Measuring Business Income:The Adjusting Process potx

Accrual Versus Cash Example✔In January 2002, Prensa Insurance sells a three-year health insurance policy to a business client.. Matching Expenses with Revenues Example ✔Parker Floor sell

Distinguish accrual accounting from cash-basis accounting.

Objective 1

Transactions are

recordedwhen revenues are

earned or expenses

Cash-basis:

Transactions arerecorded whencash is paid or

The Two Bases of Accounting:

Accrual Versus Cash Example

✔In January 2002, Prensa Insurance sells

a three-year health insurance policy to a

business client

✔The contract specifies that the client had

to pay $150,000 in advance

✔Yearly expenses amount to $20,000

✔What is the income or loss?

Accrual Versus Cash Example

Accrual Versus Cash Example

Managers adopt anartificial period of time

to evaluate performance

Accounting Period

Interim Period Statements

Apply the revenue and

matching principles.

Objective 2

Revenue Principle

✔When is revenue recognized?

✔When it is deemed earned

✔Recognition of revenue and cash receipts

do not necessarily occur at the same time

The Matching Principle

✔What is the matching principle?

✔It is the basis for recording expenses

✔Expenses are the costs of assets and the

increase in liabilities incurred in the earning

of revenues

✔Expenses are recognized when the benefit

Matching Expenses with

Revenues Example

✔Parker Floor sells a wood floor for $15,000

on the last day of May

✔The wood was purchased from the

manufacturer for $8,000 in March of the

same year

✔The floor is installed in June

✔When is income recognized?

Revenues $15,000Cost of goods sold 8,000

May

Matching Expenses with Revenues Example

Interacts with the

revenue principle and

the matching principle

Requires that income

be measured accurately each period

The Time Period Concept

✔It requires that accounting information be reported at regular intervals

Make adjusting entries.

Objective 3

Adjusting Entries

✔Assign revenue to the period earned

✔Assign expenses to the period incurred

✔Bring related asset and liability accounts into correct balance

Prepaids or Deferrals

Accruals

Two Types Of

Adjusting Entries

Cash

Prepaid Insurance

24,000

Prepaid Insurance Example

On January 2, 2005, Parker Floor paid $24,000

for a two-year health insurance policy

On January 2, 2005, Parker Floor paid $24,000

for a two-year health insurance policy

Prepaid Insurance Example

✔What is the journal entry on December 31, 2005?

Prepaid Insurance Example

✔What was the determining factor in matching this expense?

Supplies Example

✔Wood Enterprise started business the

beginning of the month

✔$800 worth of office supplies were

purchased on November 15, 2004, for cash

Office Supplies Cash

An inventory at month end indicated

An inventory at month end indicated

Supplies Example

Supplies Expense

600

Supplies

800 600 Bal 200

Supplies Example

What was the determining factor

Depreciation Example

✔On January 2, Wood Enterprise purchased

a truck for $30,000 cash

✔The truck is expected to last for 3 years

A contra account

has a companion

account A contra account’s normal balance is

opposite that of the companion

Wood Enterprise Example

Partial Balance SheetDecember 31, 2005

✔What is an accrual?

✔It is the recognition of an expense or

revenue that has arisen but has not yet been recorded

✔Expenses or revenues are recorded before the cash settlement

Accrued Expenses Example

✔ Employees at Mary Business Services are paid every Friday.

✔ Weekly salaries total $30,000.

✔ The business is closed on Saturday and Sunday.

✔ The employees were last paid on April 26,

which was a Friday.

✔ They will be paid on May 3.

Accrued Expenses Example

✔ What is the adjusting entry on April 30?

✔ They worked April 29 and 30.

✔ $30,000 ÷ 5 = $6,000 per day

✔$6,000 × 2 days = $12,000

✔ April 30, 2002 Salaries Expense 12,000 Salaries Payable 12,000 To accrue salary expense

Accrued Revenues Example

✔During the month of April, Mary Business Services rendered services to customers

totaling $15,000

✔At the end of April, the customers have not

as yet been billed

Accrued Revenues Example

✔What is the April 30 adjusting entry?

✔April 30, 2005 Accounts Receivable 15,000

Service Revenue 15,000

To accrue service revenue

Accrued Revenues Example

✔What is the determining factor in

recognizing this service revenue?

Unearned or Deferred Revenue Example

✔In January 2005, Prensa Insurance received

$150,000 from a business client to provide health insurance coverage for three years

✔January 2, 2005 Cash 150,000

Unearned Revenue 150,000 Received revenue in advance

Correct Total

accounted for revenueCorrect

Unearned or Deferred Revenue Example

✔What is the journal entry on December 31, 2005?

✔Unearned revenue 50,000

Revenue 50,000

To record revenue collected in advance

✔Adjusting entries always have

– one income statement account and – one balance sheet account

✔Adjusting entries never involve cash

Prepare an adjusted

trial balance.

Objective 4

Adjusted Trial Balance

✔ The adjusting process starts with the

unadjusted trial balance.

✔ Adjusting entries are made at the end of the accounting period and then an adjusted trial balance is prepared.

✔ The adjusted trial balance serves as the basis for the preparation of the financial

Prepare the financial statements from the adjusted trial balance.

Objective 5

Financial Statements

✔Financial statements have two parts:

1 The first part includes the following:– name of the entity

– title of the statement

– date or period covered

2 The second part is the body of the

Financial Statements Example

Revenue from insurance services $50,000 Less: Salaries expense 14,275

Supplies expense 250 Rent expense 3,600 Utilities expense 625 Interest expense 600

Revenue from insurance services $50,000

Prensa Insurance Equity, January 1, 2002 $100,000

Financial Statements Example

Prensa Insurance Statement of Owner’s Equity Year Ended December 31, 2005

Liabilities and Equities:

End of Chapter

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