Chapter 5

AdjustingAccounts and PreparingFinancial Statements

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

Learning Objective 1

Explain accrual accounting and how it improves

financial statements.

Explain accrual accounting and how it improves

financial statements.

LO1

5-2

Accrual Basis verses Cash Basis

Accrual basis accounting uses the adjusting process to recognize revenues when earned and expenses when incurred.

Accrual basis accounting uses the adjusting process to recognize revenues when earned and expenses when incurred.

Cash basis accounting recognizes revenue when cash is received and records expenses when cash is paid.Cash basis accounting recognizes revenue when cash is received and records expenses when cash is paid.

It is commonly held that accrual accounting better reflects business performance than cash basis accounting.

It is commonly held that accrual accounting better reflects business performance than cash basis accounting.

LO1

5-3

Recognizing Revenues and Expenses

Time period assumption assumes a business’ activities can be divided into specific periods, such as a month or year.

Time period assumption assumes a business’ activities can be divided into specific periods, such as a month or year.

Reports that cover a period of one year are called annual financial statements.Reports that cover a period of one year are called annual financial statements.

Interim financial statements cover one, three, or six months of activity.Interim financial statements cover one, three, or six months of activity.

LO1

5-4

Learning Objective 2

Identify the types of accounting

adjustments and their purpose.

Identify the types of accounting

adjustments and their purpose.

LO2

5-5

Types of Adjustments

Adjustments are necessary for transactions that extend over more than one accounting period.

Adjustments

Cash before work(Deferrals)

Work before cash (Accruals)

Unearned (Deferred) revenues

Prepaid (deferred) expenses

Accrued revenues

Accrued expenses

LO2

5-6

Learning Objective 3

Prepare and explain adjusting

entries.

Prepare and explain adjusting

entries.

LO3

5-7

Adjustments

An adjusting entry is recorded to bring an asset or liability account balance to its proper amount. This

entry also updates a related expense or revenue account.

Three-step Process

1. Determine the current account balance.

2. Determine what the current account balance should be.

3. Record the adjusting journal entry to get from step 1 to step 2.

LO3

5-8

Here is the checkfor my first

six months’ rent.

Here is the checkfor my first

six months’ rent.

Prepaid Expenses

Resources paid for prior to

receiving the actual benefits.

Resources paid for prior to

receiving the actual benefits.

Asset Expense

UnadjustedBalance

CreditAdjustment

DebitAdjustment

LO3

5-9

Prepaid Insurance

On December 1, 2010, FastForward paid $2,400 for insurance for 24 months. FastForward recorded the expenditure as Prepaid Insurance on December 1.

What adjustment is required?

On December 1, 2010, FastForward paid $2,400 for insurance for 24 months. FastForward recorded the expenditure as Prepaid Insurance on December 1.

What adjustment is required?

Dec. 31 Insurance Expense 100 Prepaid Insurance 100

To record first month's expired insurance

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

Prepaid Insurance 637Dec. 31 100

Insurance Expense 128

LO3

5-10

Supplies

During December, FastForward purchased $9,720 of supplies. FastForward recorded the expenditures with a debit to Supplies. On December 31, a count of the supplies indicated $8,670 on hand.

What adjustment is required?

During December, FastForward purchased $9,720 of supplies. FastForward recorded the expenditures with a debit to Supplies. On December 31, a count of the supplies indicated $8,670 on hand.

What adjustment is required?

Dec. 31 Supplies Expense 1,050 Supplies 1,050

To record supplies used during December

Bought 9,720 Dec. 31 1,050Bal. 8,670

Supplies 126Dec. 31 1,050

Supplies Expense 652

LO3

5-11

Straight-LineDepreciation

Expense=

Asset Cost - Salvage Value

Useful Life

Depreciation

Depreciation is the process of spreading the costs of plant and equipment over their

expected useful lives.

LO3

5-12

Depreciation

FastForward purchased equipment for $26,000 in early December. The equipment is expected to have a useful life of four years and a salvage value of $8,000.

What is the amount of the depreciation expense for December 2010?

FastForward purchased equipment for $26,000 in early December. The equipment is expected to have a useful life of four years and a salvage value of $8,000.

What is the amount of the depreciation expense for December 2010?

MonthlyDepreciation

Expense= $26,000 - $8,000

48 months= $375

LO3

5-13

Dec. 31 Depreciation Expense 375 Accumulated Depreciation - Equipment 375

To record equipment depreciation

Accumulated depreciation isa contra asset account.

Accumulated depreciation isa contra asset account.

Depreciation

FastForward purchased equipment for $26,000 in early December. The equipment is expected to have a useful life of four years and a salvage value of $8,000.

FastForward purchased equipment for $26,000 in early December. The equipment is expected to have a useful life of four years and a salvage value of $8,000.

LO3

5-14

Equipment Depreciation Expense12/1 26,000 12/31 375

Accumulated Depreciation

12/31 375

Depreciation

Dec. 31 Depreciation Expense 375 Accumulated Depreciation - Equipment 375

To record equipment depreciation

LO3

5-15

Equipment is shown net of accumulated depreciation.

$

DepreciationLO3

5-16

We’re about one-halfdone with this job and

want to be paid forour work!

We’re about one-halfdone with this job and

want to be paid forour work!

Costs incurred in a period that are

both unpaid and unrecorded.

Costs incurred in a period that are

both unpaid and unrecorded.

Accrued Expenses

Expense LiabilityCredit

AdjustmentDebit

Adjustment

LO3

5-17

12/31/10Year end

Last paydate

12/26/10

Next paydate

1/9/11

Record adjustingjournal entry.

Record adjustingjournal entry.

FastForward’s employee earns $70 per day, or $350 for a five-day workweek beginning on Monday and ending on Friday. This employee is paid every two weeks on Friday. On December 12 and 26, the wages are paid, recorded in the journal, and posted to the ledger. At December 31, the employee has worked for three days for FastForward and will be paid on January 9, 2011.

FastForward’s employee earns $70 per day, or $350 for a five-day workweek beginning on Monday and ending on Friday. This employee is paid every two weeks on Friday. On December 12 and 26, the wages are paid, recorded in the journal, and posted to the ledger. At December 31, the employee has worked for three days for FastForward and will be paid on January 9, 2011.

Accrued Salaries ExpenseLO3

5-18

Dec. 31 Salaries Expense 210 Salaries Payable 210

To accrue three days' salary

Dec. 1-26 1,400Dec. 31 210Bal. 1,610

Salaries ExpenseDec. 31 210

Salaries Payable

Accrued Salaries ExpenseLO3

5-19

Learning Objective 4

Explain and prepare an

adjusted trial balance.

Explain and prepare an

adjusted trial balance.

LO4

5-20

Trial Balance

An unadjusted trial balance is a list of accounts and balances prepared before adjustments are recorded.

An adjusted trial balance is a list of accounts and balances prepared after adjusting entries have been recorded and posted to the ledger.

LO4

5-21

Adjusted Trial BalanceLO4

5-22

Learning Objective 5

Prepare financial statements from an

adjusted trial balance.

Prepare financial statements from an

adjusted trial balance.

LO5

5-23

Preparing Financial StatementsLO5

5-24

Note: Investment by owner and withdrawals by owner come from the adjusted trial balance.

Preparing Financial StatementsLO5

5-25

Preparing Financial StatementsLO5

5-26

End of Chapter 5