Chapter 3 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 McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
3-2 C 1 THE ACCOUNTING PERIOD
3-3 C 2 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.
3-4 C 2 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
3-5 C 2 ACCRUAL BASIS VERSUS CASH BASIS Example: FastForward paid $2,400 for a 24-month insurance policy beginning December 1, 2011. 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 $ 100 $ 100 $ 100 May Jun Jul Aug $ 100 $ 100 $ 100 $ 100 Sep Oct Nov Dec $ 100 $ 100 $ 100 $ 100 Insurance Expense 2011 Jan Feb Mar Apr $ 100 $ 100 $ 100 $ 100 May Jun Jul Aug $ 100 $ 100 $ 100 $ 100 Sep Oct Nov 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 have delivered the product to our customer, so I think we should record the revenue earned.
3-8 C 2 RECOGNIZING REVENUES & EXPENSES Revenue Recognition Principle Matching Principle Rent Summary of Expenses Gasoline Advertising Salaries Utilities and.... $1,000 500 2,000 3,000 450.... Now that we have recognized 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 (or received) cash before expense (or revenue) recognized Paid (or received) cash after expense (or revenue) recognized Prepaid (Deferred) expenses* Unearned (Deferred) revenues Accrued expense Accrued revenues *including depreciation
3-10 P 1 PREPAID (DEFERRED) EXPENSES Resources paid for prior to receiving the actual benefits. Here is the check for my 24-month insurance policy.
3-11 P 1 PREPAID INSURANCE (a) On 12/1/11, FastForward paid $2,400 for insurance for 2-years (24-months, December 2011 through November 2013). FastForward recorded the expenditure as Prepaid Insurance on 12/31/11. What adjustment is required? Dec. 31 Insurance Expense 100 Prepaid Insurance 100 To record first month's expired insurance Prepaid Insurance 637 Dec. 1 2,400 Dec. 31 100 Bal. 2,300 Insurance Expense 128 Dec. 31 100
3-12 P 1 SUPPLIES (b) During 2011, FastForward purchased $9,720 of supplies. FastForward recorded the expenditures in the asset account, Supplies. On December 31, 2011, a count of the supplies indicated $8,670 on hand, so $1,050 of supplies were used during December. What adjustment is required? Dec. 31 Supplies Expense 1,050 Supplies 1,050 To record supplies used during 2011 Supplies 126 Bought 9,720 Dec. 31 1,050 Bal. 8,670 Supplies Expense 652 Dec. 31 1,050
3-13 P 1 OTHER PREPAID EXPENSES 1. Other prepaid expenses, such as Prepaid Rent, are accounted for exactly as Insurance and Supplies. 2. We should note that some prepaid expenses are both paid for and fully used up within a single period. 3. For example, a company may pay monthly rent on the first day of each month. This payment creates a prepaid expense on the first day of the month that fully expires by the end of the month. 4. In these special cases, we can record the cash paid with a debit to the expense account instead of an asset account.
3-14 P 1 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 Depreciation Expense = Asset Cost - Residual Value Useful Life
3-15 P 1 DEPRECIATION On December 1, 2011, FastForward purchased equipment for $26,000 cash. The equipment has an estimated useful life of four years (48 months) and FastForward expects to sell the equipment at the end of its life for $8,000 cash. (c) Let s record depreciation expense for the month ended December 31, 2011. Dec. 2011 Depreciation Expense = $26,000 - $8,000 48 months = $375 per month
3-16 P 1 DEPRECIATION Dec. 31 Depreciation Expense 375 Accumulated Depreciation - Equipment 375 To record monthly equipment depreciation Contra asset account Equipment Depreciation Expense 12/1 26,000 12/31 375 Accumulated Depreciation 12/31 375
3-17 P 1 DEPRECIATION FastForward Partial Balance Sheet At December 31, 2011 Assets Cash $. Equipment $ 26,000 Less: accumulated deprec. (375) 25,625.. Total Assets Equipment is shown net of accumulated depreciation.
3-18 P 1 UNEARNED (DEFERRED) REVENUES Cash received in advance of providing products or services. We will apply this cash you gave us towards your total consulting fees.
3-19 P 1 UNEARNED (DEFERRED) REVENUES On December 26, 2011, FastForward agrees to provide consulting services to a client for a fixed fee of $3,000 for 60 days. On this date, the client pays the entire consulting fee in advance. FastForward makes the following entry: Dec. 26 Cash 3,000 Unearned Revenue 3,000 Consulting fees received in advance Unearned Revenue Dec. 26 3,000
3-20 P 1 UNEARNED (DEFERRED) REVENUES (d) On December 31, FastForward earns 5-days of consulting fees. Each day that passes results in consulting fees of $50 ($3,000 60), so FastForward earned ($50 5 days) $250. Dec. 31 Unearned Revenue 250 Consulting Revenue 250 To recognize 5-days of consulting fees Unearned Revenue Dec 31 250 Dec 26 3,000 Bal 2,750 Consulting Revenue Dec. 31 250
3-21 P 1 Costs incurred in a period that are both unpaid and unrecorded. ACCRUED EXPENSES We re about one-half done with this job and want to be paid for our work!
3-22 P 1 ACCRUED SALARIES EXPENSES FastForward s employee earns $70 per day and is paid every two weeks on Friday. Year-end, 12/31/11, falls on a Wednesday. The last payday of 2011, is Friday, 12/26/11. From 12/26 until year-end is three working days. The employee has earned salaries of $210 for Monday through Wednesday. They will not be paid until the next Friday.
3-23 P 1 ACCRUED SALARIES EXPENSES (e) FastForward s employee has earned but not been paid on December 31, 2011, $210. Dec. 31 Salaries Expense 210 Salaries Payable 210 To accrue 3 days' salary (3 x $70) Salaries Expense Dec.12 700 Dec.26 700 Dec. 31 210 Bal. 1,610 Salaries Payable Dec. 31 210
3-24 P 1 FUTURE PAYMENT OF ACCRUED EXPENSES On January 9, 2012, FastForward will pay the payroll for the two weeks from December 26, 2011 through January 9, 2012. Here is the journal entry for the payroll: Jan 9 Salaries Payable (3 days @ $70) 210 Salaries Expense (7 days @ $70) 490 Cash (10 days @ $70) 700 Paid two-week salary
3-25 P 1 ACCRUED INTEREST EXPENSES FastForward borrowed $6,000 from First National Bank on December 1, 2011. The note bears interest at the annual rate of 6% and is due to be repaid in one year. Let s accrue interest for the month ended 12/31/11. Dec. 31 Interest Expense 30 Interest Payable 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 earned in a period that are both unrecorded and not yet received. Yes, I ve completed your consulting job, but have not had time to bill you yet.
3-27 P 1 ACCRUED SERVICE REVENUE (f) On December 12, 2011, FastForward agrees to render consulting services under a 30-day fixed fee contract for $2,700 ($90 per day). All services are to be completed by January 10, 2012, when the client will pay in 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 1,900 Dec. 31 1,800 Bal. 1,800 Consulting Revenue Other revenues 6,050 Dec. 31 1,800 Bal. 7,850
3-28 P 1 FUTURE RECEIPT OF SERVICE REVENUES On January 10, 2012, FastForward completed its obligation under the consulting contract. The client was billed $2,700 and FastForward received $2,700 in cash. Jan 10 Cash 2,700 Accounts Receivable 1,800 Consulting Revenue 900 T o record completion of contract and cash collection Revenue in January 10 days @ $90 = $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.
P 2 FastForward - Trial Balance - December 31, 2011 3-31 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, the totals are 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 1. PREPARE THE INCOME STATEMENT Adjusted Trial Balance December 31, 2011 Dr. Cr. Cash $ 4,350 Accounts receivable 1,800 Supplies 8,670 Prepaid insurance 2,300 Equipment 26,000 Accum. depr. - Equip. $ 375 Accounts payable 6,200 Salaries payable 210 Unearned revenue 2,750 C. Taylor, Capital 30,000 C. Taylor, Withdrawals 200 Consulting revenue 7,850 Rental revenue 300 Depr. expense 375 Salaries expense 1,610 Insurance expense 100 Rent expense 1,000 Supplies expense 1,050 Utilities expense 230 Totals $ 47,685 $ 47,685 FastForward Income Statement For the Month Ended December 31, 2011 Revenues: Consulting revenue $ 7,850 Rental revenue 300 Operating expenses: Depr. expense - Equip. $ 375 Salaries expense 1,610 Insurance expense 100 Rent expense 1,000 Supplies expense 1,050 Utilities expense 230 Total expenses 4,365 Net income $ 3,785
3-35 P 3 2. PREPARE THE STATEMENT OF CHANGES IN EQUITY FastForward Income Statement For the Month Ended December 31, 2011 Revenues: Consulting revenue $ 7,850 Rental revenue 300 Operating expenses: Depr. expense - Equip. $ 375 Salaries expense 1,610 Insurance expense 100 Rent expense 1,000 Supplies expense 1,050 Utilities expense 230 Total expenses 4,365 Net income $ 3,785 Note: Net Income from the Income Statement carries to the Statement of Changes in Equity. FastForward Statement of Changes in Equity For the Month Ended December 31, 2011 C. Taylor, Capital 12/1/11 $ -0- Add: Net income $ 3,785 Investment by owner 30,000 33,785 Total 33,785 Less: Withdrawal by owner 200 C. Taylor, Capital 12/31/11 $ 33,585
3-36 P 3 3. PREPARE THE BALANCE SHEET FastForward Balance Sheet 12/31/11 Assets Cash $ 4,350 Accounts Receivable 1,800 Supplies 8,670 Prepaid Insurance 2,300 Equipment $ 26,000 Accumulated Depreciation 375 25,625 Total assets $ 42,745 Liabilities Accounts Payable 6,200 Salaries Payable 210 Unearned Revenue 2,750 Total Liabilities 9,160 Equity C Taylor, Capital 33,585 Total liabilities and Equity $ 42,745 FastForward Statement of Changes in Equity For the Month Ended December 31, 2011 C. Taylor, Capital 12/1/11 $ -0- Add: Net income $ 3,785 Investment by owner 30,000 33,785 Total 33,785 Less: Withdrawal by owner 200 C. Taylor, Capital 12/31/11 $ 33,585 Adjusted Trial Balance December 31, 2011 Dr. Cr. Cash $ 4,350 Accounts receivable 1,800 Supplies 8,670 Prepaid insurance 2,300 Equipment 26,000 Accum. depr. - Equip. $ 375 Accounts payable 6,200 Salaries payable 210 Unearned revenue 2,750 C. Taylor, Capital 30,000 C. Taylor, Withdrawals 200
3-37 A 2 PROFIT MARGIN The profit margin ratio measures the company s net income to net sales. Profit Margin = Net Income Net Sales Limited Brands, Inc. $ in millions 2009 2008 2007 2006 Net income $ 220 $ 718 $ 676 $ 683 Net sales 9,043 10,134 10,671 9,699 Profit margin 2.4% 7.1% 6.3% 7.0% Industry profit margin 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.
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