hhofma3e_ch03_inst

Report
Chapter 3
1
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Accrual versus cash-basis accounting & key
elements of accrual accounting
Adjusting entries, why, what, how
Using the worksheet to facilitate the process
2
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1
Accrual versus cash-basis accounting
3
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Accrual Basis
Cash Basis
Revenues
recognized when
earned
Revenues
recognized when
cash received
Expenses
recognized when
incurred
Expenses
recorded when
cash paid
4
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For reports to be meaningful, transactions that
happen in a period, need to be reported in that
period.
Basic accounting period: one year
Calendar year
Fiscal year
Interim periods < one year
Monthly
Quarterly
Semi-annually
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When to record revenue?
When it is earned
When service is provided
When the product delivered
When the earnings process is complete
Doing this requires some tools to allow revenue
to be captured separate from the cash flow:
Asset: Accounts receivable
Liability: Unearned revenue
Want to see a time line of these?
6
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When to record expenses?
When the resources is consumed
When an asset is consumed
When we generate a liability for the use of a service
This “Matches” the expense to the revenues earned
Doing this requires tools to allow expenses to
be captured separate from the cash flow:
Prepaid or other assets: These store resources until
we use and expense them
Liabilities: Payables associate with expenses
eg wages payable
Want to see a time line of these?
7
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How would each of these events be handled
under:
Accrual Cash-Basis
Cash sale of $500
Credit sale of $900
Bought 4 months of supplies
Used 4 months of supplies
Bought a fleet of trucks for cash
In each case, which options portrays more
accurately the creation of wealth by the
company?
Which shows more accurate financial standing?
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3
Explain why adjusting entries are needed
9
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Display Earnings for
the Period
Display Financial
Standing at a Point in
Time
Must show
everything
earned and
consumed!
Including what we
owe, are owed,
and current
owner’s equity!
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Adjusting entries capture real live
transactions that took place, but for
which there was no cause to enter during
regular daily operations
Our job is to capture and report
revenues and expenses, not just to
process papers that come across your
desk.
When you find a situation where a
revenue or expense has occurred, but
was not captured by the daily journal
entries, you make an adjusting entry to
capture it.
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Adjustments take place at period
end.
The LAST CHANCE to make
changes that improve or damage
the story told by the financial
statements.
Remember the conflict of interest
inherent in accounting?
Adjusting entries is a highpressure, last minute opening
when fraudulent reporting
attempts might be made.
Know how transactions affect the
financial statements now and
later. Know how to apply GAAP
to form a first line defense.
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Non-adjusted Example Situation:
Car Broker’s cash basis income statements
All Sales in cash
Commissions paid early in month 2
Sales
COGS
Commissions (5% of sales)
Other Expenses
Net Income
Month 1
$100,000
80,000
0
7,000
13,000
Month 2
$80,000
64,000
9,000
7,000
0,000
Note: In this case we DID NOT make a month end adjustment to record
the commissions expense in Month 1. The result: Month 2 bears all of
month 1 and month 2’s commissions expense – Ouch!@
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Properly Adjusted Example Situation:
An adjustment at month end recognizes the
commissions expense in month 1 – when
commissions were earned, before paid.
Sales
COGS
Commissions (5% of sales)
Other Expenses
Net Income
Month 1
$100,000
80,000
5,000
7,000
$8,000
Month 2
$80,000
64,000
4,000
7,000
$5,000
Note: In this case we entered the commissions expense in Month 1 for
the commissions “used” in Month 1. So both months bear the
commissions expenses that month “used”.
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16
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Prepared at end of an accounting period
Assigns:
Revenues to the period when earned
Expenses to the period when incurred
Update asset and liability accounts
Need to properly match revenues and expenses
to measure:
Net Income
Assets and Liabilities
17
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Never involve
the cash account
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Either
increase revenue
or
increase an
expense
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Accrued
revenues
Unearned
revenues
Prepaid
expenses
Depreciation
19
Accrued
expenses
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4
Journalize and post adjusting entries
20
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Regular daily journal entry: Collect cash in
advance upcoming Nutcracker ballet
20-Nov Cash
Unearned revenue
Sold Nutcracker tickets in advance
130,000
130,000
Activity: Do 4 weekend shows through November,
earning $25,000 in performance revenue
Adjusting entry: Record earnings and reverse the
earned portion of the liability
30-Nov Unearned revenue
Theater revenue
Earned pre-sold ticket revenue thru Nov.
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25,000
25,000
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Activity: We finish a $4,500 car repair on
December 29th, customer pickup expected Jan 4th
Adjusting entry: Record earnings and accrue the
receivable.
31-Dec Accounts receivable
Repair revenue
Repaired Porsche steering, not picked up
4,500
4,500
Regular daily journal entry: Collect from
customer
4-Jan Cash
Accounts receivable
Customer picked up Porsche
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4,500
4,500
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Regular daily journal entry: Paid cash
for three months rent
1-May Prepaid rent
Cash
Purchased 3 months rent in advance
3,000
3,000
Activity: After a month passes, do we still really
own three months rent?
Adjusting entry: Recognize that we
used up one month of that rent.
31-May Rent expense
Prepaid rent
recognize use of one months rent
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1,000
1,000
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Plant assets
Long-lived tangible assets used in business
operations
Examples:
Land, buildings, equipment, and furniture
Depreciation
Allocation of a plant asset’s cost to expense over its
useful life
Conceptual guideline:
If you are wearing it out, depreciate it.
If you are completely consuming the asset and it is
disappearing, decrease the account directly.
24
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Regular daily journal entry: Buying $12,000
gaming systems, {Equipment}.
1-Jan Equipment
Cash
Gaming systems, 3 year life, 0 salvage value
12,000
12,000
Activity: Use the equipment for a whole year to
help us generate revenue.
Adjusting entry: Recognize one year depreciation
expense, and log the accumulated depreciation
31-Dec Depreciation expense
Accumulated depreciation
Recognized 1 year depreciation expense
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4,000
4,000
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Contra asset
Normal credit balance
Always paired with related account
Holds sum of all depreciation recorded on a
plant asset
Book value
Cost minus accumulated depreciation
A hopelessly inaccurate approximation of value
Asset cost basis is maintained untouched
Why?
26
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Activity: We use $900 in employee wages through
the end of the month, but do not have to pay until
next month.
Adjusting entry: Recognize the use of those wages,
and accrue the associate liability.
31-Dec Wages expense
Wages payable
Recognized wages from Dec 15-31
900
900
Regular daily journal entry: Pay them
1-Jan Wages payable
Cash
Paid wages from Dec 15-31
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900
900
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Accrued revenues
Unearned revenues
Prepaid
expenses
We
laundry
Weprovided
sold a house
for a client,
Used
supplies
without but
We
used
legal services,
service
clients
whohasn’t
had
but thefor
listing
agent
recording
consumption
the
invoicethe
hasn’t
arrived
paid
advance
sentinthe
payment yet
Accrued expenses
Depreciation
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Just do the journal entries as indicated by the adjustment
data given in the problem.
** Do not post. Do not prepare an adjusted trial
balance. Just do the journal entries. **
Note to self: Now would be a good time to project the
problem on the board.
29
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Recap
Adjusting entries in the news
Using a worksheet to facilitate adjusting entries
Relating the adjusted trial balance to the
upcoming financial statements
30
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Real journal entries, prepared at the end of an
accounting period. Why?
Assign:
Revenues to the period when earned
Expenses to the period when incurred
Need to properly match revenues and expenses
to measure:
Net Income
Assets and Liabilities
These transactions do not involve cash. Why?
31
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AIG: $5 billion write
down – no thank you
News!
GE: a $50 million slap
on the wrist
News!
Krispy Kreme
Can donuts be crooked?
News!
www.sec.gov
Enforcement releases
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5
Explain the purpose of and prepare an adjusted
trial balance
33
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Reflects adjusting entries to show final figures
Recalculate adjusted balances by incorporating
adjustments with your unadjusted trial balance.
Even if you use the worksheet to make adjusting
work easier, ALWAYS enter your journal entries in
the journal, then POST those journal entries to the
ledger accounts.
Contain all information for financial statements
Often appears on a work sheet
Tool accountants use at end of period
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Supplies on hand,
$300.
Depreciation,
$1,000.
Accrued interest expense, $600.
a) 600
b)1,000
c) 600
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800
300
19,100
2,000
200
600
2,500
7,400
14,800
4,500
600
a) 600
1,000
b)1,000
c) 600
1,200
2,200 2,200 27,500 27,500
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Unearned
revenues
Accrued
revenues
Do brain work on the
worksheet
Use page 69 journal
entry steps & Roberts’
Triangle
Find Rev/Exp first
Prepaid
expenses
Accrued
Depreciation expenses
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Transfer JE work to the
general journal
Post to the ledger
Complete and check
Adjusted Trial Balance
columns to match ledger
balances.
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6
Prepare the financial statements from the
adjusted trial balance
38
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The Balance Sheet is
prepared last.
A=L+E
Statement of Retained
Earnings is second
Income Statement is
prepared first.
Revenue - Expenses
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40
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42
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Refer to the adjusted trial balance in Exercise 3-21
for the month ended April 30, 2012.
Requirements:
1. Prepare the income statement.
2. Prepare the statement of retained earnings.
3. Prepare the balance sheet.
43
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44
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Jobs-4-U Employment Service, Inc.
Income Statement
Month Ended April 30, 2012
Revenue:
Service revenue
Expenses:
Salary expense
$
45
10,600
$
6,200
4,400
3,700
Rent expense
1,000
Depreciation expense
1,000
Supplies expense
Total expenses
Net income
$
500
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Jobs-4-U Employment Service, Inc.
Statement of Retained Earnings
Month Ended April 30, 2012
Retained earnings, March 31, 2012
$ 10,300
Net income
4,400
17,900
Dividends
4,800
Retained earnings, April 30, 2012
46
$
9,900
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Jobs-4-U Employment Service, Inc.
Balance Sheet
April 30, 2012
Assets
Cash
Accounts receivable
Supplies
Equipment
$32,500
Accu. Depr.
(15,400)
Liabilities
$
900
5,600
500
17,100
Salary payable
Stockholders’ Equity
Common stock
13,000
Retained earnings
9,900
Total stockholders’ equity
Total assets
47
$24,100
$ 1,200
Total liabilities and
stockholders’ equity
22,900
$24,100
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Cash-basis accounting and accrual accounting
are different. Accrual accounting records
revenues and expenses when they are
earned/incurred. Cash-basis accounting records
revenues and expenses when cash is received or
paid.
The principles guide us as to when (the time
period and accounting period concepts) and how
(the revenue recognition and matching
principles) to record revenues and expenses.
53
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We adjust accounts to make sure the balance
sheet shows the value of what we own (assets)
and what we owe (liabilities) on a specific date.
We also adjust to make sure all revenues and
expenses are recorded in the period they are
earned or incurred. Adjusting journal entries
either credit a revenue account or debit an
expense account, but they NEVER affect the
Cash account.
54
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The adjusting process has two purposes:
1. To capture all transactions that should be
reported in the period shown on the income
statement. Every adjustment affects a revenue or
an expense.
2. To update the balance sheet so that all accounts
are properly valued. Every adjustment affects an
asset or a liability (but never the Cash account).
55
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The adjusted trial balance includes all the
transactions captured during the period on the
trial balance plus/minus any adjusting journal
entries made at the end of the period. The
adjusted trial balance gives us the final adjusted
values that we use to prepare the financial
statements.
56
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The financial statements must be prepared in
order:
income statement first,
statement of retained earnings, second, and
balance sheet, third.
It is important for accountants to prepare
accurate and complete financial statements as
other people rely on the data to make decisions.
57
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Copyright
All rights reserved. No part of this publication may be reproduced,
stored in a retrieval system, or transmitted, in any form or by any
means, electronic, mechanical, photocopying, recording, or
otherwise, without the prior written permission of the publisher.
Printed in the United States of America.
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