Download Adjusting Entry

Chapter 03
The Financial Reporting
Process
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Part A
Accrual-Basis Accounting
3-2
LO1 Revenue and Expense Reporting
o Accounting information – necessary for decision
making.
o To be useful in decision making – accountants
must report revenues and expenses in a way that
reflects the ability of the company to create value
for its owners.
o Accrual-basis accounting records revenues when
earned (the revenue recognition principle) and
expenses with related revenues (the matching
principle).
3-3
Revenue Recognition Principle
Recognize revenue when it is earned
o Calvin books a cruise with Carnival Cruise Lines,
the world’s largest cruise line. He makes
reservations and pays for the cruise in November
2012, but the cruise is not scheduled to sail until
April 2013.
o When does Carnival report revenue from the
ticket sale?
3-4
Revenue Recognition Principle
1. In November 2012???
No.
Because it has not substantially fulfilled its
obligation to Calvin.
2. In April 2013???
Yes.
Because it is in April 2013 that the cruise
occurs.
3-5
Revenue Recognition Principle
Suppose that, anticipating the cruise, Calvin buys
a Jimmy Buffet CD from Best Buy.
Rather than paying cash, Calvin uses his Best
Buy card to buy the CD on account.
When does Best Buy recognize revenue?
3-6
Revenue Recognition Principle
Even though Best Buy doesn’t receive cash
immediately from Calvin, it still records the
revenue at the time it sells the CD.
3-7
Matching Principle
Expenses are reported with the revenues they
help to generate
3-8
LO2 Accrual–Basis Compared with
Cash–Basis Accounting
3-10
Accrual–Basis Compared with Cash–
Basis Accounting
Recognize Revenue?
Accrual-basis Cash-basis
November 2012 Company receives cash from
Ruby and Calvin for Hawaiian
cruise next April.
No
Yes
April 2013
Yes
No
Company provides cruise
services to Ruby and Calvin.
3-11
Accrual–Basis Compared with Cash–
Basis Accounting
Recognize Expense?
Accrual-basis Cash-basis
March 2013
April 2013
May 2013
Company pays cash for supplies to
be used next month.
Company uses supplies purchased
last month.
Company pays cash for fuel used
during the cruise this month.
Employees earn salaries but will
not be paid until next month.
Company pays cash to employee
for salaries earned last month.
No
Yes
Yes
No
Yes
Yes
Yes
No
No
Yes
3-12
Part B
The Measurement Process
LO3 Adjusting Entries
Closing Process
Reporting Process
3-14
Purpose of Adjusting Entries
o To record events that have occurred but which
have not been recorded.
o To record revenues in the period earned.
o To record expenses in the period they are
incurred in the generation of those revenues.
o To correctly state assets and liabilities in the
balance sheet.
3-15
Grouping Adjusting Entries
Prepayments:
o
Prepaid expenses – we paid cash (or had an
obligation to pay cash) for the purchase of an asset
before we incurred the expense.
o
Unearned revenues – we received cash and recorded
a liability before we earned the revenue.
Accruals:
o
Accrued expenses – we paid cash after we incurred
the expense and recorded a liability.
o
Accrued revenues – we received cash after we
earned the revenue and recorded an asset.
3-16
Prepaid Expenses
o
Costs of assets acquired in one period that will be
expensed in a future period.
o
Examples: Purchase of equipment or supplies,
payment of rent in advance, payment of insurance in
advance.
Adjusting Entry:
Debit expense account (increase an expense)
Credit asset account (decrease an asset)
3-17
Example: Prepaid Rent
$6,000
Cash paid for
prepaid rent
Jan. 1
$5,500
Remaining
prepaid rent
Jan. 31
Prepaid rent
expires
$500
Adjusting
entry
3-18
Example: Prepaid Rent
January 31
Rent Expense (+E, -SE ). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prepaid Rent (-A ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(Record prepaid rent due to the passage of time)
Balance Sheet
Debit
500
Credit
500
Income Statement
Stockholders’ Equity
Assets
-500
= Liabilities +
=
Common
Stock
+
Retained
Earnings
-500
Revenues − Expenses
+500
=
=
Net
Income
-500
3-19
Unearned Revenues
o
Once a company has provided products or services,
they can record revenue earned and reduce the
obligation to the customer. The adjusting entry for an
unearned revenue always includes a debit to a liability
account (decrease a liability) and a credit to a revenue
account (increase a revenue).
Adjusting entry:
Debit liability account (decrease a liability)
Credit revenue account (increase a revenue)
3-20
Example: Unearned Training Revenue
$600
Cash
received in
advance
Jan. 26
$540
Unearned
revenue
remains
Jan. 31
Services
provided
$60
Adjusting
entry
3-21
Example: Unearned Training Revenue
January 31
Unearned Revenue (-L ). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Service Revenue (+R, +SE ) . . . . . . . . . . . . . . . . . . . . . .
(Provide services to customers who paid in advance )
Balance Sheet
Assets
= Liabilities +
=
-60
Stockholders’ Equity
Common
Retained
Stock
+
Earnings
+60
Debit
60
Credit
60
Income Statement
Revenues − Expenses
+60
=
=
Net
Income
+60
3-22
Accrued Expenses
o
When a company has incurred an expense but hasn’t
yet paid cash or recorded an obligation to pay, it still
should record the expense.
o
Examples: Accrued salaries, accrued interest,
accrued utility costs.
Adjusting entry:
Debit expense account (increase an expense)
Credit liability account (increase a liability)
3-23
Example: Accrued Utility Costs
o
At the end of January, Eagle receives a utility bill for
$960 associated with operations in January. Eagle
plans to pay the bill on February 6.
o
Even though it won’t pay the cash until February,
Eagle must record the utility costs for January as an
expense in January.
3-24
Example: Accrued Utility Costs
$960
Utilities
owed
Jan. 31
$960
Cash paid
for utilities
Feb. 6
Jan. 1
Utilities used
$960
Adjusting
entry
3-25
Example: Accrued Utility Costs
January 31
Utilities Expense (+E, -SE ). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Utilities Payable(+L ) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(Owe for utilities costs in the current period )
Balance Sheet
Assets
= Liabilities +
=
+960
Stockholders’ Equity
Common
Retained
Stock + Earnings
-960
Debit
960
Credit
960
Income Statement
Revenues − Expenses
+960
=
=
Net
Income
-960
3-26
Accrued Revenues
o
When a company has earned revenue but hasn’t yet
received cash or recorded an amount receivable, it still
should record the revenue. This is referred to as an
accrued revenue.
o
Examples: Interest receivable, accounts receivable
Adjusting entry:
Debit asset account (increase an asset)
Credit revenue account (increase a revenue)
3-27
Example: Accounts Receivable
o
Suppose, Eagle provides $200 of golf training to
customers from January 28 to January 31. However, it
usually takes Eagle one week to mail bills to customers
and another week for customers to pay. Therefore,
Eagle expects to receive cash from these customers
during February 8-14.
o
Irrespective of when cash will be received, the revenue
should be recognized in January.
3-28
Example: Accounts Receivable
$200
$200
Owed from Cash received
customers
from
Jan. 31
customers
Feb. 8-14
Jan. 28
Revenues
earned
$200
Adjusting
entry
3-29
Example: Accounts Receivable
January 31
Accounts Receivable (+A ). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Service Revenue (+R, +SE ) . . . . . . . . . . . . . . . . . .
(Bill customers for services provided during the
current period )
Balance Sheet
Assets
+200
=
=
Liabilities
+
Stockholders’ Equity
Common
Retained
Stock + Earnings
+200
Debit
200
Credit
200
Income Statement
Revenues − Expenses
+200
=
=
Net
Income
+200
3-30
LO4 Post Adjusting Entries
o
Post adjusting entries to the T-accounts in the
general ledger to update the account balances.
o
Prepare an adjusted trial balance.
o
An adjusted trial balance is a list of all accounts and
their balances after we have updated account
balances for adjusting entries.
3-31
Unadjusted Trial Balance and Adjusted Trial
Balance of Eagle Golf Academy
EAGLE GOLF ACADEMY
Unadjusted Trial Balance and Adjusted Trial Balance
January 31
Accounts
Cash
Accounts receivable
Supplies
Prepaid rent
Equipment
Accum. depr., equip
Accounts payable
Unearned revenue
Salaries payable
Utilities payable
Interest payable
Notes payable
Common stock
Retained earnings
Dividends
Service revenue
Supplies expense
Rent expense
Depreciation expense
Salaries expense
Utilities expense
Interest expense
Totals
Unadjusted
Trial Balance
Debit
$6,200
2,500
2,300
6,000
24,000
Credit
Adjustments
Debit
Credit
(h) 200
(b) 800
(a) 500
Adjusted
Trial Balance
Debit
$6,200
2,700
1,500
5,500
24,000
(c) 400
2,300
600
$400
2,300
540
300
960
100
10,000
25,000
0
(d) 60
(e) 300
(f) 960
(g) 100
10,000
25,000
0
200
200
6,100
(b)
(a)
(c)
(e)
(f)
(g)
2,800
$44,000
Credit
$44,000
(d and h) 260
800
500
400
300
960
100
6,360
800
500
400
3,100
960
100
$45,960
$45,960
3-32
Part C
The Reporting Process
LO5 Financial Statements
EAGLE GOLF ACADEMY
Adjusted Trial Balance
January 31
Accounts
Debit
Cash
$6,200
Accounts receivable
2,700
Supplies
1,500
Prepaid rent
5,500
Equipment
24,000
Accumulated
Depreciation
Accounts payable
Unearned revenue
Salaries payable
Interest payable
STATEMENT OF
STOCKHOLDERS’
EQUITY
Common Stock
+
Retained Earnings
(= RE, Jan. 1 + NI – Div)
=
Stockholders’ Equity
Utilities payable
Notes Payable
Common stock
Retained earnings
Dividends
Service revenue
Supplies expense
Rent expense
Depreciation expense
Salaries expense
Utilities expense
Interest expense
Totals
Credit
BALANCE
SHEET
$400
2,300
540
300
100
Assets
=
Liabilities
+
Stockholders’ Equity
960
10,000
25,000
0
200
6,360
INCOME
STATEMENT
Revenues
800
500
400
3,100
960
100
$45,960
$45,960
−
Expenses
=
Net Income
3-34
Income Statement
EAGLE GOLF ACADEMY
Income Statement
For the month ended January 31
Revenues:
Service revenue
Expenses:
Salaries expense
Rent expense
Supplies expense
Depreciation expense
Interest expense
Utilities expense
Total expenses
Net income
$6,360
$3,100
500
800
400
100
960
5,860
$500
3-35
Statement of Stockholders’ Equity
EAGLE GOLF ACADEMY
Statement of Stockholders’ Equity
For the month ended January 31
Common
Stock
Balance at January 1
Issuance of common stock
Add: Net income for January
Less: Dividends
Balance at January 31
-0$25,000
$25,000
Retained
Earnings
-0$500
(200)
$300
Total
Stockholders
’
Equity
-0$25,000
500
(200)
$25,300
3-36
Classified Balance SheetSheet
January 31
Total assets equal
current plus longterm assets.
Total liabilities
equal current plus
long-term
liabilities.
Total stockholders’
equity includes
common stock and
retained earnings
from the statement
of stockholders’
equity.
Total assets must
equal total
liabilities plus
stockholders’
equity.
Assets
Current assets:
Liabilities
EAGLE GOLF ACADEMY
Current liabilities:
Classified Balance
$
Accounts payable
Cash
6,200
$ 2,300
Unearned
Accounts receivable
2,700
revenue
540
Supplies
1,500
Salaries payable
300
Prepaid rent
5,500
Utilities payable
960
Total current assets
15,90
Interest payable
100
0
Total current liabilities
4,200
Long-term assets:
24,00
Long-term
Equipment
0 liabilities:
Accum. depr., equip.
(400)
Notes payable
10,000
23,60
Total liabilities
Total long-term assets
0 14,200
Stockholders’ Equity
Common stock
25,000
Retained
earnings
300
Total stockholders’
equity
$ 25,300
Total assets
$
39,50
0
Total liabilities and
stockholders’ equity
$ 39,500
3-37
Part D
The Closing Process
LO6 Closing Entries
o
Transfer the balance of all revenue, expense,
and dividend accounts to the balance of
retained earnings.
o
Increase the retained earnings account by the
amount of revenues and decrease retained
earnings by the amount of expenses and
dividends.
o
The balance of each revenue, expense, and
dividend account equals zero after closing
entries.
o
Do not affect the balances of permanent
accounts other than retained earnings.
3-39
Close to Retained Earnings
Retained Earnings
0 Beginning balance
6,360 Total revenues
Total expenses 5,860
Total dividends
200
300 Ending balance
3-40
LO7 Post Closing Entries and
Prepare Post–Closing Trial Balance
EAGLE GOLF ACADEMY
Post-Closing Trial Balance
January 31
Accounts
Debit
Cash
$6,200
Accounts receivable
2,700
Supplies
1,500
Prepaid rent
5,500
Equipment
24,000
Accumulated Depreciation
Accounts payable
Unearned revenue
Salaries Payable
Interest Payable
Utilities Payable
Notes Payable
Common stock
Retained earnings
Totals
$39,900
Credit
$400
2,300
540
300
100
960
10,000
25,000
300
$39,900
3-41
End of Chapter 03
3-42