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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

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
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C1

THE ACCOUNTING PERIOD


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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.

Accounting
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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
Accounting
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C2

ACCRUAL BASIS VERSUS CASH BASIS


FastForward paid $2,400 for a 24-month insurance
Example: 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.
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C2

ACCRUAL BASIS VERSUS CASH BASIS


Insurance Expense 2009
Jan Feb Mar Apr

$ - $ - $ - $ -
May Jun Jul Aug

$ - $ - $ - $ -
On the accrual basis,
Sep Oct Nov Dec $100 of insurance
$ - $ - $ - $ 100
Insurance Expense 2010
expense is recognized in
$
Jan
100 $
Feb
100
Mar
$
Apr
100 $ 100
2011, $1,200 in 2012,
May Jun Jul Aug and $1,100 in 2013. The
$ 100 $ 100 $ 100 $ 100
Sep Oct Nov Dec expense is matched with
$ 100 $ 100 $ 100 $ 100

Insurance Expense 2011


the periods benefited by
$
Jan
100 $
Feb
100
Mar
$
Apr
100 $ 100
the insurance coverage.
May Jun Jul Aug
$ 100 $ 100 $ 100 $ 100
Sep Oct Nov Dec
$ 100 $ 100 $ 100 $ -
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C2

RECOGNIZING REVENUES & EXPENSES


Revenue Recognition Principle

We have delivered the


product to our customer,
so I think we should record
the revenue earned.
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C2

RECOGNIZING REVENUES & EXPENSES


Revenue Recognition Principle
Matching Principle
Now that we have
Summary recognized the revenue,
of Expenses let’s see what expenses
Rent $1,000 we incurred to
Gasoline 500
generate that revenue.
Advertising 2,000
Salaries 3,000
Utilities 450
and . . . . ....
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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 (or received) cash before Paid (or received) cash after
expense (or revenue) recognized expense (or revenue) recognized

Prepaid Unearned Accrued Accrued


(Deferred) (Deferred) expense revenues
expenses* revenues
*including depreciation
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P1

PREPAID (DEFERRED) EXPENSES


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

Dec. 31 Insurance Expense 100


Prepaid Insurance 100
To record first month's expired insurance

Prepaid Insurance 637 Insurance Expense 128


Dec. 1 2,400 Dec. 31 100 Dec. 31 100
Bal. 2,300
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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?

Dec. 31 Supplies Expense 1,050


Supplies 1,050
To record supplies used during 2011

Supplies 126 Supplies Expense 652


Bought 9,720 Dec. 31 1,050 Dec. 31 1,050
Bal. 8,670
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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 cash paid with
a debit to the expense account instead of an asset
account.
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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 - Salvage Value


Depreciation =
Expense Useful Life
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END OF CHAPTER 3