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Chapter 3

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4 views

Chapter 3

Uploaded by

a7medassem12000
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 19

Adjusting Accounts

and Preparing Financial


Statements
The time period assumption presumes that an
organization’s activities can be divided into
specific time periods such as a month, a three-
month quarter, a six-month interval, or a year.

Reports covering a one-year period are known


as annual financial statements. Many
organizations also prepare interim financial
statements covering one, three, or six months
of activity.
Accrual basis accounting uses the adjusting
process to recognize revenues when earned and
expenses when incurred

Cash basis accounting recognizes revenues when


cash is received and records expenses when cash
is paid.

This means that cash basis net income for a


period is the difference between cash receipts
and cash payments.

Cash basis accounting is not consistent with


generally accepted accounting principles GAAP.
1. Paid Cash before expenses recognized
Prepaid (Deferred) Expenses

2. Received cash before revenue recognized


Unearned (Deferred) Revenue

3. Paid Cash after expenses recognized


Accrued Expenses

4. Received cash after revenue recognized


Accrued Revenue
Prepaid expenses refer to items paid for in
advance of receiving their benefits.
Prepaid expenses are assets. When these
assets are used, their costs become expenses.

For example,

1. Pre-Paid Insurance
2. Supplies
3. Other prepaid expenses
4. Depreciation
The Prepaid Insurance account has a $5,000 debit
balance to start the year, and no insurance payments
were made during the year. A review of insurance
policies and payments shows that $1,000 of
unexpired insurance remains at its December 31
year-end.
1. Step 1: Prepaid Insurance equals $5,000 (before
adjustment)
2. Step 2: Prepaid Insurance should equal $1,000
(the unexpired part)
3. Step 3: Adjusting entry to get from step 1 to step
2
The Supplies account has a $1,000 debit balance to
start the year. Supplies of $2,000 were purchased
during the current year and debited to the Supplies
account. A December 31 physical count shows $500
of supplies remaining.
Step 1: Supplies equal $3,000 (from $1,000 1
$2,000; before adjustment)
Step 2: Supplies should equal $500 (what’s left)
Step 3: Adjusting entry to get from step 1 to step 2*
On October 1 of the current year, the company
prepaid $12,000 for one year of rent for
facilities being occupied from that day forward. The
company debited Prepaid Rent and credited Cash
for $12,000. December 31 year-end statements
must be prepared.
Step 1: Prepaid Rent equals $12,000 (before
adjustment)
Step 2: Prepaid Rent should equal $9,000 (the
unexpired part)*
Step 3: Adjusting entry to get from step 1 to step 2
The company has only one fixed asset (equipment)
that it purchased at the start of this year. That asset
had cost $38,000, had an estimated life of 10 years,
and is expected to be valued at $8,000 at the end
of the 10-year life. December 31 year-end
statements must be prepared
Step 1: Accumulated Depreciation equals $0 (before
adjustment)
Step 2: Accumulated Depreciation should equal
$3,000 (after current period depreciation of $3,000)*
Step 3: Adjusting entry to get from step 1 to step 2
The term unearned revenues refers to
cash received in advance of providing
products and services.

Unearned revenues, also called deferred


revenues, are liabilities.
The company collected $24,000 rent in advance
on September 1, debiting Cash and crediting
Unearned Rent Revenue. The tenant was paying
12 months’ rent in advance and occupancy began
September 1.
Step 1: Unearned Rent Revenue equals $24,000
(before adjustment)
Step 2: Unearned Rent Revenue should equal
$16,000 (current period earned revenue is $8,000*)
Step 3: Adjusting entry to get from step 1 to step 2
The company charges $100 per month to spray a
house for insects. A customer paid $600 on
November 1 in advance for six treatments, which
was recorded with a debit to Cash and a credit to
Unearned Services Revenue. At year-end, the
company has applied two treatments for the
customer.
b. Step 1: Unearned Services Revenue equals $600 (before
adjustment)
Step 2: Unearned Services Revenue should equal $400 (current
period earned revenue is $200*)
Step 3: Adjusting entry to get from step 1 to step 2
Accrued expenses refer to costs that are incurred
in a period but are both unpaid and unrecorded.
At year-end, salaries expense of $5,000 has been
incurred by the company, but is not yet paid to
employees.
Step 1: Salaries Payable equals $0 (before
adjustment)
Step 2: Salaries Payable should equal $5,000 (not yet
recorded)
Step 3: Adjusting entry to get from step 1 to step 2
At its December 31 year-end, the company holds a
mortgage payable that has incurred $1,000 in
annual interest that is neither recorded nor paid.
The company intends to pay the interest on January
3 of the next year.
Step 1: Interest Payable equals $0 (before
adjustment)
Step 2: Interest Payable should equal $1,000 (not
yet recorded)
Step 3: Adjusting entry to get from step 1 to step 2
The term accrued revenues refers to revenues
earned in a period that are both unrecorded
and not yet received in cash (or other assets).
At year-end, the company has completed services of
$1,000 for a client, but the client has not yet been
billed for those services.
Step 1: Accounts Receivable equals $0 (before
adjustment)
Step 2: Accounts Receivable should equal $1,000
(not yet recorded)
Step 3: Adjusting entry to get from step 1 to step 2
At year-end, the company has earned, but not yet
recorded, $500 of interest earned from its
investments in government bonds.
Step 1: Interest Receivable equals $0 (before
adjustment)
Step 2: Interest Receivable should equal $500 (not
yet recorded)
Step 3: Adjusting entry to get from step 1 to step 2

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