

$ 25,000

Retained Earnings
$ 7,000

3-34

P4

Recording Closing Entries


Salaries Expenses

Consulting Revenues
$ 25,000

$ 18,100

Income Summary
$ 25,000

$ 25,000

Close revenues
with a debit to the
revenue account
and a credit to
Income Summary.
3-35

P4

Recording Closing Entries


Salaries Expenses
$ 18,100

$ 18,100

Income Summary
$ 18,100

$ 25,000

Consulting Revenues
$ 25,000

$ 25,000

Close expense
accounts with a
credit to expenses
and a debit to
Income Summary.
3-36

P4

Recording Closing Entries


Salaries Expenses
$ 18,100

$ 18,100

Income Summary
$ 18,100

$ 25,000
$ 6,900

Consulting Revenues
$ 25,000

$ 25,000

Determine the
balance in the
Income Summary
account.
3-37

P4

Recording Closing Entries


Salaries Expenses
$ 18,100

$ 18,100

Income Summary
$ 18,100
$ 6,900

$ 25,000
$ 6,900

Close the Income


Summary to
Retained Earnings.
Retained Earnings
$ 7,000
$ 6,900

3-38

P4

Recording Closing Entries


The dividends account is closed to
Retained Earnings.
Dividends
$ 2,000

$ 2,000

Retained Earnings
$ 2,000

$ 7,000
6,900

3-39

P4

Recording Closing Entries


The dividends account is closed to
Retained Earnings.
Dividends
$ 2,000

$ 2,000

Retained Earnings
$ 2,000

Determine the ending


balance in Retained
Earnings.

$ 7,000
6,900
$ 11,900

3-40

Post Closing Trial Balance

P5

Trial Balance prepared after the


closing entries have been posted.
The purpose is to insure that all
nominal or temporary accounts have
been closed.
The only accounts on this trial balance
should be assets, liabilities, and equity
accounts.
3-41

The Accounting Cycle

C3

Start

Reverse
(optional)

Analyze
transactions

Prepare
post-closing
trial balance
Close

Journalize
Post

Prepare
statements

Prepare
unadjusted
trial balance

Prepare
adjusted
trial balance

Adjust

3-42

C4

Classified Balance Sheet

Current items are those expected to come due


(either collected or owed) within one year or the
companys operating cycle, whichever is longer.

3-43

C4

Classified Balance Sheet


Plant Assets
Plant assets are tangible assets that are both
long lived and used to produce or sell products
or services. Examples include equipment,
machinery, buildings, and land that are used to
produce or sell products and services.

Intangible Assets
Long-term resources that benefit business
operations. They usually lack physical form and
have uncertain benefits. Examples include patents,
trademarks, copyrights, franchises, and goodwill.
3-44

C4

Current Liabilities
Obligations due to be paid or settled within one year
or the operating cycle, whichever is longer.

Long Term Liabilities


Obligations not due within one year or the
operating cycle, whichever is longer.

3-45

Classified Balance Sheet

3-46

A2

Profit Margin
The profit margin ratio measures the
companys net income to net sales.
Profit
Margin

Net Income
Net Sales

3-47

A3

Current Ratio

This ratio is an important measure of a companys ability to


pay its short-term obligations.
Current
Current assets
=
ratio
Current liabilities

3-48

End of Chapter 3

3-49

You might also like