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Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 1 of 23
Chapter 3Chapter 3
The Adjusting Process
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 2 of 23
Accrual Accounting Versus Accrual Accounting Versus Cash-Basis AccountingCash-Basis Accounting
Accrual Basis
Revenues recognized when earned
Expenses recognized when incurred
Cash Basis
Revenues recognized when cash received
Expensesrecorded when cash paid
Not GAAPNot GAAP
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 3 of 23
Accrual vs. Cash-Basis: RevenueAccrual vs. Cash-Basis: Revenue
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 4 of 23
Accrual vs. Cash-Basis: RevenueAccrual vs. Cash-Basis: Revenue
Cash-basis revenue transactions
Accrual basis revenue transactions
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 5 of 23
Accrual vs. Cash-Basis: Accrual vs. Cash-Basis: ExpensesExpenses
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 6 of 23
Accrual vs. Cash-Basis Accrual vs. Cash-Basis AccountingAccounting
Accrual basis
Cash-basis
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 7 of 23
S3-2: COMPARING ACCRUAL AND CASH-BASIS ACCOUNTING
The Johnny Flowers Law Firm uses a client database. Suppose Johnny Flowers paid $2,900 for a computer.Requirements:1. Describe how the business should account for the $2,900 expenditure under
a. the cash basis.
b. the accrual basis.
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 8 of 23
2. State why the accrual basis is more realistic for this situation.
S3-2: COMPARING ACCRUAL AND CASH-BASIS ACCOUNTING
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 9 of 23
Accounting Period ConceptAccounting Period Concept• Businesses prepare financial statements for
specific periods to evaluate performance• Basic accounting period = one year• Interim periods
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 10 of 23
Revenue Recognition Revenue Recognition PrinciplePrinciple
• When to record revenue?– When it is earned
• The amount of revenue to recorded?– Value of item or service transferred to customer
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 11 of 23
Recording Revenue: The Recording Revenue: The Revenue Recognition PrincipleRevenue Recognition Principle
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 12 of 23
The Matching PrincipleThe Matching Principle• Measure all expenses incurred during
the period
• Match the expenses against the revenues earned during the same period
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 13 of 23
The Time-Period ConceptThe Time-Period Concept• Requires that accounting information be
reported at regular intervals
• Accounts are updated at the end of each accounting period
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 14 of 23
Time-Period ConceptTime-Period Concept
On May 31, Smart Touch recorded salary expense of $900 that is owed to an employee at the end of the month.
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 15 of 23
Adjusting EntriesAdjusting Entries
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 16 of 23
Adjusting EntriesAdjusting Entries• Prepared at end of an accounting period• Assigns:
– Revenues to the period when earned– Expenses to the period when incurred
• Update asset and liability accounts• Need to properly match revenues and
expenses to measure:– Net Income– Assets and Liabilities
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 17 of 23
Adjusting Entry RulesAdjusting Entry Rules
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 18 of 23
Types of Adjusting EntriesTypes of Adjusting Entries
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 19 of 23
Prepaid ExpensesPrepaid Expenses• Advance payments of expenses• Recorded as an asset• Adjusting entry records amount used as an
expense
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 20 of 23
Prepaid Expense: RentPrepaid Expense: Rent
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 21 of 23
DepreciationDepreciation• Plant assets
– Long-lived tangible assets used in business operations
• Depreciation– Allocation of a plant asset’s cost to expense over its
useful life
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 22 of 23
Depreciation EntryDepreciation Entry
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 23 of 23
Accumulated DepreciationAccumulated Depreciation• Contra asset• Holds sum of all depreciation recorded on a
plant asset• Book value
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 24 of 23
Depreciation PostingDepreciation Posting
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 25 of 23
Accrued ExpensesAccrued Expenses• Expenses incurred before payment is made• Opposite of a prepaid expense
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 26 of 23
Accrued Expense EntriesAccrued Expense Entries
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 27 of 23
Accrued RevenuesAccrued Revenues
• Revenue earned before cash is received
• Results in a receivable
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 28 of 23
Unearned RevenueUnearned Revenue• Cash is collected before revenue is earned • Also called deferred revenue
BEFORE
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 29 of 23
Unearned Revenue EntriesUnearned Revenue Entries
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 30 of 23
Summary of Adjusting EntriesSummary of Adjusting Entries• To properly measure net income for the period• To update the balance sheet
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 31 of 23
Summary of Adjusting EntriesSummary of Adjusting EntriesCategory of Adjusting Entry Debit Credit
Prepaid expense Expense Asset
Depreciation Expense Contra asset
Accrued expense Expense Liability
Accrued revenue Asset Revenue
Unearned revenue Liability Revenue
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 32 of 23
S3-5: IDENTIFYING TYPES OF ADJUSTING ENTRIES
• A select list of transactions for Anuradha’s Goals follows:
Apr 1 Paid six months of rent, $4,800.
10 Received $1,200 from customer for six-month service contract that began April 1.
15 Purchased computer for $1,000.
Requirement:
1. For each transaction, identify what type of adjusting entry would be needed.
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 33 of 23
S3-5: IDENTIFYING TYPES OF ADJUSTING ENTRIES
• A select list of transactions for Anuradha’s Goals follows:
Apr 18 Purchased $300 of office supplies on account.
30 Work performed but not yet billed to customer, $500.
30 Employees earned $600 in salary that will be paid May 2.
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 34 of 23
E3-22: JOURNALIZING ADJUSTING ENTRIES AND ANALYZING THEIR EFFECT ON THE INCOME
STATEMENTThe following data at January 31, 2012 is given for EBM, Inc.
a. Depreciation, $500
b. Prepaid rent expired, $600
c. Interest expense accrued, $300
d. Employee salaries owed for Monday through Thursday of a five-day workweek; weekly payroll, $13,000
e. Unearned service revenue earned, $1,300
Requirement:
1. Journalize the adjusting entries needed on January 31, 2012.
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 35 of 23
E3-22: JOURNALIZING ADJUSTING ENTRIES AND ANALYZING THEIR EFFECT ON THE INCOME STATEMENT
Journal
DATEACCOUNTS AND EXPLANATIONS
POST.
REF. DEBIT CREDIT2013 Adjusting Entries
Jan 31 Depreciation expenseAccumulated depreciation
31 Rent expensePrepaid rent
31 Interest expenseInterest payable
31 Salary expenseSalary payable
31 Unearned service revenueService revenue
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 36 of 23
E3-22: JOURNALIZING ADJUSTING ENTRIES AND ANALYZING THEIR EFFECT ON THE INCOME
STATEMENT
2. Suppose the adjustments made in Requirement 1 were not made. Compute the overall overstatement or understatement of net income as a result of the omission of these adjustments.
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 37 of 23
Adjusted Trial BalanceAdjusted Trial Balance• Prepared after adjusting entries are posted
• Useful step in preparing financial statements
• Often appears on a work sheet
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 38 of 23
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 39 of 23
S3-10: PREPARING AN ADJUSTED TRIAL BALANCE
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 40 of 23
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 41 of 23
Income Statement Income Statement
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 42 of 23
Statement of Retained EarningsStatement of Retained Earnings
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 43 of 23
Balance SheetBalance Sheet
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 44 of 23
E3-25: PREPARING THE FINANCIAL STATEMENTS
Refer to the adjusted trial balance in Exercise 3-21 for the month ended April 30, 2012.
Requirements:1.Prepare the income statement.
2. Prepare the statement of retained earnings.
3. Prepare the balance sheet.
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 45 of 23
E3-21:ADJUSTED
TRIAL BALANCE
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 46 of 23
E3-25: PREPARING THE FINANCIAL STATEMENTS
Jobs-4-U Employment Service, Inc.Income Statement
Month Ended April 30, 2012Revenue:
Service revenue $ 10,600
Expenses: Salary expense $ 3,700
Rent expense 1,000
Depreciation expense 1,000
Supplies expense 500Total expenses 6,200
Net income $ 4,400
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 47 of 23
E3-25: PREPARING THE FINANCIAL STATEMENTS
Jobs-4-U Employment Service, Inc.
Statement of Retained Earnings
Month Ended April 30, 2012
Retained earnings, March 31, 2012 $ 10,300
Net income 4,400
17,900
Dividends 4,800
Retained earnings, April 30, 2012 $ 9,900
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 48 of 23
Jobs-4-U Employment Service, Inc. Balance SheetApril 30, 2012
Assets LiabilitiesCash $ 900 Salary payable $ 1,200
Accounts receivable 5,600
Supplies 500 Stockholders’ Equity
Equipment $32,500 Common stock 13,000
Accu. Depr. (15,400) 17,100 Retained earnings 9,900
Total stockholders’ equity 22,900
Total assets $24,100Total liabilities and stockholders’ equity $24,100
E3-25: PREPARING THE FINANCIAL STATEMENTS
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 49 of 23
Alternative Treatment of PrepaidAlternative Treatment of PrepaidExpensesExpenses
• Prepaid Expenses (normally)– Advance payments of expenses– Debit an asset account– Adjust at end of period
• Alternative– Debit an expense account– Adjust at end of period
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 50 of 23
Prepaid ExpensePrepaid ExpenseInitially debit and expense account
Adjust at end of period for unused amount
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 51 of 23
Unearned (Deferred) Unearned (Deferred) RevenuesRevenues
• Unearned Revenues (normally)– Advance receipt of revenues–creates liability– Credit a liability account– Adjust at end of period
• Alternative– Credit a revenue account– Adjust at end of period
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 52 of 23
Unearned (Deferred) Unearned (Deferred) RevenuesRevenues
• Initially credit a revenue account
Adjust at end of period for unearned amount