Adjusting Accounts and Preparing Financial Statements

Adjusting Accounts and Preparing Financial StatementsChapter 3The Accounting PeriodC 1AccountingAccrual Basis versus Cash BasisAccrual BasisRevenues are recognized when earned and expenses are recognized when incurred.Cash BasisRevenues are recognized when cash is received and expenses are recorded when cash is paid.C 2Cash BasisRevenues are recognized when cash is received and expenses are recorded when cash is paid.AccountingAccrual Basis versus Cash BasisNon-GAAPC 2Accrual BasisRevenues are recognized when earned and expenses are recognized when incurred.Accrual Basis versus Cash BasisOn December 1, 2013, FastForward paid $2,400 cash for a twenty-four month business insurance policy. Using the cash basis, the entire $2,400 would be recognized as insurance expense in 2013. No insurance expense from this policy would be recognized in 2014 or 2015, periods covered by the policy.C 2Accrual Basis versus Cash BasisOn the accrual basis, $100 of insurance expense is recognized in 2013, $1,200 in 2014, and $1,100 in 2015. The expense is matched with the periods benefited by the insurance coverage.C 2We have delivered theproduct to our customer,so I think we should recordthe revenue earned.Recognizing Revenues and ExpensesC 2The revenue recognition principle states that we recognize revenue when the product or service is delivered to our customer.Recognizing Revenues and ExpensesThe expense recognition (or matching) principle aims to record expenses in the same accounting period as the revenues that are earned as a result of those expenses. This matching of expenses with the revenue benefits is a major part of the adjusting process.Summaryof ExpensesRentGasolineAdvertisingSalariesUtilitiesand . . . . $1,0005002,0003,000450. . . .Now that we haverecognized the revenue,let’s see what expenseswe incurred togenerate that revenue.C 2 An adjusting entry is recorded to bring an asset or liability account balance to its proper amount.Framework for AdjustmentsC 3Here is the checkfor my 24-monthinsurance policy.Prepaid (Deferred) ExpensesResources paid for prior to receiving the actual benefits.P 1Prepaid Insurance (a) On 12/1/13, FastForward paid $2,400 for insurance for 2-years (24-months, December 2013 through November 2015). FastForward recorded the expenditure as Prepaid Insurance on 12/1/13. What adjustment is required?637128P 1Supplies (b) During 2013, FastForward purchased $9,720 of supplies. FastForward recorded the expenditures in the asset account, “Supplies.” On December 31, 2013, a count of the supplies indicated $8,670 on hand, so $1,050 of supplies were used during December. What adjustment is required?126652P 1Other Prepaid ExpensesOther prepaid expenses, such as Prepaid Rent, are accounted for exactly as Insurance and Supplies. We should note that some prepaid expenses are both paid for and fully used up within a single period. 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.In these special cases, we can record the cash paid with a debit to the expense account instead of an asset account.P 1Straight-LineDepreciationExpense= Asset Cost - Salvage Value Useful LifeDepreciation Depreciation is the process of allocating the cost of a plant asset over its useful life in a systematic and rational manner.P 1Depreciation On December 1, 2013, 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 $8,000 cash. (c) Let’s record depreciation expense for the month ended December 31, 2013.P 1EquipmentDepreciation Expense12/1 26,00012/31 375Accumulated Depreciation12/31 375DepreciationP 1Contra asset accountEquipment is shown net of accumulated depreciation.$DepreciationP 1Unearned (Deferred)RevenuesWe will apply this cashyou gave us towardsyour total consulting fees.Cash received in advance of providing products or services.P 1Unearned (Deferred)RevenuesOn December 26, 2013, 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:P 1Unearned (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.P 1We’re about one-halfdone with this job andwant to be paid forour work!Costs incurred in a period that areboth unpaid and unrecorded.Accrued ExpensesP 1FastForward’s employee earns $70 per day and is paid every two weeks on Friday. Year-end, 12/31/13, falls on a Wednesday. The last payday of 2013 is Friday, 12/26/13. From 12/26 until year-end is three working days. The employee has earned $210 for Monday through Wednesday. He will not be paid until Friday 1/9/14.Accrued Salaries ExpensesP 1(e) FastForward’s employee has earned but not been paid on December 31, 2013, $210. P 1Accrued Salaries ExpensesFuture Payment ofAccrued ExpensesOn January 9, 2014, FastForward will pay the payroll for the two weeks from December 26, 2013 through January 9, 2014. Here is the journal entry for the payroll:P 1Accrued Interest ExpensesFastForward borrowed $6,000 from First National Bank on December 1, 2013. 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 December 31, 2013.P 1Yes, I’ve completed yourconsulting job, but have nothad time to bill you.Accrued RevenuesRevenues earned in a period that are both unrecorded and not yet received.P 1Accrued Service Revenue(f) On December 12, 2013, 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, 2014, when the client will pay in full.P 1Future Receipt ofService RevenuesOn January 10, 2014, FastForward completed its obligation under the consulting contract. The client was billed $2,700 and FastForward received $2,700 in cash.Revenue in January10 days @ $90 = $900P 1Links to Financial StatementsA 1P 2Preparing Financial StatementsLet’s use FastForward’s adjusted trial balance to prepare the company’s financial statements.P 3P 31. Prepare the Income StatementNote: Net Income from the Income Statement carries to the Statement of Changes in Owner’s Equity.P 32. Prepare the Statement of Owner’s Equitya3. Prepare The Balance SheetP 3Global ViewBoth U.S. GAAP and IFRS include similar guidance for adjusting accounts. Although some variations exist in revenue and expense recognition.Profit MarginThe profit margin ratio measures the company’s net income to net sales.ProfitMargin=A 2Limited Brands, Inc.Net IncomeNet SalesAppendix 3A: Alternative Accounting for PrepaymentsP4An alternative method is to record all prepaid expenseswith debits to expense accounts. The adjusting entry depends on how the original payment was recorded. Appendix 3A: Alternative Accounting for PrepaymentsP4Appendix 3A: Alternative Accounting for RevenuesP4An alternative method is to record all revenues to a liability account or a revenue account. The adjusting entry depends on how the original receipt was recorded. Appendix 3A: Alternative Accounting for RevenuesP4End of Chapter 3