Adjusting Accounts & Preparing Financial Statements

Chapter 3

Accounting period
Time

principle period

Specific time periods for accounting activities Fiscal year

Consisting of any 12 months period other than ending on December 31

Natural year
Ends December 31

Accounting basis
Accrual

basis

Uses the adjusting process to recognize revenues when earned and to match expenses with revenues
Cash

Basis

Recognized revenues when cash is received and records expenses when cash is paid

Revenue Recognition

Matching principle
Aims to record expenses in the same accounting period as the revenues that are earned as a result of these expenses

Adjustments
Adjusting

entries

To correct for transactions and events that extend over more than one period
Deferred wait till cash is paid Accrual

Rule
Debit the expense Credit the asset or liabilities For the amount used up

Prepaid insurance
Suppose

that we purchase $2,400 for insurance for one year on May 1. Record the adjustments on December 31. $2,400/12 = $200 x 8months = $1,600 Insurance expense 1600 Prepaid insurance 1600

Supplies
Suppose

that supplies account has a balance of $4,000 and inventory shows $1,000. Record the supplies used up. Balance 4,000 Inventory1,000 Used up 3,000

Supplies
Supplies

expense 3,000 Supplies 3,000

Depreciation
Plant

assets/Fixed Assets

Assets which are tanigble and long lived Building and machinery
Depreciation

The reduction in value of an asset due to its use

Depreciation
Depreciation Accumulated

expense depreciation

Annual reduction in value of asset Contra asset Increases with a credit Total reduction in value of an asset

Unearned revenues
Refers

to cash received in advance of services provided Suppose that unearned revneue has a balance of $7,000 but records shows only $3,000 is unearned Balance $7,000 Should be 3,000 Earned 4,000

Unearned Revenues
Unearned

revenues

A liability If we do not complete the work then we are liable to refund the monies. Once the work is completed then the liability does not exist
Unearned

revenues 4,000 Fees earned 4000

Accrued expenses
Refers

to costs that are incurred in a period that are unpaid and unrecorded Accrued salaries
Salaries owed at the end of the period to be made next period Suppose year ends on Wed, do we pay on Wed or wait until Friday

Salaries
Suppose Salaries

salaries at year end is $400

expense 400 Salaries payable 400

Accrued revenues
Refers

to revenues earned in a period that are both unrecorded and not yet received in cash Unrecorded accounts receivable

Trial Balance
Unadjusted

trial balance

is a list of account balances before adjustments Used to make adjusting entries

Adjusted

trial balance

Used to prepare financial statements

Financial Statements
Four

basic financial statements

Income statement Statement of Retained Earnings Balance Sheet Statement of Cash flows

Income Statement
Results of operations for a business Shows revenues minus expenses Rob Co Income Statement For period ending 12/31/04
$75,000

Revenues Sales Expense

Salaries exp Rent exp Total exp

$25,000 $10,000 35,000

Statement of Retained Earnings

Changes in net worth and equity Rob Co Statement of Retained Earnings For period ending 12/31/04 Beginning Retained Earnings +Net income -Dividends Ending Retained Earnings $60,000 40,000 100,000 20,000 $80,000

Balance sheet
Assets Cash Truck Total Assets Liabilities Accts pay Total liab. Stockholders Equity Common Stock Retained Earnings

Rob Co Balance Sheet December 3, 2004 $45,000 75,000 $120,000

$10,000 $10,000

$30,000 $80,000

Statement of Cash Flows

Inflows

and outflow of cash from

Operations Investments Financing

Accounting Cycle
Record

entries in the journal Post to ledger Prepare unadjusted Trial Balance Record and post adjusting entries Prepare adjusted trial balance Prepare financial statements
Record

and post closing entries

Closing Entries
Temporary

accounts

Accumulate data related to one accounting period

Revenue Expense Dividends Income summary

Close revenues
Revenues

DR
Cr

Income summary
Debit

whatever revenue accounts you have on the trial balance for their ending balance and the total is credited to income summary

Close Expenses
Income

summary Expenses

DR CR

Credit

each expense account separately for the amount of the balance in the account and debit income summary for the total

Close Income Summary

Income

Summary DR Retained earnings

Income Summary Debit Total expenses

CR

For the balance in the income summary account Credit Total revenues Net income

Close Dividends
Dividends

reduce the equity of the business and the amount retained in the business Retained earnings DR Dividends CR For the amount of the balance in the dividend account

Transactions
Fees

earned $50,000 Rent expense 10,000 Supplies expense 5,000 Dividends 2,000 Retained earnings $30,000 Record the closing entries

Close revenues
Fees

earned 50,000 Income summary

50,000

Close Expenses
Income

Summary $15,000 Rent expense Supplies expense

$10,000 5,000

Close Income Summary

Income

Summary $35,000 Retained earnings $35,000

Income Summary DR CR $50,000 Revenues

Expenses

$15,000

$35,000 net income

Close Dividends
Retained

earnings $2,000 Dividends $2,000

Retained Earnings DR $2,000 Dividends CR $30,000 Balance $35,000 net income $63,000 ending balance

Classification of Accounts

Current assets
Expected to be collected in less than one year Cash Accounts receivable Supplies Inventory

Plant Asset
Long lived tangible assets Factory building Machinery and equipment