Lecture slides_Chapter 3 _ 4.pptx

KEY ACCOUNTING CONCEPTS
1. Fiscal vs Calendar Years
2. Cash vs Accrual Accounting
3. Adjusting Entries
4. Correcting Entries
5. Qualities of Financial Information
6. Closing Entries
7. Accounting Cycle
8. Classified Balance Sheet
2

 Monthly and quarterly time periods are called interim
periods.
 Most large 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.
Fiscal and Calendar Years
LO 1 3

Accrual-Basis Accounting
 Transactions recorded in the periods in which the
events occur.
 Companies recognize revenues when they perform
services (rather than when they receive cash).
 Expenses are recognized when incurred (rather than
when paid).
 In accordance with generally accepted accounting
principles (GAAP).
Accrual- versus Cash-Basis Accounting
LO 1 4

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- versus Cash-Basis Accounting
LO 1 5

REVENUE RECOGNITION PRINCIPLE
Recognize revenue in the
accounting period in which the
performance obligation is satisfied.
Recognizing Revenues and Expenses
LO 1 6

EXPENSE RECOGNITION PRINCIPLE
Match expenses with revenues in
the period when the company
makes efforts that generate those
revenues.
Recognizing Revenues and Expenses
LO 1
“Let the expenses follow
the revenues.”
7

Illustration 3-1
GAAP relationships in
revenue and expense
recognition
LO 1 8

(a) Monthly and quarterly time periods.
(b) Efforts (expenses) should be matched
with results (revenues).
(c) Accountants divide the economic life of
a business into artificial time periods.
(d) Companies record revenues when they
receive cash and record expenses
when they pay out cash.
(e) An accounting time period that starts on
January 1 and ends on December 31.
(f) Companies record transactions in the
period in which the events occur.
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.
1. ___ Accrual-basis accounting.
2. ___ Calendar year.
3. ___ Time period assumption.
4. ___ Expense recognition
principle.
f
e
c
b
1 Timing Concepts
DO IT!
LO 1

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.
The Need for Adjusting Entries
LO 1 10

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
services are performed.
c. balance sheet and income statement accounts
have correct balances at the end of an accounting
period.
d. all of the above.
Question
The Need for Adjusting Entries
LO 1 11

Illustration 3-2
Categories of adjusting entries
1. Prepaid Expenses. Expenses
paid in cash before they are
used or consumed.
Deferrals
1. Accrued Revenues.
Revenues for services
performed but not yet received
in cash or recorded.
2. Accrued Expenses.
Expenses incurred but not yet
paid in cash or recorded.
2. Unearned Revenues.
Cash received before services
are performed.
Accruals
Types of Adjusting Entries
LO 1 13

Illustration: Pioneer Advertising
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 1,500
Oct. 31
Supplies
LO 2 14

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 50
Oct. 31
Insurance
LO 2 15

 Buildings, equipment, and motor vehicles (assets
that provide service for many years) are recorded as
assets, rather than an expense, on the date
acquired.
 Depreciation is the process of allocating the cost of
an asset to expense over its useful life.
 Depreciation does not attempt to report the actual
change in the value of the asset.
► Allocation concept, not a valuation concept.
Depreciation
LO 2 16

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 called a
contra asset account.
Depreciation
LO 2 17

Illustration 3-8
STATEMENT PRESENTATION
 Accumulated Depreciation is a contra asset account
(credit).
 Offsets related asset account on the balance sheet.
 Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.
Depreciation
LO 2 18

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 performed $400 of
services in October.
Service Revenue 400
Unearned Service Revenue 400
Oct. 31
Unearned Revenues
LO 2 19

The ledger of Hammond Company, on March 31, 2017, includes these
selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
An analysis of the accounts shows the following.
1. Insurance expires at the rate of $100 per month.
2. Supplies on hand total $800.
3. The equipment depreciates $200 a month.
4. During March, services were performed for one-half of the unearned
service revenue.
Prepare the adjusting entries for the month of March.
2 Adjusting Entries for Deferrals
DO IT!
LO 2

Debit Credit
Supplies 2,800
Equipment 25,000
1. Insurance expires at the rate of $100 per month.
DO IT!
LO 2

Debit Credit
Supplies 2,800
Equipment 25,000
2. Supplies on hand total $800.
DO IT!
Supplies 2,000
LO 2

Debit Credit
Supplies 2,800
Equipment 25,000
3. The equipment depreciates $200 a month.
DO IT!
Depreciation Expense 200
Accumulated Depreciation—Equipment 200
LO 2

Debit Credit
Supplies 2,800
Equipment 25,000
4. During March, services were performed for one-half of the unearned
service revenue.
DO IT!
Service Revenue 4,600
LO 2

Illustration: In October Pioneer Advertising
performed services worth $200 that were not
billed to clients on or before October 31.
Accounts Receivable 200
Cash 200
Nov. 10
200
Service Revenue 200
Accounts Receivable
Oct. 31
On November 10, Pioneer receives cash of $200 for the services
performed.
Accrued Revenues
LO 3 25

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 50
Oct. 31
Illustration 3-17
Accrued Expenses
ACCRUED INTEREST
LO 3 26

Micro Computer Services began operations on August 1, 2017. At the
end of August 2017, management prepares monthly financial
statements. The following information relates to August.
1. At August 31, the company owed its employees $800 in
salaries and wages that will be paid on September 1.
2. On August 1, the company borrowed $30,000 from a local bank
on a 15-year mortgage. The annual interest rate is 10%.
3. Revenue for services performed but unrecorded for August
totaled $1,100.
Prepare the adjusting entries needed at August 31, 2017.
3 Adjusting Entries for Accruals
DO IT!
LO 3

Prepare the adjusting entries needed at August 31, 2017.
1. At August 31, the company owed its employees $800 in
salaries and wages that will be paid on September 1.
2. On August 1, the company borrowed $30,000 from a local bank
on a 15-year mortgage. The annual interest rate is 10%.
3. Revenue for services performed but unrecorded for August
totaled $1,100.
3 Adjusting Entries for Accruals
DO IT!
Salaries and Wages Expense 800
Salaries and Wages Payable 800
Interest Expense 250
Interest Payable 250
Accounts Receivable 1,100
LO 3

Illustration 3-22
Summary of Basic Relationships
LO 3 29

4 Trial Balance
DO IT!
(a) Determine the net income for the quarter April 1 to June 30.
(b) Determine the total assets and total liabilities at June 30, 2017, for Skolnick Co.
(c) Determine the amount of owner’s capital at June 30, 2017. LO 4

 Unnecessary if accounting records are free of errors.
 Made whenever an error is discovered.
 Must be posted before closing entries.
Instead of preparing a correcting entry, it is possible to
reverse the incorrect entry and then prepare the correct entry.
Correcting Entries—An Avoidable Step
LO 3 34

CASE 1: On May 10, Mercato Co. journalized and posted a $50 cash
collection on account from a customer as a debit to Cash $50 and a
credit to Service Revenue $50. The company discovered the error on
May 20, when the customer paid the remaining balance in full.
Cash 50
Incorrect
entry
Service Revenue 50
Cash 50
Correct
entry
Service Revenue 50
Correcting
entry Accounts Receivable 50
LO 3 35

CASE 2: On May 18, Mercato purchased on account equipment
costing $450. The transaction was journalized and posted as a debit to
Equipment $45 and a credit to Accounts Payable $45. The error was
discovered on June 3.
Equipment 45
Incorrect
entry
Accounts Payable 45
Equipment 450
Correct
entry
Accounts Payable 450
Equipment 405
Correcting
entry Accounts Payable 405
LO 3 36

Sanchez Company discovered the following errors made in
January 2017 .
1. A payment of Salaries and Wages Expense of $600 was
debited to Supplies and credited to Cash, both for $600.
2. A collection of $3,000 from a client on account was debited
to Cash $200 and credited to Service Revenue $200.
3. The purchase of supplies on account for $860 was debited
to Supplies $680 and credited to Accounts Payable $680.
Correct the errors without reversing the incorrect entry.
LO 3
DO IT! Correcting Entries
3

January 2017 .
1. A payment of Salaries and Wages Expense of $600 was
debited to Supplies and credited to Cash, both for $600.
Correct the error without reversing the incorrect entry.
Salaries and Wages Expense 600
Supplies 600
LO 3
3

January 2017 .
2. A collection of $3,000 from a client on account was debited
to Cash $200 and credited to Service Revenue $200.
Service Revenue 200
Cash 2,800
Accounts Receivable 3,000
LO 3
3

January 2017 .
3. The purchase of supplies on account for $860 was debited
to Supplies $680 and credited to Accounts Payable $680.
Supplies ($860 - $680) 180
Accounts Payable 180
LO 3
3

Two fundamental qualities, relevance and faithful representation.
Relevance
 Make a difference in a business decision.
 Provides information that has predictive value and confirmatory
value.
 Materiality is a company-specific aspect of relevance.
► An item is material when its size makes it likely to influence the
decision of an investor or creditor.
LEARNING
OBJECTIVE
APPENDIX 3B: Discuss financial reporting
concepts.
6
Qualities of Useful Information
LO 6 42

Two fundamental qualities, relevance and faithful representation.
Faithful Representation
 Information accurately depicts what really happened.
 Information must be
► complete (nothing important has been omitted),
► neutral (is not biased toward one position or another), and
► free from error.
LO 6 43

ENHANCING QUALITIES
Comparability results
when different
companies use the
same accounting
principles.
Consistency means that
a company uses the
same accounting
principles and methods
from year to year.
Information is
verifiable if
independent
observers, using the
same methods, obtain
similar results.
For accounting information
to have relevance, it must
be timely.
Information has the
quality of
understandability
if it is presented in a
clear and concise
fashion.
LO 6 44

 Multiple-column form used in preparing financial
statements.
 Not a permanent accounting record.
 May be a computerized worksheet using an electronic
spreadsheet program such as Excel.
 Prepared using a five step process.
 Use of worksheet is optional.
Worksheet
LEARNING
OBJECTIVE Prepare a worksheet.
1
LO 1 49

Illustration 4-1
Steps in Preparing a Worksheet
50

Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200
Supplies 2,500
Equipment 5,000
Notes Payable 5,000
Accounts Payable 2,500
Unearned Revenue 1,200
Owner's Capital 10,000
Owner's Drawings 500
Salaries and Wages Exp. 4,000
Rent Exp. 900
Totals 28,700 28,700
Balance Sheet
Adjusted Income
Trial Balance Adjustments Trial Balance Statement
Trial balance amounts come
directly from ledger accounts.
Include all accounts
with balances.
STEP 1: PREPARE A TRIAL BALANCE ON THE WORKSHEET
Illustration 4-2
LO 1 51

Illustration 3-23
General journal
showing adjusting
entries
Adjusting
Journal
Entries
(Chapter 3)
LO 1 52

Cash 15,200
Supplies 2,500 1,500
Prepaid Insurance 600 50
Equipment 5,000
Notes Payable 5,000
Accounts Payable 2,500
Unearned Revenue 1,200 400
Owner's Capital 10,000
Owner's Drawings 500
Service Revenue 10,000 400
200
Salaries and Wages Exp. 4,000 1,200
Rent Exp. 900
Totals 28,700 28,700
Accumulated Depreciation 40
Depreciation Expense 40
Interest Expense 50
Interest Payable 50
Salaries and Wages Payable 1,200
Totals 3,440 3,440
Balance Sheet
Adjusted Income
(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
STEP 2: ENTER THE ADJUSTMENTS IN THE ADJUSTMENTS COLUMNS
Enter adjustment amounts, total
adjustments columns,
and check for equality.
Add additional accounts as needed.
Adjustments Key:
(a) Supplies Used.
(b) Insurance Expired.
(c) Depreciation Expensed.
(d) Service Revenue Recognized.
(e) Service Revenue Accrued.
(f) Interest Accrued.
(g) Salaries Accrued.
Illustration 4-3
LO 1 53

Cash 15,200 15,200
Supplies 2,500 1,500 1,000
Prepaid Insurance 600 50 550
Equipment 5,000 5,000
Notes Payable 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 400 800
Owner's Capital 10,000 10,000
Owner's Drawings 500 500
Service Revenue 10,000 400 10,600
200
Salaries and Wages Exp. 4,000 1,200 5,200
Rent Exp. 900 900
Totals 28,700 28,700
Supplies Expense 1,500 1,500
Insurance Expense 50 50
Accumulated Depreciation 40 40
Depreciation Expense 40 40
Accounts Receivable 200 200
Interest Expense 50 50
Interest Payable 50 50
Salaries and Wages Payable 1,200 1,200
Totals 3,440 3,440 30,190 30,190
Net Income
Totals
Balance Sheet
Adjusted Income
(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
STEP 3: COMPLETE THE ADJUSTED TRIAL BALANCE COLUMNS
Total the adjusted trial balance
columns and check for equality.
Illustration 4-4
LO 1 54

Cash 15,200 15,200 15,200
Supplies 2,500 1,500 1,000 1,000
Prepaid Insurance 600 50 550 550
Equipment 5,000 5,000 5,000
Notes Payable 5,000 5,000 5,000
Accounts Payable 2,500 2,500 2,500
Unearned Revenue 1,200 400 800 800
Owner's Capital 10,000 10,000 10,000
Owner's Drawings 500 500 500
Service Revenue 10,000 400 10,600 10,600
200
Salaries and Wages Exp. 4,000 1,200 5,200 5,200
Rent Exp. 900 900 900
Totals 28,700 28,700
Supplies Expense 1,500 1,500 1,500
Insurance Expense 50 50 50
Accumulated Depreciation 40 40 40
Depreciation Expense 40 40 40
Accounts Receivable 200 200 200
Interest Expense 50 50 50
Interest Payable 50 50 50
Salaries and Wages Payable 1,200 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590
Net Income
Totals
Balance Sheet
Adjusted Income
(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
Steps in Preparing a Worksheet Illustration 4-5
Extend adjusted trial balance amounts to
appropriate financial statement columns.
STEP 4: EXTEND AMOUNTS TO FINANCIAL STATEMENT COLUMNS
LO 1 55

Cash 15,200 15,200 15,200
Supplies 2,500 1,500 1,000 1,000
Prepaid Insurance 600 50 550 550
Equipment 5,000 5,000 5,000
Notes Payable 5,000 5,000 5,000
Accounts Payable 2,500 2,500 2,500
Unearned Revenue 1,200 400 800 800
Owner's Capital 10,000 10,000 10,000
Owner's Drawings 500 500 500
Service Revenue 10,000 400 10,600 10,600
200
Salaries and Wages Exp. 4,000 1,200 5,200 5,200
Rent Exp. 900 900 900
Totals 28,700 28,700
Supplies Expense 1,500 1,500 1,500
Insurance Expense 50 50 50
Accumulated Depreciation 40 40 40
Depreciation Expense 40 40 40
Accounts Receivable 200 200 200
Interest Expense 50 50 50
Interest Payable 50 50 50
Salaries and Wages Payable 1,200 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590
Net Income 2,860 2,860
Totals 10,600 10,600 22,450 22,450
Balance Sheet
Adjusted Income
(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
Compute Net Income or Net Loss.
STEP 5: TOTAL COLUMNS, COMPUTE NET INCOME (LOSS)
Steps in Preparing a Worksheet Illustration 4-6
LO 1 56

At the end of the accounting period, the company makes
the accounts ready for the next period.
LEARNING
OBJECTIVE
Prepare closing entries and a post-closing trial balance.
2
Illustration 4-8
Temporary versus permanent accounts
LO 2 57
Hint: RED
(rev,exp,drawin
gs).

Closing entries formally recognize in the ledger the transfer of
 net income (or net loss) and
 owner’s drawings
to owner’s capital.
Companies generally journalize and post closing entries only at
the end of the annual accounting period.
Closing entries produce a zero balance in each temporary
account.
Preparing Closing Entries
LO 2 58

Owner’s Capital is a
permanent account. All
other accounts are
temporary accounts.
Illustration 4-9
Diagram of closing
process—proprietorship
LO 2 59

CLOSING
ENTRIES
ILLUSTRATED
Illustration 4-10
Closing entries
journalized
60

Illustration 4-11
Posting
Closing
Entries
LO 2 61

Purpose is to prove the equality of the permanent account balances
carried forward into the next accounting period.
Preparing a Post-Closing Trial Balance
Illustration 4-12
Post-closing trial balance
LO 2 62

The worksheet for Hancock Company shows the following in the
financial statement columns:
Owner’s Drawings $15,000
Owner’s Capital $42,000
Net income $18,000
Prepare the closing entries at December 31 that affect owner’s
capital.
Income Summary 18,000
Owner’s Capital 18,000
Owner’s Capital 15,000
Owner’s Drawings 15,000
LO 2
DO IT! Closing Entries
2

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
Illustration 4-15
LEARNING
OBJECTIVE
Explain the steps in the accounting cycle and
how to prepare correcting entries.
3
LO 3 64

The Classified Balance Sheet
Illustration 4-21
LO 4 65

LO 4
Illustration 4-21
66

 Assets that a company expects to convert to cash or use
up within one year or the operating cycle, whichever is
longer.
 Operating cycle is the average time that it takes to
purchase inventory, sell it on account, and then collect
cash from customers.
Current Assets
LO 4 67

Usually listed in the order they expect to convert them into cash.
Illustration 4-22
Current Assets
LO 4 68

The correct order of presentation in a classified balance sheet
for the following current assets is:
a. accounts receivable, cash, prepaid insurance, inventory.
b. cash, inventory, accounts receivable, prepaid insurance.
c. cash, accounts receivable, inventory, prepaid insurance.
d. inventory, cash, accounts receivable, prepaid insurance.
Question
Current Assets
LO 4 69

 Investments in stocks and bonds of other companies.
 Investments in long-term assets such as land or buildings
that is not currently being used in operating activities.
 Long-term notes receivable.
Long-Term Investments
Illustration 4-23
LO 4 70

 Long useful lives.
 Currently used in operations.
 Depreciation - allocating the cost of assets to a number
of years.
 Accumulated depreciation - total amount of depreciation
expensed thus far in the asset’s life.
Property, Plant, and Equipment
LO 4 71

Illustration 4-24
Property, Plant, and Equipment
LO 4 72

 Long-lived assets that do not have physical substance.
Intangible Assets
Illustration 4-25
LO 4 73

Patents and copyrights are
a. Current assets.
b. Intangible assets.
c. Long-term investments.
d. Property, plant, and equipment.
Question
LO 4 74

 Obligations the company is to pay within the coming year
or its operating cycle, whichever is longer.
 Usually list notes payable first, followed by accounts
payable. Other items follow in order of magnitude.
 Common examples are accounts payable, salaries and
wages payable, notes payable, interest payable, income
taxes payable current maturities of long-term obligations.
 Liquidity - ability to pay obligations expected to be due
within the next year.
Current Liabilities
LO 4 75

Illustration 4-26
Current Liabilities
LO 4 76

 Obligations a company expects to pay after one year.
Long-Term Liabilities
Illustration 4-27
LO 4 78

Which of the following is not a long-term liability?
a. Bonds payable
b. Current maturities of long-term obligations
c. Long-term notes payable
d. Mortgages payable
Question
LO 4 79

 Proprietorship - one capital account.
 Partnership - capital account for each partner.
 Corporation - Common Stock and Retained Earnings.
Owner’s Equity
Illustration 4-28
LO 4 80

The following accounts were taken from the financial statements of Callahan
Company.
Match each of the following accounts to its proper balance sheet
classification, shown below. If the item would not appear on a balance sheet,
use “NA.”
Current assets (CA) Current liabilities (CL)
Long-term investments (LTI) Long-term liabilities (LTL)
Property, plant, and equipment (PPE) Owner’s equity (OE)
Intangible assets (IA)
LO 4
DO IT! Balance Sheet Classifications
4

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