6. Timing Issues Revenue Recognition Principle Companies 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. SO 1 Explain the revenue recognition principle and the matching principle.

7. Timing Issues Illustration: Assume Conrad Dry Cleaners cleans clothing on June 30, but customers do not claim and pay for their clothes until the first week of July. The journal entries for June and July would be: SO 1 Explain the revenue recognition principle and the matching principle.

8. Timing Issues “ Let the expenses follow the revenues.” SO 1 Explain the revenue recognition principle and the matching principle.

9. Timing Issues SO 1 Explain the revenue recognition principle and the matching principle.

12. Timing Issues Illustration: Suppose that Fresh Colors paints a large building in 2009. In 2009 it incurs and pays total expenses (salaries and paint costs) of $50,000. It bills the customer $80,000, but does not receive payment until 2010. SO 2 Differentiate between the cash basis and the accrual basis of accounting. Illustration 4-2

17. Trial Balance – Each account is analyzed to determine whether it is complete and up-to-date. Which of these accounts could be outdated? Types of Adjusting Entries SO 3 Explain why adjusting entries are needed, and identify the major types of adjusting entries Illustration 4-4

22. Adjusting Entries for “Prepaid Expenses” Illustration: Sierra Corporation purchased advertising supplies costing $2,500 on October 5. Sierra recorded the payment by increasing (debiting) the asset Advertising 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. Advertising supplies 1,500 Advertising supplies expense 1,500 Oct. 31 SO 4 Prepare adjusting entries for deferrals. Illustration 4-6 ($2,500 – 1,000 = $1,500)

23. Adjusting Entries for “Prepaid Expenses” Illustration: On October 4 Sierra Corporation paid $600 for a one-year fire insurance policy. Coverage began on October 1. Sierra 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 50 Oct. 31 SO 4 Prepare adjusting entries for deferrals. Illustration 4-7

25. Adjusting Entries for “Prepaid Expenses” Illustration: For Sierra Corporation, assume that depreciation on the office equipment is $480 a year, or $40 per month. Accumulated depreciation 40 Depreciation expense 40 Oct. 31 SO 4 Prepare adjusting entries for deferrals. Illustration 4-8

27. Adjusting Entries for “Prepaid Expenses” SO 4 Prepare adjusting entries for deferrals. Summary Illustration 4-10

31. Adjusting Entries for “Unearned Revenues” SO 4 Prepare adjusting entries for deferrals. Illustration: Sierra Corporation 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. From an evaluation of the work Sierra performed for Knox during October, the company determines that it has earned $400 in October. Service revenue 400 Unearned service revenue 400 Oct. 31 Illustration 4-12

32. SO 4 Prepare adjusting entries for deferrals. Summary Adjusting Entries for “Unearned Revenues” Illustration 4-13

36. Adjusting Entries for “Accrued Revenues” Accrued Revenues An adjusting entry serves two purposes: (1) It shows the receivable that exists, and (2) It records the revenues earned. SO 5 Prepare adjusting entries for accruals.

38. Adjusting Entries for “Accrued Revenues” Illustration: In October Sierra Corporation earned $200 for advertising services that were not billed to clients before October 31. Service Revenue 200 Accounts Receivable 200 Oct. 31 SO 5 Prepare adjusting entries for accruals. Illustration 4-15

39. Summary Illustration 4-16 Adjusting Entries for “Accrued Revenues” SO 5 Prepare adjusting entries for accruals.

41. Adjusting Entries for “Accrued Expenses” Accrued Expenses An adjusting entry serves two purposes: (1) It records the obligations, and (2) It recognizes the expenses. SO 5 Prepare adjusting entries for accruals.

43. Adjusting Entries for “Accrued Expenses” SO 5 Prepare adjusting entries for accruals. Illustration: Sierra Corporation signed a three-month note payable in the amount of $5,000 on October 1. The note requires Sierra to pay interest at an annual rate of 12%. Interest payable 50 Interest expense 50 Oct. 31 Illustration 4-19 Illustration 4-18

44. Adjusting Entries for “Accrued Expenses” SO 5 Prepare adjusting entries for accruals. Illustration: Sierra Corporation last paid salaries on Friday, October 26 for wages through that day; 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). Salary payable 1,200 Salary expense 1,200 Oct. 31 Illustration 4-21

45. Adjusting Entries for “Accrued Expenses” Accrued Expenses An adjusting entry serves two purposes: (1) It records the obligations, and (2) it recognizes the expenses. SO 5 Prepare adjusting entries for accruals.

46. Adjusting Entries for “Accrued Expenses” SO 5 Prepare adjusting entries for accruals. Summary Illustration 4-22

47. Summary of Basic Relationships SO 5 Prepare adjusting entries for accruals.

48. The Adjusted Trial Balance After all adjusting entries are journalized and posted the company prepares another trial balance from the ledger accounts ( Adjusted Trial Balance ). Its purpose is to prove the equality of debit balances and credit balances in the ledger. SO 6 Describe the nature and purpose of the adjusted trial balance.

49. The Adjusted Trial Balance

51. Preparing Financial Statements Financial Statements are prepared directly from the Adjusted Trial Balance . Balance Sheet Income Statement Retained Earnings Statement SO 6 Describe the nature and purpose of the adjusted trial balance.

52. Preparing Financial Statements

53. Preparing Financial Statements Illustration 4-28

54. Closing the Books At the end of the accounting period, companies transfer the temporary account balances to the permanent stockholders’ equity account—Retained Earnings. SO 7 Explain the purpose of closing entries. Illustration 4-29

55. Closing the Books In addition to updating Retained Earnings to its correct ending balance, closing entries produce a zero balance in each temporary account. SO 7 Explain the purpose of closing entries. Illustration 4-30

56. Closing the Books Illustration 4-31

57. Closing the Books SO 7 Explain the purpose of closing entries.

58. Preparing a Post-Closing Trial Balance The purpose of this trial balance is to prove the equality of the permanent account balances that the company carries forward into the next accounting period. All temporary accounts will have zero balances. SO 7 Explain the purpose of closing entries.

59. Summary of the Accounting Cycle 1. Analyze business transactions 2. Journalize the transactions 6. Prepare an adjusted trial balance 7. Prepare financial statements 8. Journalize and post closing entries 9. Prepare a post-closing trial balance 4. Prepare a trial balance 3. Post to ledger accounts 5. Journalize and post adjusting entries SO 8 Describe the required steps in the accounting cycle.

62. Keep an Eye on Cash Sierra Corporation’s income statement shows net income of $2,860 . Net income and net cash provided by operating activities often differ.

63. Keep an Eye on Cash The difference for Sierra is $2,840 ($5,700 - $2,860). The following summary shows the causes of this difference of $2,840.

64. Adjusting Entries – Using a Worksheet (Appendix) Illustration 4A-1 Form and procedure for a worksheet SO 10 Describe the purpose and the basic form of a worksheet.

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