Download Document

The Adjusting
Process
Chapter 3
3-1
What is the Difference between Cash
Basis Accounting & Accrual Basis
Accounting?
CASH BASIS
• Revenue is recorded
when Cash is
received
• Expenses are
recorded when Cash
is paid
• Not allowed under
GAAP
ACCRUAL BASIS
• Revenue is recorded
when it is earned
• Expenses are
recorded when
incurred
• Generally used by
larger businesses
3-2
The Time Period Concept
• Assumes that a business’s activities can
be sliced into small
OCTOBER 2012
segments and that
Su Mo Tu We Th Fr Sa
financial statements
1
2
3
4
5
6
7
8
9 10 11 12 13
can be prepared for
14 15 16 17 18 19 20
specific time periods,
21 22 23 24 25 26 27
such as a month,
28 29 30 31
quarter, or year.
• Any twelve month period is referred to as
a fiscal year.
3-3
The Revenue Recognition Principle
Revenue should be
recorded when it is
EARNED.
A good has
been delivered
or a service
has been
performed.
The
earnings
process is
complete.
The amount of
revenues must
represent the
actually selling
price.
If a $200 item is
discounted to
$100, then the
revenue is $100.
3-4
The Matching Principle
Expenses are
recorded when
they are
incurred during
the period.
Expenses are matched
at the end of the period
against the revenues
for that period.
For example, rent expense
for January should be
matched against January
revenues, even if was
actually paid in December.
3-5
Smart Touch Learning
The initial trial balance
that comes from the
General Ledger is
referred to as an
Unadjusted Trial
Balance.
Trial Balance
December 31, 2014
Debit
Cash
$
Accounts Receivable
Credit
12,200
1,000
Office Supplies
500
Prepaid Rent
3,000
Furniture
18,000
Building
60,000
Land
20,000
Accounts Payable
200
Utilities Payable
100
Unearned Revenue
600
Notes Payable
60,000
Common Stock
48,000
Dividends
5,000
Service Revenue
16,500
Rent Expense
2,000
Salaries Expense
3,600
Utilities Expense
100
$
125,400
$
125,400
Because of the Time
Period Concept,
Revenue Recognition
Principle, and
Matching Principle
some adjustments are
needed.
3-6
Smart Touch Learning
Trial Balance
December 31, 2014
Debit
Cash
$
Accounts Receivable
Credit
12,200
1,000
Office Supplies
500
Prepaid Rent
3,000
Furniture
18,000
Building
60,000
Land
20,000
For example, the Office
Supplies account
shows $500 at the end
of December.
If a count of the actual
supplies on hand
100
600
shows that some
60,000
supplies have been
48,000
used, we will need to
16,500
adjust the account.
Accounts Payable
200
Utilities Payable
Unearned Revenue
Notes Payable
Common Stock
Dividends
5,000
Service Revenue
Rent Expense
2,000
Salaries Expense
3,600
Utilities Expense
100
$
125,400
$
125,400
3-7
Adjusting Journal Entries
• Adjustments to the Trial Balance are made
by recording actual Adjusting Journal
Entries.
Date
Accounts and Explanation
Dec. 31 Account
Account
Debit
$$$
Credit
$$$
3-8
Adjusting Journal Entries
• Each Adjusting Journal Entry will adjust
a balance sheet account and an income
statement account.
Date
Accounts and Explanation
Dec. 31 Supplies Expense
Office Supplies
To record office supplies used.
Debit
$$$
Credit
$$$
3-9
Adjusting Journal Entries
Adjusting Journal Entries (AJE’s) can be
divided into two basic categories:
Prepaids
1.Prepaid Expenses
2.Unearned Revenues
Accruals
1.Accrued revenues
2.Accrued expenses
3-10
Information for Adjustments
a.
b.
c.
d.
e.
Prepaid rent expired, $1,000.
Supplies used, $400.
Depreciation on furniture, $300.
Depreciation on building, $250.
Service revenue collected in advance and
now earned $200
f. Accrued salaries expense, $1,200.
g. Accrued interest on note, $100.
h. Accrued service revenue, $800.
3-11
Prepaid Rent Example
Paying rent in advance gives us the right to use
the property for 3 months (in this case). By the end
of December, 1/3 of that right has been used.
Date
Accounts and Explanation
Dec. 1 Prepaid Rent
Cash
Paid rent in advance.
Debit
3,000
Credit
3,000
Prepaid Rent
Dec. 1
3,000
3-12
Prepaid rent expired, $1,000.
To adjust the Prepaid Rent account, we need to
reduce it by 1/3, and we need to show the rent
expense related to the December revenues.
Date
Accounts and Explanation
Dec. 31 Rent Expense
Prepaid Rent
To record rent expense.
Debit
1,000
Credit
1,000
3-13
Supplies used, $400.
3-14
Depreciation
• Long-lived, tangible assets used to
generate revenue are referred to as plant
assets.
• Plant assets act like Prepaid Expenses
Paid for
when
acquired
Used up
over time
Used to
produce
revenues
3-15
Depreciation
• The process of
systematically recording
the periodic usage of
plant assets to generate
revenues is called
Depreciation.
• The accounts used are:
– Depreciation Expense
– Accumulated
Depreciation
Land is never
depreciated.
Accumulated
Depreciation is a
contra-asset.
- Has a credit balance
- Appears in the Asset
section of the Balance
Sheet
3-16
Depreciation Example
Assume that, on December 2, Smart Touch
Learning received a contribution of furniture with a
market value of $18,000 from a stockholder.
Date
Accounts and Explanation
Debit
Credit
Dec. 2 Furniture
18,000
Common Stock
18,000
Contribution of furniture in exchange for common stock
At the end of December, Smart Touch Learning will
need to record depreciation for the use of the
furniture, assuming it has a 5 year useful life.
3-17
Depreciation on furniture, $300.
Using the straight-line method of computing
depreciation, Smart Touch Learning will need to
record $300 of depreciation for December.
Straight-Line Depreciation = ( Cost
- Residual Value ) ÷ Useful Life
= ( $18,000 $0
) ÷ 5 Years
=
$3,600 per year
Monthly Amount =
=
$3,600 ÷
$300
12 months
3-18
Depreciation Example
Recording the entry requires the use of two
accounts: Depreciation Expense and
Accumulated Depreciation.
Date
Accounts and Explanation
Dec. 31 Depreciation Expense—Furniture
Accumulated Depreciation—Furniture
To record depreciation on furniture.
Debit
300
Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall
Credit
300
3-19
300
300
3-20
3-21
Depreciation on building, $250.
3-22
Unearned Revenue Example
On December 21, a law firm engages Smart Touch
Learning to provide e-learning services for the next
30 days, paying $600 in advance.
Date
Accounts and Explanation
Dec. 21 Cash
Unearned Revenue
Collected cash for future services.
Debit
600
Credit
600
Unearned Revenue
600
Dec. 21
3-23
Unearned Revenue Example
Smart Touch Learning is obligated to perform the
services. During the last 10 days of the month, 1/3
of the services are performed.
Date
Accounts and Explanation
Dec. 31 Unearned Revenue
Service Revenue
To record service revenue earned
that was collected in advance.
Debit
200
Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall
Credit
200
3-24
Accrued Expenses Example
Smart Touch Learning pays its employee a
monthly salary of $2,400, half on the 15th and half
on the first day of the next month.
3-25
Accrued Expenses Example
On December 31, Smart Touch Learning still owes
the employee $1,200, which won’t be paid until
January 1.
Date
Accounts and Explanation
Dec. 31 Salaries Expense
Salaries Payable
To accrue salaries expense.
Debit
1,200
Credit
1,200
1,200
1,200
Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall
3-26
Accrued interest on note, $100.
100
100
3-27
Accrued Revenue Example
Accrued revenues arise when the company
recognizes that it has performed a service, or
delivered a product, but has not yet recorded that
they have “earned” the revenue.
Date
Accounts and Explanation
Dec. 31 Accounts Receivable
Service Revenue
To accrue service revenue.
Debit
xxxx
Credit
xxxx
3-28
Accrued Revenue Example
On December 15, Smart Touch Learning agrees to
perform e-learning services for $1,600 per month.
By the end of December, they have earned ½ of
the monthly fee for December.
Date
Accounts and Explanation
Dec. 31 Accounts Receivable
Service Revenue
To accrue service revenue.
Debit
800
Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall
Credit
800
3-29
Prepaid
Adjusting
entries
• Never involve cash
• Will either
• Increase expense account and reduce asset
account or
• Reduce Liability account and increase
Revenue account
©2014 Pearson Education, Inc. Publishing as Prentice Hall
3-30
Accrual
Adjusting
entries
• Never involve cash
• Increase
• Revenue account
or
• Expense account
3-31
Account Balances after
Posting
©2014 Pearson Education, Inc. Publishing as Prentice Hall
3-32
The Adjusted Trial Balance
• After journalizing and posting all the
adjusting journal entries at the end of the
fiscal period, a new adjusted trial balance
is prepared.
– List all accounts
– List debit balances in the debit column
– List credit balance in the credit column
• If it balances, financial statements can be
prepared.
Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall
3-33
• The adjusted trial
balance includes
accounts that did not
appear on the original
unadjusted trial
balance.
• The financial
statements are
prepared directly from
the adjusted trial
balance.
Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall
3-34
impact of adjusting entries on the
financial statements
3-35
Purpose of a worksheet
• Useful tool for the adjusting process
• Typically done on a spreadsheet
• Lists
– Accounts
– Unadjusted balances
– Adjustments
– Adjusted balance
3-36
Unadjusted Trial
Balance
Account Names
Cash
Accounts Receivable
Office Supplies
Prepaid Rent
Delivery Van
Accumulated Depreciation - Delivery Van
Equipment
Accumulated Depreciation - Equipment
Accounts Payable
Utilities Payable
Salaries Payable
Unearned Revenue
Common Stock
Dividends
Delivery Revenue
Rent Expense
Salaries Expense
Supplies Expense
Utilities Expense
Depreciation Expense - Delivery Van
Depreciation Expense - Equipment
Total
Debit
6,500
800
250
1,000
23,000
Credit
15,000
800
230
400
37,800
8,000
23,000
3,000
4,500
Adjustments
Debit
Credit
Adjusted Trial
Balance
Debit
Credit
First, enter the
information from
the unadjusted
trial balance into
the first two
columns of the
worksheet.
180
62,230
62,230
3-37
Unadjusted Trial
Balance
Account Names
Cash
Accounts Receivable
Office Supplies
Prepaid Rent
Delivery Van
Accumulated Depreciation - Delivery Van
Equipment
Accumulated Depreciation - Equipment
Accounts Payable
Utilities Payable
Salaries Payable
Unearned Revenue
Common Stock
Dividends
Delivery Revenue
Rent Expense
Salaries Expense
Supplies Expense
Utilities Expense
Depreciation Expense - Delivery Van
Depreciation Expense - Equipment
Total
Debit
6,500
800
250
1,000
23,000
Credit
Adjustments
Debit
Credit
Adjusted Trial
Balance
Debit
Credit
225
80
800
15,000
Second, enter
the information 800
for the adjusting 230
400
journal entries 37,800
into the8,000
23,000
Adjustments
3,000
4,500
columns.
750
300
875
130
355
800
875
80
180
62,230
62,230
750
300
3,160
3,160
3-38
Unadjusted Trial
Balance
Account Names
Cash
Accounts Receivable
Office Supplies
Prepaid Rent
Delviery Van
Accumulated Depreciation - Delivery Van
Equipment
Accumulated Depreciation - Equipment
Accounts Payable
Utilities Payable
Salaries Payable
Unearned Revenue
Common Stock
Dividends
Delivery Revenue
Rent Expense
Salaries Expense
Supplies Expense
Utilities Expense
Depreciation Expense - Delivery Van
Depreciation Expense - Equipment
Total
Third, cross-foot
the numbers
across the
spreadsheet to
the Adjusted
Trial Balance
columns.
Debit
6,500
800
250
1,000
23,000
Credit
Adjustments
Debit
Credit
225
80
800
Adjusted Trial
Balance
Debit
6,500
1,025
170
200
23,000
750
15,000
750
15,000
300
300
800
230
875
270
37,800
800
230
875
400
37,800
130
8,000
8,000
23,000
3,000
4,500
355
800
875
80
180
62,230
Credit
62,230
750
300
3,160
3,160
23,355
3,800
5,375
80
180
750
300
64,380
64,380
3-39