Chapter 3

Recording Changes in
Financial Position
The Matching Concept and the Adjusting Process

PowerPoint Presentation – Farrukh Iqbal

Iqra University
 Objectives
Objectives
1. Explain how the matching concept relates to the
accrual basis ofAfter studying
studying this
accounting.
After this
2. Explain why adjustments are necessary
chapter,
chapter, you
you should and list the
should
characteristics of adjusting entries.
be
be able
able to:
to:requiring adjustment.
3. Journalize entries for accounts
4. Summarize the adjustment process and prepare an
adjusted trial balance.
5. Use vertical analysis to compare financial statement
items with each other and with industry averages.
The Matching Concept
Reporting Revenue and Expenses
TWO METHODS
Cash Basis of Accounting
Accrual Basis of Accounting
 Under the cash basis for the
accounting period concept, revenues
and expenses are reported in the
income statement in the period in
which cash is received or paid.
 Under the accrual basis for the
accounting period concept, revenues
are reported in the income statement in
the period in which they are earned.
 Recognition of Revenues

• Significant risks and benefits of

ownership passes from the seller to the
buyer
(Transfer of title of goods)
 Recognition of Expenses

• Expenses are recognized when they are

incurred and helped to produce revenues
Accrual Basis of Accounting


Revenue
Revenue reported
reported when
when earned
earned

Expense
Expense reported
reported when
when
incurred
incurred

Properly
Properly matches
matches revenues
revenues
and
and expenses
expenses in
in determining
determining
net
net income
income

Requires
Requires adjusting
adjusting entries
entries at
at
end
end of
of period
period
Generally Accepted Accounting Principles
and Concepts
• Entity - Every entity is a separate economic unit and should be
kept distinct from the activities of its owners and other
companies
• Monetary Unit- only economic events that have monetary
transactions will be reported in the financial statements
• Cost Principle- assets are presented at their original (historical)
cost
• Going Concern- companies are established with the goal that
they will operate for an indefinitely long period of time
• Periodicity - economic activities of any firm can be divided into
discrete time periods for reporting purposes
• Matching Principle -all revenues must be recorded in the
accounting period in which the goods are sold or services are
rendered and all expenses must be recorded in the accounting
period in which they are incurred to produce such revenues
 Accounting Cycle

Adjust the
Analyze and Post the
accounts
record the transactions and and prepare
transactions prepare trial trial balance
balance

Prepare the
financial
statements Close the
accounts and
prepare trial
Chapter 2 Mugan-Akman
balance 2007 11
 Analysis and Recording
Business Transactions
• Business transaction is an economic
event that causes a change in the
financial position
• Financial Position:
– What we own
– How we own

Chapter 2 Mugan-Akman 2007 12

The
The matching
matching concept
concept supports
supports
reporting
reporting revenues
revenues and
and related
related
expenses
expenses inin the
the same
same period.
period.

Paid $10,000 for Sold the

an advertising advertised
campaign for a $10,000
product.
$10,000
product thataswill expensed in
recorded an
be introduced 2005 to match
asset in
2003.
2005. revenues

2004 2005
 NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable
Unearned Rent
Unadjusted
Unadjusted 900 00
360 00
Chris Clark, Capital trial
trial 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned balance
balance 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
 NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Chris Clark, Capital 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned Assets
Assets 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
 NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Chris Clark, Capital 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 340 00
Wages Expense Liabilities
Liabilities 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
 NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Chris Clark, Capital 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense Owner’s
Owner’s 985 00
Supplies Expense 800 00
Miscellaneous Expense Equity
Equity 455 00
42 600 00 42 600 00
 NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Chris Clark, Capital 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense Revenue
Revenue 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
 NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Chris Clark, Capital Expenses
Expenses 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
 NetSolutions
Chart of Accounts
Balance Sheet Income Statement
1. Assets 4. Revenue
11 Cash 41 Fees Earned
12 Accounts Receivable 42 Rent Revenue
14 Supplies
5. Expenses
15 Prepaid Insurance
51 Wages Expense
17 Land
52 Rent Expense
18 Office Equipment
53 Depreciation Expense
19 Accumulated
54 Utilities Expense
Depreciation19
55 Supplies Expense
Accumulated Depreciation
2. Liabilities 56 Insurance Expense
21 Accounts Payable 59 Miscellaneous Expense
22 Wages Payable
23 Unearned Rent
3. Owner’s Equity
31 Chris Clark, Capital
32 Chris Clark, Drawing
Deferred
Expenses
(Prepaid
Expenses)
 NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land Some
Someof
ofthese
thesesupplies
20have
supplies have
000 00
Office Equipment been
beenused.
used. On
OnDecember
December 31,
1 800 aa
31,00
Accounts Payable count 900 00
Unearned Rent countreveals
revealsthat
that$760
$760ofof 360 00
Chris Clark, Capital supplies
suppliesare
areon
onhand.
hand. 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
 Supplies (balance on trial balance) $2,000
Supplies on hand, December 31 – 760
Supplies used $1,240

2005
1 Dec. 31 Supplies Expense 55 1 240 00
2 Supplies 14 1 240 00
3
4

Supplies 14 Supplies Expense 55

Bal. 2,000 Dec. 31 1,240 Bal. 800
Dec. 31 1,240
760
2,040
 NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable
The
The prepayment for 24 months
prepayment for 24 months900 00
Unearned Rent of
of insurance
insurance does
does not
not reflect
reflect that
that
360 00
Chris Clark, Capital 25 000 00
Chris Clark, Drawing December’s
December’s insurance4 000 has
insurance has
00
Fees Earned theoretically
theoretically expired.
expired. 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
4
31 Insurance Expense 56 100 00
5
Prepaid Insurance 15 100 00
6
7

Prepaid Insurance 15 Insurance Expense 56

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

Note:
Note: You
You probably
probably have
have the
the idea
idea of
of
how
how posting
posting flows,
flows, so
so the
the rest
rest of
of
the
the slides
slides will
will omit
omit the
the arrows.
arrows.
Effect
Effect of
of Omitting
Omitting Adjustment
Adjustment
Deferred Revenue
(Unearned
Revenue)
 NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance
Three months’ rent, $360,
Three months’ rent, $360, was
2 400 00was
Land received
received on
on December
December 20 1.
1. As
000 As of
00 of
Office Equipment 1 800 00
Accounts Payable
December
December 31, only $120 has
31, only $120 has been
been900 00
Unearned Rent earned.
earned. 360 00
Chris Clark, Capital 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
7
31 Unearned Rent 23 120 00
8
Rent Revenue 42 120 00
9
10

Unearned Rent 23 Rent Revenue 42

Dec. 31 120 Bal. 360 Dec. 31 120
240
Effect
Effect of
of Omitting
Omitting Adjustment
Adjustment
 Accrued
Expenses
(Accrued
Liabilities)
 NetSolutions 25
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable At
At the
the end
end ofof December,
2 220 00 accrued
December, accrued
Supplies 2 000 00
Prepaid Insurance
wages amounted
wages amounted to $250.
2 400to00$250.
Land Currently,
Currently, Wages
Wages Expense
20 000Expense
00 isis
Office Equipment understated 1 800 00 is no
Accounts Payable understated and
and there
there is no900 00
Unearned Rent liability
liability shown
shown for
for these
these wages.
wages.
360 00
Chris Clark, Capital 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
10 31 Wages Expense 51 250 00
11 Wages Payable 22 250 00
12
13

Wages Payable 22 Wages Expense 51

Dec. 31 250 Bal. 4,275
Dec. 31 250
Effect
Effect of
of Omitting
Omitting Adjustment
Adjustment
 Accrued
Revenues
(Accrued Assets)
 NetSolutions 29
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance NetSolutions provided 2$500
400 00
Land NetSolutions provided20$500
000 00
Office Equipment in
in services
services during
during December
December
1 800 00
Accounts Payable for
for which
which the
the customer
customer has
has 900 00
Unearned Rent 360 00
Chris Clark, Capital
not
not been
been billed.
billed. 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
13 31 Accounts Receivable 12 500 00
14 Fees Earned 41 500 00
15
16

Accounts Receivable 12 Fees Earned 41

Bal. 2,220 Bal. 16,340
Dec. 31 500 Dec. 31 500
2,720 16,840
Effect
Effect of
of Omitting
Omitting Adjustment
Adjustment
Fixed
Assets
 Land
Land

Land has an infinite life; therefore,

it does not depreciate.
 Building
Building

A building has a limited life, so it must be depreciated.

The contra account used in the adjusting entry is
Accumulated Depreciation—Building
 Equipment
Equipment

Because equipment has a limited life, it

depreciates. The contra account used is
Accumulated Depreciation—Equipment
 NetSolutions
NetSolutions estimates
estimates the
the
depreciation
depreciation onon its
its office
office equipment
equipment
to
to be
be $50
$50 for
for the
the month
month of of December.
December.

16
17 31 Depreciation Expense 53 50 00
18 Accumulated Depreciation—
19 Office Equipment 19 50 00

Accumulated Depreciation—
Office Equipment
19 Depreciation Expense 53
Dec. 31 50 Dec. 31 50
 NetSolutions’
NetSolutions’ balance
balance sheet
sheet
would
would show
show the
the office
office
equipment
equipment at
at cost,
cost, less
less the
the
accumulated
accumulated depreciation.
depreciation.

Office equipment $1,800

Less accumulated
depreciation 50 $1,750

Book
value
Effect
Effect of
of Omitting
Omitting Adjustment
Adjustment
Summary
Summary of
of Basic
Basic Adjustments
Adjustments
NetSolutions’ Adjusted
Trial Balance for
December 31, 2005
 NetSolutions 41
Adjusted Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 720 00
Supplies 760 00
Prepaid Insurance 2 300 00
Land 20 000 00
Office Equipment 1 800 00
Accumulated Depreciation 50 00
Accounts Payable 900 00
Wages Payable 250 00
Unearned Rent 240 00
Chris Clark, Capital 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 840 00
Rent Revenue 120 00
Wages Expense 4 525 00
Rent Expense 1 600 00
Utilities Expense 985 00
Continued
 NetSolutions 42
Trial Balance
December 31, 2005 (Continued)
Supplies Expense 2 040 00
Insurance Expense 100 00
Miscellaneous Expense 455 00
43 400 00 43 400 00
 Vertical
Analysis and
Interpretation
 J. Holmes, Attorney-at-Law
Income Statements
For the Years Ended December 31, 2005 and 2006
2006 2005
Amount Percent Amount Percent
Fees earned $187,500 $150,000
Operating expenses:
Wages expense $60,000 $45,000
Rent expense 15,000 12,000
Utilities expense 12,500 9,000
Supplies expense 2,700 3,000
Miscellaneous exp. 2,300 1,800
Total operating
expenses $92,500 $70,800
Net income $95,000 $79,200
 2006 2005
Amount Percent Amount Percent
Fees earned $187,500 100.0% $150,000 100.0%
Operating expenses:
Wages expense $60,000 $45,000
Rent expense 15,000 12,000
Utilities expense 12,500 9,000
Supplies expense 2,700 3,000
Miscellaneous exp. 2,300 1,800
Total operating
expenses $92,500 $70,800
Net income $95,000 $79,200
 2006 2005
Amount Percent Amount Percent
Fees earned $187,500 100.0% $150,000 100.0%
Operating expenses: $60,000
$60,000
Wages expense $60,000 32.0% $45,000
$187,500
$15,000
$187,500
$15,000
Rent expense 15,000 38.0% 12,000
$187,500
$187,500
Utilities expense 12,500 9,000
Supplies expense 2,700 3,000
Miscellaneous exp. 2,300 1,800
Total operating
expenses $92,500 $70,800
Net income $95,000 $79,200
 2006 2005
Amount Percent Amount Percent
Fees earned $187,500 100.0% $150,000 100.0%
Operating expenses:
Wages expense $60,000 32.0% $45,000 30.0%
Rent expense 15,000 8.0% 12,000 8.0%
Utilities expense 12,500 6.7% 9,000 6.0%
Supplies expense 2,700 1.4% 3,000 2.0%
Miscellaneous exp. 2,300 1.2% 1,800 1.2%
Total operating
expenses $92,500 49.3% $70,800 47.2%
Net income $95,000 50.7% $79,200 52.8%
Chapter 3

The
The End
End