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After completing this chapter you should be able to: Explain the importance of periodic reporting and the time period assumption, explain accrual accounting and how it improves financial statements, identify the types of adjustments and their purpose.
Chapter Adjusting Accounts and Preparing Financial Statements PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W Caldwell, D.B.A., CMA Jon A Booker, Ph.D., CPA, CIA Cynthia J Rooney, Ph.D., CPA Winston Kwok, Ph.D., CPA McGrawHill/Irwin Copyright © 2011 by The McGrawHill Companies, Inc. All rights reserved 3 2 C 1 The Accounting Period 3 3 C 2 Accrual Basis versus 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 are recorded when cash is paid 3 4 C 2 Accrual Basis versus 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 are recorded when cash is paid Non-GAAP 3 5 C 2 Accrual Basis versus Cash Basis Insurance Expense 2009 Jan Feb Mar Apr $ May $ Jun $ Jul $ Aug $ Sep $ Oct $ Nov $ Dec $ - $ - $ - $ 2,400 On the cash basis, the entire $2,400 would be recognized as insurance expense in 2011 No insurance expense from this policy would be recognized in 2012 or 2013, periods covered by the policy 3 6 C 2 Accrual Basis versus Cash Basis Insurance Expense 2009 Jan Feb Mar Apr $ May $ Jun $ Jul $ Aug $ Sep $ Oct $ Nov $ Dec $ - $ - $ - $ 100 Insurance Expense 2010 Jan Feb Mar Apr $ 100 May $ 100 Jun $ 100 Jul $ 100 Aug $ 100 Sep $ 100 Oct $ 100 Nov $ 100 Dec $ 100 $ 100 $ 100 $ 100 Insurance Expense 2011 Jan Feb Mar Apr $ 100 May $ 100 Jun $ 100 Jul $ 100 Aug $ 100 Sep $ 100 Oct $ 100 Nov $ 100 Dec $ 100 $ 100 $ 100 $ - On the accrual basis, $100 of insurance expense is recognized in 2011, $1,200 in 2012, and $1,100 in 2013 The expense is matched with the periods benefited by the insurance coverage 3 7 C 2 Recognizing Revenues & Expenses Revenue Recognition Principle We We have have delivered delivered the the product product to our our customer, so so II think think we we should should record the the revenue revenue earned earned 3 8 C 2 Recognizing Revenues & Expenses Revenue Recognition Principle Matching Principle Summary of Expenses Rent Gasoline Advertising Salaries Utilities and $1,000 500 2,000 3,000 450 Now that we have recognized the the revenue, let’s see what expenses we incurred to generate that revenue 3 9 C 3 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 Prepaid (Deferred) (Deferred) expenses* expenses* *including depreciation Unearned Unearned (Deferred) (Deferred) revenues revenues Paid Paid (or (or received) received) cash cash after after expense expense (or (or revenue) revenue) recognized recognized Accrued Accrued expense expense Accrued Accrued revenues revenues 3 10 P 1 Prepaid (Deferred) Expenses Resources paid for prior to receiving the actual benefits Here Here is is the the check check for for my my 24-month 24-month insurance insurance policy policy 3 25 P 1 ACCRUED INTEREST EXPENSES FastForward FastForward borrowed borrowed $6,000 $6,000 from from First First National National Bank Bank on on December December 1, 1, 2011 2011 The The note note bears bears interest interest at at the the annual annual rate rate of of 6% 6% and and is is due due to to be be repaid repaid in in one one year year Let’s Let’s accrue accrue interest interest for for the the month month ended ended 12/31/11 12/31/11 Dec 31 Interest Expense Interest Payable 30 30 To accrue interest ($6,000 × 6% × 30/360) Interest Expense Dec 31 30 Interest Payable Dec 31 30 3 26 P 1 Accrued Revenues Revenues Revenues earned earned in in aa period period that that are are both both unrecorded unrecorded and and not not yet yet received received Yes, Yes, I’ve I’ve completed completed your your consulting consulting job, job, but but have have not not had had time time to to bill bill you you yet yet 3 27 P 1 Accrued Service Revenue (f) (f) On On December December 12, 12, 2011, 2011, FastForward FastForward agrees agrees to to render render consulting consulting services services under under aa 30-day 30-day fixed fixed fee fee contract contract for for $2,700 $2,700 ($90 ($90 per per day) day) All All services services are are to to be be completed completed by by January January 10, 10, 2012, 2012, when when the the client client will will pay pay in in full full Dec 31 Accounts Receivable 1,800 Consulting Revenue 1,800 To accrue revenue (20-days @ $90 per day) Accounts Receivable Other receivables 1,900 Receipts Dec 31 1,800 Bal 1,800 1,900 Consulting Revenue Other revenues 6,050 Dec 31 1,800 Bal 7,850 3 28 Future Receipt of Service Revenues P 1 On On January January 10, 10, 2012, 2012, FastForward FastForward completed completed its its obligation obligation under under the the consulting consulting contract contract The The client client was was billed billed $2,700 $2,700 and and FastForward FastForward received received $2,700 $2,700 in in cash cash Jan 10 Cash 2,700 Accounts Receivable Consulting Revenue T o re c ord c om p le tion of c on trac t an d c as h c olle c tion Revenue in January 10 days @ $90 = $900 1,800 900 3 29 A 1 Links to Financial Statements 3 30 P 2 FastForward - Trial Balance - December 31, 2011 Unadjusted Trial Balance Adjustments Adjusted Trial Balance First, the initial unadjusted amounts are added to the worksheet 3 31 P 2 FastForward - Trial Balance - December 31, 2011 Unadjusted Trial Balance Adjustments Adjusted Trial Balance Next, FastForward’s adjustments are added 3 32 P 2 FastForward – Adjusted Trial Balance - December 31, 2011 Unadjusted Trial Balance Adjustments Adjusted Trial Balance Finally, Finally, the the totals totals are are determined determined 3 33 P 3 Preparing Financial Statements Let’s use FastForward’s adjusted trial balance to prepare the company’s financial statements 3 34 P 3 Prepare the Income Statement 3 35 P 3 PREPARE THE STATEMENT OF CHANGES IN EQUITY Note: Net Income from the Income Statement carries to the Statement of Changes in Equity 3 36 P 3 Prepare The Balance Sheet 3 37 Profit Margin A 2 The profit margin ratio measures the company’s net income to net sales Profit Net Income = Margin Net Sales Limited Brands, Inc $ in millions Net income Net sales Profit margin Industry profit margin 2009 $ 220 2008 $ 718 2007 $ 676 2006 $ 683 9,043 10,134 10,671 9,699 2.4% 7.1% 6.3% 7.0% 0.3% 1.1% 1.6% 1.5% 3 38 P4 Appendix 3A: Alternative Accounting for Prepayments An alternative method is to record all prepaid expenses with debits to expense accounts The adjusting entry depends on how the original payment was recorded 3 39 END OF CHAPTER ... Depreciation Depreciation is the process of allocating the cost of a plant asset over its useful life in a systematic and rational manner Straight-Line Asset Cost - Residual Value Depreciation = Useful... period that that are are both both unpaid unpaid and and unrecorded unrecorded We’re We’re about about one-half one-half done done with with this job and want want to to be be paid paid for for our... day and and is is paid paid every every two two weeks weeks on on Friday Friday Year-end, Year-end, 12/31/11, 12/31/11, falls falls on on aa Wednesday Wednesday The The last last payday payday of