Weygandt Financial 8e PowerPoint Review Ch03

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Chapter 3 Adjusting the Accounts

Learning Objectives

After studying this chapter, you should be able to:

1. Explain the time period assumption.

2. Explain the accrual basis of accounting.

3. Explain the reasons for adjusting entries.

4. Identify the major types of adjusting entries.

5. Prepare adjusting entries for deferrals.

6. Prepare adjusting entries for accruals.

7. Describe the nature and purpose of an adjusted trial balance.

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Financial AccountingEighth Edition

Weygandt Kieso Kimmel

Preview of Chapter 3

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Generally a month, a quarter, or a year.

Also known as the “Periodicity Assumption”

Timing Issues

Accountants divide the economic life of a business into

artificial time periods (Time Period Assumption).

LO 1 Explain the time period assumption.

Jan. Feb. Mar. Apr. Dec.. . . . .

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Monthly and quarterly time periods are called interim

periods.

Public companies must prepare both quarterly and

annual financial statements.

Fiscal Year = Accounting time period that is one year in

length.

Calendar Year = January 1 to December 31.

Timing Issues


Fiscal and Calendar Years

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The time period assumption states that:

a. revenue should be recognized in the accounting

period in which it is earned.

b. expenses should be matched with revenues.

c. the economic life of a business can be divided into

artificial time periods.

d. the fiscal year should correspond with the calendar

year.


Timing Issues

Question

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Accrual-Basis Accounting

Transactions recorded in the periods in which the

events occur.

Revenues are recognized when earned, rather than

when cash is received.

Expenses are recognized when incurred, rather than

when paid.

Accrual- vs. Cash-Basis Accounting

LO 2 Explain the accrual basis of accounting.

Timing Issues

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Cash-Basis Accounting

Revenues recognized when cash is received.

Expenses recognized when cash is paid.

Cash-basis accounting is not in accordance with

generally accepted accounting principles (GAAP).

Accrual- vs. Cash-Basis Accounting


Timing Issues

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Revenue Recognition Principle

Recognizing Revenues and Expenses


Recognize revenue in the

accounting period in which it

is earned.

In a service enterprise,

revenue is considered to be

earned at the time the service

is performed.

Timing Issues

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Expense Recognition Principle

Recognizing Revenues and Expenses


Match expenses with

revenues in the period when

the company makes efforts to

generate those revenues.

“Let the expenses follow

the revenues.”

Timing Issues

3-11 LO 2 Explain the accrual basis of accounting.

Timing Issues

Illustration 3-1 GAAP relationships in revenue and expense recognition

3-12 LO 2 Explain the accrual basis of accounting.

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One of the following statements about the accrual basis of accounting is false. That statement is:

a. Events that change a company’s financial statements are recorded in the periods in which the events occur.

b. Revenue is recognized in the period in which it is earned.

c. The accrual basis of accounting is in accord with generally accepted accounting principles.

d. Revenue is recorded only when cash is received, and expenses are recorded only when cash is paid.


Timing Issues

Question

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A list of concepts is provided in the left column below, with a

description of the concept in the right column below. There are more

descriptions provided than concepts. Match the description of the

concept to the concept.

LO 2

fecb

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Adjusting Entries

Ensure that the revenue recognition and expense

recognition principles are followed.

Necessary because the trial balance may not contain

up-to-date and complete data.

Required every time a company prepares financial

statements.

Will include one income statement account and one

balance sheet account.

LO 3 Explain the reasons for adjusting entries.

The Basics of Adjusting Entries

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Adjusting entries are made to ensure that:

a. expenses are recognized in the period in which they

are incurred.

b. revenues are recorded in the period in which they are

earned.

c. balance sheet and income statement accounts have

correct balances at the end of an accounting period.

d. all of the above.

LO 3 Explain the reasons for adjusting entries.


Question

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1. Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed.

Deferrals

3. Accrued Revenues. Revenues earned but not yet

received in cash or recorded.

4. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded.

2. Unearned Revenues. Cash received and recorded as liabilities before revenue is earned.

Accruals

Illustration 3-2Categories of adjusting entries


LO 4 Identify the major types of adjusting entries.

Types of Adjusting Entries

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Trial Balance –

Each account is

analyzed to

determine whether

it is complete and

up-to-date.

Illustration 3-3


LO 4 Identify the major types of adjusting entries.

Types of Adjusting Entries

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Deferrals are either:

Prepaid expenses

OR

Unearned revenues.

LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for Deferrals


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Payment of cash, that is recorded as an asset because

service or benefit will be received in the future.

insurance

supplies

advertising

Cash PaymentCash Payment Expense RecordedExpense RecordedBEFORE

rent

equipment

buildings

Prepayments often occur in regard to:



Prepaid Expenses

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Expire either with the passage of time or through use.

Adjusting entry:

► Increase (debit) to an expense account and

► Decrease (credit) to an asset account.



Prepaid Expenses

Illustration 3-4

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Illustration: Pioneer Advertising Agency

purchased supplies costing $2,500 on

October 5. Pioneer recorded the payment

by increasing (debiting) the asset

Supplies. This account shows a balance

of $2,500 in the October 31 trial balance.

An inventory count at the close of

business on October 31 reveals that

$1,000 of supplies are still on hand.

Supplies 1,500

Supplies expense 1,500Oct. 31



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Illustration 3-5

LO 5

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Illustration: On October 4, Pioneer

Advertising paid $600 for a one-year fire

insurance policy. Coverage began on

October 1. Pioneer recorded the payment

by increasing (debiting) Prepaid

Insurance. This account shows a balance

of $600 in the October 31 trial balance.

Insurance of $50 ($600 ÷ 12) expires

each month.

Prepaid insurance 50

Insurance expense 50Oct. 31



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Illustration 3-6

LO 5

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Depreciation

Buildings, equipment, and vehicles (assets with long

lives) are recorded as assets, rather than an expenses,

in the year acquired.

Depreciation allocates a portion of the asset’s cost as

an expense during each period of the asset’s useful life.

Depreciation does not attempt to report the actual

change in the value of the asset.



3-27

40

Illustration: For Pioneer Advertising,

assume that depreciation on the

equipment is $480 a year, or $40 per

month.

Accumulated depreciation 40

Depreciation expense

Oct. 31



Accumulated Depreciation is a contra asset account.

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LO 5

Illustration 3-7

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Statement Presentation

Accumulated Depreciation is a contra asset account (credit).

Appears just after the account it offsets (Equipment) on the balance sheet.

Book value is the difference between the cost of any depreciable asset and its accumulated depreciation.



Illustration 3-8

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Illustration 3-9



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Receipt of cash that is recorded as a liability because the

revenue has not been earned.

Rent

Airline tickets

Cash ReceiptCash Receipt Revenue RecordedRevenue RecordedBEFORE

Magazine subscriptions

Customer deposits

Unearned revenues often occur in regard to:



Unearned Revenues

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Adjusting entry is made to record the revenue that has

been earned and to show the liability that remains.

Results in a decrease (debit) to a liability account and

an increase (credit) to a revenue account.



Unearned Revenues

Illustration 3-10

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Illustration: Pioneer Advertising received $1,200 on October 2

from R. Knox for advertising services expected to be completed by

December 31. Unearned Service Revenue shows a balance of

$1,200 in the October 31 trial balance. Analysis reveals that the

company earned $400 of those fees in October.

Service revenue 400

Unearned service revenue 400Oct. 31



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LO 5

Illustration 3-11

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Illustration 3-12



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Accruals are made to record

Revenues earned

OR

Expenses incurred

in the current accounting period that have not been recognized through daily entries.

Adjusting Entries for Accruals


LO 6 Prepare adjusting entries for accruals.

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Revenues earned but not yet received in cash or recorded.

Rent

Interest

Services performed

Accrued revenues often occur in regard to:


Accrued Revenues


BEFORE Cash ReceiptCash ReceiptRevenue RecordedRevenue Recorded

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Adjusting entry shows the receivable that exists and

records the revenues earned.

Adjusting entry:

► Increases (debits) an asset account and

► Increases (credits) a revenue account.


Illustration 3-13

LO 6

Accrued Revenues

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Illustration: In October Pioneer Advertising

Agency earned $200 for advertising services

that had not been recorded.

Accounts receivable 200

Cash 200Nov. 10



200

Service revenue 200

Accounts receivable

Oct. 31

On November 10, Pioneer receives cash of

$200 for the services performed.

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Illustration 3-14

LO 6

3-42

Illustration 3-15



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Expenses incurred but not yet paid in cash or recorded.

Rent

Interest

Taxes

Salaries

Accrued expenses often occur in regard to:


Accrued Expenses

BEFORE Cash PaymentCash PaymentExpense RecordedExpense Recorded


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Adjusting entry records the obligation and recognizes

the expense.

Adjusting entry:

► Increase (debit) an expense account and

► Increase (credit) a liability account.

LO 6


Accrued Expenses

Illustration 3-16

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Illustration: Pioneer Advertising signed a three-month note

payable in the amount of $5,000 on October 1. The note requires

Pioneer to pay interest at an annual rate of 12%.

Interest payable 50

Interest expense 50Oct. 31



Illustration 3-17

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Illustration 3-18

LO 6

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Illustration: Pioneer Advertising last paid salaries on October 26;

the next payment of salaries will not occur until November 9. The

employees receive total salaries of $2,000 for a five-day work

week, or $400 per day. Thus, accrued salaries at October 31 are

$1,200 ($400 x 3 days).



Illustration 3-19

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Illustration 3-20

LO 6

3-50

Illustration 3-21



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Micro Computer Services Inc. began operations on August 1,

2014. At the end of August 2014, management attempted to

prepare monthly financial statements. The following information

relates to August. 1. Prepare the adjusting journal entries needed

at August 31, 2014.

1. At August 31, the company owed its employees $800 in

salaries and wages that will be paid on September 1.

LO 6

Salaries and wages expense 800

Salaries and wages payable 800

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at August 31, 2014.

2. On August 1, the company borrowed $30,000 from a local

bank on a 15-year mortgage. The annual interest rate is 10%.

LO 6

Interest expense 250

Interest payable 250

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at August 31, 2014.

3. Revenue for services performed but unrecorded for August

totaled $1,100.

LO 6

Accounts receivable 1,100

Service revenue 1,100

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Summary of Basic RelationshipsIllustration 3-22

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Prepared after all adjusting entries are journalized and

posted.

Purpose is to prove the equality of debit balances and

credit balances in the ledger.

Is the primary basis for the preparation of financial

statements.

LO 7 Describe the nature and purpose of the adjusted trial balance.

The Adjusted Trial Balance

Adjusted Trial Balance

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Illustration 3-25

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Which of the following statements is incorrect concerning the

adjusted trial balance?

a. An adjusted trial balance proves the equality of the total debit

balances and the total credit balances in the ledger after all

adjustments are made.

b. The adjusted trial balance provides the primary basis for the

preparation of financial statements.

c. The adjusted trial balance lists the account balances

segregated by assets and liabilities.

d. The adjusted trial balance is prepared after the adjusting

entries have been journalized and posted.

LO 7

The Adjusted Trial Balance

Question

3-59

Financial Statements are prepared directly from the Adjusted Trial Balance.

Financial Statements are prepared directly from the Adjusted Trial Balance.

Balance Sheet

Income Statement

Retained Earnings

Statement

LO 7 Describe the nature and purpose of the adjusted trial balance.

Preparing Financial Statements

3-60 LO 7Illustration 3-26

3-61 LO 7Illustration 3-27

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When a company prepays an expense, it debits that

amount to an expense account.

When a company receives payment for future

services, it credits the amount to a revenue account.

Alternative Treatment of Prepaid Expenses and Unearned Revenues

LO 8 Prepare adjusting entries for the alternative treatment of deferrals.

APPENDIX 3A

3-63 LO 8 Prepare adjusting entries for the alternative treatment of deferrals.

Illustration 3A-2

Prepaid Expenses

Company may choose to debit (increase) an expense account

rather than an asset account. This alternative treatment is simply

more convenient.

APPENDIX 3A


Illustration 3A-5

Company may credit (increase) a revenue account when they

receive cash for future services.

APPENDIX 3A

Unearned Revenues


Illustration 3A-7

APPENDIX 3A

Summary of Additional Adjustment Relationships

3-66 LO 9 Discuss financial reporting concepts.

APPENDIX 3B CONCEPTS IN ACTION

Qualities of Useful InformationIllustration 3B-1



Enhancing Qualities

Comparability

Consistency

Verifiability

Timeliness

Understandability

3-68 LO 9


Assumptions in Financial Reporting

Illustration 3B-2

3-69 LO 9


Assumptions in Financial Reporting

Illustration 3B-2



Principles of Financial Reporting

Measurement Principles

► Cost Principle

► Fair Value Principle

Revenue Recognition Principle

Expense Recognition Principle

Full Disclosure Principle

3-71 LO 9


Principles of Financial Reporting

Constraints in Financial ReportingIllustration 3B-3

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Key Points

Companies applying IFRS also use accrual-basis accounting to ensure that they record transactions that change a company’s financial statements in the period in which events occur.

Similar to GAAP, cash-basis accounting is not in accordance with IFRS.

IFRS also divides the economic life of companies into artificial time periods. Under both GAAP and IFRS, this is referred to as the time period assumption.

IFRS requires that companies present a complete set of financial statements, including comparative information annually.

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The general revenue recognition principles required by GAAP that are used in this textbook are similar to those under IFRS.

As the Feature Story illustrates, revenue recognition fraud is a major issue in U.S. financial reporting. The same situation occurs in other countries, as evidenced by revenue recognition breakdowns at Dutch software company Baan NV, Japanese electronics giant NEC, and Dutch grocer AHold NV.

Under IFRS, revaluation of items such as land and buildings is permitted. IFRS allows depreciation based on revaluation of assets, which is not permitted under GAAP.

Key Points

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The terminology used for revenues and gains, and expenses and losses, differs somewhat between IFRS and GAAP. For example, income is defined as:

Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from shareholders.

Expenses are defined as:

Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity other than those relating to distributions to shareholders.

Key Points

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The IASB and FASB are now involved in a joint project on revenue recognition. The purpose of this project is to develop comprehensive guidance on when to recognize revenue. This approach focuses on changes in assets and liabilities as the basis for revenue recognition. It is hoped that this approach will lead to more consistent accounting in this area.

Looking into the Future

3-76

GAAP:

a. provides very detailed, industry-specific guidance on

revenue recognition, compared to the general guidance

provided by IFRS.

b. provides only general guidance on revenue recognition,

compared to the detailed guidance provided by IFRS.

c. allows revenue to be recognized when a customer makes

an order.

d. requires that revenue not be recognized until cash is

received.

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Which of the following statements is false?

a. IFRS employs the periodicity assumption.

b. IFRS employs accrual accounting.

c. IFRS requires that revenues and costs must be capable of

being measured reliably.

d. IFRS uses the cash basis of accounting.

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As a result of the revenue recognition project being undertaken

by the FASB and IASB:

a. revenue recognition will place more emphasis on when

revenue is earned.

b. revenue recognition will place more emphasis on when

revenue is realized.

c. revenue recognition will place more emphasis on when

changes occur in assets and liabilities.

d. revenue will no longer be recorded unless cash has been

received

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Weygandt Financial 8e PowerPoint Review Ch03

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