Adjusting Accounts & Preparing

Financial Statements

Chapter 3

Accounting period
Time

principle period

Specific time periods for accounting

activities
Fiscal year
Consisting of any 12 months period other than
ending on December 31

Natural year
Ends December 31

Accounting basis
Accrual

basis

Uses the adjusting process to recognize

revenues when earned and to match
expenses with revenues
Cash

Basis

Recognized revenues when cash is

received and records expenses when cash
is paid

Revenue Recognition

Matching principle
Aims to record
expenses in the
same accounting
period as the
revenues that are
earned as a result of
these expenses

Adjustments
Adjusting

entries

To correct for transactions and events that

extend over more than one period
Deferred wait till cash is paid
Accrual

Rule
Debit the expense
Credit the asset or liabilities
For the amount used up

Prepaid insurance
Suppose

that we purchase $2,400 for

insurance for one year on May 1.
Record the adjustments on December
31.
$2,400/12 = $200 x 8months = $1,600
Insurance expense 1600
Prepaid insurance
1600

Supplies
Suppose

that supplies account has a

balance of $4,000 and inventory shows
$1,000. Record the supplies used up.
Balance 4,000
Inventory1,000
Used up 3,000

Supplies
Supplies

expense 3,000
Supplies
3,000

Depreciation
Plant

assets/Fixed Assets

Assets which are tanigble and long lived

Building and machinery
Depreciation

The reduction in value of an asset due to

its use

Depreciation
Depreciation

expense

Annual reduction in value of asset

Accumulated

depreciation

Contra asset
Increases with a credit
Total reduction in value of an asset

Unearned revenues
Refers

to cash received in advance of

services provided
Suppose that unearned revneue has a
balance of $7,000 but records shows
only $3,000 is unearned
Balance $7,000
Should be 3,000
Earned
4,000

Unearned Revenues
Unearned

revenues

A liability
If we do not complete the work then we are
liable to refund the monies.
Once the work is completed then the
liability does not exist
Unearned

revenues 4,000
Fees earned
4000

Accrued expenses
Refers

to costs that are incurred in a

period that are unpaid and unrecorded
Accrued salaries
Salaries owed at the end of the period to
be made next period
Suppose year ends on Wed, do we pay on
Wed or wait until Friday

Salaries
Suppose
Salaries

salaries at year end is $400

expense 400
Salaries payable 400

Accrued revenues
Refers

to revenues earned in a period

that are both unrecorded and not yet
received in cash
Unrecorded accounts receivable

Trial Balance
Unadjusted

trial balance

is a list of account balances before

adjustments
Used to make adjusting entries
Adjusted

trial balance

Used to prepare financial statements

Financial Statements
Four

basic financial statements

Income statement
Statement of Retained Earnings
Balance Sheet
Statement of Cash flows

Income Statement
Results of operations for a business
Shows revenues minus expenses
Rob Co
Income Statement
For period ending
12/31/04

Revenues
Sales

$75,000

Expense
Salaries exp

$25,000

Rent exp

$10,000

Total exp
Net income

35,000
$40,000

Statement of Retained Earnings

Changes in net worth and equity
Rob Co
Statement of Retained Earnings
For period ending 12/31/04
Beginning Retained Earnings
+Net income
-Dividends
Ending Retained Earnings

$60,000
40,000
100,000
20,000
$80,000

Balance sheet

Rob Co
Balance Sheet
December 3, 2004

Assets
Cash
Truck

$45,000
75,000

Total Assets

$120,000

Liabilities
Accts pay

$10,000

Total liab.

$10,000

Stockholders Equity
Common Stock

$30,000

Retained Earnings

$80,000

Total S.E.

$110,000

Total S.E. & Liabilities

$120,000

Statement of Cash Flows

Inflows

and outflow of cash from

Operations
Investments
Financing

Accounting Cycle
Record

entries in the journal

Post to ledger
Prepare unadjusted Trial Balance
Record and post adjusting entries
Prepare adjusted trial balance
Prepare financial statements
Record

and post closing entries

Closing Entries
Temporary

accounts

Accumulate data related to one accounting

period

Revenue
Expense
Dividends
Income summary

Close revenues
Revenues

Income summary
Debit

DR
Cr

whatever revenue accounts you

have on the trial balance for their
ending balance and the total is credited
to income summary

Close Expenses
Income

summary
Expenses

Credit

DR
CR

each expense account

separately for the amount of the
balance in the account and debit
income summary for the total

Close Income Summary

Income

Summary DR
Retained earnings

CR

For the balance in the income summary account

Income Summary
Debit
Total expenses

Credit
Total revenues
Net income

Close Dividends
Dividends

reduce the equity of the

business and the amount retained in
the business
Retained earnings DR

Dividends
CR
For the amount of the balance in the
dividend account

Transactions
Fees

earned
$50,000
Rent expense
10,000
Supplies expense
5,000
Dividends
2,000
Retained earnings $30,000
Record the closing entries

Close revenues
Fees

earned 50,000
Income summary

50,000

Close Expenses
Income

Summary $15,000
Rent expense
Supplies expense

$10,000
5,000

Close Income Summary

Income

Summary $35,000
Retained earnings
$35,000
Income Summary
DR

Expenses

$15,000

CR
$50,000

Revenues

$35,000 net income

Close Dividends
Retained

earnings $2,000
Dividends
$2,000
Retained Earnings
DR
$2,000
Dividends

CR
$30,000 Balance
$35,000 net income
$63,000 ending balance

Classification of Accounts

Current assets
Expected to be
collected in less than
one year
Cash
Accounts receivable
Supplies
Inventory

Plant Asset
Long lived tangible
assets
Factory building
Machinery and
equipment