Adjusting Accounts

ACCT 101 – Fundamentals of Accounting Chapter 3 – Adjusting Accounts and Preparing Financial Statements Overview: Much of this chapter should be a review for you. However, there may be some new terminology related to adjustments. In addition, the Statement of Retained Earnings will be new to you. Accounting Periods – important to determine because users need information frequently and promptly. Regular intervals for information are necessary. Annual financial statements are needed, but more frequent interim statements are also usually necessary. Cash Basis Accrual Basis Recognizes revenues when cash is received Recognizes revenues when the revenues are earned, not when received Recognizes expenses when they are incurred, regardless of when paid Required by GAAP Net Income = Revenues Earned – Expenses incurred. Does not match cash balance. Comparability is increased Profitability determined by accrual basis accounting is required by GAAP. The income statement, in addition to a statement of cash flows tells investors and other users much information about a company. Recognizes expenses when cash is paid Not GAAP Net Income = Cash Receipts – Cash Paid Comparability questionable over periods Cash basis accounting may be useful for business decisions, so that’s why we now have a statement of cash flows Adjusting Accounts       Is necessary under accrual basis of accounting. Necessary for transactions that extend over more than one account period. Affect an income statement account and a balance sheet account. Process is to determine what the current balance is, decide what balance should be, and make an adjustment for the difference. All adjustments can be categorized as deferrals or accruals. Key question to ask is “Has the Cash Changed Hands?” If so, it’s a deferral, if not, it’s an accrual. Overview of Framework Adjustments Has the CASH changed hands? YES DEFERRALS Prepaid or deferred expenses Unearned or deferred revenues NO ACCRUALS Accrued Expenses Accrued Revenues Prepaid or deferred expenses – Items paid for in advance or things you pay for ahead of time and receive benefits later. Examples are insurance, advertising, supplies, and even depreciation. If you pay for season tickets to sporting events to entertain clients, this is a prepaid asset until the game is played. Unearned or deferred revenues – Cash received in advance of providing products or services. When cash is received ahead a time, an obligation or liability is received to provide something later. If you receive money for the season tickets, then you have an obligation to provide a game. In this respect, it’s the flipside of a prepaid. The amount received is a liability until the game is played. Accrued Expenses - Costs that are incurred in one period but are unpaid and unrecorded. Accrued expenses must be reported in the period incurred. Examples of accrued expenses are salaries, interest, taxes. Accrued Revenues – Revenues earned in a period that are unrecorded and for which no cash has yet been received. Accrued revenues usually arise from services and products that have been performed/delivered but not yet billed. Also arises from interest that you have earned but not yet received. Prepaid or deferred expenses What Is it? Paid for something in advance of benefit Accounts Affected: One asset and one expense are affected Types of AJE’s Prepaid Insurance Supplies Depreciation JE’s: Insurance Used: Dr. Insurance Exp. Cr. Prepaid Ins Supplies Used: Dr. Supplies Exp Cr. Supplies Unearned or deferred revenues Accrued Expenses Accrued Revenues Cash received in advance of providing goods or services Costs incurred in one period but not paid for until another Revenues earned in one period but cash not received until another A revenue and a liability are affected One expense and a liability account An asset and a revenue account Subscriptions Tickets Salary Accruals Interest on amounts owed Taxes owed Unbilled amounts Partially completed work Interest earned but not paid on investments Wage Accrual Dr. Salary Exp. Cr. Salaries Pybl Interest on Debt Dr. Interest Exp. Cr. Interest Pybl Unbilled Items Dr. A/R Cr. Fees Earned Anything else where cash is received ahead of time Subscriptions Earned Dr. Unearned Subs. Cr. Subsc Income Tickets – Games Played Dr. Unearned Tkt Inc Cr. Ticker Income Assets Used Up: Dr. Depn Exp. Cr. Accum Depn Taxes owed Dr. Tax Expense Cr. Taxes Pybl Closing Entries: You learned how to do these in Acct 100. Why: (1) to get certain accounts ready for the next accounting period (2) to update the Retained earnings account for net income and dividends How: (1) close revenues to income summary (2) close expenses to income summary (3) close income summary to retained earnings (4) close dividends to retained earnings After: Prepare a post closing trial balance. The only accounts that should have balances are assets, liability, and equity accounts. Classified Balance Sheet    Assets should be classified into Current Assets, Long Term investments, and Plan Assets. Liabilities should be classified into current liabilities and long-term liabilities. Equity is classified into two main subsections, Common Stock (contributed capital) and Retained earnings. Ratios Profit Margin – return on sales – very common. It represents the percentage of profit for each dollar in sales. Profit Margin = Net Income Net Sales