ACC101- PRINCIPLE OF ACCOUNTING

Session 4-5
CHAPTER 3: ADJUSTING ACCOUNTS AND PREPARING
FINANCIAL STATEMENTS

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 OBJECTIVES

C1. Explain the importance of periodic reporting and the time period assumption.

C2. Explain accrual accounting and how it improves financial statements

C3. Identify the types of adjustments and their purpose.

P1. Prepare and explain adjusting entries.

A1. Explain how accounting adjustments link to financial statements.

P2. Explain and prepare an adjusted trial balance

P3. Prepare financial statements from an adjusted trial balance

A2. Compute profit margin and describe its use in analyzing company performance.

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 1. Timing & Reporting
C1 1.1. The Accounting Period
Time period assumption presumes that an organization’s activities can be divided into
specific time periods such as a month, a three-month quarter, a six-month interval, or a year.

Annual Financial
Annually
Reports

1 2
Semiannually
Interim Financial
Reports 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 3
 1. Timing & Reporting
C2 1.2. Accrual Basis versus Cash Basis

Accrual Basis Cash Basis

Revenues are recognized Revenues are recognized
when earned and when cash is received
expenses are recognized and expenses recorded
when incurred. when cash is paid.

Not GAAP

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 1. Timing & Reporting
C2 1.2. Accrual Basis versus Cash Basis
FastForward paid $2,400 for a 24-month insurance
Example: policy beginning December 1, 2009.
Insurance Expense 2009
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 2009. No insurance expense from this policy
would be recognized in 2010 or 2011, periods covered by the policy.
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 1. Timing & Reporting
C2 1.2. Accrual Basis versus Cash Basis
Insurance Expense 2009
Jan Feb Mar Apr

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

$ - $ - $ - $ - On the accrual basis $100 of insurance

Sep Oct Nov Dec
expense is recognized in 2009, $1,200 in
$ - $ - $ - $ 100
Insurance Expense 2010 2010, and $1,100 in 2011. The expense is
Jan Feb Mar Apr
$ 100 $ 100 $ 100 $ 100 matched with the periods benefited by the
May Jun Jul Aug
$ 100 $ 100 $ 100 $ 100 insurance coverage.
Sep Oct Nov Dec
$ 100 $ 100 $ 100 $ 100

Insurance Expense 2011

Jan Feb Mar Apr
$ 100 $ 100 $ 100 $ 100
May Jun Jul Aug
$ 100 $ 100 $ 100 $ 100
Sep Oct Nov Dec
$ 100 $ 100 $ 100 $ - 6
 1. Timing & Reporting
C2 1.3. Recognizing Revenues & Expenses
1. Revenue recognition principle requires that revenue be recorded when earned, not
before and not after.
2. Expense recognition (or matching) principle aims to record expenses in the same
accounting period as the revenues that are earned as a result of those expenses.
We have delivered the Now that we have
product to our customer, recognized the revenue, Summary
so I think we should record let’s see what expenses of Expenses
we incurred to Rent $1,000
the revenue earned.
generate that revenue. Gasoline 500
Advertising 2,000
Salaries 3,000
Utilities 450
and . . . . ....

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 2. Adjusting Accounts
C3 2.1. Framework for Adjustments
An adjusting entry is recorded to bring an asset or liability account balance to
its proper amount.

Deferrals (Deferred)

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 2. Adjusting Accounts
P1 2.2. Prepaid (Deferred) Expenses
Resources paid for prior to
receiving the actual benefits. Asset Expense
Here is the check
Unadjusted Credit Debit
for my 24-month
Balance Adjustment Adjustment
insurance policy.

On 12/1/09, FastForward paid $2,400 for insurance for 2-years (24-months,

December 2009 through November 2011). FastForward recorded the expenditure
as Prepaid Insurance on 12/31/09.What adjustment is required?
Dec. 31 Insurance Expense 100
Prepaid Insurance 100
To record first month's expired insurance
$100 (1/24thof $2,400)
Prepaid Insurance 637 Insurance Expense 128
Dec. 1 2,400 Dec. 31 100 Dec. 31 100
Bal. 2,300
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 2. Adjusting Accounts
P1 2.2. Prepaid (Deferred) Expenses
Supplies Asset Expense
Unadjusted Credit Debit
Resources paid for prior to Balance Adjustment Adjustment
receiving the actual benefits.

During 2009, FastForward purchased $9,720 of supplies. FastForward recorded the

expenditures in the asset account, “Supplies.” On December 31, 2009, a count of the
supplies indicated $8,670 on hand, so $1,050 of supplies were used during December.
What adjustment is required?

Dec. 31 Supplies Expense 1,050

Supplies 1,050
To record supplies used during 2009

Supplies 12 Supplies Expense 65

Bought 9,720 Dec. 31 1,050 Dec. 31 1,050
Bal. 8,670
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 2. Adjusting Accounts
P1 2.2. Prepaid (Deferred) Expenses
Other Prepaid Expenses
1. Other prepaid expenses, such as Prepaid Rent, are accounted for exactly as
Insurance and Supplies.
2. We should note that some prepaid expenses are both paid for and fully used
up within a single period.
3. For example, a company may pay monthly rent on the first day of each month.
This payment creates a prepaid expense on the first day of the month that
fully expires by the end of the month.
4. In these special cases, we can record the cash paid with a debit to the
expense account instead of an asset account.
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 2. Adjusting Accounts
P1 2.2. Prepaid (Deferred) Expenses
Depreciation

Depreciation is the process of allocating the cost of a plant asset over its useful
life in a systematic and rational manner.

Straight-Line Asset Cost-Salvage Value

Depreciation =
Expense Useful Life

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 2. Adjusting Accounts
P1 2.2. Prepaid (Deferred) Expenses
Depreciation
On December 1, 2009, FastForward purchased equipment for $26,000 cash. The
equipment has an estimated useful life of four years (48 months) and FastForward
expects to sell the equipment at the end of its life for $8,000 cash.

Let’s record depreciation expense for the month ended December 31, 2009.

Dec. 2009 = $26,000-$8,000 = $375 per month

Depreciation Expense 48 months

Dr. Cr.
Dec. 31 Depreciation Expense 375
Accumulated Depreciation - Equipment 375
To record monthl y equi pment depreci ati on

Accumulated depreciation is a contra asset account.

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 2. Adjusting Accounts
P1 2.2. Prepaid (Deferred) Expenses
Depreciation

Dr. Cr. Equipment is shown net of accumulated

Dec. 31 Depreciation Expense 375 depreciation.
Accumulated Depreciation - Equipment 375
To record monthly equipment depreciation FastForward
Partial Balance Sheet
At December 31, 2009
Equipment Depreciation Expense
Assets
1/1 26,000 12/31 375 Cash
.
Accumulated Depreciation Equipment $ 26,000
Less: accumulated deprec. (375) 25,625
12/31 375 .
.
Total Assets

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 2. Adjusting Accounts
P1 2.3. Unearned (Deferred) Revenues
Cash received in advance of
providing products or services. Liability Revenue
Debit Unadjusted Credit
Adjustment Balance Adjustment

On December 26, 2009, FastForward agrees to provide consulting services to a client for a fixed
fee of $3,000 for 60 days. On this date, the client pays the entire consulting fee in advance.
Dr. Cr.
Dr. Cr. Dec. 31 Unearned Revenue 250
Dec. 26 Cash 3,000
Unearned Revenue 3,000
Consulting Revenue 250
Consulting fees received in advance To recognize 5-days of consulting fees.

Unearned Revenue
Dec. 26 3,000
Unearned Revenue Consulting Revenue
Dec 31 250 Dec 26 3,000 Dec. 31 250
Bal 2,750
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 2. Adjusting Accounts
P1 2.4. Accrued Expenses
Expense Liability
Costs incurred in a period that are
both unpaid and unrecorded. Debit Credit
Adjustment Adjustment

FastForward’s employee earns $70 per day and is paid every two weeks on Friday.Year-end,
12/31/09, falls on a Wednesday. The last payday of 2009, is Friday, 12/26/09. From 12/26 until
year-end is three working days. The employee has earned salaries of $210 for Monday through
Wednesday. They will not be paid until the next Friday.
Last pay Next pay
date date
12/26/09 1/9/10

12/31/09 Record adjusting

Year end journal entry. 16
 2. Adjusting Accounts
P1 2.4. Accrued Expenses
Expense Liability
Costs incurred in a period that are
both unpaid and unrecorded. Debit Credit
Adjustment Adjustment

FastForward’s employee earns $70 per day and is paid every two weeks on Friday.Year-end,
12/31/09, the employee has earned salaries of $210.
Dr. Cr.
Dec. 31 Salaries Expense 210
Salaries Payable 210
To accrue 3 days' salary (3 x $70)

Salaries Expense Salaries Payable

Dec.12 700 Dec. 31 210
Dec.26 700
Dec. 31 210
Bal. 1,610

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 2. Adjusting Accounts
P1 2.4. Accrued Expenses

Future Payment of Accrued Expenses

On January 9, 2010, FastForwardwill pay the payroll for the two weeks from
December 26, 2009 through January 9, 2010. Here is the journal entry for the payroll:

Dr. Cr.
Jan 9 Salaries Payable (3 days @ $70) 210
Salaries Expense (7 days @ $70) 490
Cash (10 days @ $70) 700
P a id t wo - we e k s a la ry

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 2. Adjusting Accounts
P1 2.4. Accrued Expenses
Expense Liability
Costs incurred in a period that are
both unpaid and unrecorded. Debit Credit
Adjustment Adjustment
ACCRUED INTEREST EXPENSE

FastForward borrowed $6,000 from First National Bank on December 1, 2009. The
note bears interest at the annual rate of 6% and is due to be repaid in one year. Let’s
accrue interest for the month ended 12/31/09.
Dr. Cr.
Dec. 31 Interest Expense 30
Interest Payable 30
To accrue interest ($6,000 × 6% × 30/360)

Interest Expense Interest Payable

Dec. 31 30 Dec. 31 30

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 2. Adjusting Accounts
P1 2.5. Accrued Revenue
Asset Revenue
Revenues earned in a period
Debit Credit
that are both unrecorded and Adjustment Adjustment
not yet received.

On December 12, 2009, FastForward agrees to render consulting services

under a 30-day fixed fee contract for $2,700 ($90 per day). All services are
to be completed by January 10, 2010, when the client will pay in full.
Dr. Cr.
Dec. 31 Accounts Receivable 1,800
Consulting Revenue 1,800
To accrue revenue (20-days @ $90 per day)
Accounts Receivable Consulting Revenue
Other receivables Other revenues
1,900 Receipts 1,900 6,050
Dec. 31 1,800 Dec. 31 1,800
Bal. 1,800 Bal . 7,850
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 2. Adjusting Accounts
P1 2.5. Accrued Revenue

Future Payment of Accrued Expenses

On January 10, 2010, FastForward completed its obligation under the consulting
contract. The client was billed $2,700 and FastForward received $2,700 in cash

Dr. Cr.
Jan 10 Cash 2,700
Accounts Receivable 1,800
Consulting Revenue 900
T o re c o rd c o m ple t io n o f c o nt ra c t a nd c a s h c o lle c t io n

Revenue in January
10 days @ $90 = $900
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 2. Adjusting Accounts
A1 2.6. Links to Financial Statements
Summary of Adjustments and Financial Statement Links
Before Adjustment
Income
Balance Sheet Statement
Type Account Account Adjusting Entry
Prepaid Asset Overstated Expense Dr. Expense
Expenses Equity Overstated Understated Cr. Asset
Unearned Liability Overstated Revenue Dr. Liability
Revenues Equity Understated Understated Cr. Revenue
Accrued Liability Understated Expense Dr. Expense
Expenses Equity Overstated Understated Cr. Liability
Accrued Asset Understated Revenue Dr. Asset
Revenues Equity Understated Understated Cr. Revenue

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 2. Adjusting Accounts
P2 2.7. Adjusted Trial Balance
FastForward - Trial Balance -December 31, 2009
Unadjusted Adjusted
Trial Balance Adjustments Adjusted Trial Balance
Dr. Cr. Dr. Cr. Dr. Cr.
Cash 4,350
Accounts receivable -
Supplies 9,720
Prepaid insurance 2,400
Equipment 26,000
Accum. depr. - Equip. - First, the initial
Accounts payable 6,200
Salaries payable - unadjusted
Unearned revenue
C. Taylor, Capital
3,000
30,000
amounts are
C. Taylor Withdrawals
Consulting revenue
200
5,800
added to the
worksheet.
Rental revenue 300
Depr. expense -
Salaries expense 1,400
Insurance expense -
Rent expense 1,000
Supplies expense -
Utilities expense 230
Totals 45,300 45,300

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 2. Adjusting Accounts
P2 2.7. Adjusted Trial Balance
FastForward - Trial Balance -December 31, 2009
Unadjusted Adjusted
Trial Balance Adjustments Trial Balance
Dr. Cr. Dr. Cr. Dr. Cr.
Cash 4,350
Accounts receivable - f 1,800
Supplies 9,720 b 1,050
Prepaid insurance 2,400 a 100
Equipment 26,000
Accum. depr. - Equip. - c 375
Accounts payable 6,200
Salaries payable - e 210 Next,
Unearned revenue 3,000 d 250
C. Taylor, Capital 30,000 FastForward’s
C. Taylor, Withdrawals 200
Consulting revenue 5,800 d 250
adjustments are
f 1,800 added.
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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 2. Adjusting Accounts
P2 2.7. Adjusted Trial Balance
FastForward - Trial Balance -December 31, 2009
Unadjusted Adjusted
Trial Balance Adjustments Trial Balance
Dr. Cr. Dr. Cr. Dr. Cr.
Cash 4,350 4,350
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
C. Taylor, Capital 30,000 - 30,000
C. Taylor, Withdrawals 200 200
Consulting revenue 5,800 d 250 7,850
f 1,800
Rental revenue
Depr. expense -
300
c 375
Finally, the 375
300

Salaries expense 1,400 e 210 totals are 1,610

Insurance expense - a 100 100
Rent expense 1,000 determined. 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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 3. Preparing Financial Statements
P3
FastForward - Trial Balance -December 31, 2009

Let’s use FastForward’s adjusted trial balance to prepare

the company’s financial statements.

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 3. Preparing Financial Statements
P3 3.1. Prepare the Income Statement
Adjusted
Trial Balance FastForward
December 31, 2009
Income Statement
Dr. Cr.
Cash $ 4,350 For the Month Ended December 31, 2009
Accounts receivable 1,800 Revenues:
Supplies 8,670
Prepaid insurance 2,300 Consulting revenue $ 7,850
Equipment 26,000 Rental revenue 300
Accum. depr. - Equip. $ 375
Accounts payable 6,200 Operating expenses:
Salaries payable 210 Depr. expense - Equip. $ 375
Unearned revenue 2,750
C. Taylor, Capital 30,000 Salaries expense 1,610
C. Taylor, Withdrawals 200 Insurance expense 100
Consulting revenue 7,850
Rental revenue 300 Rent expense 1,000
Depr. expense 375
Supplies expense 1,050
Salaries expense 1,610
Insurance expense 100 Utilities expense 230
Rent expense 1,000
Total expenses 4,365
Supplies expense 1,050
Utilities expense 230 Net income $ 3,785
Totals $ 47,685 $ 47,685
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 3. Preparing Financial Statements
P3 3.2. Prepare the Statement of Changes in Owner’s Equity.
FastForward
Income Statement
For the Month Ended December 31, 2009
Revenues: Note: Net Income from the Income
Consulting revenue $ 7,850
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 FastForward
Total expenses 4,365
Net income $ 3,785
Statement of Changes in Owner's Equity
For the Month Ended December 31, 2009

C. Taylor, Capital 12/1/09 $ -0-

Add: Net income $ 3,785
Investment by owner 30,000 33,785
Total 33,785
Less: Withdrawal by owner 200
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C. Taylor, Capital 12/31/09 $ 33,585
 3. Preparing Financial Statements
FastForward
P3 3.3. Prepare the Balance Sheet. Statement of Changes in Owner's Equity
For the Month Ended December 31, 2009

C. Taylor, Capital 12/1/07 $ -0-

FastForward Add: Net income $ 3,785
Investment by owner 30,000 33,785
Balance Sheet
Total 33,785
12/31/09 Less: Withdrawal by owner 200
Assets C. Taylor, Capital 12/31/07 $ 33,585

Cash $ 4,350
Accounts Receivable 1,800 Adjusted
Supplies 8,670 Trial Balance
Prepaid Insurance 2,300 December 31, 2009
Dr. Cr.
Equipment $ 26,000
Cash $ 4,350
Accumulated Depreciation 375 25,625
Accounts receivable 1,800
Total assets $ 42,745 Supplies 8,670
Prepaid insurance 2,300
Liabilities
Equipment 26,000
Accounts Payable 6,200 Accum. depr. - Equip. $ 375
Salaries Payable 210 Accounts payable 6,200
Unearned Revenue 2,750 Salaries payable 210
Total Liabilities 9,160 Unearned revenue 2,750
C. Taylor, Capital 30,000
Equity C. Taylor, Withdrawals 200
C Taylor, Capital 33,585
Total liabilities and Equity $ 42,745 29
 3. Preparing Financial Statements
P3

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A2 4. Profit Margin

The profit margin ratio measures the company’s net income to net sales.
Ind. Assignment-
read Analysis pg.
𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆
147 Net P𝐫𝐨𝐟𝐢𝐭 𝑴𝒂𝒓𝒈𝒊𝒏 =
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔

Comparison of profit margin at Limited Brands, Inc. to the

industry-wide profit margin.
Profit Margin

9.0% 8.0%
$ in millions 2007 2006 2005 2004
7.0% 7.5%
8.0%
7.0%
6.3% Net income $676 $683 $705 $717
6.0%
5.0% Net sales 10,671 9,699 9,408 8,934
4.0%
3.0%
1.6% 1.5% 1.4% 1.5%
Profit margin 6.3% 7.0% 7.5% 8.0%
2.0%
1.0% Industry profit margin 1.6% 1.5% 1.4% 1.5%
0.0%
2007 2006 2005 2004

Limited Brands, Inc. Industry

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Homework

HOMEWORK:
E3-7, 3-8, pg. 159, 3-12 pg.160
Problem 3-1A, page 161; Problem 3-3A, page 162 (Wild 22nd ed)

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