Adjusting Accounts For Financial Statements Chapter 3 John

Adjusting Accounts For Financial Statements Chapter 3 John

Adjusting Accounts For Financial Statements Chapter 3 John J. Wild Financial Accounting Fundamentals 5th Edition Copyright 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 03-C1: Explain the importance of periodic reporting and the role of accrual accounting 2 The Accounting Period C1 3 Accrual Basis versus Cash Basis Accrual Basis

Revenues are recognized when earned and expenses are recognized when incurred. C1 Cash Basis Revenues are recognized when cash is received and expenses are recorded when cash is paid. 4 Accrual Basis versus Cash Basis Accrual Basis Revenues are recognized when earned and expenses are recognized when incurred. Cash Basis

Revenues are recognized when cash is received and expenses are recorded when cash is paid. Non-GAAP C1 5 Accrual Basis versus Cash Basis On December 1, 2015, FastForward paid $2,400 cash for a twenty-four month business insurance policy. C1 Using the cash basis, the entire $2,400 would be recognized as insurance expense in 2015. No insurance expense from this policy would be recognized in 2016 or 2017, periods covered by the policy. 6

Accrual Basis versus Cash Basis On the accrual basis, $100 of insurance expense is recognized in 2015, $1,200 in 2016, and $1,100 in 2017. The expense is matched with the periods benefited by the insurance coverage. C1 7 Recognizing Revenues The revenue recognition principle states that we recognize revenue when the product or service is delivered to our customer. C1 8 Recognizing Expenses The expense recognition (or matching) principle aims to record expenses in the same accounting period as the revenues

that are earned as a result of those expenses. This matching of expenses with the revenue benefits is a major part of the adjusting process. C1 9 03-P1: Prepare and explain adjusting entries 10 Framework for Adjustments An adjusting entry is made at the end of an accounting period to reflect a transaction or event that is not yet recorded. P1 11 Prepaid (Deferred) Expenses (ex. Prepaid Insurance, Prepaid Rent, Supplies, etc.

Resources paid for prior to receiving the actual benefits. P1 12 PREPAID INSURANCE On December 1, 2015, FastForward paid $2,400 to cover insurance for 24 months that began on December 1 of 2015. Scott recorded the expenditure as Prepaid Insurance on December 1. PREPAID INSURANCE 24-month policy Beginning 12/01 P1 $2,400 13 PREPAID INSURANCE PREPAID INSURANCE

$2,400 $100 INSURANCE EXPENSE $100 $2,400/24 months = $100 Insurance Expense is debited $100 to recognize the amount of insurance coverage for Dec. and Prepaid Insurance is credited for $100 to reduce its balance. P1 14 PREPAID INSURANCE (Balance Sheet) PREPAID INSURANCE $2,400 (Income Statement)

INSURANCE EXPENSE adj $100 $100 adj $2,300 Bal. The Balance Sheet will show $2,300 (23 months) of Prepaid Insurance remaining! P1 The Income Statement will show $100 (1 month) of insurance expired! 15 Adjusting Journal entry for Insurance expired: Weve seen the adjustment in the T-accounts but we need to record the adjustment on Dec. 31, in the General Journal. . .

Insurance Expense Dec. 1 2,400 Dec. 31 Bal. 2,300 637 100 Prepaid Insurance Dec. 31 100 Dec. 31 Insurance Expense Prepaid Insurance 128 100 100 To record first month's expired insurance P1

16 Another adjusting entry which needs to be made is for Depreciation Instead of expensing the cost of a plant asset (equipment, building, cars, etc.) in the year it is purchased we allocate or spread out the cost over their expected useful lives. The formula for straight-line depreciation is: Straight-Line Asset Cost - Salvage Value Depreciation = Useful Life Expense P1 17 USEFUL LIFE The period of time that an asset is expected to help produce revenues. Useful life expires as a result of wear and tear, or because it no longer satisfies the needs of the business.

P1 18 SALVAGE VALUE The expected market value or selling price of an asset at the end of its useful life Also called: Scrap Value or Residual Value P1 .. . ED S U at ! e r G ion t i d

con 19 DEPRECIATION EXAMPLE FastForward purchased equipment on Dec 1 for $26,000. It has an estimated useful live of 60 months. The equipment is expected to be worth about $8,000 at the end of five years. They purchased the equipment on Dec 1 but it is now Dec 31. Because FastForward expects the equipment to be worth $8,000 when the five years are over, only $18,000 of the cost needs to be spread over the next 60 months. P1 20 STRAIGHT-LINE METHOD 1st step: Calculate Net Cost (the amount to depreciate). FORMULA: Original Cost $26,000

P1 Salvage Value = $8,000 = Net Cost $18,000 21 Calculating Depreciation Expense 2nd step: Determine depreciation expense for this accounting period (one month). FORMULA: Net Cost Estimated Useful Life P1

$18,000 60 mos. $300 per month Now that we know depreciation for the month is $300, lets figure out the adjusting entry. . . 22 Depreciation adjustment reflected in our T-accounts looks like this: Depreciation Expense Equipment 12/1 26,000 12/31 300 Accumulated Depreciation 12/31 300 The depreciation amount of $300 is credited to this

account instead of the asset account. 23 Let look at the journal entry for the adjustment for Depreciation.. Equipment 12/1 26,000 Depreciation Expense 12/31 300 Accumulated Depreciation-Equipment 12/31 300 Dec. 31 Depreciation Expense Accumulated Depreciation - Equipment P1 300 300 To record monthly equipment depreciation 24

Depreciation would show up on our balance sheet like this: FastForward Partial Balance Sheet At February 28, 2016 $ Assets Cash . Equipment Less: accumulated deprec. . . Total Assets P1 $ 26,000 (900) 25,100 After three months of

depreciation have been taken, the Equipment is shown net of accumulated depreciation. 25 NEED-TO-KNOW For each separate case below, follow the three-step process for adjusting the prepaid asset account. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Step 3: Record an adjusting entry to get from step 1 to step 2. Assume no other adjusting entries are made during the year. Prepaid Insurance.The Prepaid Insurance account has a $5,000 debit balance to start the year. A review of insurance policies and payments shows that $1,000 of unexpired insurance remains at yearend. Prepaid Rent. On October 1 of the current year, the company prepaid $12,000 for one year of rent for facilities being occupied from that day forward. The company debited Prepaid Rent and credited Cash for $12,000. December 31 year-end statements must be prepared. Supplies. The Supplies account has an $1,000 debit balance to start the year. Supplies of $2,000 were purchased during the current year and debited to the Supplies account. A December 31 physical count shows $500 of supplies remaining. Accumulated Depreciation. The company has only one fixed asset (equipment) that it purchased at the start of this year. That asset had cost $38,000, had an estimated life of 10 years, and is expected to be valued at $8,000 at the end of the 10-year life.

P1 26 NEED-TO-KNOW Prepaid Insurance. The Prepaid Insurance account has a $5,000 debit balance to start the year. A review of insurance policies and payments shows that $1,000 of unexpired insurance remains at yearend. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Unadj. Adj. Prepaid Insurance 5,000 Adjustment 1,000 $5,000 $1,000 4,000 Step 3: Record an adjusting entry to get from step 1 to step 2. Date

Dec. 31 General Journal Insurance expense Prepaid Insurance Income Statement Revenue Debit Expense P1 Debit 4,000 Credit 4,000 Balance Sheet Credit Asset Liability 27 NEED-TO-KNOW Prepaid Rent. On October 1 of the current year, the company prepaid $12,000 for one year of rent for

facilities being occupied from that day forward. The company debited Prepaid Rent and credited Cash for $12,000. December 31 year-end statements must be prepared. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Oct. 1 Dec. 31 Prepaid Rent 12,000 Adjustment 9,000 $12,000 $9,000 3,000 Step 3: Record an adjusting entry to get from step 1 to step 2. Date Dec. 31 General Journal Rent Expense Prepaid Rent

Income Statement Revenue Debit Expense P1 Debit 3,000 Credit 3,000 Balance Sheet Credit Asset Liability 28 NEED-TO-KNOW Supplies. The Supplies account has a $1,000 debit balance to start the year. Supplies of $2,000 were purchased during the current year and debited to the Supplies account. A December 31 physical count shows $500 of supplies remaining. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Unadj.

Dec. 31 Supplies 3,000 Adjustment 500 $3,000 $500 2,500 Step 3: Record an adjusting entry to get from step 1 to step 2. Date Dec. 31 General Journal Supplies Expense Supplies Income Statement Revenue Debit Expense P1

Debit 2,500 Credit 2,500 Balance Sheet Credit Asset Liability 29 NEED-TO-KNOW Accumulated Depreciation. The company has only one fixed asset (equipment) that it purchased at the start of this year. That asset had cost $38,000, had an estimated life of 10 years, and is expected to be valued at $8,000 at the end of the 10-year life. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. $0 $3,000 Accumulated Depreciation Unadj. Adjustment Dec. 31

0 3,000 3,000 ($38,000 - $8,000) 10 years Step 3: Record an adjusting entry to get from step 1 to step 2. Date Dec. 31 General Journal Depreciation Expense Accumulated Depreciation Income Statement Revenue Debit Expense P1 Debit 3,000 Credit 3,000 Balance Sheet

Credit Contra-Asset Liability 30 Unearned (Deferred) Revenues Cash received in advance of providing products or services. P1 31 NEED-TO-KNOW For each separate case below, follow the three-step process for adjusting the unearned revenue liability account. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Step 3: Record an adjusting entry to get from step 1 to step 2. Assume no other adjusting entries are made during the year. Unearned Rent Revenue. The company collected $24,000 rent in advance on September 1, debiting Cash and crediting Unearned Rent Revenue. The tenant was paying 12 months rent in advance and occupancy began September 1. Unearned Services Revenue. The company charges $100 per month to spray a house for insects. A customer paid $600 on November 1 in advance for six treatments, which was recorded with a debit

to Cash and a credit to Unearned Services Revenue. At year-end, the company has applied two treatments for the customer. P1 32 NEED-TO-KNOW Unearned Rent Revenue. The company collected $24,000 rent in advance on September 1, debiting Cash and crediting Unearned Rent Revenue. The tenant was paying 12 months rent in advance and occupancy began September 1. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Unearned Rent Revenue Sept. 1 Adjustment 8,000 Dec. 31 $24,000 $16,000 24,000 16,000 (8 mos. @ $2,000) Step 3: Record an adjusting entry to get from step 1 to step 2.

Date Dec. 31 General Journal Unearned Rent Revenue Rent Revenue Income Statement Credit Revenue Expense P1 Debit 8,000 Credit 8,000 Balance Sheet Asset Debit Liability 33 NEED-TO-KNOW

Unearned Services Revenue. The company charges $100 per month to spray a house for insects. A customer paid $600 on November 1 in advance for six treatments, which was recorded with a debit to Cash and a credit to Unearned Services Revenue. At year-end, the company has applied two treatments for the customer. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Unearned Services Revenue Nov. 1 Adjustment 200 Dec. 31 $600 $400 600 400 Step 3: Record an adjusting entry to get from step 1 to step 2. Date Dec. 31 General Journal Unearned Services Revenue Services Revenue

Income Statement Credit Revenue Expense P1 Debit 200 Credit 200 Balance Sheet Asset Debit Liability 34 Accrued Expenses Costs incurred in a period that are both unpaid and unrecorded. P1

35 NEED-TO-KNOW For each separate case below, follow the three-step process for adjusting the accrued expense account. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Step 3: Record an adjusting entry to get from step 1 to step 2. Assume no other adjusting entries are made during the year. Salaries Payable. At year-end, salaries expense of $5,000 has been incurred by the company, but is not yet paid to employees. Interest Payable. At its December 31 year-end, the company holds a mortgage payable that has incurred $1,000 in annual interest that is neither recorded nor paid. The company intends to pay the interest on January 3 of the next year. P1 36 NEED-TO-KNOW Salaries Payable. At year-end, salaries expense of $5,000 has been incurred by the company, but is not yet paid to employees. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Salaries Payable Unadj. Adjustment

Dec. 31 $0 $5,000 0 5,000 5,000 Step 3: Record an adjusting entry to get from step 1 to step 2. Date Dec. 31 General Journal Salaries Expense Salaries Payable Income Statement Revenue Debit Expense P1 Debit 5,000

Credit 5,000 Balance Sheet Asset Credit Liability 37 NEED-TO-KNOW Interest Payable. At its December 31 year-end, the company holds a mortgage payable that has incurred $1,000 in annual interest that is neither recorded nor paid. The company intends to pay the interest on January 3 of the next year. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Interest Payable Unadj. Adjustment Dec. 31 $0 $1,000 0 1,000 1,000

Step 3: Record an adjusting entry to get from step 1 to step 2. Date Dec. 31 General Journal Interest Expense Interest Payable Income Statement Revenue Debit Expense P1 Debit 1,000 Credit 1,000 Balance Sheet Asset Credit Liability 38

Accrued Revenues Revenues earned in a period that are both unrecorded and not yet received. P1 39 NEED-TO-KNOW For each separate case below, follow the three-step process for adjusting the accrued revenue account. Step 1: Determine what the current account balance equals. Step 2:Determine what the current account balance should equal. Step 3:Record an adjusting entry to get from step 1 to step 2. Assume no other adjusting entries are made during the year. Accounts Receivable.At year-end, the company has completed services of $1,000 for a client, but the client has not yet been billed for those services. Interest Receivable.At year-end, the company has earned, but not yet recorded, $500 of interest earned from its investments in government bonds. P1 40

NEED-TO-KNOW Accounts Receivable. At year-end, the company has completed services of $1,000 for a client, but the client has not yet been billed for those services. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. $0 $1,000 Accounts Receivable Unadj. 0 Adjustment 1,000 Dec. 31 1,000 Step 3: Record an adjusting entry to get from step 1 to step 2. Date Dec. 31 General Journal Accounts Receivable Services Revenue Income Statement Credit Revenue

Expense P1 Debit 1,000 Credit 1,000 Balance Sheet Debit Asset Liability 41 NEED-TO-KNOW Interest Receivable. At year-end, the company has earned, but not yet recorded, $500 of interest earned from its investments in government bonds. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Unadj. Adjustment Dec. 31

$0 $500 Interest Receivable 0 500 500 Step 3: Record an adjusting entry to get from step 1 to step 2. Date Dec. 31 General Journal Interest Receivable Interest Revenue Income Statement Credit Revenue Expense P1 Debit 500 Credit

500 Balance Sheet Debit Asset Liability 42 Links to Financial Statements P1 43 03-P2: Adjusted Trial Balance 44 Adjusted Trial Balance P2 45 03-P3: Prepare financial statements from an adjusted

trial balance 46 Preparing Financial Statements from an Adjusted Trial Balance Step 1 Prepare income statement using revenue and expense accounts from trial balance. Step 2Prepare statement of retained earnings using retained earnings and dividends from trial balance; and pull net income from step 1. Step 3Prepare balance sheet using asset and liability account from trial balance; and pull updated retained earnings balance from step 2. Step 4Prepare statement of cash flows from changes in cash flows for the period (illustrated later in the book). P3 47 NEED-TO-KNOW Use the following adjusted trial balance of Magic Company to prepare its (1) income statement, (2) statement of Retained earnings, and (3) balance sheet (unclassified), for the year ended, or date of, December 31, 2015. The Retained Earnings account balance is $45,000 at December 31, 2014. Magic Company

Adjusted Trial Balance December 31, 2015 Debit Credit Cash $13,000 Accounts receivable 17,000 Land 85,000 Accounts payable $12,000 Long-term notes payable 33,000 30,000 Common Stock Retained Earnings 45,000 Dividends 20,000 Fees earned 79,000 Salaries expense 56,000 Office supplies expense 8,000

Totals $199,000 $199,000 P3 48 Debit Credit Magic Company Adjusted Trial Balance December 31, 2015 Debit Credit Cash $13,000 Accounts receivable 17,000 Land 85,000 Accounts payable $12,000 Long-term notes payable 33,000

30,000 Common Stock Retained Earnings 45,000 Dividends 20,000 Fees earned 79,000 Salaries expense 56,000 Office supplies expense 8,000 Totals $199,000 $199,000 P3 The Income Statement Magic Company Income Statement For Year Ended December 31, 2015 Fees earned $79,000 Expenses

Salaries expense $56,000 Office supplies expense 8,000 64,000 Net income $15,000 49 Debit Credit Magic Company Adjusted Trial Balance December 31, 2015 Debit Credit Cash $13,000 Accounts receivable 17,000 Land 85,000 Accounts payable $12,000

Long-term notes payable 33,000 30,000 Common Stock Retained Earnings 45,000 Dividends 20,000 Fees earned 79,000 Salaries expense 56,000 Office supplies expense 8,000 Totals $199,000 $199,000 P3 Magic Company Income Statement For Year Ended December 31, 2015 Fees earned $79,000 Expenses Salaries expense

$56,000 Office supplies expense 8,000 64,000 Net income $15,000 Magic Company Statement of Retained Earnings For Year Ended December 31, 2015 Retained Earnings, Dec. 31 2014 $45,000 Plus: Net income 15,000 Less: Dividends (20,000) Retained Earnings, Dec. 31 2015 $40,000 The Statement of Retained Earnings 50 Debit Credit Magic Company Adjusted Trial Balance

December 31, 2015 Debit Credit Cash $13,000 Accounts receivable 17,000 Land 85,000 Accounts payable $12,000 Long-term notes payable 33,000 30,000 Common Stock Retained Earnings 45,000 Dividends 20,000 Fees earned 79,000 Salaries expense 56,000 Office supplies expense 8,000 Totals

$199,000 $199,000 Magic Company Income Statement For Year Ended December 31, 2015 Fees earned $79,000 Expenses Salaries expense $56,000 Office supplies expense 8,000 64,000 Net income $15,000 Magic Company Statement of Owners Equity For Year Ended December 31, 2015 Retained Earnings, Dec. 31 2014 $45,000 Plus: Net income 15,000 Less: Dividends (20,000) Retained Earnings, Dec. 31 2015 $40,000

Magic Company Balance Sheet December 31, 2015 Assets Cash Accounts receivable Land P3 Total assets $13,000 17,000 85,000 $115,000 Liabilities Accounts payable Long-term notes payable Total liabilities Equity Common Stock Retained Earnings Total Equity

Total liabilities and equity $12,000 33,000 45,000 Balance Sheet 30,000 40,000 70,000 115,000 51 03-P4: Describe and prepare closing entries 52 Recording Closing Entries Close Credit Balances in Revenue Accounts to Income Summary.

Close Debit Balances in Expense accounts to Income Summary. Close Income Summary account to Retained Earnings. Close Dividends to Retained Earnings. P4 53 NEED-TO-KNOW Use the adjusted trial balance of Magic Company to prepare its closing entries. Magic Company Trial Balance Magic Company December 31,Balance 20X2 Adjusted Trial Credit December 31, 2015Debit Debit Credit

Cash $13,000 Accounts receivable 17,000 Land 85,000 Accounts payable $12,000 Long-term notes payable 33,000 30,000 Common Stock Retained Earnings 45,000 Dividends 20,000 Fees earned 79,000 Salaries expense 56,000 Office supplies expense 8,000 Totals $199,000 $199,000 P4

54 Debit $13,000 17,000 85,000 Cash Accounts receivable Land Accounts payable Long-term notes payable Common stock Retained earnings Dividends 20,000 Fees earned Salaries expense 56,000 Office supplies expense 8,000 Totals $199,000 Date Dec. 31

Dec. 31 Dec. 31 Dec. 31 P4 Credit Expenses $12,000 33,000 30,000 45,000 79,000 Closing Income summary 64,000 Revenues Net income 15,000 79,000

15,000 0 Retained earnings 12/31/2014 20,000 Net income 12/31/2015 Dividends 45,000 15,000 40,000 $199,000 General Journal Fees earned Income summary Debit 79,000 Credit 79,000

Income summary Salaries expense Office supplies expense 64,000 Income summary Retained earnings 15,000 Retained earnings Dividends 20,000 56,000 8,000 15,000 20,000 55 Debit

$13,000 17,000 85,000 Cash Accounts receivable Land Accounts payable Long-term notes payable Common Stock Retained earnings Totals $115,000 Credit Expenses $12,000 33,000 30,000 40,000 $115,000 Closing Income Summary 64,000

Revenues Net income 15,000 79,000 15,000 0 Dividends Retained Earnings 12/31/2014 20,000 Net income 12/31/2015 45,000 15,000 40,000 Magic Company Balance Sheet December 31, 2015 Assets Cash Accounts receivable Land

Total assets P4 $13,000 17,000 85,000 $115,000 Liabilities Accounts payable Long-term notes payable Total liabilities Equity $12,000 33,000 45,000 Common stock Retained earnings Total equity Total liabilities and equity

30,000 40,000 75,000 115,000 56 03-P5: Explain and prepare a postclosing trial balance 57 Post-Closing Trial Balance List of permanent accounts and their balances after posting closing entries. Total debits and credits must be equal. P5 58 Post-Closing Trial Balance P5 59

03-C2: Identify steps in the accounting cycle. 60 Accounting Cycle C2 61 03-C3: Explain and prepare a classified balance sheet 62 Classified Balance Sheet Current items are those expected to come due (both collected and owed) within the longer of one year or the companys normal operating cycle. C3 63

Current Assets Current assets are expected to be sold, collected, or used within one year or the companys operating cycle. C3 64 Long-Term Investments Long-term investments are expected to be held for more than one year or the operating cycle. C3 65 Plant Assets Plant assets are tangible long-lived assets used to produce or sell products and services. C3 66

Intangible Assets Intangible assets are long-term resources used to produce or sell products and services and that lack physical form. C3 67 Current Liabilities Current liabilities are obligations due within the longer of one year or the companys operating cycle. C3 68 Long-Term Liabilities Long-term liabilities are obligations not due within the longer of one year or the companys operating cycle. C3 69

Equity Equity is the owners claim on the assets. C3 70 NEED-TO-KNOW Use the adjusted trial balance of Magic Company to prepare its classified balance sheet as of December 31, 2015. Magic Company Magic Company Adjusted Trial Balance Adjusted Trial Balance December 31, 20X2 December 31, 2015 Debit Credit Debit Credit Cash $13,000

Accounts receivable 17,000 Land 85,000 Accounts payable $12,000 Long-term notes payable 33,000 30,000 Common Stock Retained Earnings 45,000 Dividends 20,000 Fees earned 79,000 Salaries expense 56,000 Trial Balance Office supplies expense 8,000 Totals $199,000 $199,000 Debit Credit

C3 71 NEED-TO-KNOW Use the adjusted trial balance of Magic Company to prepare its classified balance sheet as of December 31, 2015. Magic Company Magic Company Adjusted Trial Balance Adjusted Trial Balance Adjusted Trial DecemberBalance 31, 20X2 December 31, 20X2 December 31, 2015 Debit

Debit Debit Cash Accounts receivable Land Accounts payable Long-term notes payable Common Stock Retained Earnings Dividends Fees earned Salaries expense Credit Credit Credit $13,000 17,000 85,000 $12,000 33,000 30,000 45,000 20,000 Trial Balance 56,000

Office supplies expense 8,000 Totals C3 79,000 $199,000 Debit $199,000 Credit Magic Company Balance Sheet December 31, 2015 Assets Current assets Cash Accounts receivable Total current assets Plant assets Land Total plant assets Total assets Liabilities Current liabilities

Accounts payable Total current liabilities Long-term liabilities Long-term notes payable Total liabilities Equity Common Stock Retained Earnings Total equity Total liabilities and equity $13,000 17,000 30,000 85,000 85,000 $115,000 $12,000 12,000 33,000 $45,000 30,000 40,000 70,000 $115,000

72 Global View The definition of an asset is similar under U.S. GAAP and IFRS and involves three basic criteria: (1) the company owns or controls the right to use the item, (2) the right arises from a past transaction or event, and (3) the item can be reliably measured. Both systems define the initial asset value as historical cost for nearly all assets. The The definition definition of of aa liability liability is is similar similar under under U.S. U.S. GAAP GAAP and and IFRS IFRS and and involves involves three three basic

basic criteria: criteria: (1) (1) the the item item is is aa present present obligation obligation requiring requiring aa probable probable future future resource resource outlay, outlay, (2) (2) the the obligation obligation arises arises from from aa past past transaction transaction or or event, event, and and

(3) (3) the the obligation obligation can can be be reliably reliably measured. measured. 73 Global View Both Both U.S. U.S. GAAP GAAP and and IFRS IFRS include include similar similar guidance guidance for for adjusting adjusting accounts. accounts. Although Although some some variations

variations exist exist in in revenue revenue and and expense expense recognition. recognition. 74 03-A1: Compute profit margin and describe its use in analyzing company performance. 75 Profit Margin The profit margin ratio measures the companys net income to net sales. Profit Net Income = Margin Net Sales Limited Brands, Inc.

A1 76 03-A2: Compute the current ratio and describe what it reveals about a companys financial condition. 77 Current Ratio Helps assess the companys ability to pay its debts in the near future Current assets Current ratio = Current liabilities Limited Brands, Inc. A2 78

03-P6: Appendix 3A Alternative Accounting for Prepayments 79 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. P6 80 Appendix 3A: Alternative Accounting for Prepayments P6 81 Appendix 3A: Alternative Accounting for Revenues

An alternative method is to record all revenues to a liability account or a revenue account. The adjusting entry depends on how the original receipt was recorded. P6 82 Appendix 3A: Alternative Accounting for Revenues P6 83 03-P7: Appendix 2C Prepare a work sheet and explain its usefulness. 84 Benefits of a Work Sheet Aids the preparation of

financial statements. Reduces possibility of errors. Links accounts and their adjustments. P7 Assists in planning and organizing an audit. Not a required report. Helps in preparing interim financial statements. Shows the effects of proposed

transactions. 85 NEED-TO-KNOW The following 10-column work sheet contains the year-end unadjusted trial balance for Sampson Company as of December 31, 2016. Complete the work sheet by entering the necessary adjustments, computing the adjusted account balances, extending the adjusted balances into the appropriate financial statement columns, and entering the amount of net income for the period. Note: The common stock account balance was $32,000 at December 31, 2015. Unadjusted Trial Balance No. Dr. Cr. 101 Cash 23,000 106 Accounts receivable 8,000 183 Land 52,000 201 Accounts payable 10,000 251 Long-term notes payable 43,000 301 Common Stock 32,000

302 Dividends 10,000 401 Fees earned 70,000 622 Salaries expense 54,000 650 Office supplies expense 8,000 Totals 155,000 155,000 Adjustments Dr. Cr. Adjusted Trial Balance Dr. Cr. Income Statement Dr. Cr. Balance Sheet

and Statement of Ret. Earnings 1. Prepare and complete the work sheet, starting with the unadjusted trial balance and including adjustments based on the following. a. The company has earned $9,000 in fees that were not yet recorded at year-end. b. The company incurred $2,000 in salary expense that was not yet recorded at year-end. (Hint: For simplicity, assume it records any salary not yet paid as part of accounts payable.) c. The long-term note payable was issued on December 31 this year. Thus, no interest has yet accrued on this loan. P7 Dr. Cr. 86 Unadjusted Adjusted Trial Balance Trial Balance Adjustments No. Dr.

Cr. Dr. Cr. Dr. Cr. 101 Cash 23,000 23,000 106 Accounts receivable 8,000 (a) 9,000 17,000 183 Land 52,000 52,000 201 Accounts payable 10,000 (b) 2,000 12,000 251 Long-term notes payable 43,000 43,000 301 Common Stock 32,000 32,000 302 Dividends

10,000 10,000 401 Fees earned 70,000 (a) 9,000 79,000 622 Salaries expense 54,000 (b) 2,000 56,000 650 Office supplies expense 8,000 8,000 Totals 155,000 155,000 11,000 11,000 166,000 166,000 Net income Totals Income Statement Dr. Cr. Balance Sheet

and Statement of Owner's Equity Dr. Cr. 23,000 17,000 52,000 12,000 43,000 32,000 10,000 79,000 56,000 8,000 64,000 15,000 79,000 79,000 102,000 87,000 15,000 79,000 102,000 102,000 a. The company has earned $9,000 in fees that were not yet recorded at year-end.

b. The company incurred $2,000 in salary expense that was not yet recorded at year-end. (Hint: For simplicity, assume it records any salary not yet paid as part of accounts payable.) c. The long-term note payable was issued on December 31 this year. Thus, no interest has yet accrued on this loan. P7 87 Unadjusted Adjusted Trial Balance Trial Balance Adjustments No. Dr. Cr. Dr. Cr. Dr. Cr. 101 Cash 23,000 23,000 106 Accounts receivable

8,000 (a) 9,000 17,000 183 Land 52,000 52,000 201 Accounts payable 10,000 (b) 2,000 12,000 251 Long-term notes payable 43,000 43,000 301 Common Stock 32,000 32,000 302 Dividends 10,000 10,000 401 Fees earned 70,000 (a) 9,000 79,000 622 Salaries expense 54,000 (b) 2,000

56,000 650 Office supplies expense 8,000 8,000 Totals 155,000 155,000 11,000 11,000 166,000 166,000 Net income Totals Income Statement Dr. Cr. Balance Sheet and Statement of Ret. Earnings Dr. Cr. 23,000 17,000 52,000 12,000 43,000

32,000 10,000 79,000 56,000 8,000 64,000 15,000 79,000 79,000 102,000 87,000 15,000 79,000 102,000 102,000 2. Use information from the completed work sheet in part 1 to prepare adjusting entries. Date General Journal Dec. 31 Accounts Receivable Debit 9,000

Fees earned Dec. 31 Salaries expense Accounts payable Credit 9,000 2,000 2,000 Dec. 31 No journal entry required P7 88 3. Prepare the income statement and the statement of retained earnings for the year ended December 31 and the unclassified balance sheet at December 31. Debit $23,000 17,000 52,000 Cash Accounts receivable

Land Accounts payable Long-term notes payable Common Stock Dividends 10,000 Fees earned Salaries expense 56,000 Office supplies expense 8,000 Totals $166,000 Credit $12,000 43,000 32,000 79,000 $166,000 Sampson Company Income Statement For Year Ended December 31, 2016

Fees earned $79,000 Expenses Salaries expense $56,000 Office supplies expense 8,000 64,000 Net income $15,000 Sampson Company Statement of Retained Earnings For Year Ended December 31, 2016 Retained Earnings, Dec. 31 2015 $ 00 Plus: Net income 15,000 Less: Dividends (10,000) Retained Earnings, Dec. 31 2016 $ 5,000 Sampson Company Balance Sheet December 31, 2016 Assets

Cash Accounts receivable Land P7 Total assets $23,000 17,000 52,000 $92,000 Liabilities Accounts payable Long-term notes payable Total liabilities Equity Common Stock Retained Earnings Total liabilities and equity $12,000 43,000 55,000

32,000 5,000 92,000 89 03-P8: Appendix 3C Reversing Entries 90 Appendix 4A Reversing Entries Reversing entries are optional. They are recorded in response to accrued assets and accrued liabilities that were created by adjusting entries at the end of a reporting period. The purpose of reversing entries is to simplify a companys recordkeeping. Lets see how the accounting for our payroll accrual will be handled with and without reversing entries. P8 91 P8

92 Without Reversing Entries P8 With Reversing Entries 93 End of Chapter 3 94

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