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

C1

THE ACCOUNTING PERIOD

 3-3

C2 ACCRUAL BASIS VERSUS CASH

BASIS
Accrual Basis Cash Basis
Revenues are Revenues are
recognized when recognized when cash
earned and expenses is received and
are recognized when expenses are recorded
incurred. when cash is paid.
 3-4

C2 ACCRUAL BASIS VERSUS CASH

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

Non-GAAP
 3-5

C2 ACCRUAL BASIS VERSUS CASH

BASIS

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

C2 ACCRUAL BASIS VERSUS CASH

BASIS

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

C2 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

C2 RECOGNIZING REVENUES &

EXPENSES
Revenue Recognition Principle
Matching Principle
Now that we have
Summary recognized the revenue,
of Expenses lets see what expenses
Rent $1,000 we incurred to
Gasoline 500
Advertising 2,000
generate that revenue.
Salaries 3,000
Utilities 450
and . . . . ....
 3-9

C3

ADJUSTING ACCOUNTS
An adjusting entry is recorded to bring an asset or
liability account balance to its proper amount.
Framework for Adjustments
Adjustments

Paid
Paid (or
(or received)
received) cash
cash before
before Paid
Paid (or
(or received)
received) cash
cash after
after
expense
expense (or(or revenue)
revenue) recognized
recognized expense
expense (or
(or revenue)
revenue) recognized
recognized

Prepaid
Prepaid Unearned
Unearned Accrued
Accrued Accrued
Accrued
(Deferred)
(Deferred) (Deferred)
(Deferred) expense
expense revenues
revenues
expenses*
expenses* revenues
revenues
*including depreciation
 3 - 10

P1

PREPAID (DEFERRED) EXPENSES

Here
Here is
is the
the check
check
for
for my
my 24-month
Resources paid insurance
24-month
insurance policy.
policy.
for prior to
receiving the
actual benefits.
 3 - 11

P1

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?

637 128
 3 - 12

P1

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?

126 652
 3 - 13

P1

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
 3 - 14

P1

DEPRECIATION
Depreciation is the process of allocating the
cost of a plant asset over its useful life in a
systematic and rational manner.

Straight-Line Asset Cost - Residual Value

Depreciation =
Expense Useful Life
 3 - 15

P1

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) Lets record depreciation expense for the
month ended December 31, 2011.
 3 - 16

P1

DEPRECIATION

Contra asset account

Equipment Depreciation Expense

12/1 26,000 12/31 375

Accumulated Depreciation
12/31 375
 3 - 17

P1

DEPRECIATION

Equipment
Equipment isis
shown
shown net
net of
of
$
accumulated
accumulated
depreciation.
depreciation.
 3 - 18

P1 UNEARNED (DEFERRED)
REVENUES
We
We will
will apply
apply this
this cash
cash
Cash received in you
you gave
gave usus towards
towards
advance of providing your
your total
total consulting
consulting fees.
fees.
products or services.
 3 - 19

P1 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:
 3 - 20

P1 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.
 3 - 21

P1

ACCRUED EXPENSES
Were about one-half
Costs
Costs incurred
incurred in
in done with this job and
aa period
period that
that are
are want to be paid for
our work!
both
both unpaid
unpaid and
and
unrecorded.
unrecorded.
 3 - 22

P1

ACCRUED SALARIES EXPENSES

FastForwards
FastForwards employee
employee earnsearns $70
$70 per
per dayday and
and is
is paid
paid
every
every two
two weeks
weeks on
on Friday.
Friday. Year-end,
Year-end, 12/31/11,
12/31/11, falls
falls on
on aa
Wednesday.
Wednesday. TheThe last
last payday
payday of of 2011,
2011, is
is Friday,
Friday, 12/26/11.
12/26/11.
From
From 12/26
12/26 until
until year-end
year-end isis three
three working
working days.
days. The
The
employee
employee hashas earned
earned salaries
salaries ofof $210
$210 for
for Monday
Monday through
through
Wednesday.
Wednesday. They
They will
will not
not be
be paid
paid until
until the
the next
next Friday.
Friday.
 3 - 23

P1

ACCRUED SALARIES EXPENSES

(e) FastForwards employee has earned but not been paid
on December 31, 2011, $210.
 3 - 24

P1 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:
 3 - 25

P1

ACCRUED INTEREST EXPENSES

FastForward
FastForward borrowed
borrowed $6,000
$6,000 from
from First
First National
National Bank
Bank on
on
December
December 1, 1, 2011.
2011. The
The note
note bears
bears interest
interest at
at the
the annual
annual
rate
rate of
of 6%
6% and
and is
is due
due toto be
be repaid
repaid in
in one
one year.
year. Lets
Lets accrue
accrue
interest
interest for
for the
the month
month ended
ended 12/31/11.
12/31/11.
 3 - 26

P1

ACCRUED REVENUES
Revenues
Revenues earned
earned Yes,
Yes, Ive
Ive completed
completed youryour
in
in aa period
period that
that consulting
consulting job,
job, but
but have
have not
not
had
had time
time to
to bill
bill you
you yet.
yet.
are
are both
both
unrecorded
unrecorded and and not
not
yet
yet received.
received.
 3 - 27

ACCRUED SERVICE REVENUE

P1

(f)
(f) On
On December
December 12,12, 2011,
2011, FastForward
FastForward agrees
agrees to to render
render
consulting
consulting services
services under
under aa 30-day
30-day fixed
fixed fee
fee contract
contract forfor
$2,700
$2,700 ($90
($90 per
per day).
day). All
All services
services are
are to
to be
be completed
completed by by
January
January 10,
10, 2012,
2012, when
when the
the client
client will
will pay
pay in
in full.
full.
 3 - 28

P1 FUTURE RECEIPT OF
SERVICE REVENUES
On
On January
January 10,
10, 2012,
2012, FastForward
FastForward completed
completed itsits
obligation
obligation under
under the
the consulting
consulting contract.
contract. The
The client
client was
was
billed
billed $2,700
$2,700 and
and FastForward
FastForward received
received $2,700
$2,700 in
in cash.
cash.

Revenue in January
10 days @ $90 = $900
 3 - 29

A1

LINKS TO FINANCIAL STATEMENTS

 3 - 30

P2 FastForward - Trial Balance - December 31, 2011

Unadjusted Adjusted
Trial Balance Adjustments Trial Balance

First, the
initial
unadjusted
amounts are
added to the
worksheet.
 3 - 31

P 2 FastForward - Trial Balance - December 31, 2011

Unadjusted Adjusted
Trial Balance Adjustments Trial Balance

Next,
FastForwards
adjustments
are added.
 3 - 32

P 2
FastForward Adjusted Trial Balance - December 31, 2011

Unadjusted Adjusted
Trial Balance Adjustments Trial Balance

Finally,
Finally, the
the
totals
totals are
are
determined.
determined.
 3 - 33

P 3

PREPARING FINANCIAL STATEMENTS

Lets use FastForwards adjusted trial balance to
prepare the companys financial statements.
 3 - 34

P 3 1. PREPARE THE INCOME

STATEMENT
 3 - 35

P 3
2. PREPARE THE STATEMENT
OF CHANGES IN EQUITY

Note: Net Income from the Income

Statement carries to the Statement of
Changes in Equity.
 3 - 36

P 3

3. PREPARE THE BALANCE SHEET

 3 - 37

PROFIT MARGIN
A2

The profit margin ratio measures the companys

net income to net sales.
Profit Net Income
=
Margin 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

END OF CHAPTER 3
 3 - 39

SUGGESTED QUESTIONS TO ENSURE

YOUR LECTURE UNDERSTANDING

Chapter 3
Questions 2, 6
QS3-2, QS3-4
Ex3-2, Ex3-3, Ex3-7, Ex3-9
P3-1B, P3-4B,