BPA 11403-Wk 4 &5-Accruals & Closing (3)

8/10/2019 BPA 11403-Wk 4 &5-Accruals & Closing (3)

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COMPLETING THE ACCOUNTING

CYCLE

ACCRUAL ACCOUNTING, THE ADJUSTEDTRIAL BALANCE AND PREPARATION OF

FINANCIAL STATEMENTS


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Learning Objectives

Relate accrual accounting and cashaccounting

Apply the revenue and matchingprinciples

Identify the major types of adjusting

entries Prepare adjusting entries for

prepayments

6


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Learning Objectives

Prepare adjusting entries for accruals

Describe the nature and purpose of anadjusted trial balance

Update the financial statements by adjustingthe accounts

Close the books


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Accrual-basis:

Transactions arerecorded

when revenues are

earned or expensesare incurred.

Cash-basis:Transactions are

recorded whencash is paid or

cash is received.

The Two Bases of Accounting:


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Accrual vs Cash Accounting

Generally accepted accounting principles(GAAP) require that business use accrualaccounting.

cash basis often causes misleading financialstatements as it has matching problems.

The cash basis of accounting recognizesrevenues when received in cash andexpenses when paid in cash, thus, notreflecting the transaction of the period beingreported.


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Accrual Accounting Impact of business transactions are recorded

when the transaction occurs

Revenuesare recognized when earned.

Expensesare recognized when incurred.

Cash Accounting Transactions are recorded when cash is received

or paid.

Revenuesare recorded when cash is received.

Expensesare recorded when cash is paid.


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Accrual accounting is accomplished by :

(1) recording revenues when earned andexpenses when incurred,and

(2) making end-of-period adjustments torevenue and expense accounts.


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Under accrual accounting, cash transactions

are recordedas well as non-cashtransactionssuch as:

Purchases of inventory on account

Sales on account

Depreciation expense Accrual of expenses incurred but not yet paid

Usage of prepaid rent, insurance, and supplies


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Accrual vs. Cash Accounting

On the cash basis the entire $2,400 would be recognizedas insurance expense in 2004. No insurance expense from

this policy would be recognized in 2005 or 2006, periods

covered by the policy.

Jan Feb Mar Apr

-$ -$ -$ -$

May Jun Jul Aug

-$ -$ -$ -$

Sep Oct Nov Dec

-$ -$ -$ 2.400$

Insurance Expense 2004

FastForward paid $2,400 for a 24-month insurance policybeginning December 1, 2004.


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Jan Feb Mar Apr

-$ -$ -$ -$

May Jun Jul Aug

-$ -$ -$ -$

Sep Oct Nov Dec

-$ -$ -$ 100$

Jan Feb Mar Apr

100$ 100$ 100$ 100$

May Jun Jul Aug

100$ 100$ 100$ 100$

Sep Oct Nov Dec

100$ 100$ 100$ 100$

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$100of insurance

expense is recognized in2004, $1,200in 2005,

and $1,100in 2006. Theexpense is matched with

the periods benefited bythe insurance coverage.


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On the cash basis the entire $150,000 would be recognized as revenuein 2002. No revenue from this policy would be recognized in 2003 or

2004, periods covered by the policy.

000 omitted 2.002 2.003 2.004

Revenue 150$ -$ -$

Expenses (20) (20) (20)

Net inc./(loss) 130$ (20)$ (20)$

Cash Basis Accounting

In January 2002, Prensa Insurance sells a three-year health insurancepolicy to a business client.The contract specifies that the client had topay $150,000 in advance.Yearly expenses amount to $20,000.What isthe income or loss?


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On the accrual basis $50,000of revenue is recognized in 2002,$50,000in 2003, and $50,000in 2004.The revenue is matched with

the periods benefited by the insurance coverage.

000 omitted 2.002 2.003 2.004

Revenue 50$ 50$ 50$

Expenses (20) (20) (20)

Net inc./(loss) 30$ 30$ 30$

Accrual Basis Accounting


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Ethical Issues in Accrual

Accounting

Accruals require the use of judgment to determinewhich period should reflect revenues earned.

Example : Service revenue of RM32,000 paid in advance byclient for 16 month in July 2012.Accounting period ends on31 December 2012. So at the end of the year, only 6months revenue of RM12,000 can be recognized as servicerevenue, whilst the remaining 10 month revenue ofRM20,000 is categorized as Unearned Service Revenue

Managers should notuse accruals to smoothincome by delaying or accelerating recognition ofeither revenues or expenses.


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The Time Period Concept

The time-period assumption ensures that accounting informationis reported at regular intervals.

assumes the economic life of a business can be divided intoartificial time periods

Accounting time periods

generally month, a quarter, half yearly or a year

Basic accounting period is 1 year.

Calendar yearis January 1 to December 31 If other than calendar ,referred to as afiscal year

A fiscal yearends on a date other than December 31. (Example :30 June,30 March etc)

Interim financial statements are usually prepared for periodssuch as a month, a quarter, or semiannual period.


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Interacts with therevenue principle

and the matchingprinciple

Requires thatincome be

measuredaccurately each

period

The Time Period Concept

It requires that accounting information be

reported at regular intervals.


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Revenue Recognition Principle

When should revenue be recorded?

Revenue must be recognized in the accounting period in

which it is earned, not just when money is exchanged. Delivered Good or Service to a Customer

In a service business, revenue is earned at the time theservice is performed.

Recognition of revenue and cash receipts do not

necessarily occur at the same time.

What amount of revenue should be recorded?

The amountof revenue recorded is the cash value of thegoods transferred to the customer.


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Matching Principle

Expenses are costs of assets used up and/orliabilities created in earning revenue.

Expenses are recognized when the benefit from theexpense is received.

Matching involves two steps: Identify all expenses incurredduring the period.

Measure the expenses and match the expenses againstrevenues earned.

Expenses may bepaid in cash.

result from using up an assetsuch as supplies

result from creating a liability(payable)


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The Matching Issue

To adequately measure net income,revenues and expensesmust be assignedto the appropriate accounting period.


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The Matching Rule

The match ing ru lestates that:

Revenuesmust be assigned to theaccounting periodin which thegoodsare sold or services performed.

Expensesmust be assigned to the

accounting periodin whichthey areused to produce revenue.


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The Matching Rule

Expense recognition is thematching

principle. Efforts (expenses)must be matched with

accomplishments (revenues).

Revenuesearned

this month

are offsetagainst....

Expenses

incurred inearning

therevenue


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Matching Expenses with Revenues

Example

Parker Floor sells a wood floor for $15,000

on the last day of May. The wood was purchased from the

manufacturer for $8,000 in March of thesame year.

The floor is installed in June. When is income recognized?


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Revenues $15,000

Cost of goods sold 8,000

Net income $ 7,000

May

Matching Expenses with Revenues

Example


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Discussion

Q. Why must a business recognize rentalexpense in the month of the rent incurred

rather than in the month when cash is paidfor rent?

A.Tomeasure a businesss performanceaccurately, each expense must be matchedwith its related revenue. Otherwise,net

incomewill beoverstatedand the liabilitywill beunderstated.


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GAAP Relationships in Revenue and

Expense RecognitionTime-Period Assumption

Economic life of businesscan be divided into

artificial time periodsRevenue-Recognition

Principle

Revenue recognized inthe accounting period in

which it is earned

Matching Principle

Expenses matched withrevenues

in the same period when effortsare expended to generate

revenues


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Recording Accruals and

Deferrals andAdjusting Accounts for

Accruals and Deferrals


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The Adjusting Process

Accruals and Deferrals:Timing is Everything in Accounting


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Accrual Accounting

Accrual accounting is an applicationof the matching rule.

Accrual Accounting:Recording thefinancial transactions of a business inthe period in which they occu r,rather than in the period in whichcash is exchanged.


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Implementation of

Accrual Accounting

Accrual accounting is done in two ways.

1. By recording revenues when earnedand expenses when incurred.

When a sale is made on credit, revenue isrecorded, as the cash is not received, the

Accounts Receivable account is recorded. When an expense is incurred on credit, an

expense is recorded as thethe cash is not paid,the Accounts Payable account is recorded.


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2. By making end-of-period adjustments torevenue and expense accounts.

Those transactions that span the cutoffperiod must be allocatedto theproperaccounting period.

Example : A prepayment of 6 months office rent must be

adjusted on a monthly basis if accurate monthly financialstatements are to be prepared.

E.g : On February 2010,XYZ co. paid in advance, 6 monthoffice rent of RM6,000. So, at the end of February, 1 monthoffice rent of RM1,000 has incurred and must be allocated toFebruary transactions.

Implementation of

Accrual Accounting


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Why Adjust Accounts?

Allows financial statements to more

accuratelyrepresent financial positionof businessIncome Statement

Matches Expenses with RevenuesBalance Sheet

Prevents Misstatement of Assets,Liabilities and Equity


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The Adjustment Process

Adjusting entriesare used to apply accrual

accounting to transactions that span morethan one accounting period.

Adjusting entriesinvolve at least onebalance sheet account and at least one

income statement account.

Adjusting entriesnever involve the Cashflowaccount.


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Adjusting Entries

Adjusting entries are required each timefinancial statements are prepared

Adjusting entries are made in order for: revenuesto be recorded in the period in which they

are earned

expenses to be recognized in the period in whichthey are incurred


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Adjusting Entries

Assign revenueto the period earned.

Assign expensesto the period incurred. Bring related assetand liability

accountsinto correct balance.


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Four Types of Adjusting Entries

1.Costs have been recorded that must be allocatedbetween two or more accounting periods.

2. Expenses have been incurred but are not yetrecorded.

3. Revenues have been recorded that must be allocatedbetween two or more accounting periods.

4. Revenues have been earned but not yet recorded.


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Categories of Accounting

Adjustments

Deferrals/Prepayments

Converting assets to expenses Converting liabilities to revenues

Depreciation

Accruals Accruing unpaid expenses

Accruing uncollected revenue


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What is a Deferral?

A deferral eventoccurs when cash isreceived or paid before revenue is earned oran expense is incurred.

Adeferralis the postponementof:

The recognition of an expense already paid

or a revenue received in advance Deferral events are a part of the accrual

basis of accounting


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What is an Accrual

An accrualisthe recognition of an expenseor revenue that has arisen but has not yet

been recorded.

Expenses or revenues arerecorded beforethe cash settlement.


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Adjustments

An adjusting entry is recorded to bring an asset or

liability account balance to its proper amount.

Adjusting Accounts

Paid (or received) cash beforeexpense (or revenue) recognized

Paid (or received) cash afterexpense (or revenue) recognized

Prepaid(Deferred)expenses*

Unearned(Deferred)revenues

Accruedexpense

Accruedrevenues

Framework for Adjustments

*including depreciation


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Examine the trial balance for accounts that may needto be adjusted.

Basic categories of adjusting entries:


Paid Cash in Advancefor resource that will beused up in the future

Supplies, Insurance, Rent, Plant assets, etc.

Received Cash BEFOREperforming Service

Collected subscription revenue, paid for class


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Basic categories of adjusting entries:

Depreciation Special type of Deferral for Long Term Assets

Allocation of the cost of an asset to expense over theassets useful life e.g motor vehicle, plant, off.equipment, etc will be depreciated.

Accruals Provided Service or sold product before receiving Cash on account

An Expense has occurred before paying Cash


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Deferral/Prepayments

The first category of adjusting entry isprepayments.

Required to record revenues earned andexpenses incurred

Also ensures that assets and liabilities are not overstated

The adjusting entry for prepayments:Increases an income statement account

Decreases a balance sheet account

Adjusting Entries for



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Adjusting Entries for

Deferrals Prepayments

Adjusting Entries

Asset

UnadjustedBalance

CreditAdjustingEntry (-)

Expense

DebitAdjustingEntry (+)

PrepaidExpenses

Liability

UnadjustedBalance

DebitAdjusting

Entry (-)

Revenue

CreditAdjusting

Entry (+)

Unearned Revenues


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Types of Adjusting Entries-Deferrals


Prepaid ExpensesExpenses paid in cash - recorded as assets beforeused or consumed

Unearned Revenues

Cash received - recorded as liabilities beforethe revenue is earned


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Adjusting Deferred Assets

Prepaid Expense

A prepaid expense is an expense paid forin advance in cash and recorded as assetsbefore they are used or consumed

Because they provide future economic

benefit, prepaid expenses are classified asassets.

Prepaid Insurance, Prepaid Rent, etc.


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Prepaid Expense

Prepaid expenses expire with the passageof time or through use and consumption

Anasset-expense account relationshipexists with prepaid expenses

Before financial statements are prepared,prepaid expenses are adjusted to reflect theamount of the asset used up during the

period of the statements.


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Upon the transaction

debit asset(prepaid exp.) account

credit asset (cash) account

Prior to adjustment

assets are overstatedand expenses are understated

Adjusting entry debit expense account

credit asset (prepaid exp.) account


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Adjustment records the effect of using up an Asset Using Up an Asset

the Asset value has been reduced We need to Credit the Asset-Prepaid exp.

Debits must Equal Credits

If Assets create economic benefits,

Using them up leads to a Cost/Expense

We need to Debit an Expense Account

Deferred Asset Rule

Debit Expense and Credit Asset-Prepaid Exp.


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Adjusting Prepaid Expenses

To record $3,000 paid for 3 months rent on April 1, 20X3.

DATE ACCOUNTS AND EXPLANATION DEBIT CREDIT

Apr 1 Prepaid Rent 3,000

Cash 3,000Paid 3 months rent in advance

Prepaid RentApr 1 3,000

CashApr 1 3,000


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To adjust for one months rent expired at April 30.


Apr 30 Rent Expense (3,000/3) 1,000

Prepaid Rent 1,000Expensed one months rent

Rent

ExpenseApr 30 1,000

Prepaid

RentApr 30 1,000


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The following shows the effect of the adjustment.

Prepaid Rent

Apr 1 3,000 Apr 30 1,000Bal. 2,000

Bal. 2,000

Rent Expense

Apr 30 1,000

Bal. 1,0003,000 3,000

Bal. 1,000

1,000 1,000


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Adjusting Supplies

To record the purchase of supplies.


Apr 2 Supplies 700

Cash 700

Paid cash for supplies

SuppliesApr 2 700

CashApr 2 700


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Adjusting Supplies

To adjust for supplies used during April.

Calculate Supplies Expense:

Supplies available during the periodLess: Supplies on hand at end of period

Equals: Supplies used during the period (expense)

$700 - $400 = $300


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Adjusting Supplies

To adjust for supplies used during April.


Apr 30 Supplies Expense 300

Supplies 300To record Supplies Expense

Supplies ExpenseApr 30 300

SuppliesApr 30 300


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Adjusting Supplies


Supplies

Apr 1 700 Apr 30 300

Bal. 400

Supplies Expense

Apr 30 300

Bal. 300700 700

Bal. 400Bal. 300

300 300


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Unearned revenues

revenues received and recorded asliabilities before they are earned

earned by rendering a service to a

customer

A liability-revenueaccount relationship existswith unearned revenues

Deferred Revenue/Unearned

Revenue


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Revenue

Unearned revenueexists when customers have paidin advance for services that have not yet beenprovided.

The organization owes the customer the service in thefuture

Thus, Unearned Revenue is a liability(an obligation) Liability Increases, thus Credit Unearned Revenue Received Cash, thus Debit Cash

Revenue is recognized when the services areprovided. Reduces the organizations obligation

Thus Liability is reduced, Debit Unearned Revenue Revenue is increased, Credit Service Revenue


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Prior to adjustment

liabilities are overstatedand revenues are

understated Adjusting entry

debitto a liability account

creditto a revenue account

Examples rent, magazine subscriptions and customer

deposits for future services


Revenue


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Unearned Revenue

To record cash received in advance from customers.


Apr 20 Cash 450

Unearned Service Revenue 450

Received cash for revenue in advance

Cash

Apr 20 450

UnearnedService Revenue

Apr 20 450


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Unearned Revenue

To record revenues earned at the end of the month.


Apr 30 Unearned Service Revenue (450/3) 150

Service Revenue 150To record unearned service revenue that has beenearned

Unearned

Service RevenueApr 30 150

Service

RevenueApr 30 150


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Unearned Revenue


ServiceRevenue

Apr 30 250

Bal. 7,400

Unearned Service

RevenueApr 30 150

Bal. 300

Apr 20 450 7,000

Apr 30 150

Bal. 300Bal. 7,400

450450 7,4007,400


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Depreciation

the allocation of the cost of an asset toexpense over its useful life in a rational andsystematic manner

Equipment or a building

viewed as a long-term prepayment of services allocated in the same manner as other prepaid

expenses

Depreciation


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Depreciation

Depreciation is an estimate rather than a factual measurement of the

cost that has expired

Recording depreciation

Debit Depreciation Expense

CreditAccumulated Depreciation (contra asset)

Depreciation Expense

XXX

Accumulated DepreciationXXX


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Balance Sheet

Accumulated Depreciation is offsetagainst the asset account

Book Value

difference between the cost of any

depreciable asset and its relatedaccumulated depreciation is the bookvalue of the asset

not market value

Depreciation


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Depreciation of Long Term Assets

On April 3, the business purchased furnitureon account for $16,500. The furniture isexpected to last 5 years.

16,500

Furniture Accounts Payable

16,500


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Straight-line method of depreciation allocates

equal amounts each accounting period.

SLM Method :

Depreciation exp.per year = Cost of Asset- Salvage Value

Period of expected life

$16,000 5 years = $3,300 per year $3,300 12 months = $275 per month


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To record the depreciation expense at the end of the month.


Apr 30 Depreciation Expense -Furniture 275

Accum. Depreciation Exp.-Furniture 275To record depreciation expense for furniture

Depreciation

Expense-Furniture275

Accum. Dep.Exp-

Furniture275


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Book Value

The net amount of a plant Long Term Assets(cost minus accumulated depreciation)

Furniture 16.500$

Less Accumulated Depreciation (275)

Net Book Value of Furniture 16.225$

Building 48.000$Less Accumulated Depreciation (200)

Net Book value of Building 47.800

Long Term Assets of Air & Sea at April 30, 2012


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Accruals

Second category of adjusting entries isaccruals

Adjusting entries

required to record revenues earned and expenses

incurred in the current period

Adjusting entry for accruals increase both a balance sheetand an income

statement account


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Adjusting Entries

Asset


AccruedRevenues Revenue

CreditAdjustingEntry (+)

Accrued ExpensesExpense


Liability

CreditAdjustingEntry (+)

Adjusting Entries for Accruals


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Types of Adjusting Entries-Accruals

Accruals

Accrued Revenuesrevenues earned but not yet received in cash orrecorded

Accrued Expenses

expenses incurred but not yet paid in cash or recorded


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Accruals that need to be made before thefinancial statements are prepared --

adjustments to the books

1. Any revenue earned that has not been billed(no receivable has been recorded)-Accrued

revenue2. Any interest revenue that has been earned on

investments that has not been recordedAccrued interest revenue

3. Any expense that has been incurred (used) but

has not been recorded (a common one is salaryexpense)- (Accrued salary exp.)

4. Income tax expense incurred but not recorded-(Accrued Income tax exp.)


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Accrued Revenues

Revenue that needs to be accruedAnyrevenue earnedthat hasnot been billed.

( Work that has been completed -- but nothing has beenrecorded for the financial statements.)

This situation arises when a

customer has not been billedyet and has not paid for thework or services done


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Adjusting Accrued Revenues

Accrued revenueis revenue that has been earnedbut cash has not been collected.

On Account, On Credit

The other type of accrued revenueis for interest--thecost of borrowing money.

If you loaned the money, youd be dealing with

interest revenue. If you borrowed the money, youd be dealing with

interest expense.


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Accrued revenues

accumulate with the passing of time or through

services performed but not billed or collected An asset-revenue account relationship exists

Prior to adjustment

assets and revenuesare understated

Adjusting entry

debit an asset account

credit a revenue account

Adjusting Accrued Revenues


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Accruing Service Revenue Example

The company has performed a service ofRM 250, which the client has not beenbilled at month end.


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To accrue revenues at the end of the month.


Apr 30 Accounts Receivable 250

Service Revenue 250

To accrue service revenue

Accounts

Receivable250

Service

Revenue250


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ServiceRevenue

Apr 30 250

Bal. 7,250

AccountsReceivable

2,250

Bal. 2,500

Apr 30 250

7,000


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Accruing Interest Revenue Example

The company have a 12-month, $100 CD thatearns 12% p.a,(always given as an annual rate),

purchased on April 1. The natural recording of this interest revenue will

happen when you receive the money.

An income statement for April needs to show the

amount of interest revenue for April.


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Interest = principal x rate x time

Interest = $100 x .12 x 1/12 = $1 Since the rate is per year, the time has to be

given in terms of a year.

Interest receivable and interest revenuewill each be $1. What would be the

month end journal entry?


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To accrue interest revenues at the end of the month.


Apr 30 Interest Receivable 1

Interest Revenue 1Monthly interest earned

Interest

ReceivableApr 30 1

Interest

RevenueApr 30 1


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InterestRevenue

Apr 30 1

Bal. 1

Interest Receivable

Bal. 1

Apr 30 1 Bal. 1Bal. 1

1 1 1 1


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Adjusting Accrued Expenses

Accrued Expense An expense of an Organization that hasnt been paid for by

Cash Matching Principle requires that we determine all Costs

associated with Revenue, even if cash hasnt been paid

Taxes owed, Salaries owed, Interest owed, etc.

Before financial statements are prepared, expenses

are adjusted to reflect the cost to the organization forthe period of the statements.


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Accrued expenses

Expenses incurred but not paid yet

A liability-expense account relationshipexists

Prior to adjustment,

liabilities and expenses are understated

Adjusting Entry The expense value has increased, debit an expense

account

Liability value has increased, credit a liability account

Adjusting Accrued Expenses


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Accruing Expenses Example

Any expense that has been incurred (used) but hasnot been recorded(a common one is salary expense

and tax expenses)

Salary expense and tax expense is a commonexpense that needs to be accrued before financialstatements are prepared.


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Accruing Salary Expense Example

Salaries for the month is RM1,900. Only half

of the amount was paid on April 15


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To record salaries expense during the month.


Apr 15 Salaries Expense 950Cash 950

To pay salaries

Salaries

ExpenseApr 15 950

CashApr 15 950


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To adjust salaries expense at the end of the month.


Apr 30 Salaries Expense 950

Salaries Payable 950To accrue salaries expense

Salaries

Expense15/4 95030/4 950

Salaries

Payable30/4 950


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SalariesPayable

Apr 30 950

Salaries Expense

Apr 15 950Apr 30 950


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Accruing Salary Expense Example 2

Suppose employees work five days per week

and are paid every Friday, but April 30 falls on aTuesday.

The salary expense for the week from April 30 toMay 3 will not be paid until Friday, May 4.

The income statement for January should havethe expense for January 30 and 31, while theFebruary income statement will have theexpense for February 1, 2, and 3.


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April February

29 30

1 2 3



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Suppose a weeks payroll is $5,000.

On April 30, the company should accrue$2,000 worth of salary expense.

i.e., 2 out of 5 days worth of the salary mustbe an April expense.

How is this reflected in the accounts?


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Accrued Salary Expenses Example 2

What is the entry on April 30?

They worked April 29 and 30.

$5,000 5 = $1,000 per day

$1,000 2 days = $2,000


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Accrued Salary Expenses Example 2



Apr 30 Salaries Expense 2,000

Salaries Payable 2,000To accrue salaries expense for 29 & 30 April

SalariesExpense

Apr 15 950Apr 30 950Apr 30 2,000

SalariesPayable

Apr 30 950Apr 30 2,000


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SalariesPayableApr 30 950

Bal. 2,950

Salaries Expense

Apr 15 950Apr 30 950

Bal. 3,900

Apr 30 2,000Apr 30 2,000

Bal. 3,900

3,900 3,900

Bal. 2,950

2,9502,950


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Accruing Tax Expense Example

The estimated tax expense calculated forcompany A is RM24,000 per year and isusually due in June.

So what is the portion of tax expense forApril? Show the entry at month end.

Tax per month =24,000/12 = 2,000


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Accrued Tax Expenses Example



Apr 30 Tax Expense 2,000

Tax Payable 2,000To accrue tax expense for April

TaxExpense

Apr 30 2,000

TaxPayable

Apr 30 2,000


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Accruing Tax Expense Example


Tax Payable

Bal. 2,000

Tax Expense

Bal. 2,000Apr 30 2,000 Apr 30 2,000

Bal. 2,000

2,000 2,000

Bal. 2,000

2,0002,000


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Summary of Adjusting Entries


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Summary of Adjusting Process

Prepare a trial balance.

Review trial balance and other records for

adjustments that should be made: Accruals

Deferrals

Depreciation

Prepare and post adjusting entries. Prepare an adjusted trial balance to ensure accuracy

of debits and credits after posting.

Prepare financial statements.

S


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Type

Balance

Sheet Account

Income

Statement

Account Adjusting Entry

Prepaid Asset Expense Dr. Expense

Expenses Overstated Understated Cr. Asset

Unearned Liability Revenue Dr. Liability

Revenues Overstated Understated Cr. Revenue

Accrued Liability Expense Dr. ExpenseExpenses Understated Understated Cr. Liability

Accrued Asset Revenue Dr. Asset

Revenues Understated Understated Cr. Revenue

Before Adjustment

Summary of Adjustments and Financial Statement Links

Links to Financial Statements


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The Adjusting Process inPerspective

The recording process has a final goal - thepreparation of accurate financial statements

prepared on the accrual basis. The final steps of the process can be shown as:

LedgerUnadjusted

Trial Balance

Journalize &

Post Adjustments

Adjusted

Trial Balance

Financial

Statements


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Adjusted Trial Balance

The adjusting process starts with theunadjusted trial balance.

Adjusting entries are made at the end of the

accounting periodand then an adjusted trialbalance is prepared.

The adjusted trial balance serves as thebasis for the preparation of the financial

statements.


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Adjusted Trial Balance

Prepared after all adjusting entries havebeen journalized and posted

purpose is to prove equality of the totaldebit and credit balances in the ledger

after adjustments have been made

Financial statementsprepared directly fromthe adjusted trial balance


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The Adjustments Worksheet

Shows adjustments and their effects on TrialBalance

Simplifies preparation of adjusting entries

Account Trial Balance AdjustingEntries

AdjustedTrial Balance

No. Title dr. cr. dr. cr. dr. cr.

Trial Balance and the Adjusted TrialBalance Compared


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Balance Compared


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Preparing Financial Statements

Financial statements are prepared directly fromthe adjusted trial balance Income statement

use the revenue and expense accounts

Owners Equity Statementuse the owners capital and drawing accounts and the net

income (or net loss) from the Income Statement

Balance sheetuse asset and liability accounts and ending owners capitalbalance reported in Owners Equity Statement


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Preparing Financial Statements

Financial statements have two parts:

1 The first part includes the following:

name of the entity

title of the statement

date or period covered

2 The second part is the body of the statement.

PREPARATION OF THE INCOME STATEMENT AND

THE OWNERS EQUITY ST TEMENT FROM THE


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PIONEER ADVERTISING AGENCYAdjusted Trial Balance

October 31, 2005

Debit Credit

Cash $ 15,200

Accounts Receivable 200

Advertising Supplies 1,000

Prepaid Insurance 550

Office Equipment 5,000Accumulated Depreciation - Office Equipment $ 40

Notes Payable 5,000

Accounts Payable 2,500

Interest Payable 50

Unearned Revenue 800

Salaries Payable 1,200

C. R. Byrd, Capital 10,000

C. R. Byrd, Drawing 500

Service Revenue 10,600

Salaries Expense 5,200

Advertising Supplies Expense 1,500

Rent Expense 900


Interest Expense 50

Depreciation Expense 40

$ 30,190 $ 30,190

ADJUSTED TRIAL BALANCE

PREPARATION OF THE INCOME STATEMENT AND

THE OWNERS EQUITY ST TEMENT FROM THE


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ADJUSTED TRIAL BALANCE

PIONEER ADVERTISING AGENCYIncome Statement

For the Month Ended October 31, 2005

RevenuesFees earned $ 10,600

ExpensesSalaries expense $ 5,200Advertising supplies expense 1,500Rent expense 900Insurance expense 50Interest expense 50

Depreciation expense 40Total expenses 7,740

Net income $ 2,860

The income statement is prepared from the revenue and expense accounts.

PREPARATION OF THE INCOME STATEMENT AND THEOWNERS EQUITY STATEMENT FROM THE ADJUSTED

TRIAL BALANCE


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October 31, 2005

Debit Credit

Cash $ 15,200Accounts Receivable 200Advertising Supplies 1,000Prepaid Insurance 550

Office Equipment 5,000Accumulated DepreciationOffice Equipment $ 40Notes Payable 5,000Accounts Payable 2,500Interest Payable 50Unearned Revenue 800Salaries Payable 1,200C. R. Byrd, Capital 10,000C. R. Byrd, Drawing 500

Service Revenue 10,600Salaries Expense 5,200Advertising Supplies Expense 1,500Rent Expense 900Insurance Expense 50Interest Expense 50Depreciation Expense 40

$ 30,190 $ 30,190

PREPARATION OF THE INCOME STATEMENT AND THEOWNERS EQUITY STATEMENT FROM THE ADJUSTED

TRIAL BALANCE


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TRIAL BALANCE

PIONEER ADVERTISING AGENCYOwners Equity Statement

For the Month Ended October 31, 2005

C.R. Byrd, Capital, October 1 $ -0-Add: Investments $ 10,000

Net income 2,860 12,86012,860

Less: Drawings 500C.R . Byrd, Capital, October 31 $ 12,360

The owners equity statement is prepared from the owners capitaland drawing accountsand the net income (or net loss)shown in theincome statement.

PREPARATION OF THE BALANCE SHEET FROMTHE ADJUSTED TRIAL BALANCE


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October 31, 2005

Debit Credit

Cash $ 15,200Accounts Receivable 200Advertising Supplies 1,000Prepaid Insurance 550

Office Equipment 5,000Accumulated DepreciationOffice Equipment $ 40Notes Payable 5,000Accounts Payable 2,500Interest Payable 50Unearned Revenue 800Salaries Payable 1,200C. R. Byrd, Capital 10,000C. R. Byrd, Drawing 500

Service Revenue 10,600Salaries Expense 5,200Advertising Supplies Expense 1,500Rent Expense 900Insurance Expense 50Interest Expense 50Depreciation Expense 40

$ 30,190 $ 30,190

PREPARATION OF THE BALANCE SHEET


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FROM THE ADJUSTED TRIAL BALANCE

PIONEER ADVERTISING AGENCY

Balance SheetOctober 31, 2005

Assets Liabilities and Owners Equity

Cash $ 15,200 LiabilitiesAccounts receivable 200 Notes payable $ 5,000Advertising supplies 1,000 Accounts payable 2,500Prepaid insurance 550 Interest payable 50Office equipment $ 5,000 Unearned fees 800Less: Accumulated Salaries payable 1,200

depreciation 40 4,960 Total liabilities 9,550

Owners equity

C.R. Byrd, Capital 12,360Total liabilities and owners

Total assets $ 21,910 equity $ 21,910

The balance sheet is then prepared from the assetand liabilityaccounts and theending owners capital balanceas reported in the owners equity statement.

Overview of the Accounting Cycle


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THE ACCOUNTING CYCLE

DECISIONMAKERS

MEASUREMENT

1.

Analyzebusinesstransactions

COMMUNICATION

6.

Preparefinancialstatements

PROCESSING

5.

Close theaccountsand preparea post-closing trialbalance

2.

Record theentries

4.

Adjust theaccountsand preparean adjustedtrial balance

3.

Post theentries andprepare atrial balance

BUSINESSACTIVITIES

Overview of the Accounting Cycle

Documents

BPA 11403-Wk 4 &5-Accruals & Closing (3)