Accounting excel sheet due in 24 hours

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WRD27e_IEPPT_Ch03.pptx

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Warren

Reeve

Duchac

Accounting

27e

The Adjusting Process

C H A P T E R

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Learning Objectives

LO1: Describe the nature of the adjusting process.

LO2: Prepare adjusting entries for accruals.

LO3: Prepare adjusting entries for deferrals.

LO4: Prepare adjusting entries for depreciation.

LO5: Summarize the adjusting process.

LO6: Prepare an adjusted trial balance.

LO7: Describe and illustrate the use of vertical analysis in evaluating a company’s performance and financial condition.

Accrual and Cash Basis of Accounting (slide 1 of 2)

Under the accrual basis of accounting, revenues are reported on the income statement in the period in which a service has been performed or a product has been delivered.

Cash may or may not be received from customers during this period.

The accrual basis of accounting also requires expenses to be recorded when they are incurred, not necessarily when cash is paid.

Generally accepted accounting principles (GAAP) require the accrual basis of accounting.

Accrual and Cash Basis of Accounting (slide 2 of 2)

Under the cash basis of accounting, revenues and expenses are reported on the income statement in the period in which cash is received or paid.

Most individuals and small service businesses may use the cash basis of accounting. For most large businesses, however, the cash basis will not provide accurate financial statements for user needs.

Revenue and Expense Recognition (slide 1 of 2)

Under the revenue recognition principle, revenues are recorded when services have been performed or products have been delivered to customers.

Revenue is normally measured as the assets received, such as cash or accounts receivable.

The process of recognizing revenues is called revenue recognition.

Revenue and Expense Recognition (slide 2 of 2)

Under the expense recognition principle, the expenses incurred in generating revenue must be reported in the same period as the related revenue.

This is also called the matching principle.

By matching revenues and expenses, net income or loss for the period is properly reported on the income statement.

Adjusting entries are required to properly match revenues and expenses.

The Adjusting Process (slide 1 of 3)

At the end of an accounting period, an unadjusted trial balance is prepared to verify that the total debit balances equal the total credit balances.

Many of these account balances are reported in the financial statements without change.

The Adjusting Process (slide 2 of 3)

Some accounts on the unadjusted trial balance, however, require adjustments for the following reasons:

Some expenses are not recorded daily.

For example, the daily use of supplies would require many entries with small amounts.

Some revenues and expenses are incurred as time passes rather than as separate transactions.

For example, rent received in advance (unearned rent) expires and becomes revenue with the passage of time.

Some revenues and expenses may be unrecorded at the end of the accounting period.

For example, a company may have provided services to customers that it has not billed or recorded at the end of the accounting period.

The Adjusting Process (slide 3 of 3)

The analysis and updating of accounts at the end of the period before the financial statements are prepared is called the adjusting process.

The journal entries that bring the accounts up to date at the end of the accounting period are called adjusting entries.

All adjusting entries affect at least one income statement account and one balance sheet account.

Thus, an adjusting entry will always involve a revenue or an expense account and an asset or a liability account.

Indicate with a Yes or No whether or not each of the following accounts normally requires an adjusting entry:

Cash

Utilities Expense

Wages Expense

Land

Accounts Receivable

Unearned Rent

Accounts Requiring Adjustment

Example Exercise

Types of Accounts Requiring Adjustment

The two general classifications of accounts requiring adjustment are as follows:

Accruals

Deferrals

Types of Accounts Requiring Adjustment: Accruals

An accrual occurs when revenue has been earned or an expense has been incurred but has not been recorded.

If the accrual is for revenue, the adjusting entry debits an asset (Accounts Receivable) and credits a revenue account.

If the accrual is for an expense, the adjusting entry debits an expense account and credits a related liability account such as Accounts Payable or Wages Payable.

Accruals

Types of Accounts Requiring Adjustment: Deferrals

A deferral occurs when cash related to a future revenue or expense has been initially recorded as a liability or an asset.

If the cash received is related to future revenue, it is initially recorded as a liability called unearned revenue.

The adjusting entry in the period when the revenue is earned debits an unearned revenue account and credits a revenue account.

If the cash paid is related to a future expense, it is initially recorded as an asset called prepaid expense.

The adjusting entry in the period when the expense is incurred debits an expense account and credits a prepaid expense (asset) account.

Deferrals

Classify the following items as (1) prepaid expense, (2) unearned revenue, (3) accrued expense, or (4) accrued revenue:

Wages owed but not yet paid.

Supplies on hand.

Fees received but not yet earned.

Fees earned but not yet received.

Type of Adjustment

Example Exercise

Unadjusted Trial Balance for NetSolutions

Expanded Chart of Accounts for NetSolutions

Accrued Revenues

Assume that NetSolutions signed an agreement with Dankner Co. on December 15 to provide services at a rate of $20 per hour. As of December 31, NetSolutions had provided 25 hours of services. The revenue will be billed on January 15.

increase

Effects of Omitting the Adjusting Entry for Accrued Revenues

If the adjustment for the accrued revenue ($500) is not recorded, the income statement and balance sheet prepared on December 31 will be misstated.

At the end of the current year, $13,680 of fees have been earned but have not been billed to clients. Journalize the adjusting entry to record the accrued fees.

Adjustment for Accrued Revenues

Example Exercise

Accrued Expenses (slide 1 of 2)

NetSolutions pays it employees biweekly. During December, NetSolutions paid wages of $950 on December 13 and $1,200 on December 27. As of December 31, NetSolutions owes $250 of wages to employees for Monday and Tuesday, December 30 and 31.

increase

Accrued Expenses (slide 2 of 2)

NetSolutions paid wages of $1,275 on January 10. This payment includes the $250 of accrued wages recorded on December 31.

Accrued Wages

Effects of Omitting the Adjusting Entry for Accrued Expenses

If the adjustment for wages ($250) is not recorded, the income statement and balance sheet prepared on December 31 will be misstated.

Sanregret Realty Co. pays weekly salaries of $12,500 on Friday for a five-day week ending on that day. Journalize the necessary adjusting entry at the end of the accounting period, assuming that the period ends on Thursday.÷×

Adjustment for Accrued Expense

Example Exercise

Unearned Revenues

The December 31 unadjusted trial balance of NetSolutions indicates a balance in the unearned rent account of $360. This balance represents the receipt of three months’ rent on December 1 for December, January, and February. At the end of December, one month’s rent has been earned.

increase

decrease

Effects of Omitting the Adjusting Entry for Unearned Revenues

If the preceding adjustment of unearned rent and rent revenue is not recorded, the income statement and balance sheet prepared on December 31 will be misstated.

The balance in the unearned fees account, before adjustment at the end of the year, is $44,900. Journalize the adjusting entry required if the amount of unearned fees at the end of the year is $12,300.

Adjustment for Unearned Revenue

Example Exercise

Prepaid Expenses: Supplies (slide 1 of 2)

The December 31, 2018, unadjusted trial balance of NetSolutions indicates a balance in the supplies account of $2,000. Some of these supplies were used during December, and some are still on hand (not used). Assuming that on December 31 the amount of supplies on hand is $760, the amount to be transferred from the asset account to the expense account is computed as follows:

Prepaid Expenses: Supplies (slide 2 of 2)

increase

decrease

Prepaid Expenses: Prepaid Insurance

The December 31, unadjusted trial balance of NetSolutions indicates a balance in the prepaid insurance account of $2,400. The debit balance of $2,400 represents the December 1 prepayment of insurance for 12 months. At the end of December, the insurance expense account is increased (debited), and the prepaid insurance account is decreased (credited) by $200, the insurance for one month.

increase

decrease

Effects of Omitting the Adjusting Entries for Prepaid Expenses

If the preceding adjustments for supplies ($1,240) and insurance ($200) are not recorded, the financial statements prepared as of December 31 will be misstated.

Arrow (1) indicates the effect of the understated expenses on assets.

Arrow (2) indicates the effect of the overstated net income on stockholders’ equity.

The prepaid insurance account had a beginning balance of $2,400 and was debited for $3,600 of premiums paid during the year. Journalize the adjusting entry required at the end of the year, assuming the amount of unexpired insurance related to future periods is $3,250.

Adjustment for Prepaid Expense

Example Exercise

Depreciation Expense (slide 1 of 8)

Fixed assets, or plant assets, are physical resources that are owned and used by a business and are permanent or have a long life.

Examples of fixed assets include land, buildings, and equipment.

Depreciation Expense (slide 2 of 8)

As time passes, a fixed asset loses its ability to provide useful services.

This decrease in usefulness is called depreciation.

Depreciation Expense (slide 3 of 8)

All fixed assets, except land, lose their usefulness and, thus, are said to depreciate.

As a fixed asset depreciates, a portion of its cost should be recorded as an expense.

This periodic expense is called depreciation expense.

Depreciation Expense (slide 4 of 8)

The adjusting entry to record depreciation expense is similar to the adjusting entry for supplies used.

The depreciation expense account is increased (debited) for the amount of depreciation.

However, the fixed asset account is not decreased (credited).

This is because both the original cost of a fixed asset and the depreciation recorded since its purchase are reported on the balance sheet.

Instead, an account entitled Accumulated Depreciation is increased (credited).

Depreciation Expense (slide 5 of 8)

Accumulated depreciation accounts are called contra accounts, or contra asset accounts.

This is because accumulated depreciation accounts are deducted from their related fixed asset accounts on the balance sheet.

The normal balance of a contra account is opposite to the account from which it is deducted.

Because the normal balance of a fixed asset account is a debit, the normal balance of an accumulated depreciation account is a credit.

Depreciation Expense (slide 6 of 8)

The normal titles for fixed asset accounts and their related contra asset accounts are as follows:

Depreciation Expense (slide 7 of 8)

NetSolutions’ office equipment depreciates $50 during December.

increase

Depreciation Expense (slide 8 of 8)

The difference between the original cost of the office equipment and the balance in the accumulated depreciation—office equipment account is called the book value of the asset (or net book value).

It is computed as follows:

Book Value of Asset = Cost of the Asset – Accumulated Depreciation of Asset

Effects of Omitting the Adjusting Entry for Depreciation

If the adjustment for depreciation ($50) is not recorded, the income statement and balance sheet prepared on December 31 will be misstated.

The estimated amount of depreciation on equipment for the current year is $4,250. Journalize the adjusting entry to record the depreciation.

Adjustment for Depreciation

Example Exercise

Summary of Adjustments (slide 1 of 2)

Summary of Adjustments (slide 2 of 2)

Adjusting Entries—NetSolutions

Ledger with Adjusting Entries—NetSolutions (slide 1 of 4)

Ledger with Adjusting Entries—NetSolutions (slide 2 of 4)

Ledger with Adjusting Entries—NetSolutions (slide 3 of 4)

Ledger with Adjusting Entries—NetSolutions (slide 4 of 4)

For the year ending December 31, 2019, Mann Medical Co. mistakenly omitted adjusting entries for (1) $8,600 of unearned revenue that was earned, (2) earned revenue of $12,500 that was not billed, and (3) accrued wages of $2,900. Indicate the combined effect of the errors on (a) revenues, (b) expenses, and (c) net income for the year ended December 31, 2019.

Effects of Adjustments

Example Exercise

Adjusted Trial Balance

After the adjusting entries are posted, an adjusted trial balance is prepared.

The adjusted trial balance verifies the equality of the total debit and credit balances before the financial statements are prepared.

Adjusted Trial Balance Illustrated

For each of the following errors, considered individually, indicate whether the error would cause the adjusted trial balance totals to be unequal. If the error would cause the adjusted trial balance totals to be unequal, indicate whether the debit or credit total is higher and by how much.

The adjustment for accrued fees of $5,340 was journalized as a debit to Accounts Payable for $5,340 and a credit to Fees Earned of $5,340.

The adjustment for depreciation of $3,260 was journalized as a debit to Depreciation Expense for $3,620 and a credit to Accumulated Depreciation for $3,260.

Effects of Errors

Example Exercise

Analysis for Decision Making: Vertical Analysis (slide 1 of 3)

Comparing each item in a financial statement with a total amount from the same statement is referred to as vertical analysis.

In vertical analysis of a balance sheet, each asset item is stated as a percent of the total assets. Each liability and stockholders’ equity item is stated as a percent of total liabilities and stockholders’ equity.

In vertical analysis of an income statement, each item is stated as a percent of revenues or fees earned.

Analysis for Decision Making: Vertical Analysis (slide 2 of 3)

$12,500

$187,500

= 0.067 or 6.7%

Analysis for Decision Making: Vertical Analysis (slide 3 of 3)

$169,005

$600,233

= 0.282 or 28.2%

Two income statements for Fortson Company follow:

Prepare a vertical analysis of Fortson Company’s income statements.

Does the vertical analysis indicate a favorable or an unfavorable trend?

Vertical Analysis (slide 1 of 2)

Example Exercise

Vertical Analysis (slide 2 of 2)

Example Exercise