Chapter 3 _part 2_

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					 Chapter 3


Adjusting the Accounts


          ACCT 100
Objectives of the Chapter
I. Introduce the accrual accounting
    concept.
II. Introduce the adjusting entries.




               Accrual Accounting and the Financial Statements   2
I. Accrual Accounting
1. The time-period concept, the revenue
   recognition and the matching
   principles.
2. Accrual versus cash basis accounting.




              Accrual Accounting and the Financial Statements   3
    The Time-Period Concept (Periodicity)

   Income and financial position of a
    business are reported periodically, not
    until the end of life of a business.




                 Accrual Accounting and the Financial Statements   4
Revenue Recognition Principle
(SFAS No. 5) (-An Accrual Basis)
   Revenue is recognized when it is earned
    and realized.
   Earned : the entity has substantially
    accomplished what it must do to be entitled
    to compensation.
   Realized: goods are exchanged for cash or
    claims.
   In general, these conditions are met at time
    of sale (delivery) or when services are
    rendered regardless whether cash is
    collected or not.
                    Income Measurement And Profit Analysis   5
The Matching Principle
    If revenues are recognized in a period, all
     related expenses should be recognized in
     the same period regardless whether
     expenses are paid or not.
    The related expenses include traceable
     costs (i.e., product costs), period costs, (i.e.,
     interest and rent expenses) and
     estimated/allocation expenses (i.e.,
     depreciation expense and bad debt expense).
                        Accrual Accounting and the Financial Statements   6
Accrual vs. Cash Basis Accounting
Accrual-basis accounting:
 Revenues are recognized based on revenue
 recognition principle (i.e., recognized when
 realized and earned regardless whether
 cash is collected or not).
 Expenses are recognized based on
 matching principle.
Note: revenue and expense recognize before
 cash settlement.

                Accrual Accounting and the Financial Statements   7
Accrual vs. Cash Basis Accounting
(contd.)
   Cash-basis accounting:
    The accountant does not record a
    transaction until cash is received or
    paid.
    Cash-basis accounting is NOT
    acceptable for financial reporting.



                  Accrual Accounting and the Financial Statements   8
II. Adjusting Entries
   Due to the periodicity concept, financial
    reports are prepared periodically.
   Based on revenue recognition principle,
    adjusting entries are prepared at the
    end of a period to recognize revenues
    earned during the period but not yet
    recorded (i.e., accrued revenues).


                  Accrual Accounting and the Financial Statements   9
Adjusting Entries (contd.)
   Based on the matching principle, the
    accrued expenses (i.e., expenses
    incurred but not yet paid/recorded) and
    estimated expenses (i.e., depreciation
    expense and bad debt expense) are
    recorded at the end of a period.



                 Accrual Accounting and the Financial Statements   10
Types of Adjusting Entries

      A. Accruals
      B. Deferrals
      C. Estimated Expenses




            Accrual Accounting and the Financial Statements   11
A. Accruals
   Unrecorded revenues or expenses (i.e.,
    revenues earned or expenses occurred
    but not yet recorded).
    a. Accrued expenses.
    b. Accrued revenues.




                Accrual Accounting and the Financial Statements   12
a. Accrued Expenses- An Example
   A one-year note payable was issued on
    11/1/x1 to purchase an equipment. The full
    amount of the note is $2,400. The annual
    interest rate is 10% and interests are paid on
    4/30/x2 and 11/1/x2.
    11/1/x1 Equipment           2,400
                  Note Payable        2,400
     Adjusting Entry:
     12/31/x1 Interest Expense     40
                 Interest payable         40
                   Accrual Accounting and the Financial Statements   13
b. Accrued Revenues – An
Example
   A one year note was received from a credit
    sale with a face amount of $3,000 and an
    annual interest rate of 12% on 9/1/x1.
    Interests are received on 3/1/x2 and 9/1/x2.
    9/1/x1 Note Receivable      3,000
                Sales Revenue         3,000
     Adjusting Entry:
    12/31/x1 Interest Receivable 120
                 Interest Revenue        120
                   Accrual Accounting and the Financial Statements   14
B. Deferrals
   Postponing the recognition of Revenues
    or expenses
    a. Unearned revenues
    b. Prepaid expenses




                Accrual Accounting and the Financial Statements   15
a. Unearned Revenues
   Receiving $2,400 for a one-year advanced
    rent payment from a tenant on 12/1/x1
    (B/S Approach)          (I/S Approach)
12/1/x1                12/1/x1
Cash         2,400     Cash          2,400
   Unearned Rent 2,400    Rent Revenue     2,400
12/30/x1              12/30/x1
Unearned Rent 200     Rent Revenue 2,200
   Rent Revenue   200    Rent Unearned 2,200
                  Accrual Accounting and the Financial Statements   16
b. Prepaid Expense
   Prepaid a 12 month insurance premium of
    $1,200 on 11/1/x1
    (B/S Approach)              (I/S Approach)
Prepaid Insur. 1,200       Insurance Exp. 1,200
   Cash              1,200    Cash              1,200
12/31/x1                 12/31/x1
Insurance Exp. 200       Prepaid Insur. 1,000
   Prepaid Insurance 200    Insurance Exp. 1,000

                   Accrual Accounting and the Financial Statements   17
C. Estimated Expenses (based on the
matching principle)
Depreciation Expense
12/31 Depreciation Expense         XXX
          Accumulated Depreciation     XXX
Bad Debt Expense
12/31 Bad Debt Expense                                     XXX
          Allowance for B/D                                        XXX
Income Tax Expense
12/31 Income Tax Expense                                   XXX
          Income Tax Payable                                       XXX
                 Accrual Accounting and the Financial Statements         18
Example (from Financial Accounting by Harrison and Horngren):
Information for Adjustments at 4/30/ 19x1
(a) Prepaid rent expired, $1,000.
(b) Supplies on hand, $400 (balance of
    supplies equals $700 before adjustment).
(c) Depreciation on furniture, $275.
(d) Accrued salary expense, $950.
(e) Accrued service revenue, $250.
(f) Amount of unearned service revenue that
    has been earned, $150.
(g) Accrued income tax expense, $540.
                        Accrual Accounting and the Financial Statements   19
Adjusting Entries
(a) Rent Expense                     1,000
       Prepaid Rent                        1,000
    To record rent expense.
(b) Supplies Expense                   300
       Supplies                              300
    To record supplies used.
(c) Depreciation Exp. - Furniture      275
       Accumulated Depr. - Furniture         275
    To record depreciation on furniture.
(d) Salary Expense                     950
       Salary Payable                        950
    To accrue salary expense.
                  Accrual Accounting and the Financial Statements   20
Exhibit 3-9 Panel B (contd.)
(e) Accounts Receivable                                   250
       Service Revenue                                             250
    To accrue service revenue.
(f) Unearned Service Revenue        150
       Service Revenue                     150
    To record unearned revenue that has been
    earned.
(g) Income Tax Expense                                    540
       Income Tax Payable                                          540
    To accrue income tax expense.

                 Accrual Accounting and the Financial Statements     21

				
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