Week 2 Homework Problems

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Accrual Accounting Concepts

Kimmel ● Weygandt ● Kieso

Financial Accounting, Eighth Edition

4

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Prepare adjusting entries for deferrals.

CHAPTER OUTLINE

Explain the accrual basis of accounting and the reasons for adjusting entries.

1

2

LEARNING OBJECTIVES

Prepare adjusting entries for accruals.

3

Prepare an adjusted trial balance and closing entries.

4

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LEARNING OBJECTIVE

Explain the accrual basis of accounting and the reasons for adjusting entries.

1

LO 1

Generally a month, a quarter, or a year.

Fiscal year vs. calendar year.

Accountants divide the economic life of a business into artificial time periods (Periodicity Assumption).

Jan.

Feb.

Mar.

Apr.

Dec.

. . . . .

▼ HELPFUL HINT

An accounting time period that is one year long is called a fiscal year.

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Periodicity Assumption

Review Question

What is the periodicity assumption?

Companies should recognize revenue in the accounting period in which it is earned.

Companies should match expenses with revenues.

The economic life of a business can be divided into artificial time periods.

The fiscal year should correspond with the calendar year.

LO 1

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Companies recognize revenue in the accounting period in which the performance obligation is satisfied.

REVENUE RECOGNITION PRINCIPLE

LO 1

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TEACHING TIP

Service businesses recognize revenue when the services are performed, although many customers may have been billed for the services (on account). The cash has not been received; however, the services have been performed. Therefore, revenue should be recognized.

Illustration: Assume Conrad Dry Cleaners cleans clothing on June 30, but customers do not claim and pay for their clothes until the first week of July. The journal entries for June and July would be:

REVENUE RECOGNITION PRINCIPLE

LO 1

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“Let the expenses follow the revenues.”

ILLUSTRATION 4-1

EXPENSE RECOGNITION PRINCIPLE

LO 1

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ILLUSTRATION 4-1

GAAP relationships in revenue and expense recognition

EXPENSE RECOGNITION PRINCIPLE

LO 1

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INVESTOR INSIGHT

Reporting Revenue Accurately

The Until recently, electronics manufacturer Apple was required to spread the revenues from iPhone sales over the two-year period following the sale of the phone. Accounting standards required this because Apple was obligated to provide software updates after the phone was sold. Since Apple had service obligations after the initial date of sale, it was forced to spread the revenue over a two-year period. As a result, the rapid growth of iPhone sales was not fully reflected in the revenue amounts reported in Apple’s income statement. A new accounting standard now enables Apple to report much more of its iPhone revenue at the point of sale. It was estimated that under the new rule revenues would have been about 17% higher and earnings per share almost 50% higher.

Apple Inc.

LO 1

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Accrual-Basis Accounting

Transactions recorded in the periods in which the events occur.

Revenues are recognized when services performed, even if cash was not received.

Expenses are recognized when incurred, even if cash was not paid.

ACCRUAL VERSUS CASH BASIS

LO 1

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Cash-Basis Accounting

Revenues are recognized only when cash is received.

Expenses are recognized only when cash is paid.

Not in accordance with generally accepted accounting principles (GAAP).

ACCRUAL VERSUS CASH BASIS

LO 1

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TEACHING TIP

Explain to students that many businesses use the cash basis of accounting. These businesses outgrow the method when accounts receivable and accounts payable become substantial. Also, if the businesses need audited financial statements, they must comply with GAAP and use the accrual basis. Remind them that companies can use the cash method and that its use does not mean that income is being manipulated. Without this discussion, some students may unfairly criticize an employer, relative or friend who is using the cash basis of accounting.

2016

2017

Illustration: Suppose that Fresh Colors paints a large building in 2016. In 2016, it incurs and pays total expenses (salaries and paint costs) of $50,000. It bills the customer $80,000, but does not receive payment until 2017.

ACCRUAL VERSUS CASH BASIS

ILLUSTRATION 4-2

Accrual-versus cash-basis accounting

LO 1

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Periodicity Assumption

Review Question

Which one of these statements about the accrual basis of accounting is false?

Companies record events that change their financial statements in the period in which events occur, even if cash was not exchanged.

Companies recognize revenue in the period in which the performance obligation is satisfied.

This basis is in accord with generally accepted accounting principles.

Companies record revenue only when they receive cash, and record expense only when they pay out cash.

LO 1

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Adjusting entries

ensure that the revenue recognition and expense recognition principles are followed.

are required every time a company prepares financial statements.

includes one income statement account and one balance sheet account.

THE NEED FOR ADJUSTING ENTRIES

LO 1

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Adjusting entries are made to ensure that:

a. expenses are recognized in the period in which they are incurred.

b. revenues are recognized in the period in which the performance obligation is satisfied.

c. balance sheet and income statement accounts have correct balances at the end of an accounting period.

d. All of the above.

Review Question

THE NEED FOR ADJUSTING ENTRIES

LO 1

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Deferrals:

1. Prepaid expenses: Expenses paid in cash and recorded as assets before they are used or consumed.

2. Unearned revenues: Cash received before service are performed.

Accruals:

1. Accrued revenues: Revenues for services performed but not yet received in cash or recorded.

2. Accrued expenses: Expenses incurred but not yet paid in cash or recorded.

TYPES OF ADJUSTING ENTRIES

ILLUSTRATION 4-3

Categories of adjusting entries

LO 1

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LO 1

Trial Balance – Each account is analyzed to determine whether it is complete and up-to-date.

TYPES OF ADJUSTING ENTRIES

ILLUSTRATION 4-4

Trial balance

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Timing Concepts

Below is a list of concepts in the left column, with descriptions of the concepts in the right column. There are more descriptions provided than concepts. Match the description of the concept to the concept.

DO IT!

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LO 1

1. ____ Accrual-basis accounting.

2. ____ Calendar year.

3. ____ Periodicity assumption.

4. ____ Expense recognition principle.

(a) Monthly and quarterly time periods.

(b) Efforts (expenses) should be matched with results (revenues).

(c) Accountants divide the economic life of a business into time periods.

(d) Companies record revenues when they receive cash and record expenses when they pay out cash.

(e) An accounting time period that starts on January 1 and ends on December 31.

(f) Companies record transactions in the period in which the events occur.

f

e

c

b

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Analyze business transactions

Journalize

Post

Trial Balance

Journalize and Post Adjusting Entries

Adjusted Trial Balance

Financial Statements

Closing Entries

Post-Closing Trial Balance

To defer means to postpone or delay.

LO 2

LEARNING OBJECTIVE

Prepare adjusting entries for deferrals.

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Deferrals are either:

Prepaid expenses

OR

Unearned revenues.

Deferrals

LO 2

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Expenses paid in cash before they are used or consumed.

insurance

supplies

advertising

Cash Payment

Expense Recorded

BEFORE

rent

equipment

buildings

Prepayments often occur in regard to:

PREPAID EXPENSES

LO 2

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Prepaid Expenses

Costs that expire either with the passage of time or through use.

Adjusting entry results in an increase (a debit) to an expense account and a decrease (a credit) to an asset account.

PREPAID EXPENSES

LO 2

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Adjusting entries for prepaid expenses

Increases (debits) an expense account and

Decreases (credits) an asset account.

ILLUSTRATION 4-5

Adjusting entries for prepaid expenses

PREPAID EXPENSES

LO 2

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Illustration: Sierra Corporation purchased supplies costing $2,500 on October 5. Sierra recorded the purchase by increasing (debiting) the asset Supplies. This account shows a balance of $2,500 in the October 31 trial balance. An inventory count at the close of business on October 31 reveals that $1,000 of supplies are still on hand.

Supplies

1,500

Supplies Expense

1,500

Oct. 31

ILLUSTRATION 4-6

($2,500 – 1,000 = $1,500)

Supplies

LO 2

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Illustration: On October 4, Sierra Corporation paid $600 for a one-year fire insurance policy. Coverage began on October 1. Sierra recorded the payment by increasing (debiting) Prepaid Insurance. This account shows a balance of $600 in the October 31 trial balance. Insurance of $50 ($600 ÷ 12) expires each month.

Prepaid Insurance

50

Insurance Expense

50

Oct. 31

ILLUSTRATION 4-7

Insurance

LO 2

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Buildings, equipment, and motor vehicles (long-lived assets) are recorded as assets, rather than an expense, in the year acquired.

Depreciation is the process of allocating the cost of an asset to expense (depreciation) over its useful life.

Depreciation does not attempt to report the actual change in the value of the asset.

Depreciation

LO 2

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Illustration: For Sierra Corporation, assume that depreciation on the office equipment is $480 a year, or $40 per month.

Accumulated Depreciation-Equipment

40

Depreciation Expense

40

Oct. 31

ILLUSTRATION 4-8

Depreciation

LO 2

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Statement Presentation

Accumulated Depreciation-Equipment is a contra asset account.

Appears just after the account it offsets (Equipment) on the balance sheet.

ILLUSTRATION 4-9

Balance sheet presentation of

accumulated depreciation

Depreciation

▼ HELPFUL HINT

All contra accounts have increases, decreases, and normal balances opposite to the account to which they relate.

LO 2

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ILLUSTRATION 4-10

Accounting for prepaid expenses

PREPAID EXPENSES

LO 2

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Receipt of cash recorded as a liability before services are performed.

rent

airline tickets

Cash Receipt

Revenue Recorded

BEFORE

magazine subscriptions

customer deposits

Unearned revenues often occur in regard to:

UNEARNED REVENUES

LO 2

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Adjusting entry is made to record the revenue for services performed during the period and to show the liability that remains.

Adjusting entry results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account.

UNEARNED REVENUES

LO 2

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Adjusting entries for unearned revenues

Decrease (a debit) to a liability account.

Increase (a credit) to a revenue account.

ILLUSTRATION 4-11

UNEARNED REVENUES

LO 2

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Illustration: Sierra Corporation received $1,200 on October 2 from R. Knox for guide services for multi-day trips expected to be completed by December 31. Unearned Service Revenue shows a balance of $1,200 in the October 31 trial balance. From an evaluation of the service Sierra performed for Knox during October, the company determines that it has earned $400 in October.

Service Revenue

400

Unearned Service Revenue

400

Oct. 31

ILLUSTRATION 4-12

UNEARNED REVENUES

LO 2

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ILLUSTRATION 4-13

Accounting for unearned revenues

Unearned Revenues recorded in liability accounts are now recognized as revenue for services performed.

ACCOUNTING FOR UNEARNED REVENUES

Examples

Reason for

Adjustment

Accounts Before

Adjustment

Adjusting

Entry

Rent, magazine subscriptions, customer deposits for future service.

Liabilities overstated.

Revenues understated.

Dr. Liabilities

Cr. Revenues

UNEARNED REVENUES

LO 2

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ACCOUNTING ACROSS THE ORGANIZATION

Turning Gift Cards into Revenue

Those of you who are marketing majors (and even most of you who are not) know that gift cards are among the hottest marketing tools in merchandising today. Customers purchase gift cards and give them to someone for later use. In a recent year, gift-card sales were expected to exceed $124 billion. Although these programs are popular with marketing executives, they create accounting questions. Should revenue be recorded at the time the gift card is sold, or when it is exercised? How should expired gift cards be accounted for? In a recent balance sheet, Best Buy reported unearned revenue related to gift cards of $406 million.

Source: “2014 Gift Card Sales to Top $124 Billion, But Growth Slowing,” PRNewswire (December 10, 2014).

LO 2

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Adjusting Entries for Deferrals

The ledger of Hammond, Inc. on March 31, 2017, includes these selected accounts before adjusting entries are prepared.

Debit Credit

Prepaid Insurance $ 3,600

Supplies 2,800

Equipment 25,000

Accumulated Depreciation—Equipment $5,000

Unearned Service Revenue 9,200

An analysis of the accounts shows the following.

1. Insurance expires at the rate of $100 per month.

2. Supplies on hand total $800.

3. The equipment depreciates $200 a month.

4. During March, services were performed for $4,000 of the unearned service revenue reported.

Prepare the adjusting entries for the month of March.

DO IT!

2

LO 2

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Adjusting Entries for Deferrals

The ledger of Hammond, Inc. on March 31, 2017, includes these selected accounts before adjusting entries are prepared.

Debit Credit

Prepaid Insurance $ 3,600

Supplies 2,800

Equipment 25,000

Accumulated Depreciation—Equipment $5,000

Unearned Service Revenue 9,200

Prepare the adjusting entries for the month of March.

Insurance expires at the rate of $100 per month.

SOLUTION

DO IT!

2

Insurance Expense 100

Prepaid Insurance 100

LO 2

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Adjusting Entries for Deferrals

The ledger of Hammond, Inc. on March 31, 2017, includes these selected accounts before adjusting entries are prepared.

Debit Credit

Prepaid Insurance $ 3,600

Supplies 2,800

Equipment 25,000

Accumulated Depreciation—Equipment $5,000

Unearned Service Revenue 9,200

Prepare the adjusting entries for the month of March.

Supplies on hand total $800.

SOLUTION

DO IT!

2

Supplies Expense 2,000

Supplies 2,000

LO 2

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Adjusting Entries for Deferrals

The ledger of Hammond, Inc. on March 31, 2017, includes these selected accounts before adjusting entries are prepared.

Debit Credit

Prepaid Insurance $ 3,600

Supplies 2,800

Equipment 25,000

Accumulated Depreciation—Equipment $5,000

Unearned Service Revenue 9,200

Prepare the adjusting entries for the month of March.

The equipment depreciates $200 a month.

SOLUTION

DO IT!

2

Depreciation Expense 200

Accumulated Depreciation 200

LO 2

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Adjusting Entries for Deferrals

The ledger of Hammond, Inc. on March 31, 2017, includes these selected accounts before adjusting entries are prepared.

Debit Credit

Prepaid Insurance $ 3,600

Supplies 2,800

Equipment 25,000

Accumulated Depreciation—Equipment $5,000

Unearned Service Revenue 9,200

Prepare the adjusting entries for the month of March.

During March, services were performed for $4,000 of the unearned service revenue reported.

SOLUTION

DO IT!

2

Unearned Service Revenue 4,000

Service Revenue 4,000

LO 2

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Analyze business transactions

Journalize

Post

Trial Balance

Journalize and Post Adjusting Entries

Adjusted Trial Balance

Financial Statements

Closing Entries

Post-Closing Trial Balance

Increase both a balance sheet and an income statement account.

LO 3

LEARNING OBJECTIVE

Prepare adjusting entries for accruals.

3

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Made to record:

Revenues for services performed and

OR

Expenses incurred

in the current accounting period that have not been recognized through daily entries.

Adjusting Entries for Accruals

LO 3

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Revenues for services performed but not yet received in cash or recorded.

rent

interest

services performed

BEFORE

Accrued revenues often occur in regard to:

Cash Receipt

Revenue Recorded

Adjusting entry results in:

ACCRUED REVENUES

LO 3

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Accrued Revenues

An adjusting entry serves two purposes:

Shows the receivable that exists, and

Records the revenues for services performed.

ACCRUED REVENUES

LO 3

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Adjusting entries for accrued revenues

Increases (debits) an asset account.

Increases (credits) a revenue account.

ILLUSTRATION 4-14

ACCRUED REVENUES

LO 3

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Illustration: In October, Sierra Corporation performed guide services for $200 that were not billed to clients before October 31.

Service Revenue

200

Accounts Receivable

200

Oct. 31

ILLUSTRATION 4-15

ACCRUED REVENUES

LO 3

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ILLUSTRATION 4-16

Accounting for accrued revenues

Services performed but not yet received in cash or recorded.

ACCOUNTING FOR ACCRUED REVENUES

Examples

Reason for

Adjustment

Accounts Before

Adjustment

Adjusting

Entry

Interest, rent, services performed but not collected.

Assets understated.

Revenues understated.

Dr. Assets

Cr. Revenues

ACCRUED REVENUES

LO 3

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Expenses incurred but not yet paid in cash or recorded.

BEFORE

Accrued expenses often occur in regard to:

Cash Payment

Expense Recorded

utilities

salaries

Adjusting entry results in:

Interest

taxes

ACCRUED EXPENSES

LO 3

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An adjusting entry serves two purposes:

Records the obligations, and

Recognizes the expenses.

ACCRUED EXPENSES

LO 3

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Adjusting entries for accrued expenses

Increases (debits) an expense account.

Increases (credits) a liability account.

ILLUSTRATION 4-17

ACCRUED EXPENSES

LO 3

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Illustration: Sierra Corporation signed a three-month note payable in the amount of $5,000 on October 1. The note requires Sierra to pay interest at an annual rate of 12%.

Interest Payable

50

Interest Expense

50

Oct. 31

ILLUSTRATION 4-19

ILLUSTRATION 4-18

Formula for computing interest

Accrued Interest

$5,000 x 12% x 1/12 = $50

LO 3

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ILLUSTRATION 4-20

Illustration: Sierra Corporation last paid salaries on October 26; the next payment of salaries will not occur until November 9. The employees receive total salaries of $2,000 for a five-day work week, or $400 per day. Thus, accrued salaries at October 31 are $1,200 ($400 × 3 days).

Accrued Salaries

LO 3

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Salaries and Wages Payable

1,200

Salaries and Wages Expense

1,200

Oct. 31

ILLUSTRATION 4-21

Illustration: Sierra Corporation last paid salaries on October 26; the next payment of salaries will not occur until November 9. The employees receive total salaries of $2,000 for a five-day work week, or $400 per day. Thus, accrued salaries at October 31 are $1,200 ($400 × 3 days).

Accrued Salaries

LO 3

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ILLUSTRATION 4-22

Accounting for accrued expenses

ACCRUED EXPENSES

LO 3

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PEOPLE, PLANET, AND PROFIT INSIGHT

Got Junk?

Do you have an old computer or two in your garage? How about an old TV that needs replacing? Many people do. Approximately 163,000 computers and televisions become obsolete each day. Yet, in a recent year, only 11% of computers were recycled. It is estimated that 75% of all computers ever sold are sitting in storage somewhere, waiting to be disposed of. Each of these old TVs and computers is loaded with lead, cadmium, mercury, and other toxic chemicals. If you have one of these electronic gadgets, you have a responsibility, and a probable cost, for disposing of it. Companies have the same problem, but their discarded materials may include lead paint, asbestos, and other toxic chemicals.

LO 3

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ILLUSTRATION 4-23

Summary of adjusting entries

SUMMARY OF BASIC RELATIONSHIPS

LO 3

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Adjusting Entries for Accruals

Micro Computer Services Inc. began operations on August 1, 2017. At the end of August 2017, management attempted to prepare monthly financial statements. The following information relates to August.

At August 31, the company owed its employees $800 in salaries that will be paid on September 1.

On August 1, the company borrowed $30,000 from a bank on a 15-year mortgage. The annual interest rate is 10%.

Revenue for services performed but unrecorded for August totaled $1,100.

Prepare the adjusting entries needed at August 31, 2017.

DO IT!

3

LO 3

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Adjusting Entries for Accruals

Micro Computer Services Inc. began operations on August 1, 2017. At the end of August 2017, management attempted to prepare monthly financial statements. Prepare the adjusting entries needed at August 31, 2017.

At August 31, the company owed its employees $800 in salaries that will be paid on September 1.

SOLUTION

DO IT!

3

Salaries and Wages Expense 800

Salaries and Wages Payable 800

LO 3

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Adjusting Entries for Accruals

Micro Computer Services Inc. began operations on August 1, 2017. At the end of August 2017, management attempted to prepare monthly financial statements. Prepare the adjusting entries needed at August 31, 2017.

On August 1, the company borrowed $30,000 from a bank on a 15-year mortgage. The annual interest rate is 10%.

SOLUTION

DO IT!

3

Interest Expense 250

Interest Payable 250

LO 3

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Adjusting Entries for Accruals

Micro Computer Services Inc. began operations on August 1, 2017. At the end of August 2017, management attempted to prepare monthly financial statements. Prepare the adjusting entries needed at August 31, 2017.

Revenue for services performed but unrecorded for August totaled $1,100.

SOLUTION

DO IT!

3

Accounts Receivable 1,100

Service Revenue 1,100

LO 3

4-‹#›

Analyze business transactions

Journalize

Post

Trial Balance

Adjusting Entries

Adjusted trial balance

Prepare financial statements

Journalize and post closing entries

Prepare a post-closing trial balance

LO 4

LEARNING OBJECTIVE

Prepare an adjusted trial balance and closing entries.

4

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After all adjusting entries are journalized and posted the company prepares another trial balance from the ledger accounts (Adjusted Trial Balance).

The adjusted trial balance’s purpose is to prove the equality of debit balances and credit balances in the ledger.

The adjusted trial balance is the primary basis for the preparation of the financial statements.

PREPARE ADJUSTED TRIAL BALANCE

LO 4

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LO 4

ILLUSTRATION 4-26

Adjusted trial balance

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PREPARE ADJUSTED TRIAL BALANCE

Which of the following statements is incorrect concerning the adjusted trial balance?

An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger after all adjustments are made.

The adjusted trial balance provides the primary basis for the preparation of financial statements.

The adjusted trial balance lists the account balances segregated by assets and liabilities.

The adjusted trial balance is prepared after the adjusting entries have been journalized and posted.

Review Question

LO 4

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Financial statements are prepared directly from the Adjusted Trial Balance.

Balance Sheet

Income Statement

Retained Earnings Statement

PREPARING FINANCIAL STATEMENTS

LO 4

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ILLUSTRATION 4-27

Preparation of the income statement and retained earnings statement from the adjusted trial balance

4-68

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Tell students to look at the date on the income statement in Illustration 4-27. The date is “For the Month Ending October 31, 2014.” How can one be sure the revenues and expenses reported on the income statement are just for that period? Closing entries transfer the temporary account balances to the stockholders’ equity account and reduce the balances in the temporary accounts to zero. Therefore, at the beginning of the period the temporary accounts have a balance of zero and the revenues and expenses accumulated are for that particular period.

ILLUSTRATION 4-28

Preparation of the balance sheet from the adjusted trial balance

LO 4

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Quality of Earnings – company provides full and transparent information.

Earnings Management - the planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income. Companies may manage earnings by:

one-time items to prop up earnings numbers.

inflating revenue numbers in the short-run.

improper adjusting entries.

As a result of the Sarbanes-Oxley Act, many companies are trying to improve the quality of their financial reporting.

QUALITY OF EARNINGS

LO 4

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Trial Balance

DO IT!

4a

LO 4

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Trial Balance

DO IT!

(a) Determine the net income for the quarter April 1 to June 30.

LO 4

4a

4-‹#›

Trial Balance

DO IT!

Determine the total assets and total liabilities at June 30, 2017.

LO 4

4a

4-‹#›

Trial Balance

DO IT!

Determine the balance in Retained Earnings at June 30, 2017.

Retained earnings, April 1 $ 0

Add: Net income 2,490

Less: Dividends 600

Retained earnings, June 30 $1,890

LO 4

4a

4-‹#›

At the end of the accounting period, companies transfer the temporary account balances to the permanent stockholders’ equity account—Retained Earnings.

ILLUSTRATION 4-29

Temporary versus permanent accounts

CLOSING THE BOOKS

LO 4

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In addition to updating Retained Earnings to its correct ending balance, closing entries produce a zero balance in each temporary account.

ILLUSTRATION 4-30

The closing process

Preparing Closing Entries

LO 4

4-‹#›

LO 4

ILLUSTRATION 4-31

4-‹#›

Illustration 4-32

Posting of closing entries

Preparing Closing Entries

LO 4

4-‹#›

The purpose of the post-closing trial balance is to prove the equality of the permanent account balances that the company carries forward into the next accounting period.

All temporary accounts will have zero balances.

Preparing a Post-Closing Trail Balance

LO 4

4-‹#›

1. Analyze business transactions

2. Journalize the transactions

6. Prepare an adjusted trial balance

7. Prepare financial statements

8. Journalize and post closing entries

9. Prepare a post-closing trial balance

4. Prepare a trial balance

3. Post to ledger accounts

Journalize and post adjusting entries:

Deferrals/Accruals

ILLUSTRATION 4-33

Required steps in the accounting cycle

SUMMARY OF THE ACCOUNTING CYCLE

LO 4

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SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33

Required steps in the accounting cycle

LO 4

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SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33

Required steps in the accounting cycle

LO 4

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SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33

Required steps in the accounting cycle

LO 4

4-‹#›

SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33

Required steps in the accounting cycle

LO 4

4-‹#›

SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33

Required steps in the accounting cycle

LO 4

4-‹#›

SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33

Required steps in the accounting cycle

LO 4

4-‹#›

SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33

Required steps in the accounting cycle

LO 4

4-‹#›

SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33

Required steps in the accounting cycle

LO 4

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SUMMARY OF THE ACCOUNTING CYCLE

ILLUSTRATION 4-33

Required steps in the accounting cycle

LO 4

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Sierra Corporation’s income statement shows net income of $2,860. Net income and net cash provided by operating activities often differ.

Net income on a cash basis is referred to as “Net cash provided by operating activities.”

The statement of cash flows, reports net cash provided by operating activities.

Illustration 4-27

KEEPING AN EYE ON CASH

LO 4

4-‹#›

The difference for Sierra is $2,840 ($5,700 - $2,860). The following summary shows the causes of this difference.

LO 4

KEEPING AN EYE ON CASH

4-‹#›

Closing Entries

Hancock Company has the following balances in selected accounts of its adjusted trial balance.

Accounts Payable $27,000 Dividends $15,000

Service Revenue 98,000 Retained Earnings 42,000

Rent Expense 22,000 Accounts Receivable 38,000

Salaries and Wages Expense 51,000 Supplies Expense 7,000

Prepare the entries to close the revenue and expense accounts.

SOLUTION

DO IT!

4b

Service Revenue 98,000

Income Summary 98,000

Income Summary 80,000

Salaries and Wages Expense 51,000

Rent Expense 22,000

Supplies Expense 7,000

LO 4

4-‹#›

Closing Entries

Hancock Company has the following balances in selected accounts of its adjusted trial balance.

Accounts Payable $27,000 Dividends $15,000

Service Revenue 98,000 Retained Earnings 42,000

Rent Expense 22,000 Accounts Receivable 38,000

Salaries and Wages Expense 51,000 Supplies Expense 7,000

Prepare the entries to close income summary and dividends.

SOLUTION

DO IT!

4b

Income Summary 18,000

Retained Earnings 18,000

Retained Earnings 15,000

Dividends 15,000

LO 4

4-‹#›

LO 5

LEARNING OBJECTIVE

APPENDIX 4A: Describe the purpose and the basic form of a worksheet.

*5

Worksheet

A multiple-column form that may be used in the adjustment process and in preparing financial statements.

Manual or computer spreadsheet.

A working tool, not a permanent accounting record.

Neither a journal nor a part of the general ledger.

4-‹#›

ILLUSTRATION 4A-1

Form and procedure for a worksheet

SIERRA CORPORATION

Worksheet

For the Month Ended October 31, 2017

LO 5

4-‹#›

(a)

(b)

(a)

(g)

(c)

(d)

(d)

(e)

(b)

(e)

(f)

(f)

(g)

(c)

ILLUSTRATION 4A-1

Form and procedure for a worksheet

SIERRA CORPORATION

Worksheet

For the Month Ended October 31, 2017

LO 5

4-‹#›

KEY POINTS

A Look at IFRS

LEARNING OBJECTIVE

Compare the procedures for adjusting entries under GAAP and IFRS.

6

Similarities

Companies applying IFRS also use accrual-basis accounting to ensure that they record transactions that change a company’s financial statements in the period in which events occur.

Similar to GAAP, cash-basis accounting is not in accordance with IFRS.

LO 6

4-‹#›

A Look at IFRS

KEY POINTS

Similarities

IFRS also divides the economic life of companies into artificial time periods. Under both GAAP and IFRS, this is referred to as the periodicity assumption.

The general revenue recognition principle required by GAAP that is used in this textbook is similar to that used under IFRS.

Revenue recognition fraud is a major issue in U.S. financial reporting. The same situation occurs in other countries, as evidenced by revenue recognition breakdowns at Dutch software company Baan NV, Japanese electronics giant NEC, and Dutch grocer Ahold NV.

LO 6

4-‹#›

A Look at IFRS

KEY POINTS

Differences

Under IFRS, revaluation (using fair value) of items such as land and buildings is permitted. IFRS allows depreciation based on revaluation of assets, which is not permitted under GAAP.

The terminology used for revenues and gains, and expenses and losses, differs somewhat between IFRS and GAAP. For example, income under IFRS includes both revenues, which arise during the normal course of operating activities, and gains, which arise from activities outside of the normal sales of goods and services.

LO 6

4-‹#›

A Look at IFRS

KEY POINTS

Differences

Under IFRS, expenses include both those costs incurred in the normal course of operations as well as losses that are not part of normal operations. This is in contrast to GAAP, which defines each separately.

LO 6

4-‹#›

A Look at IFRS

LOOKING TO THE FUTURE

The IASB and FASB are completing a joint project on revenue recognition. The purpose of this project is to develop comprehensive guidance on when to recognize revenue. It is hoped that this approach will lead to more consistent accounting in this area. For more on this topic, see www.fasb.org/project/revenue_recognition.shtml.

LO 6

4-‹#›

IFRS Practice

IFRS:

uses accrual accounting.

uses cash-basis accounting.

allows revenue to be recognized when a customer makes an order.

requires that revenue not be recognized until cash is received.

A Look at IFRS

LO 6

4-‹#›

IFRS Practice

Which of the following statements is false?

IFRS employs the periodicity assumption.

IFRS employs accrual accounting.

IFRS requires that revenues and costs must be capable of being measured reliably.

IFRS uses the cash basis of accounting.

A Look at IFRS

LO 6

4-‹#›

IFRS Practice

Accrual-basis accounting:

is optional under IFRS.

results in companies recording transactions that change a company’s financial statements in the period in which events occur.

has been eliminated as a result of the IASB/FASB joint project on revenue recognition.

is not consistent with the IASB conceptual framework.

A Look at IFRS

LO 6

4-‹#›

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COPYRIGHT

4-‹#›

Account TitlesDr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.

Cash15,200

Supplies2,500

Prepaid Insurance600

Equipment5,000

Notes Payable5,000

Accounts Payable2,500

Unearned Service Revenue1,200

Common Stock10,000

Dividends500

Service Revenue10,000

Salaries & Wages Exp.4,000

Rent Expense900

Totals28,700 28,700

Balance Sheet

AdjustedIncome

Trial BalanceAdjustmentsTrial BalanceStatement

Sheet1

Adjusted Income
Trial Balance Adjustments Trial Balance Statement Balance Sheet
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200
Supplies 2,500
Prepaid Insurance 600
Equipment 5,000
Notes Payable 5,000
Accounts Payable 2,500
Unearned Service Revenue 1,200
Common Stock 10,000
Dividends 500
Service Revenue 10,000
Salaries & Wages Exp. 4,000
Rent Expense 900
Totals 28,700 28,700
Miscellaneous Expense 200
55,970 55,970

Account TitlesDr.Cr.Dr.Cr.Dr.Cr. Dr. Cr. Dr. Cr.

Cash15,200 15,200 15,200

Supplies2,500 1,500 1,000 1,000

Prepaid Insurance600 50 550 550

Equipment5,000 5,000 5,000

Notes Payable5,000 5,000 5,000

Accounts Payable2,500 2,500 2,500

Unearned Service Revenue1,200 400 800 800

Common Stock10,000 10,000 10,000

Dividends500 500 500

Service Revenue10,000 400 10,600 10,600

200

Salaries & Wages Exp.4,000 1,200 5,200 5,200

Rent Expense900 900 900

Totals28,700 28,700

Supplies Expense1,500 1,500 1,500

Insurance Expense50 50 50

Accumulated Depreciation40 40 40

Depreciation Expense40 40 40

Accounts Receivable200 200 200

Interest Expense50 50 50

Interest Payable50 50 50

Salaries and Wages Payable1,200 1,200 1,200

Totals3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590

Net Income2,860 2,860

Totals10,600 10,600 22,450 22,450

Balance Sheet

Adjusted Income

Trial BalanceAdjustmentsTrial Balance Statement

Sheet1

Adjusted Income
Trial Balance Adjustments Trial Balance Statement Balance Sheet
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200 15,200
Supplies 2,500 1,500 1,000 1,000
Prepaid Insurance 600 50 550 550
Equipment 5,000 5,000 5,000
Notes Payable 5,000 5,000 5,000
Accounts Payable 2,500 2,500 2,500
Unearned Service Revenue 1,200 400 800 800
Common Stock 10,000 10,000 10,000
Dividends 500 500 500
Service Revenue 10,000 400 10,600 10,600
200
Salaries & Wages Exp. 4,000 1,200 5,200 5,200
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense 1,500 1,500 1,500
Insurance Expense 50 50 50
Accumulated Depreciation 40 40 40
Depreciation Expense 40 40 40
Accounts Receivable 200 200 200
Interest Expense 50 50 50
Interest Payable 50 50 50
Salaries and Wages Payable 1,200 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590
Net Income 2,860 2,860
Totals 10,600 10,600 22,450 22,450
Miscellaneous Expense 200
55,970 55,970