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Chapter 03 - Adjusting Accounts and Preparing Financial Statements
VISUAL #3-1
ACCRUAL BASIS ACCOUNTING
(Follows GAAP)
requires that the
Income Statement
(for a period)
reports
ALL REVENUES EARNED in period (Collected or Not)
Minus ALL EXPENSES INCURRED in period (Paid
or Not)
Equals Net Income or Net Loss for the period
ACCOUNTS MUST BE ADJUSTED TO FOLLOW
PRINCIPLES
GAAP
Revenue
Recognition
GAAP
Matching
Chapter 03 - Adjusting Accounts and Preparing Financial Statements
VISUAL #3-2
DEFERRALS
The converse of statements in Visual #3-1 also applies.
Revenue not earned or expense not incurred results in
Deferrals*
UNEARNED = LIABILITY *
A REVENUE not earned cannot be shown, even if collected.
An EXPENSE not incurred cannot be shown, even if paid.
PREPAID = ASSET *
*We defer or postpone the reporting of the collected revenues
(as revenues) and prepaid expenses (as expenses) until the
revenue is earned and the expense is incurred.
Chapter 03 - Adjusting Accounts and Preparing Financial Statements
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VISUAL #3-3
ADJUSTMENTS
TYPE
GENERALIZED*
ENTRY
AMOUNT
1. Prepaid items or supplies
a) initially recorded as assets
Dr. _________ Expense
Cr. The Asset* acct.
Amount used, or
consumed, or expired
b) initially recorded as
expenses (alternate
treatment)
Dr. the Asset** acct.
Cr. ________ Expense
Amount left, or
not consumed, or
unexpired
2. Accrued expenses
(expenses incurred but not
yet recorded)
Dr. _________ Expense
Cr. _________ Payable
Amount accrued
3. Accrued revenues
(revenues earned but not
yet recorded)
Dr. ________ Receivable
Cr. The Revenue**
acct.
Amount accrued
4. Long-term assets that are
depreciable
Dr. Depreciation Expense
Cr. Accumulated
Depreciation
Portion of cost
allocated to this period
as depreciation
5. Unearned revenues
(received in advance)
a) record initially as liability
(unearned account)
Dr. Unearned ________
Cr. The Revenue**
acct.
Amount earned to date
b) initially recorded as a
revenue (alternate
treatment)
Dr. the Revenue** acct.
Cr. Unearned________
Amount still not
earned
* Note: (1) Each adjustment affects a Balance Sheet Account and an Income
Statement Account (2) CASH NEVER appears in an adjustment.
** Title or account name varies.
Chapter 03 - Adjusting Accounts and Preparing Financial Statements
a website, in whole or part. 3-16
VISUAL #3-4
THE ACCOUNTING CYCLE
STEPS
PURPOSE
TIMING
1. Analyze
transactions
Analyze transactions to prepare for
journalizing.
During the period
2. Journalize
Record accounts, including debits and
credits, in a journal.
During the period
3. Post
Transfer debits and credits from the
journal to the ledger.
During the period
4. Prepare
unadjusted
trial balance
Summarize unadjusted ledger
accounts and amounts.
End of period
5. Adjust
Record adjustments to bring account
balances up to date; journalize and
post adjusting entries.
End of period
6. Prepared adjusted
trial balance
Summarize adjusted ledger accounts
and amounts.
End of period
7. Prepare
statements
Use adjusted trial balance to prepare
financial statements.
End of period
8. Close
Journalize and post entries to close
temporary accounts.
End of year
9. Prepare post-
closing trial
balance
Test clerical accuracy of the closing
procedures.
End of year
10. Reverse
(Optional)
Reverse certain adjustments in the
next period
Beginning of next
year
Chapter 03 - Adjusting Accounts and Preparing Financial Statements
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VISUAL #3-5
MUSIC WORLD
BALANCE SHEET
DECEMBER 31, xxxx
Assets
Current Assets
Cash
$30,360
Short-Term Investments
2,000
Notes Receivable
8,000
Accounts Receivable
35,300
Merchandise Inventory
60,400
Prepaid Insurance
6,600
Supplies
1,696
Total Current Assets
$144,356
Investments
Land Held for Future Use
13,950
Property, Plant, and Equipment
Land
$ 4,500
Building
$20,650
Less Accumulated Depreciation
8,640
12,010
Office Equipment
$ 8,600
Less Accumulated Depreciation
5,000
3,600
Total Property, Plant, and Equipment
20,110
Intangible Assets
Trademark
500
Total Assets
$178,916
Liabilities
Current Liabilities
Notes Payable
$15,000
Accounts Payable
25,683
Salaries Payable
2,000
Current Portion of Mortgage Payable
10,200
Total Current Liabilities
$ 52,883
Long-Term Liabilities
Mortgage Payable
27,600
Total Liabilities
$ 80,483
Equity
Common Stock
40,000
Retained Earnings
58,433
Total Liabilities and Equity
$178,916
Chapter 03 - Adjusting Accounts and Preparing Financial Statements
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Chapter 3 – Alternate Demonstration Problem #1
On July 1, 2013, Howard M. Tenant, Inc., rents office space from John Q.
Landlord for two years, starting immediately, at a rate of $100 per month,
or $2,400 in total. The full $2,400 was paid on this date.
Required:
Record the original transaction on 7/1 and the appropriate adjusting
entries in 2013, 2014, and 2015 from the point of view of Tenant and
Landlord.
Chapter 03 - Adjusting Accounts and Preparing Financial Statements
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Solution: Chapter 3 – Alternate Demonstration Problem #1
Tenant
Landlord
7/1/13
Prepaid Rent ................
2,400
Cash ..............................
2,400
Cash
2,400
Unearned Rent
Rev. .....................
2,400
12/31/13
Rent Expense ..............
600
Unearned Rent Rev.
600
Prepaid Rent ........
600
Rent Revenue
600
12/31/14
Rent Expense ..............
1,200
Unearned Rent Rev.
1,200
*Prepaid Rent .......
1,200
Rent Revenue
1,200
12/31/15
*Rent Expense .............
600
Unearned Rent Rev.
600
Prepaid Rent ........
600
Rent Revenue
600
Alternative Solution (Reversing Entries)
7/1/13
Rent Expense ..............
2,400
Cash ..............................
2,400
Cash......................
2,400
Rent Rev. ..............
2,400
12/31/13
Prepaid Rent ...............
1,800
Rent Rev.
1,800
Rent Expense ......
1,800
Unearned Rent
Revenue ..............
1,800
*12/31/14
Rent Expense ..............
1,200
Unearned Rent Rev.
1,200
Prepaid Rent ........
1,200
Rent Revenue
1,200
*12/31/15
Rent Expense ..............
600
Unearned Rent Rev.
600
Prepaid Rent ........
600
Rent Revenue
600
* Notice the adjustment is the same in 10 and 11 under both methods.
This is because the 10 adjustment in the alternative solution (using
reversing entries) places all remaining unexpired/unearned amounts in
the asset/liability accounts to be considered for future adjustment.
a website, in whole or part. 3-20
Chapter 03 - Adjusting Accounts and Preparing Financial Statements
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Solution: Chapter 3 – Alternate Demonstration Problem #2
Insurance Expense ..........................................
600
Prepaid Insurance .....................................
600
Supplies Expense ............................................
1,300
Supplies .....................................................
1,300
Depreciation Expense Equip. ..........................
1,000
Accumulated Depreciation Equip. ...........
1,000
Salaries Expense .............................................
700
Salaries Payable ........................................
700
Chapter 03 - Adjusting Accounts and Preparing Financial Statements
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Chapter 3 – Alternate Demonstration Problem #3
The trial balance of Large Company, Inc. at the end of its annual
accounting period is as follows:
LARGE COMPANY, INC.
Trial Balance
December 31, 2013
Cash ..........................................................................
$ 4,000
Prepaid Insurance ...................................................
1,600
Supplies ..................................................................
2,100
Equipment ...............................................................
20,000
Accumulated depreciation equipment ..................
$ 2,000
Common stock .......................................................
10,000
Retained earnings ...................................................
7,000
Revenue ...................................................................
33,000
Salaries expense .....................................................
18,300
Rent expense ..........................................................
6,000
______
Totals ........................................................................
$52,000
$52,000
Additional information:
▪ Expired insurance, $600.
▪ Unused supplies, per inventory, $800.
▪ Estimated depreciation, $1,000.
▪ Earned but unpaid salaries, $700.
Required:
1. Prepare adjusting entries.
2. Prepare closing entries.
3. Prepare a post-closing trial balance.
Chapter 03 - Adjusting Accounts and Preparing Financial Statements
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Solution: Chapter 3 – Alternate Demonstration Problem #3
1.
Insurance Expense .................................................
600
Prepaid Insurance ...........................................
600
Supplies Expense ...................................................
1,300
Supplies ...........................................................
1,300
Depreciation Expense Equip. ................................
1,000
Accumulated Depreciation Equip. ..................
1,000
Salaries Expense ....................................................
700
Salaries Payable ..............................................
700
2.
Revenue ..................................................................
33,000
Income Summary ............................................
33,000
Income Summary ...................................................
27,900
Salaries Expense .............................................
19,000
Rent Expense...................................................
6,000
Insurance Expense ..........................................
600
Supplies Expense ............................................
1,300
Depreciation Expense .....................................
1,000
Income Summary ...................................................
5,100
Retained Earnings ...........................................
5,100
3.
LARGE COMPANY, INC.
Post-Closing Trial Balance
December 31, 2013
Dr.
Cr.
Cash ........................................................................
$4,000
Prepaid Insurance ..................................................
1,000
Supplies ..................................................................
800
Equipment...............................................................
20,000
Accumulated depreciation, equipment .................
$ 3,000
Salaries payable .....................................................
700
Common stock .......................................................
10,000
Retained earnings ..................................................
______
12,100
Totals ......................................................................
$25,800
$25,800
