Chapter 03

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

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
expense is recognized in
$ - $ - $ - $ 100

Insurance Expense 2010

$
Jan
100 $
Feb
100
Mar
$
Apr
100 $ 100
2011, $1,200 in 2012,
$
May
100 $
Jun
100 $
Jul
100 $
Aug
100
and $1,100 in 2013. The
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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P1

DEPRECIATION
On December 1, 2011, FastForward purchased
equipment for $26,000 cash. The equipment has
an estimated useful life of four years (48 months)
and FastForward expects to sell the equipment at
the end of its life for $8,000 cash.
(c) Let’s record depreciation expense for the
month ended December 31, 2011.
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P1

DEPRECIATION

Dec. 31 Depreciation Expense 375

Accumulated Depreciation - Equipment 375
To record monthly equipment depreciation

Contra asset account

Equipment Depreciation Expense

12/1 26,000 12/31 375

Accumulated Depreciation
12/31 375
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P1

DEPRECIATION

Equipment is
$
shown net of
accumulated
depreciation.
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P1 UNEARNED (DEFERRED)
REVENUES
We will apply this cash
Cash received in you gave us towards
advance of providing your total consulting fees.
products or services.
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P1 UNEARNED (DEFERRED)
REVENUES
On December 26, 2011, FastForward agrees to
provide consulting services to a client for a fixed fee
of $3,000 for 60 days. On this date, the client pays
the entire consulting fee in advance. FastForward
makes the following entry:

Dec. 26 Cash 3,000

Unearned Revenue 3,000
Consulting fees received in advance

Unearned Revenue
Dec. 26 3,000
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P1 UNEARNED (DEFERRED)
REVENUES
(d) On December 31, FastForward earns 5-days of
consulting fees. Each day that passes results in
consulting fees of $50 ($3,000 ÷ 60), so FastForward
earned ($50 × 5 days) $250.

Dec. 31 Unearned Revenue 250

Consulting Revenue 250
To recognize 5-days of consulting fees

Unearned Revenue Consulting Revenue

Dec 31 250 Dec 26 3,000 Dec. 31 250
Bal 2,750
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P1

ACCRUED EXPENSES
We’re about one-half
Costs incurred in done with this job and
a period that are want to be paid for
our work!
both unpaid and
unrecorded.
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P1

ACCRUED SALARIES EXPENSES

FastForward’s employee earns $70 per day and is paid
every two weeks on Friday. Year-end, 12/31/11, falls on a
Wednesday. The last payday of 2011, is Friday, 12/26/11.
From 12/26 until year-end is three working days. The
employee has earned salaries of $210 for Monday through
Wednesday. They will not be paid until the next Friday.
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P1

ACCRUED SALARIES EXPENSES

(e) FastForward’s employee has earned but not been paid
on December 31, 2011, $210.

Dec. 31 Salaries Expense 210

Salaries Payable 210
To accrue 3 days' salary (3 x $70)

Salaries Expense Salaries Payable

Dec.12 700 Dec. 31 210
Dec.26 700
Dec. 31 210
Bal. 1,610
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P1 FUTURE PAYMENT OF
ACCRUED EXPENSES
On January 9, 2012, FastForward will pay the payroll for
the two weeks from December 26, 2011 through January
9, 2012. Here is the journal entry for the payroll:

Jan 9 Salaries Payable (3 days @ $70) 210

Salaries Expense (7 days @ $70) 490
Cash (10 days @ $70) 700
P aid two-we e k s alary
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P1

ACCRUED INTEREST EXPENSES

FastForward borrowed $6,000 from First National Bank on
December 1, 2011. The note bears interest at the annual
rate of 6% and is due to be repaid in one year. Let’s accrue
interest for the month ended 12/31/11.

Dec. 31 Interest Expense 30

Interest Payable 30
To accrue interest ($6,000 × 6% × 30/360)

Interest Expense Interest Payable

Dec. 31 30 Dec. 31 30
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P1

ACCRUED REVENUES
Revenues earned Yes, I’ve completed your
in a period that consulting job, but have not
had time to bill you yet.
are both
unrecorded and not
yet received.
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ACCRUED SERVICE REVENUE

P1

(f) On December 12, 2011, FastForward agrees to

render consulting services under a 30-day fixed fee
contract for $2,700 ($90 per day). All services are to be
completed by January 10, 2012, when the client will pay
in full.

Dec. 31 Accounts Receivable 1,800

Consulting Revenue 1,800
To accrue revenue (20-days @ $90 per day)

Accounts Receivable Consulting Revenue

Other receivables Other revenues
1,900 Receipts 1,900 6,050
Dec. 31 1,800 Dec. 31 1,800
Bal. 1,800 Bal . 7,850
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P1 FUTURE RECEIPT OF
SERVICE REVENUES
On January 10, 2012, FastForward completed its
obligation under the consulting contract. The client was
billed $2,700 and FastForward received $2,700 in cash.

Jan 10 Cash 2,700

Accounts Receivable 1,800
Consulting Revenue 900
T o re c ord c om p le tion of c on trac t an d c as h c olle c tion

Revenue in January
10 days @ $90 = $900
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A1

LINKS TO FINANCIAL STATEMENTS

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P2 FastForward - Trial Balance - December 31, 2011

First, the
initial
unadjusted
amounts are
added to the
worksheet.
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P 2
FastForward - Trial Balance - December 31, 2011

Next,
FastForward’s
adjustments
are added.
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P 2 FastForward – Adjusted Trial Balance - December 31, 2011

Finally, the
totals are
determined.
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P 3 PREPARING FINANCIAL
STATEMENTS
Let’s use FastForward’s adjusted trial balance to
prepare the company’s financial statements.
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P 3 1. PREPARE THE INCOME

STATEMENT
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P 3 2. PREPARE THE STATEMENT

OF OWNER’S EQUITY
Note: Net Income from the Income
Statement carries to the Statement of
Changes in Owner’s Equity.
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P 3

3. PREPARE THE BALANCE SHEET

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GLOBAL VIEW
Both U.S. GAAP and IFRS include broad and similar
guidance for adjusting accounts. Although some
variations exist in revenue and expense recognition.

Both U.S. GAAP and IFRS include similar guidance for adjusting
accounts. Although some variations exist in revenue and expense
recognition.
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PROFIT MARGIN
A2

The profit margin ratio measures the company’s

net income to net sales.
Profit Net Income
=
Margin Net Sales

Limited Brands, Inc.

$ in millions 2009 2008 2007 2006

Net income $ 220 $ 718 $ 676 $ 683

Net sales 9,043 10,134 10,671 9,699

Profit margin 2.4% 7.1% 6.3% 7.0%
Industry profit margin 0.3% 1.1% 1.6% 1.5%
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P4 APPENDIX 3A: ALTERNATIVE

ACCOUNTING FOR PREPAYMENTS
An alternative method is to record all prepaid expenses with debits
to expense accounts.

The adjusting entry depends on how the original payment

was recorded.
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END OF CHAPTER 03