THE ADJUSTING PROCESS

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Accrual Basis vs Cash Basis

Accrual Basis- revenues are recognized when earned and expenses are recognized when incurred

Cash Basis- revenues are recognized when cash is received and expenses recorded when cash is paid
(NO!)

Revenue Principle
When to record revenue? -- when it is EARNED
- when the service is provided or product is delivered
- NOT necessarily the time cash is received

Matching Principle
measures all expenses incurred during the accounting period
match the expenses against the revenues earned during the SAME period

Adjusting Entries
Prepared at end of an accounting period (usually a year)

Assign:
- Revenues to the period when earned
- Expenses to the period when incurred
Update asset and liability amount

Need to properly measure:

- Net income
- Assets and liabilities

Adjusting Entry Rules

1) Never involve cash
2) Either increase revenue (revenue credit) or increase an expense (expense credit)
3) "Accrued" means amount must be recorded

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Types of Adjusting Entries
1) Prepaid expenses
- Rent
- Insurance
* Recorded an as asset
2) Depreciation
- Land (NOT DEPRECIATED)
- Buildings
- Equipment
3) Accrued expenses (expenses incurred before payment is made)
- Salaries
- Interest
4) Accrued revenues (revenue earned before cash is received)
5) Unearned revenues

**Depreciation Entry:
Depreciation expense (Debit)
Accumulated deprec. (Credit)

**Accrued Expenses Entry:

Salaries expense (Debit)
Salaries payable (Credit)
Interest expense (Debit)
Interest payable (Credit)

**Accrued Revenues Entry:

Accounts Receivable (Debit)
Service Revenue (Credit)

**Unearned Revenue Entry:

Cash (Debit)
Service Revenue [or Unearned revenue if it was just cash] (Credit)

ADJUSTED TRIAL BALANCE

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Adjusted Trial Balance

- Prepared after adjusting entries are posted

(So;; trial balance, adjustments, adjusted trial balance)

PREPARE FINANCIAL STATEMENTS FROM THE ADJUSTED TRIAL BALANCE

Income Statement
Retained Earnings Statement
Balance Sheet
The Accounting Cycle
Process by which companies produce their financial statements
Use of a work sheet summarizes needed data in one place

1) Journal Transaction (During period)

2) Post to Accounts (Ledger) (During period)
3) Adjust Accounts (End of period)
4) Prepare Financial Statements (End of Period)
5) Close Accounts (End of Period)

Worksheet (and steps)

Internal summary device... NOT a journal, ledger, or financial statement

1) Enter account titles and their unadjusted balance in the Trial Balance columns
2) Total the amounts
3) Enter the adjusting entries in the Adjustments columns
4) Total the amounts
5) Compute each account's adjusted balance by combing the Trial Balance and Adjustment Figures
6) Enter each account's adjusted amount in the Adjusted Trail Balance columns
7) Draw imaginary line above the first revenue account
8) Every account above goes to the Balance Sheet columns
9) Every account below goes to the Income Statement columns
10) On the income statement, compute net income (Revs - Exps)
11) Enter net income as the balancing amount
12) Also enter net income as a balancing amount on the balance sheet

Preparing Financial Statements from a Work Sheet

- both have the same account balances and net income (or loss)
- Worksheet = INTERNAL doc
- Financial Statements = EXTERNAL

CLOSING ACCOUNTS
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Closing Accounts
Occurs at the end of the period
-Get accounts ready for next period
Zeroes out all revenues and all expense accounts
In order to measure each period's net income separately from all other periods

Temporary vs Permanent Accounts

Temporary
- Closed at the end of the period
(Revenues, expenses, dividends)
- Start next period with a zero balance

Permanent
- Not closed at the end of the period
(Assets, Liabilities, Common Stock, Retained Earnings)
- Ending balance carries forward to next period

To close accounts... (and 4 closing entries)

1) Transfer temporary accounts to Retained Earnings
2) Income summary account used in closing process
- summarized net income
- temporary holding tank
- closed into retained earnings

4 Closing Entries:
1) Close Revenues
Service revenue (Debit)
Income summary (Credit)
2) Close expenses
Income summary (Debit)
Salaries Expense (Credit)
Supplies Expense (Credit)
Depreciation Expense (Credit)
3) Close Income Summary
Income summary (Debit)
Retained earnings (Credit)
4) Close Dividends
Retained earnings (Debit)
Dividends (Credit)

Post-Closing Trial Balance

- List of permanent accounts and their balances after posting closing entries
- Total debits and credits MUST EQUAL
- Same accounts as on the Balance Sheet