Adjusting Accounts

and Preparing
Financial Statements

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 Learning objective
1. Periodic reporting / Time period principle
2. Accrual Accounting and Cash Accounting
3. Account Adjustment
 Prepaid expense
 Unearned revenue
 Accrued expense
 Accrued revenue
4. Adjusted Trial Balance (ATB)
5. Preparation of Financial statement from ATB
6. Decision Analysis: Profit Margin
• Case: Intel & AMD

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 1. Periodic reporting
The Accounting Period

Annual

1 2
Semiannual
1 2 3 4
Quarterly
1 2 3 4 5 6 7 8 9 10 11 12
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Monthly
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 The 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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 2. Accrual Basis vs. Cash Basis
Accrual Basis Cash Basis
Revenues are Revenues are
recognized when recognized when
earned and expenses cash is received and
are recognized when expenses recorded
incurred. when cash is paid.

Not GAAP
Accounting

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 Accrual Basis vs. Cash Basis
FastForward paid $2,400 for a 24-month insurance
Example: policy beginning December 1, 2004.
Insurance Expense 2004
Jan Feb Mar Apr

$ - $ - $ - $ -
May Jun Jul Aug

$ - $ - $ - $ -
Sep Oct Nov Dec

$ - $ - $ - $ 2,400

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.
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 Accrual Basis vs. Cash Basis
Insurance Expense 2004
Jan Feb Mar Apr

$ - $ - $ - $ -
May Jun Jul Aug On the accrual basis
$ -
Sep
$ -
Oct
$ -
Nov
$ -
Dec $100 of insurance
$ - $ - $ - $ 100 expense is recognized in
Jan
Insurance Expense 2005
Feb Mar Apr
2004, $1,200 in 2005,
$ 100
May
$ 100
Jun
$ 100
Jul
$ 100
Aug
and $1,100 in 2006. The
$ 100 $ 100 $ 100 $ 100 expense is matched with
Sep Oct Nov Dec
$ 100 $ 100 $ 100 $ 100 the periods benefited by
Jan
Insurance Expense 2006
Feb Mar Apr
the insurance coverage.
$ 100 $ 100 $ 100 $ 100
May Jun Jul Aug
$ 100 $ 100 $ 100 $ 100
Sep Oct Nov Dec
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$ 100 $ 100 $ 100 $ -
 Recognizing Revenues and Expenses
 Revenue Recognition
We have delivered the
product to our customer,
so I think we should record
the revenue earned.

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 Recognizing Revenues and Expenses
 Revenue Recognition
 Matching Principle Now that we have
recognized the revenue,
let’s see what expenses
Summary
of Expenses we incurred to
Rent $1,000 generate that revenue.
Gasoline 500
Advertising 2,000
Salaries 3,000
Utilities 450
and . . . . ....

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 Recognizing 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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 3. Adjusting Accounts
An adjusting entry is recorded to bring an asset or
liability account balance to its proper amount.

Framework for Adjustments

Adjustments

Paid (or received) cash before Paid (or received) cash after
expense (or revenue) recognized expense (or revenue) recognized

Prepaid Unearned Accrued Accrued

(Deferred) (Deferred) expense revenues
expenses* revenues
*including depreciation © The McGraw-Hill Companies, Inc., 2005
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 Adjusting Accounts – Prepaid expenses
Paid Cash Actually used
E.g. Paid
4 years
rental fee
Accounting Accounting Accounting Accounting $ 4 million
Period 1 Period 2 Period 3 Period 4

At the beginning of period 1 recognize all cash payment as prepaid

expense (asset account):
Dr. Prepaid Rent 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 1 million

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 Adjusting Accounts – Unearned revenue
Received Cash Revenue Earned E.g. Long-term
contract:
Received $40m
in advance to
Accounting Accounting Accounting Accounting
build a ship
Period 1 Period 2 Period 3 Period 4

 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

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 Adjusting Accounts – Accrued expenses
Received Cash Interest expense incurred Paid Cash E.g. Borrow 40
million from bank.
Annual interest
rate is 10%.
Interest and
Accounting Accounting Accounting Accounting principal are paid
Period 1 Period 2 Period 3 Period 4 at the end of 4th
year.
 When borrowing money:
Dr. Cash 40 million
Cr. loan payable 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. loan payable 40 million
Cr. Cash 56 million
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 Adjusting Accounts – Accrued revenues
Revenue Earned Received Cash Long-term
Contract:
Received $40
million after
building one ship
Accounting Accounting Accounting Accounting
Period 1 Period 2 Period 3 Period 4

 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

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 Prepaid expense
Here is the check
for my first
Resources paid 6 months’ rent.
for prior to
receiving the
actual benefits.

Asset Expense
Unadjusted Credit Debit
Balance Adjustment Adjustment

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 Prepaid 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?
Dec. 31 Dr. Insurance Expense 100
Cr. Prepaid Insurance 100
To record first month's expired insurance

Prepaid Insurance 128 Insurance Expense 637

Dec. 1 2,400 Dec. 31 100 Dec. 31 100
Bal. 2,300

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 Prepaid 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?

Dec. 31 Dr. Supplies Expense 1,050

Cr. Supplies 1,050
To record supplies used during 2004

Supplies 126 Supplies Expense 652

Bought 9,720 Dec. 31 1,050 Dec. 31 1,050
Bal. 8,670

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 Prepaid expense 3
Depreciation
Depreciation is the process of allocating the cost of plant
and equipment over their expected useful lives.

Straight-Line Asset Cost - Salvage Value

Depreciation =
Expense Useful Life

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 Adjusting 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.

2004 $26,000 - $8,000

Depreciation = 48 = $375
Expense

Dec. 31 Dr. Depreciation Expense 375

Cr. Accumulated Depreciation - Equipment 375
To record equipment depreciation

Accumulated depreciation is
a contra asset account.
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 contra 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.

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 Adjusting for Depreciation
Dec. 31 Dr. Depreciation Expense 375
Cr. Accumulated Depreciation - Equipment 375
To record equipment depreciation

Equipment Depreciation Expense

1/1 26,000 12/31 375

Accumulated Depreciation
12/31 375

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 Adjusting for Depreciation
Fastforward
Partial Balance Sheet
At December 31, 2004

Assets Equipment is
Cash
.
$
shown net of
Equipment $ 26,000 accumulated
Less: accumulated deprec. (375) 25,625
. depreciation.
.
Total Assets

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 Unearned (Deferred) Revenues
Cash received in
E.g. The New York Times
advance of
Company: Subscriptions-
providing
unearned revenue.
products or
services.

Liability Revenue
Debit Unadjusted Credit
Adjustment Balance Adjustment

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 Adjusting 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

Unearned Revenue
Dec 26 3,000

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 Adjusting 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.

Unearned Revenue Consulting Revenue

Dec. 31 250 Dec. 26 3000 Dec.5 4,200
Bal. 2,750 Dec. 12 1,600
Dec. 31 250
Balance 6,050

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 Accrued Expenses
Costs incurred in a We’re about one-half
done with this job and
period that are
want to be paid for
both unpaid and our work!
unrecorded.

Expense Liability
Debit Credit
Adjustment Adjustment

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 Adjusting 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.

Last pay Next pay

date date
12/26/04 1/2/05

12/1/04 12/31/04 Record adjusting

Year end journal entry.

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 Adjusting 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.

Dec. 31 Dr. Salaries Expense 210

Cr. Salaries Payable 210
To accrue 3-days' salary
Salaries Expense Salaries Payable
Dec.12 700 Dec. 31 210
Dec. 26 700
Dec. 31 210
Bal. 1,610

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 Accrued Revenues
Revenues earned Yes, I’ve completed your
in a period that tax return, but have not had
time to bill you yet.
are both
unrecorded and
not yet received.

Asset Revenue
Debit Credit
Adjustment Adjustment

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 Adjusting 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.

Dec. 31 Dr. Accounts Receivable 31,200

Cr. Service Revenue 31,200
To accrue revenue earned
Accounts Receivable Service Revenue
Other receivables Other revenues
1,325,268 6,589,500
Dec. 31 31,200 Dec. 31 31,200
Bal. 1,356,468 Bal . 6,620,700

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 Adjusting 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

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 Adjusting Accrued Revenues

Accounts Receivable Consulting Revenue

Dec.12 1,900 Dec. 22 1,900 Dec.5 4,200
Dec.31 1,800 Dec. 12 1,600
Bal. 1,800 Dec. 31 250
Dec. 31 1,800
Balance 7,850

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 Future 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

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 Links to Financial Statements
Summary of Adjustments and Financial Statement Links
Before Adjustment
Income
Balance Statement
Type Sheet Account Account Adjusting Entry
Prepaid Asset Expense Dr. Expense
Expenses Overstated Understated Cr. Asset
Unearned Liability Revenue Dr. Liability
Revenues Overstated Understated Cr. Revenue
Accrued Liability Expense Dr. Expense
Expenses Understated Understated Cr. Liability
Accrued Asset Revenue Dr. Asset
Revenues Understated Understated Cr. Revenue

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 4. Adjusted Trial Balance
 Explain and prepare an adjusted trial balance.
 Prepare financial statements from an adjusted
trial balance.

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 FastForward
Trial Balance
December 31, 2004
Unadjusted Adjusted
Trial Balance Adjustments Trial Balance
Dr. Cr. Dr. Cr. Dr. Cr.
Cash $ 3,950
Accounts receivable -
Supplies 9,720
Prepaid insurance 2,400
Equipment 26,000
Accum. depr. - Equip. - First, the
$
Accounts payable
Salaries payable
6,200
-
initial
Unearned revenue
Chuck Taylor, Capital
3,000
30,000
unadjusted
Chuck Taylor, Withdrawals
Consulting revenue
600
5,800
amounts are
added to the
Rental revenue 300
Depr. expense - worksheet.
Salaries expense 1,400
Insurance expense -
Rent expense 1,000
Supplies expense -
Utilities expense 230
Totals $ 45,300 $ 45,300

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 FastForward
Trial Balance
December 31, 2004
Unadjusted Adjusted
Trial Balance Adjustments Next,
Trial Balance
Dr. Cr. Dr. Cr. FastForward’s
Dr. Cr.
Cash $ 3,950
Accounts receivable - f $ 1,800 adjustments
Supplies 9,720 b $ 1,050 are added.
Prepaid insurance 2,400 a 100
Equipment 26,000
Accum. depr. - Equip. - c 375
Accounts payable $ 6,200
Salaries payable - e 210
Unearned revenue 3,000 d 250
Chuck Taylor, Capital 30,000
Chuck Taylor, Withdrawals 600
Consulting revenue 5,800 d 250
f 1,800
Rental revenue 300
Depr. expense - c 375
Salaries expense 1,400 e 210
Insurance expense - a 100
Rent expense 1,000
Supplies expense - b 1,050
Utilities expense 230
Totals $ 45,300 $ 45,300 $ 3,785 $ 3,785

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 FastForward
Finally, the totals are Trial Balance
determined. December 31, 2004
Unadjusted Adjusted
Trial Balance Adjustments Trial Balance
Dr. Cr. Dr. Cr. Dr. Cr.
Cash $ 3,950 $ 3,950
Accounts receivable - f $ 1,800 1,800
Supplies 9,720 b $ 1,050 8,670
Prepaid insurance 2,400 a 100 2,300
Equipment 26,000 26,000
Accum. depr. - Equip. - c 375 $ 375
Accounts payable $ 6,200 6,200
Salaries payable - e 210 210
Unearned revenue 3,000 d 250 2,750
Chuck Taylor, Capital 30,000 - 30,000
Chuck Taylor, Withdrawals 600 600
Consulting revenue 5,800 d 250 7,850
f 1,800
Rental revenue 300 300
Depr. expense - c 375 375
Salaries expense 1,400 e 210 1,610
Insurance expense - a 100 100
Rent expense 1,000 1,000
Supplies expense - b 1,050 1,050
Utilities expense 230 230
Totals $ 45,300 $ 45,300 $ 3,785 $ 3,785 $ 47,685 $ 47,685

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 5. 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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 Adjusted
Trial Balance
December 31, 2004
Dr. Cr.
Prepare the Income
Cash
Accounts receivable
$ 3,950
1,800
Statement.
Supplies 8,670
Prepaid insurance 2,300
Equipment 26,000
Accum. depr. - Equip. $ 375 FastForward
Accounts payable 6,200 Income Statement
Salaries payable 210 For the Month Ended December 31, 2004
Unearned revenue 2,750 Revenues:
Chuck Taylor, Capital 30,000 Consulting revenue $ 7,850
Chuck Taylor, Withd'l. 600 Rental revenue 300
Consulting revenue 7,850 Operating expenses:
Rental revenue 300 Depr. expense - Equip. $ 375
Depr. expense 375 Salaries expense 1,610
Salaries expense 1,610 Insurance expense 100
Insurance expense 100 Rent expense 1,000
Rent expense 1,000
Supplies expense 1,050
Supplies expense 1,050
Utilities expense 230
Utilities expense 230
Total expenses 4,365
Totals $ 47,685 $ 47,685
Net income $ 3,785

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 FastForward
Income Statement
Prepare the Statement of
For the Month Ended December 31, 2004
Revenues:
Changes in Owner’s Equity.
Consulting revenue $ 7,850 Note: Net Income from the Income
Rental revenue 300 Statement carries to the Statement of
Operating expenses: Changes in Owner’s Equity.
Depr. expense - Equip. $ 375
Salaries expense 1,610
Insurance expense 100
Rent expense 1,000
Supplies expense 1,050
Utilities expense 230
Total expenses 4,365 FastForward
Net income $ 3,785 Statement of Changes in Owner's Equity
For the Month Ended December 31, 2004

C. Taylor, Capital 12/1/04 $ -0-

Add: Net income $ 3,785
Investment by owner 30,000 33,785
Total 33,785
Less: Withdrawal by owner 600
C. Taylor, Capital 12/31/04 $ 33,185
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 Adjusted
FastForward
Trial Balance Balance Sheet
Dr. Cr. December 31, 2001
Cash $ 3,950 Assets
Accounts receivable 1,800 Cash $ 3,950
Supplies 8,670 Accounts receivable 1,800
Prepaid insurance 2,300 Supplies 8,670
Equipment 26,000 Prepaid insurance 2,300
Accum. depr. - Equip. $ 375 Equipment 26,000
Accounts payable 6,200 Less: accum. depr. (375) 25,625
Salaries payable 210 Total assets $ 42,345
Unearned revenue 2,750 Liabilities
Chuck Taylor, Capital 30,000 Accounts payable $ 6,200
FastForward
ChuckStatement
Taylor, Withd'l. 600
of Changes in Owner's Equity Salaries payable 210
Consulting revenue
For the Month Ended December 31, 2004 7,850 Unearned consulting revenues 2,750
Rental revenue 300 Total liabilities $ 9,160
C. Taylor,
Depr. Capital 12/1/01
expense 375 $ -0- Owner's Equity
Add: Net income $ 3,785 Chuck Taylor, Capital 33,185
Salaries expense 1,610
Investment by owner 30,000 33,785 Total liabilities and equity $ 42,345
Insurance expense 100
Total 33,785
Rent expense
Less: Withdrawal by owner
1,000
600
Supplies expense
C. Taylor, Capital 12/31/01
Utilities expense
1,050
230
$ 33,185
Prepare the
Totals $ 47,685 $ 47,685
Balance Sheet.
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 6. Decision Analysis
- Profit Margin

 Profit margin ratio measures the company’s profitability

 Comparison technique
• with competitors
• with prior period

Profit Net Income

Margin = Net Sales

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 Profit Margin
- Semiconductor Industry

1. Industry Characteristics
 Highly technology intensive
 Cyclical with economic cycle
2. Key success factors:
 Technology innovation
3. Companies for analysis
 Intel
 AMD

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 6. Profit Margin
- 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%

Profit Margin

40.00%

30.00%
20.00%

10.00%
Profit Margin

0.00%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
-10.00%

-20.00%
-30.00%

-40.00%
-50.00%

-60.00%
Year

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Intel AMD Companies, Inc., 2005
 ROA
- Intel & AMD
ROA

30.00%

20.00%

10.00%

ROA
0.00%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
-10.00%

-20.00%

-30.00%
Year

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%

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