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Chapter 4 Adjustments, Financial Statements, and the Quality of Financial Reporting McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. Supercuts’ Situation Supercuts needs to update or adjust their financial information, such as the amount of supplies inventory on hand and interest owed on debt, to ensure the financial statements include the financial results of all the company’s activities for the period. SUPERCUTS Unadjusted Trial Balance As of September 30, 2008 Debit Credit Cash $ 6,100 Supplies 630 Accounts Receivable 200 Prepaid Rent 7,200 Prepaid Insurance 3,600 Equipment 60,000 Accounts Payable $ 1,030 Unearned Revenues 300 Notes Payable 20,000 Contributed Capital 50,000 Haircut Revenue 15,500 Wages Expense 8,100 Utilities Expense 600 Advertising Expense 400 Total $ 86,830 $ 86,830 4-2 Learning Objective 1 Explain why adjustments are needed. 4-3 Why Adjustments Are Needed Accounting systems are designed to record most recurring daily transactions, particularly any involving cash. The problem is that cash is not always received or paid in the period when the revenue is earned or when the expense is incurred. The solution for this timing difference is to record adjusting entries at the end of the period to get the amounts reported as revenues and expenses up to date. 4-4 Why Adjustments Are Needed For example, at the end of September, does Supercuts still have $7,200 of Prepaid Rent to use in the future? No, because Supercuts used 1/ of the Prepaid Rent in 3 September. During September, Supercuts incurred Rent Expense of $2,400. Supercuts needs to adjust or update the balances in both the Prepaid Rent account and the Rent Expense account. SUPERCUTS Unadjusted Trial Balance As of September 30, 2008 Debit Credit Cash $ 6,100 Supplies 630 Accounts Receivable 200 Prepaid Rent 7,200 Prepaid Insurance 3,600 Equipment 60,000 Accounts Payable $ 1,030 Unearned Revenues 300 Notes Payable 20,000 Contributed Capital 50,000 Haircut Revenue 15,500 Wages Expense 8,100 Utilities Expense 600 Advertising Expense 400 Total $ 86,830 $ 86,830 4-5 Deferral Adjustments (a) What we want to accomplish: (b) How do we accomplish it? Report up-to-date information. Income Statement Cost of Goods Sold Supplies Expense Rent Expense Ticket Sales Revenue Subscriptions Revenue In R In P Revenues Liabilities (c) What accounts do they affect? Balance Sheet Inventories Supplies Prepaid Rent Unearned Ticket Revenue Subscriptions Paid in Advance Expenses Assets Update what's already recorded. W In Deferral adjustments are needed when: (a) some or all of an asset’s future benefits have expired or been used up in the current period, or (b)the company provides goods or services in the current period to satisfy an existing liability. The accounts in a deferral adjustment always go in opposite directions. That is, a decrease in an asset goes with an increase in an expense, and a decrease in a liability goes with an increase in a revenue. 4-6 Accrual Adjustments (a) What we want to accomplish: (b) How do we accomplish it? Report complete information. Income Statement Interest Revenue Rent Revenue Income Taxes Payable Income Tax Expense Wages Payable Wages Expense Interest Payable Interest Expense Liabilities (c) What accounts do they affect? Revenues Balance Sheet Interest Receivable Rent Receivable Expenses Assets Include what's not yet recorded. Accrual adjustments are needed when: The accounts in an accrual adjustment always go in same direction. That is, an increase in an asset goes with an increase in a revenue, and an increase in a liability goes with an increase in an expense. (a) assets and revenues are generated in the current period but haven’t been recorded as of the end of the period, or (b) liabilities and expenses are incurred in the current period but haven’t been recorded as of the end of the period. 4-7 Types of Adjustments Report complete information. Update what's already recorded. Include what's not yet recorded. Ticket Sales Revenue Subscriptions Revenue Liabilities Income Statement Cost of Goods Sold Supplies Expense Rent Expense Balance Sheet Interest Receivable Rent Receivable Income Statement Interest Revenue Rent Revenue Income Taxes Payable Income Tax Expense Wages Payable Wages Expense Interest Payable Interest Expense Expenses Balance Sheet Inventories Supplies Prepaid Rent Unearned Ticket Revenue Subscriptions Paid in Advance Assets Report up-to-date information. Revenues Liabilities Accrual Adjustments Expenses Revenues (c) What accounts do they affect? Assets (a) What we want to accomplish: (b) How do we accomplish it? Deferral Adjustments The accounts in any adjustment always include one balance sheet account (an asset or liability) and one income statement account (revenue or expense). 4-8 Learning Objective 2 Prepare adjustments needed at the end of the period. 4-9 Making Required Adjustments Timing Daily (1) Analyze Transactions (2) Record Journal entries (JEs) (3) Summarize Ledgers (T-Accounts) Unadjusted Trial Balance Month-end Adjustments Year-end Closing Adjusting journal entries Ledgers (T-Accounts) (AJEs) Adjusted Trial Balance Financial Statements Closing journal entries Ledgers (T-Accounts) (CJEs) Post-Closing Trial Balance 4-10 Deferral Adjustments Remember this entry we made in Chapter 2 to record the receipt of hair supplies? Accounts Supplies (+A) Accounts Payable (+L) Debit 630 Credit 630 During September, Supercuts used supplies but their use wasn’t recorded simply because it wasn’t efficient to record a journal entry each day when supplies were used. Let’s see how to record the necessary adjustment. 4-11 Deferral Adjustments Step 1 At the end of September, by counting the bottles of shampoo and tubes of gel on hand, your salon manager determined that $400 of supplies were left. That means we used $230 of supplies this month. Step 2 Prepare the adjusting entry to record the use of $230 of supplies. Step 3 The Supplies T-account currently has an unadjusted balance of $630, but the desired balance is $400 (from Step 2). To go from $630 to $400, we need an adjustment to decrease (credit) this asset by $230. Unadj. Bal. Adj. Bal. Supplies 630 Supplies Expense Unadj. Bal. Adj. Bal. 4-12 Deferral Adjustments Step 1 At the end of September, by counting the bottles of shampoo and tubes of gel on hand, your salon manager determined that $400 of supplies were left. That means we used $230 of supplies this month. Step 2 Prepare the adjusting entry to record the use of $230 of supplies. Step 3 The Supplies T-account currently has an unadjusted balanceAccounts of $630, but the desired balance isDebit $400 (from StepCredit 2). To go from $630(+E, to $400, we need an adjustment Supplies Expense -SE) 230to decrease (credit) this asset by $230. Supplies (-A) Unadj. Bal. Adj. Bal. Supplies 630 230 Supplies Expense Unadj. Bal. Adj. Bal. 4-13 Deferral Adjustments Step 1 At the end of September, by counting the bottles of shampoo and tubes of gel on hand, your salon manager determined that $400 of supplies were left. That means we used $230 of supplies this month. Step 2 Prepare the adjusting entry to record the use of $230 of supplies. Step 3 The Supplies T-account currently has an unadjusted balance of $630, but the desired balance is $400 (from Step 2). To go from $630 to $400, we need an adjustment to decrease (credit) this asset by $230. Unadj. Bal. Adj. Bal. Supplies 630 400 230 Adj. Entry Supplies Expense Unadj. Bal. Adj. Entry 230 Adj. Bal. 230 4-14 Deferral Adjustments SUPERCUTS Unadjusted Trial Balance As of September 30, 2008 Debit Credit Cash $ 6,100 Supplies 630 Accounts Receivable 200 Prepaid Rent 7,200 Prepaid Insurance 3,600 Equipment 60,000 Accounts Payable $ 1,030 Unearned Revenues 300 Notes Payable 20,000 Contributed Capital 50,000 Haircut Revenue 15,500 Wages Expense 8,100 Utilities Expense 600 Advertising Expense 400 Total $ 86,830 $ 86,830 Take a minute and look at this Unadjusted Trial Balance. In addition to Supplies, other assets we need to adjust include Prepaid Rent, Prepaid Insurance, and Equipment. First, let’s look at how to adjust the Prepaid Rent and Prepaid Insurance accounts. 4-15 Deferral Adjustments Recall that the Prepaid Rent of $7,200 was for September, October, and November rent. So, during September, we used 1/3 of the rent, or $2,400. Accounts Rent Expense (+E, -SE) Prepaid Rent (-A) Debit 2,400 Credit 2,400 After posting this adjusting entry, the ledger accounts would look like this: Unadj. Bal. Adj. Bal. Prepaid Rent 7,200 2,400 Adj. Entry 4,800 Unadj. Bal. Adj. Entry Adj. Bal. Rent Expense 2,400 2,400 4-16 Deferral Adjustments Recall that the Prepaid Insurance of $3,600 was for 12 months of insurance. So, during September, we used 1/12 of the insurance, or $300. Accounts Insurance Expense (+E, -SE) Prepaid Insurance (-A) Debit 300 Credit 300 After posting this adjusting entry, the ledger accounts would look like this: Prepaid Insurance Unadj. Bal. 3,600 300 Adj. Entry Adj. Bal. 3,300 Insurance Expense Unadj. Bal. Adj. Entry 300 Adj. Bal. 300 4-17 Deferral Adjustments Notice: Deferral adjustments have two effects: Carrying value simply means the amount an asset or liability is reported at (“carried at”) in the financial statements. It is also known as “net book value” or simply “book value.” 1) They reduce the carrying value of assets on the balance sheet, and 2) They transfer the amount of the reductions to related expense accounts. 4-18 Deferral Adjustments—Depreciation Recording Depreciation Expense and Accumulated Depreciation Depreciation is the process of allocating the cost of property and equipment to the accounting periods in which they are used to generate revenues. A contra-account is an account that is an offset to, or reduction of, another account. 4-19 Deferral Adjustments—Depreciation Your salon manager determined that depreciation on the equipment for this month should be $1,000. Accounts Depreciation Expense (+E, -SE) Accumulated Depreciation (+xA, -A) Debit 1,000 Credit 1,000 After posting this adjusting entry, the ledger accounts would look like this: Accumulated Depreciation Unadj. Bal. 1,000 Adj. Entry 1,000 Adj. Bal. Unadj. Bal. Adj. Bal. Depreciation Expense Unadj. Bal. Adj. Entry 1,000 Adj. Bal. 1,000 Equipment 60,000 60,000 4-20 Deferral Adjustments—Depreciation Depreciation Market Value In accounting, depreciation is never intended to show a reduction in market value. 4-21 Deferral Adjustments During September, stylists accepted $175 of gift certificates to pay for haircuts. Accounts Unearned Revenue (-L) Haircut Revenue (+R, +SE) Debit 175 Credit 175 After posting this adjusting entry, the ledger accounts would look like this: Unearned Revenue 300 Unadj. Bal. Adj. Entry 175 125 Adj. Bal. Haircut Revenue 15,500 Unadj. Bal. 175 Adj. Entry 15,675 Adj. Bal. 4-22 Accrual Adjustments On September 30, Supercuts provided $40 of haircut services to the salon manager, with payment to be received in October. Let’s see how to record the necessary adjustment. 4-23 Accrual Adjustments Step 1 Step 2 Step 3 Analyze the transactions and see that Supercuts provided $40 of haircut services that have not been recorded. And, the salon manager owes Supercuts $40 for the haircut services received. Record the adjusting journal entry by debiting Accounts Receivable and crediting Haircut Revenue for $40. Post the adjusting entry to the Accounts Receivable and Haircut Revenue accounts. Accounts Receivable Unadj. Bal. 200 Adj. Bal. Haircut Revenue 15,500 Unadj. Bal. 175 Adj. Entry Adj. Bal. 4-24 Accrual Adjustments Step 1 Step 2 Step 3 Analyze the transactions and see that Supercuts provided $40 of haircut services that have not been recorded. And, the salon manager owes Supercuts $40 for the haircut services received. Record the adjusting journal entry by debiting Accounts Receivable and crediting Haircut Revenue for $40. Post the adjusting entry to the Accounts Receivable and Haircut Revenue accounts. Accounts Accounts Receivable (+A) Haircut Revenue (+R) Accounts Receivable Unadj. Bal. 200 Adj. Bal. Debit 40 Credit 40 Haircut Revenue 15,500 Unadj. Bal. 175 Adj. Entry Adj. Bal. 4-25 Accrual Adjustments Step 1 Step 2 Step 3 Analyze the transactions and see that Supercuts provided $40 of haircut services that have not been recorded. And, the salon manager owes Supercuts $40 for the haircut services received. Record the adjusting journal entry by debiting Accounts Receivable and crediting Haircut Revenue for $40. Post the adjusting entry to the Accounts Receivable and Haircut Revenue accounts. Accounts Accounts Receivable (+A) Haircut Revenue (+R) Accounts Receivable Unadj. Bal. 200 Adj. Entry 40 Adj. Bal. 240 Debit 40 Credit 40 Haircut Revenue 15,500 175 40 15,715 Unadj. Bal. Adj. Entry Adj. Entry Adj. Bal. 4-26 Accrual Adjustments Supercuts owes $900 of wages to stylists for work done in the last three days of September. Accounts Wages Expense (+E, -SE) Wages Payable (+L) Debit 900 Credit 900 After posting this adjusting entry, the ledger accounts would look like this: Wages Payable Unadj. Bal. 900 Adj. Entry 900 Adj. Bal. Wages Expense Unadj. Bal. Adj. Entry 900 Adj. Bal. 900 4-27 Accrual Adjustments Supercuts has not paid or recorded the $100 interest that it owes for this month on its note payable to the bank. Accounts Interest Expense (+E, -SE) Interest Payable (+L) Debit 100 Credit 100 After posting this adjusting entry, the ledger accounts would look like this: Interest Payable Unadj. Bal. 100 Adj. Entry 100 Adj. Bal. Interest Expense Unadj. Bal. Adj. Entry 100 Adj. Bal. 100 4-28 Accrual Adjustments Supercuts pays income tax at an average rate equal to 40% of the salon’s income before taxes ($1,685). Accounts Income Tax Expense (+E, -SE) Income Taxes Payable (+L) Debit 674 Credit 674 After posting this adjusting entry, the ledger accounts would look like this: Income Taxes Payable Unadj. Bal. 674 Adj. Entry 674 Adj. Bal. Income Unadj. Bal. Adj. Entry Adj. Bal. Tax Expense 674 674 4-29 Final Comments Adjusting journal entries never involve cash Dividends are not expenses of the business. 4-30 Dividends Supercuts declares and pays a $500 cash dividend. Accounts Dividends Declared (+D, -SE) Cash (-A) Debit 500 Credit 500 After posting this adjusting entry, the ledger accounts would look like this: Unadj. Bal. Cash 6,100 500 Adj. Entry Adj. Bal. 5,600 Dividends Declared Unadj. Bal. Adj. Entry 500 Adj. Bal. 500 4-31 Learning Objective 3 Prepare an adjusted trial balance. 4-32 SUPERCUTS Adjusted Trial Balance As of September 30, 2008 Debit Credit Cash $ 5,600 Supplies 400 Accounts Receivable 240 Prepaid Rent 4,800 Prepaid Insurance 3,300 Equipment 60,000 Accumulated Depreciation $ 1,000 Accounts Payable 1,030 Unearned Revenues 125 Wages Payable 900 Income Taxes Payable 674 Interest Payable 100 Notes Payable 20,000 Contributed Capital 50,000 Retained Earnings Dividends Declared 500 Haircut Revenue 15,715 Wages Expense 9,000 Rent Expense 2,400 Depreciation Expense 1,000 Utilities Expense 600 Advertising Expense 400 Insurance Expense 300 Supplies Expense 230 Interest Expense 100 Income Tax Expense 674 Total $ 89,544 $ 89,544 The adjusted trial balance is a list of all accounts and their adjusted balances to check on the equality of recorded debits and credits. Here is the adjusted trial balance for Supercuts. The amounts were taken from the balances in the ledger accounts after adjusting entries were made. 4-33 Learning Objective 4 Prepare adjusted financial statements. 4-34 SUPERCUTS Adjusted Trial Balance As of September 30, 2008 Debit Credit Cash $ 5,600 Supplies 400 Accounts Receivable 240 Prepaid Rent 4,800 Prepaid Insurance 3,300 Equipment 60,000 Accumulated Depreciation $ 1,000 Accounts Payable 1,030 Unearned Revenues 125 Wages Payable 900 Income Taxes Payable 674 Interest Payable 100 Notes Payable 20,000 Contributed Capital 50,000 Retained Earnings Dividends Declared 500 Haircut Revenue 15,715 Wages Expense 9,000 Rent Expense 2,400 Depreciation Expense 1,000 Utilities Expense 600 Advertising Expense 400 Insurance Expense 300 Supplies Expense 230 Interest Expense 100 Income Tax Expense 674 Total $ 89,544 $ 89,544 Now let’s prepare the financial statements for Supercuts. Let’s prepare the financial statements in this order: 1. Income Statement 2. Statement of Retained Earnings 3. Balance Sheet 4-35 SUPERCUTS Adjusted Trial Balance As of September 30, 2008 Debit Credit Cash $ 5,600 Supplies 400 Accounts Receivable 240 Prepaid Rent 4,800 Prepaid Insurance 3,300 Equipment 60,000 Accumulated Depreciation $ 1,000 Accounts Payable 1,030 Unearned Revenues 125 Wages Payable 900 Income Taxes Payable 674 Interest Payable 100 Notes Payable 20,000 Contributed Capital 50,000 Retained Earnings Dividends Declared 500 Haircut Revenue 15,715 Wages Expense 9,000 Rent Expense 2,400 Depreciation Expense 1,000 Utilities Expense 600 Advertising Expense 400 Insurance Expense 300 Supplies Expense 230 Interest Expense 100 Income Tax Expense 674 Total $ 89,544 $ 89,544 SUPERCUTS SUPER SALON Income Statement For the Month Ended September 30, 2008 Revenues Haircuts Total Revenue Expenses Wages Expense Rent Expense Depreciation Expense Utilities Expense Advertising Expense Insurance Expense Supplies Expense Interest Expense Income Tax Expense Total Expenses Net Income $ $ 15,715 15,715 9,000 2,400 1,000 600 400 300 230 100 674 14,704 1,011 4-36 SUPERCUTS Adjusted Trial Balance As of September 30, 2008 Debit Credit Cash $ 5,600 Supplies 400 Accounts Receivable 240 Prepaid Rent 4,800 Prepaid Insurance 3,300 Equipment 60,000 Accumulated Depreciation $ 1,000 Accounts Payable 1,030 Unearned Revenues 125 Wages Payable 900 Income Taxes Payable 674 Interest Payable 100 Notes Payable 20,000 Contributed Capital 50,000 Retained Earnings Dividends Declared 500 Haircut Revenue 15,715 Wages Expense 9,000 Rent Expense 2,400 Depreciation Expense 1,000 Utilities Expense 600 Advertising Expense 400 Insurance Expense 300 Supplies Expense 230 Interest Expense 100 Income Tax Expense 674 Total $ 89,544 $ 89,544 SUPERCUTS SUPER SALON Income Statement For the Month Ended September 30, 2008 Revenues Haircuts Total Revenue Expenses Wages Expense Rent Expense Depreciation Expense Utilities Expense Advertising Expense Insurance Expense Supplies Expense Interest Expense Income Tax Expense Total Expenses Net Income $ $ 15,715 15,715 9,000 2,400 1,000 600 400 300 230 100 674 14,704 1,011 SUPERCUTS SUPER SALON Statement of Retained Earnings For the Month Ended September 30, 2008 Retained Earnings, September 1 $ Net Income 1,011 Dividends Declared (500) Retained Earnings, September 30 $ 511 4-37 SUPERCUTS Adjusted Trial Balance As of September 30, 2008 Debit Credit Cash $ 5,600 Supplies 400 Accounts Receivable 240 Prepaid Rent 4,800 Prepaid Insurance 3,300 Equipment 60,000 Accumulated Depreciation $ 1,000 Accounts Payable 1,030 Unearned Revenues 125 Wages Payable 900 Income Taxes Payable 674 Interest Payable 100 Notes Payable 20,000 Contributed Capital 50,000 Retained Earnings Dividends Declared 500 Haircut Revenue 15,715 Wages Expense 9,000 Rent Expense 2,400 Depreciation Expense 1,000 Utilities Expense 600 Advertising Expense 400 Insurance Expense 300 Supplies Expense 230 Interest Expense 100 Income Tax Expense 674 Total $ 89,544 $ 89,544 SUPERCUTS SUPER SALON Statement of Retained Earnings For the Month Ended September 30, 2008 Retained Earnings, September 1 $ Net Income 1,011 Dividends Declared (500) Retained Earnings, September 30 $ 511 SUPERCUTS SUPER SALON Balance Sheet At September 30, 2008 Assets Current Assets Cash Supplies Accounts Receivables Prepaid Rent Prepaid Insurance Total Current Assets Equipment Accumulated Depreciation Equipment, net Total Assets $ 5,600 400 240 4,800 3,300 14,340 $ 60,000 (1,000) $ 59,000 73,340 Liabilities Current Liabilities Accounts Payable Unearned Revenues Wages Payable Income Tax Payable Interest Payable Total Current Liabilities Notes Payable Total Liabilities Stockholders' Equity Contributed Capital Retained Earnings Total Stockholders' Equity Total Liabilities and Stockholders' Equity $ $ 1,030 125 900 674 100 2,829 20,000 22,829 50,000 511 50,511 73,340 4-38 Learning Objective 5 Explain the closing process. 4-39 Closing Temporary Accounts Timing Daily (1) Analyze Transactions (2) Record Journal entries (JEs) Month-end Adjustments Year-end Closing Adjusting journal entries Ledgers (T-Accounts) (AJEs) Adjusted Trial Balance Financial Statements Closing journal entries Ledgers (T-Accounts) (CJEs) Post-Closing Trial Balance Transfers net income (or loss) and dividends to Retained Earnings. (3) Summarize Ledgers (T-Accounts) Unadjusted Trial Balance Establishes zero balances in all income statement and dividend accounts. 4-40 Closing Temporary Accounts Temporary accounts track financial results for a limited period of time. Liabilities Permanent Accounts Equity Temporary Accounts Assets Dividends Expenses Revenues Permanent accounts track financial results from year to year. 4-41 Recording Closing Entries Debit Revenue accounts and credit Expense accounts. Debit or credit the difference to Retained Earnings. Let’s prepare the closing entries for Supercuts! Credit Dividends Declared and debit Retained Earnings. 4-42 SUPERCUTS Adjusted Trial Balance As of September 30, 2008 Debit Credit Cash $ 5,600 Supplies 400 Accounts Receivable 240 Prepaid Rent 4,800 Prepaid Insurance 3,300 Equipment 60,000 Accumulated Depreciation $ 1,000 Accounts Payable 1,030 Unearned Revenues 125 Wages Payable 900 Income Taxes Payable 674 Interest Payable 100 Notes Payable 20,000 Contributed Capital 50,000 Retained Earnings Dividends Declared 500 Haircut Revenue 15,715 Wages Expense 9,000 Rent Expense 2,400 Depreciation Expense 1,000 Utilities Expense 600 Advertising Expense 400 Insurance Expense 300 Supplies Expense 230 Interest Expense 100 Income Tax Expense 674 Total $ 89,544 $ 89,544 Accounts Haircut Revenue (-R) Wages Expense (-E) Rent Expense (-E) Depreciation Expense (-E) Utilities Expense (-E) Advertising Expense (-E) Insurance Expense (-E) Supplies Expense (-E) Interest Expense (-E) Income Tax Expense (-E) Retained Earnings (+SE) Debit 15,715 Accounts Retained Earnings (-SE) Dividends Declared (-D) Debit 500 Credit 9,000 2,400 1,000 600 400 300 230 100 674 1,011 Credit 500 4-43 Accounts Haircut Revenue (-R) Wages Expense (-E) Rent Expense (-E) Depreciation Expense (-E) Utilities Expense (-E) Advertising Expense (-E) Insurance Expense (-E) Supplies Expense (-E) Interest Expense (-E) Income Tax Expense (-E) Retained Earnings (+SE) Debit 15,715 Accounts Retained Earnings (-SE) Dividends Declared (-D) Debit 500 Closing Entry Credit 9,000 2,400 1,000 600 400 300 230 100 674 1,011 Haircut Revenue 15,715 Adj. Bal. 15,715 - Closing Bal. After posting these closing entries, all the income statement accounts and the dividend account will have a zero balance. Below is an example of how two accounts would look after posting the closing entries. Credit 500 Adj. Bal. Closing Bal. Wages Expense 9,000 9,000 Closing Entry 4-44 Post-Closing Trial Balance SUPERCUTS Post-ClosingTrial Balance As of September 30, 2008 Debit Credit Cash $ 5,600 Supplies 400 Accounts Receivable 240 Prepaid Rent 4,800 Prepaid Insurance 3,300 Equipment 60,000 Accumulated Depreciation $ 1,000 Accounts Payable 1,030 Unearned Revenues 125 Wages Payable 900 Income Taxes Payable 674 Interest Payable 100 Notes Payable 20,000 Contributed Capital 50,000 Retained Earnings 511 Total $ 74,340 $ 74,340 Final check that all debits still equal credits and that all temporary accounts have been closed. Contains only permanent accounts. Is the last step in the accounting process. 4-45 Learning Objective 6 Explain how adjustments affect information quality. 4-46 Adjustments and Information Quality If a company bases its adjustments on honest but optimistic estimates that lead to a higher net income, most people will refer to the company as “aggressive” and its earnings as “lower quality”— having been influenced by management’s optimism about the future. Accounting research studies have found that, overall, adjustments significantly improve the quality of financial statements by ensuring that revenues are recognized when they are earned and expenses are recorded when incurred. 4-47 End of Chapter 4 4-48