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© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Adjusting Accounts and Preparing Financial Statements
Chapter
33
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Learning objectiveLearning objective
1. Periodic reporting / Time period principle2. Accrual Accounting and Cash Accounting3. Account Adjustment
Prepaid expense Unearned revenue Accrued expense Accrued revenue
4. Adjusted Trial Balance (ATB)5. Preparation of Financial statement from ATB6. Decision Analysis: Profit Margin
• Case: Intel & AMD
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
1 2 3 4 5 6 7 8 9 10 11 12
1 2 3 4
Annual
1 2
Monthly
Quarterly
Semiannual
1. Periodic reportingThe Accounting Period1. Periodic reportingThe Accounting Period
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
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The Time Period PrincipleThe Time Period Principle
The time period principle assumes that an organization’s activities can be divided into specific time periods such as a month, a quarter, a six-month interval, or a year.
Fiscal year VS. calendar year (Jan. 1 ~ Dec. 31).
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Accounting
2. Accrual Basis vs. Cash Basis2. Accrual Basis vs. Cash Basis
Accrual Basis
Revenues are recognized when
earned and expenses are recognized when
incurred.
Cash Basis
Revenues are recognized when
cash is received and expenses recorded when cash is paid.
Not GAAPNot GAAPNot GAAPNot GAAP
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Accrual Basis vs. Cash BasisAccrual Basis vs. Cash Basis
On the cash basis the entire $2,400 would be recognized as insurance expense in 2004. No insurance expense from this policy would be recognized in 2005 or
2006, periods covered by the policy.
On the cash basis the entire $2,400 would be recognized as insurance expense in 2004. No insurance expense from this policy would be recognized in 2005 or
2006, periods covered by the policy.
Jan Feb Mar Apr
-$ -$ -$ -$ May Jun Jul Aug
-$ -$ -$ -$ Sep Oct Nov Dec
-$ -$ -$ 2,400$
Insurance Expense 2004
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Accrual Basis vs. Cash BasisAccrual Basis vs. Cash BasisJan Feb Mar Apr
-$ -$ -$ -$ May Jun Jul Aug
-$ -$ -$ -$ Sep Oct Nov Dec
-$ -$ -$ 100$
Jan Feb Mar Apr
100$ 100$ 100$ 100$ May Jun Jul Aug
100$ 100$ 100$ 100$ Sep Oct Nov Dec
100$ 100$ 100$ 100$
Jan Feb Mar Apr
100$ 100$ 100$ 100$ May Jun Jul Aug
100$ 100$ 100$ 100$ Sep Oct Nov Dec
100$ 100$ 100$ -$
Insurance Expense 2004
Insurance Expense 2005
Insurance Expense 2006
On the accrual basis $100 of insurance
expense is recognized in 2004, $1,200 in 2005,
and $1,100 in 2006. The expense is matched with the periods benefited by the insurance coverage.
On the accrual basis $100 of insurance
expense is recognized in 2004, $1,200 in 2005,
and $1,100 in 2006. The expense is matched with the periods benefited by the insurance coverage.
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
We have delivered theproduct to our customer,
so I think we should recordthe revenue earned.
We have delivered theproduct to our customer,
so I think we should recordthe revenue earned.
Recognizing Revenues and ExpensesRecognizing Revenues and Expenses
Revenue Recognition
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Recognizing Revenues and ExpensesRecognizing Revenues and Expenses
Revenue Recognition Matching Principle
Summaryof Expenses
Rent
Gasoline
Advertising
Salaries
Utilities
and . . . .
$1,000
500
2,000
3,000
450
. . . .
Now that we haverecognized the revenue,let’s see what expenses
we incurred togenerate that revenue.
Now that we haverecognized the revenue,let’s see what expenses
we incurred togenerate that revenue.
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Recognizing Revenues and ExpensesRecognizing Revenues and Expenses
Revenue recognition principle requires that revenue be recorded when earned, not before or after.
Matching principle intends to record expenses in the same accounting period as the revenues that are earned as a result of these expenses.
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AdjustmentsAdjustments
An adjusting entry is recorded to bring an asset or liability account balance to its proper amount.
3. Adjusting Accounts3. Adjusting Accounts
Paid (or received) cash before expense (or revenue) recognizedPaid (or received) cash before
expense (or revenue) recognizedPaid (or received) cash after
expense (or revenue) recognizedPaid (or received) cash after
expense (or revenue) recognized
Prepaid (Deferred) expenses*
Prepaid (Deferred) expenses*
Unearned (Deferred) revenues
Unearned (Deferred) revenues
AccruedexpenseAccruedexpense
AccruedrevenuesAccruedrevenues
Framework for Adjustments
*including depreciation
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At the beginning of period 1 recognize all cash payment as prepaid expense (asset account):
Dr. Prepaid Rent Expense 4 million
Cr. Cash 4 million
At the end of each accounting period recognize the portion that is used
Dr. Rent Expense 1 million
Cr. Prepaid Rent Expense 1 million
Adjusting Accounts – Prepaid expensesAdjusting Accounts – Prepaid expensesPaid Cash Actually used
Accounting Period 1
Accounting Period 2
Accounting Period 3
Accounting Period 4
E.g. Paid 4 years
rental fee $ 4 million
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At the beginning of period 1 recognize all cash receipt as unearned revenue (liability account).
Dr. Cash 40 million
Cr. Unearned revenue 40 million
At the end of each accounting period recognize the portion that is earned:
Dr. Unearned revenue 10 million
Cr. Revenue 10 million
Adjusting Accounts – Unearned revenueAdjusting Accounts – Unearned revenueReceived Cash Revenue Earned
Accounting Period 1
Accounting Period 2
Accounting Period 3
Accounting Period 4
E.g. Long-term contract:
Received $40m in advance to build a ship
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Adjusting Accounts – Accrued expensesAdjusting Accounts – Accrued expensesPaid CashInterest expense incurred
Accounting Period 1
Accounting Period 2
Accounting Period 3
Accounting Period 4
When borrowing money:Dr. Cash 40 million Cr. Bank loan 40 million
At the end of each period (1 to 4) recognize the portion of interest expense that is due but not paid:
Dr. Interest Expense 4 million
Cr. interest payable 4 million
At the end of the period 4:
Dr. Interest payable 16 million
Dr. Bank loan 40 million
Cr. Cash 56 million
E.g. Borrow 40 million from bank.
Annual interest rate is 10%. Interest and
principal are paid at the end of 4th
year.
Received Cash
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Adjusting Accounts – Accrued revenuesAdjusting Accounts – Accrued revenues
At the end of each accounting period (1 to 4) recognize the portion of revenue that is earned but not received:
Dr. Accounts Receivable 10 million Cr. Revenue 10 million
At the end of period 4:Dr. Cash 40 million Cr. Accounts receivable 40 million
Received Cash
Accounting Period 1
Accounting Period 2
Accounting Period 3
Accounting Period 4
Revenue Earned Long-term
Contract: Received $40 million after
building one ship
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Here is the checkfor my first
6 months’ rent.
Here is the checkfor my first
6 months’ rent.
Prepaid expensePrepaid expense
Resources paid for prior to
receiving the actual benefits.
Resources paid for prior to
receiving the actual benefits.
Asset Expense
UnadjustedBalance
CreditAdjustment
DebitAdjustment
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Prepaid expense 1 Prepaid InsurancePrepaid expense 1 Prepaid Insurance
On December 1, 2004, Fastforward paid $2,400 for 24 months of insurance benefits beginning on December
1, 2004. Fastforward recorded the expenditure as Prepaid Insurance on December 1. What adjustment
is required?
On December 1, 2004, Fastforward paid $2,400 for 24 months of insurance benefits beginning on December
1, 2004. Fastforward recorded the expenditure as Prepaid Insurance on December 1. What adjustment
is required?
Dec. 31 Dr. Insurance Expense 100 Cr. Prepaid Insurance 100
To record first month's expired insurance
Dec. 1 2,400 Dec. 31 100Bal. 2,300
Prepaid Insurance 128Dec. 31 100
Insurance Expense 637
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Prepaid expense 2 SuppliesPrepaid expense 2 Supplies
During 2004, Fastforward purchase $9,720 of supplies. Fastforward recorded the expenditures as Supplies. At December 31, a count of the supplies indicated $8,670
on hand. What adjustment is required?
During 2004, Fastforward purchase $9,720 of supplies. Fastforward recorded the expenditures as Supplies. At December 31, a count of the supplies indicated $8,670
on hand. What adjustment is required?
Dec. 31 Dr. Supplies Expense 1,050 Cr. Supplies 1,050
To record supplies used during 2004
Bought 9,720 Dec. 31 1,050Bal. 8,670
Supplies 126Dec. 31 1,050
Supplies Expense 652
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Straight-LineDepreciationExpense
= Asset Cost - Salvage Value
Useful Life
Prepaid expense 3 DepreciationPrepaid expense 3 Depreciation
Depreciation is the process of allocating the cost of plant and equipment over their expected useful lives.
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Adjusting for DepreciationAdjusting for Depreciation
Dec 1, 2004,• Fastforward purchased equipment for $26,000 cash. • The equipment has an estimated useful life of 4 years• Fastforward expects to sell the equipment at the end of its life for
$8,000 cash.
2004Depreciation
Expense=
$26,000 - $8,000 48 = $375
Dec. 31 Dr. Depreciation Expense 375 Cr. Accumulated Depreciation - Equipment 375
To record equipment depreciation
Accumulated depreciation isa contra asset account.
Accumulated depreciation isa contra asset account.
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contra accountcontra account
A contra account is an account linked with another account, it has an opposite normal balance, and it is reported as a subtraction from that other account’s balance.
A contra account allow information users to know both the full costs of assets and the total amount of depreciation.
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Equipment Depreciation Expense
1/1 26,000 12/31 375
Accumulated Depreciation12/31 375
Adjusting for DepreciationAdjusting for DepreciationDec. 31 Dr. Depreciation Expense 375
Cr. Accumulated Depreciation - Equipment 375 To record equipment depreciation
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Adjusting for DepreciationAdjusting for Depreciation
Equipment is shown net of accumulated depreciation.
$
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Unearned (Deferred) RevenuesUnearned (Deferred) Revenues
Cash received in advance of providing
products or services.
Cash received in advance of providing
products or services.
Liability RevenueUnadjusted
BalanceCredit
AdjustmentDebit
Adjustment
E.g. The New York Times Company: Subscriptions- unearned revenue.
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Adjusting Unearned (Deferred) RevenuesAdjusting Unearned (Deferred) Revenues
Dec 26, 2004, Fastforward agreed to provide consulting services to a client for a
fixed fee of $3,000 for 60 days. On the same day, the client paid the 60-day fee in advance,
covering the period from Dec 27 to Feb 24.
Dec. 26 Dr. Cash 3,000 Cr. Unearned Revenue 3,000
Received advance payment for services over next 60 days
Dec 26 3,000Unearned Revenue
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Adjusting Unearned (Deferred) RevenuesAdjusting Unearned (Deferred) Revenues
December 31, Fastforward has provided 5 days’ service and earned 5/60 of $3000.
Dec. 31 Dr. Unearned Revenue 250
Cr. Consulting Revenue 250
To record earned revenue.
Dec. 31 250 Dec. 26 3000Bal. 2,750
Unearned Revenue
Dec.5 4,200Dec. 12 1,600Dec. 31 250Balance 6,050
Consulting Revenue
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We’re about one-halfdone with this job and
want to be paid forour work!
We’re about one-halfdone with this job and
want to be paid forour work!
Costs incurred in a period that are
both unpaid and unrecorded.
Costs incurred in a period that are
both unpaid and unrecorded.
Accrued ExpensesAccrued Expenses
Expense LiabilityCredit
AdjustmentDebit
Adjustment
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12/1/04 12/31/04Year end
Last paydate
12/26/04
Next paydate
1/2/05
Record adjustingjournal entry.
Record adjustingjournal entry.
Adjusting for Accrued ExpensesAdjusting for Accrued Expenses
Fastforward pays its employee $700 every two weeks on Friday. Year-end, 12/31/04, falls on a Wednesday. As of
12/31/04, the employees have earned salaries of 3 days for Monday through Wednesday of the week ended 1/02/05.
Fastforward pays its employee $700 every two weeks on Friday. Year-end, 12/31/04, falls on a Wednesday. As of
12/31/04, the employees have earned salaries of 3 days for Monday through Wednesday of the week ended 1/02/05.
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Adjusting for Accrued ExpensesAdjusting for Accrued Expenses
Fastforward pays its employee $700 every two weeks on Friday. Year-end, 12/31/04, falls on a Wednesday. As of
12/31/04, the employees have earned salaries of 3 days for Monday through Wednesday of the week ended 1/02/05.
Fastforward pays its employee $700 every two weeks on Friday. Year-end, 12/31/04, falls on a Wednesday. As of
12/31/04, the employees have earned salaries of 3 days for Monday through Wednesday of the week ended 1/02/05.
Dec. 31 Dr. Salaries Expense 210 Cr. Salaries Payable 210
To accrue 3-days' salary
Dec.12 700 Dec. 26 700 Dec. 31 210Bal. 1,610
Salaries ExpenseDec. 31 210
Salaries Payable
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Yes, I’ve completed yourtax return, but have not had
time to bill you yet.
Yes, I’ve completed yourtax return, but have not had
time to bill you yet.
Accrued RevenuesAccrued Revenues
Revenues earned in a period that
are both unrecorded and not yet received.
Revenues earned in a period that
are both unrecorded and not yet received.
Asset Revenue
CreditAdjustment
DebitAdjustment
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Adjusting for Accrued RevenuesAdjusting for Accrued Revenues
Smith & Jones, CPAs, had $31,200 of work completed but not yet billed to clients. Let’s make
the adjusting entry necessary on December 31, 2004, the end of the company’s fiscal year.
Smith & Jones, CPAs, had $31,200 of work completed but not yet billed to clients. Let’s make
the adjusting entry necessary on December 31, 2004, the end of the company’s fiscal year.
Dec. 31 Dr. Accounts Receivable 31,200 Cr. Service Revenue 31,200
To accrue revenue earned
Other receivables1,325,268
Dec. 31 31,200Bal. 1,356,468
Accounts ReceivableOther revenues
6,589,500 Dec. 31 31,200Bal . 6,620,700
Service Revenue
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Adjusting Accrued RevenuesAdjusting Accrued Revenues
Dec 12, 2004 FastForward agreed to provide 30 days of consulting services
to a local sports club for a fixed fee of $2700, beginning from Dec 12.
The club agrees to pay FastForward on Jan 10, 2005.
Dec. 31 Dr. Accounts Receivable 1,800 Cr. Consulting Revenue 1,800
To accrue revenue earned
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Adjusting Accrued RevenuesAdjusting Accrued Revenues
Dec.12 1,900 Dec. 22 1,900Dec.31 1,800
Bal. 1,800
Accounts Receivable
Dec.5 4,200Dec. 12 1,600Dec. 31 250Dec. 31 1,800Balance 7,850
Consulting Revenue
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Future receipts of accrued revenuesFuture receipts of accrued revenues
Jan 10, 2005• FastForward received $2,700 cash for the entire
contract amount.
Jan 10 Dr. Cash 2,700
Cr. Accounts Receivable 1,800
Cr. Consulting Revenue 900 To record cash collection
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Type
Balance Sheet Account
Income Statement Account Adjusting Entry
Prepaid Asset Expense Dr. ExpenseExpenses Overstated Understated Cr. Asset
Unearned Liability Revenue Dr. LiabilityRevenues Overstated Understated Cr. Revenue
Accrued Liability Expense Dr. ExpenseExpenses Understated Understated Cr. Liability
Accrued Asset Revenue Dr. AssetRevenues Understated Understated Cr. Revenue
Before Adjustment
Summary of Adjustments and Financial Statement Links
Links to Financial StatementsLinks to Financial Statements
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4. Adjusted Trial Balance4. Adjusted Trial Balance
Explain and prepare an adjusted trial balance. Prepare financial statements from an adjusted
trial balance.
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
FastForwardTrial Balance
December 31, 2004
First, the initial
unadjusted amounts are added to the worksheet.
First, the initial
unadjusted amounts are added to the worksheet.
$
$
$$
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Next, FastForward’s adjustments are added.
Next, FastForward’s adjustments are added.
FastForwardTrial Balance
December 31, 2004
$
$
$$
$$
$$
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
FastForwardTrial Balance
December 31, 2004Finally, the totals are determined.
Finally, the totals are determined.
$
$
$$
$$
$$
$
$
$$
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
5. Preparing Financial Statements5. Preparing Financial Statements
Let’s use FastForward’s adjusted trial balance to prepare the company’s financial statements.
Remember order: • Income Statement,
• Statement of Owner’s Equity,
• Balance Sheet,
• Statement of Cash Flow
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Prepare the IncomeStatement.
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Prepare the Statement of Changes in Owner’s Equity.Note: Net Income from the Income Statement carries to the Statement of Changes in Owner’s Equity.
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Prepare the Balance Sheet.
FastForwardBalance Sheet
December 31, 2001
AssetsCash 3,950$ Accounts receivable 1,800 Supplies 8,670 Prepaid insurance 2,300 Equipment 26,000 Less: accum. depr. (375) 25,625 Total assets 42,345$
LiabilitiesAccounts payable 6,200$ Salaries payable 210 Unearned consulting revenues 2,750 Total liabilities 9,160$
Owner's EquityChuck Taylor, Capital 33,185 Total liabilities and equity 42,345$
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Profit margin ratio measures the company’s profitability Comparison technique
• with competitors• with prior period
ProfitMargin
Net Income Net Sales=
6. Decision Analysis - Profit Margin6. Decision Analysis - Profit Margin
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
1. Industry Characteristics
Highly technology intensive
Cyclical with economic cycle
2. Key success factors:
Technology innovation
3. Companies for analysis
Intel
AMD
Profit Margin - Semiconductor Industry Profit Margin - Semiconductor Industry
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
6. Profit Margin - Intel & AMD 6. Profit Margin - Intel & AMD
Profit Margin
-60.00%
-50.00%
-40.00%
-30.00%
-20.00%
-10.00%
0.00%
10.00%
20.00%
30.00%
40.00%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Year
Pro
fit
Mar
gin
Intel AMD
PM 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996
Intel 22.31% 21.97% 18.72% 11.65% 4.86% 31.24% 24.89% 23.10% 27.70% 24.74%
AMD 2.83% 1.82% -7.80% -48.31% -1.56%
Industry 14.85% 14.07% 13.16%
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
ROA - Intel & AMD ROA - Intel & AMD
ROA
-30.00%
-20.00%
-10.00%
0.00%
10.00%
20.00%
30.00%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Year
RO
A
Intel AMD
ROA 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996
Intel 17.93% 15.61% 11.97% 7.05% 2.91% 21.97% 16.68% 19.28% 24.05% 21.73%
AMD 2.27% 1.16% -3.89% -22.88% -1.07%
Industry 9.22% 8.06% 7.41%
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
Homework for Chap 1, 2, 3Homework for Chap 1, 2, 3
Chap 1: Problem 1-8 A Chap 2: Problem 2-3 B Chap 3: Problem 3-3 A
Due on June,16,2006 (Friday) in class. Please submit hard copy. Please submit on time for me to keep your
homework record.