03 Adjusting Entries.pdf

Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations Adjusting the Accounts STUDY OBJECTIVES 1. EXPLAIN THE TIME PERIOD ASSUMPTION. 2. EXPLAIN THE ACCRUAL BASIS OF ACCOUNTING. 3....

Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations Adjusting the Accounts STUDY OBJECTIVES 1. EXPLAIN THE TIME PERIOD ASSUMPTION. 2. EXPLAIN THE ACCRUAL BASIS OF ACCOUNTING. 3. EXPLAIN WHY ADJUSTING ENTRIES ARE NEEDED. 4. IDENTIFY THE MAJOR TYPES OF ADJUSTING ENTRIES. 5. PREPARE ADJUSTING ENTRIES FOR PREPAYMENTS. 6. PREPARE ADJUSTING ENTRIES FOR ACCRUALS. 7. DESCRIBE THE NATURE AND PURPOSE OF AN ADJUSTED TRIAL BAL- ANCE. 8. PREPARE ADJUSTING ENTRIES FOR THE ALTERNATIVE TREATMENT OF PREPAYMENTS. Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 1 Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations Time-Period Assumption 1. (S.O. 1) The time period (or periodicity) assumption assumes that the economic life of a business can be divided into artificial time periods. 2. Accounting time periods are generally a month, a quarter, or a year. The accounting time period of one year in length is usually known as a fiscal year. Accrual Basis of Accounting 3. (S.O. 2) The revenue recognition and matching principles are used under the accrual basis of accounting. Under cash basis accounting, revenue is recorded only when cash is received and expenses are recorded only when paid. 4. Generally accepted accounting principles require accrual basis accounting rather than cash basis accounting because the cash basis of accounting often leads to misleading financial statements. Revenue Recognition Principle 5. The revenue recognition principle states that reve- nue should be recognized in the accounting period in which it is earned. Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 2 Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations The Matching Principle 6. The matching principle dictates that efforts (expenses) be matched with accomplishments (revenues). Adjusting Entries 7. (S.O. 3) Adjusting entries are made in order for: a. Revenues to be recorded in the period in which they are earned, and for ex- penses to be recognized in the period in which they are incurred. b. The revenue recognition and matching principles to be followed. 8. (S.O. 4) Adjusting entries are required every time financial statements are prepared. Ad- justing entries can be classified as (a) prepayments (prepaid expenses or unearned reve- nue) or (b) accruals (accrued revenues or accrued expenses). Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 3 Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations Prepayments 9. (S.O. 5) Prepaid expenses are expenses paid in cash and recorded as assets before they are used or consumed. a. Prepaid expenses expire with the passage of time or through use and consumption. b. An asset-expense account relationship exists with prepaid expenses. c. Prior to adjustment, assets are overstated and expenses are understated. d. The adjusting entry results in a debit to an expense account and a credit to an asset account. e. Examples of prepaid expenses include supplies, insurance, and depreciation. f. To illustrate a prepaid adjusting entry, assume on October 1, Kubitz Company pays P2,400 cash to Sandy Insurance Co. for a one-year insurance policy effective October 1. The adjusting entry at October 31 is: Insurance Expense (P2,400 X 1/12).......................... 200 Prepaid Insurance............................................... 200 Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 4 Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations 10. Depreciation is the process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner. a. The purchase of equipment or a building is viewed as a long-term prepayment of ser- vices and, therefore, is allocated in the same manner as other prepaid expenses. b. Depreciation is an estimate rather than a factual measurement of the cost that has expired. c. In recording depreciation, Depreciation Expense is debited and a contra asset account, Accumulated Depreciation, is credited. d. In the balance sheet, Accumulated Depreciation is offset against the asset account. The difference between the cost of the asset and its related accumulated depreciation is referred to as the book value of the asset. e. To illustrate an adjusting entry for depreciation, assume Resch Co. purchases a ma- chine for P6,000 cash on January 1, 2002. Assuming that annual depreciation is P1,200, the adjusting entry at December 31, 2002 is: Depreciation Expense................................................ 1,200 Accumulated Depreciation¾Machinery.............. 1,200 Another Example: Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 5 Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations 11. Unearned revenues are revenues received and recorded as liabilities before they are earned. a. Unearned revenues are subsequently earned by rendering service to a customer. b. A liability-revenue account relationship exists with unearned revenues. c. Prior to adjustment, liabilities are overstated and revenues are understated. d. The adjusting entry results in a debit to a liability account and a credit to a revenue account. e. Examples of unearned revenues include rent, magazine subscriptions, and customer deposits for future service. f. To illustrate an unearned revenue adjusting entry, assume on October 1, Schoen Co. receives P3,000 cash from a renter in payment of monthly rent for the period October through December. At October 31, the adjusting entry to record the rent earned in Oc- tober is: Unearned Rent Revenue............................................. 1,000 Rent Revenue (P3,000 X 1/3)............................. 1,000 Accruals 12. (S.O. 6) Accrued revenues are revenues earned but not yet received in cash. a. Accrued revenues may accumulate with the passing of time as in the case of interest and rent, or through services performed but not billed or collected. b. An asset-revenue account relationship exists with accrued revenues. c. Prior to adjustment, both assets and revenues are understated. Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 6 Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations d. The adjusting entry results in a debit to an asset account and a credit to a revenue account. e. To illustrate an accrued revenue adjusting entry, assume in October, Mayer, a dentist, performs P800 of services for patients who are not billed until November. The adjusting entry at October 31 is: Accounts Receivable................................................... 800 Dental Fees Earned............................................ 800 13. Accrued expenses are expenses incurred but not yet paid or recorded. a. Accrued expenses result from the same causes as accrued revenues and include inter- est, rent, taxes, and salaries. b. A liability-expense account relationship exists with accrued expenses. c. Prior to adjustment, both liabilities and expenses are understated. d. The adjusting entry results in a debit to an expense account and a credit to a liability account. e. To illustrate an accrued expense adjusting entry, assume Schwenk Company incurs salaries of P4,000 during the last week of October that will be paid in November. The adjusting entry on October 31 is: Salaries Expense......................................................... 4,000 Salaries Payable................................................. 4,000 Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 7 Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations 14. Each adjusting entry affects one balance sheet account and one income statement account. Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 8 Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations The data needed to determine adjustments for the two-month period ending July 31,2010, are as follows: a. During July, Music Depot provided guest disc jockeys for WHBD for a total of 120 hours. For information on the amount of the accrued revenue to be billed to WHBD, see the contract described in the July 3,2010, transaction at the end of chapter 2. b. Supplies on hand at July 31, P175. c. The balance of the prepaid insurance account relates to the July 1, 2010, transaction at the end of chapter 2. d. Depreciation of the office equipment is P60. e. The balance of the unearned revenue account relates to the contract between Music Depot and WHBD, described in the July 3, 2010, transaction at the end of chapter 2. f. Accrued wages as of July 31,2010, were P120. INSTRUCTIONS 1. Prepare adjusting journal entries. You will need the following additional accounts: 18 Accumulated Depreciation – Office Equipment 22 Wages Payable 57 Insurance Expense 58 Depreciation 2. Post the adjusting entries, inserting balances in the accounts in the accounts affected. 3. Prepare an adjusted trial balance. Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 9 Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations Adjusted Trial Balance 15. (S.O. 7) After all adjusting entries have been journalized and posted an adjusted trial bal- ance is prepared. This trial balance shows the balances of all accounts, including those that have been adjusted, at the end of the accounting period. 16. The purpose of an adjusted trial balance is to prove the equality of the total debit balances and the total credit balances in the ledger after all adjustments have been made. 17. The accounts in the adjusted trial balance contain all data that are needed for the prepara- tion of financial statements. MUSIC DEPOT Adjusted Trial Balance July 31, 2010 Debit Credit Balances Balances Cash............................................................................. 12,780 Accounts Receivable.................................................... 4,750 Supplies....................................................................... 175 Prepaid Insurance........................................................ 2,475 Office Equipment.......................................................... 5,000 Accumulated Depreciation—Office Equipment............ 60 Accounts Payable........................................................ 5,680 Wages Payable............................................................ 120 Unearned Revenue...................................................... 3,600 Lee Chang, Capital...................................................... 10,500 Lee Chang, Drawing.................................................... 1,700 Fees Earned................................................................. 20,500 Wages Expense........................................................... 2,520 Office Rent Expense.................................................... 2,750 Equipment Rent Expense............................................ 1,100 Utilities Expense........................................................... 860 Music Expense............................................................. 2,810 Advertising Expense.................................................... 1,600 Supplies Expense........................................................ 855 Insurance Expense...................................................... 225 Depreciation Expense.................................................. 60 Miscellaneous Expense............................................... 800 40,460 40,460 Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 10 Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations Alternative Treatment 18. (S.O. 8) Under the alternative treatment, at the time an expense is prepaid, an expense account is debited, and when unearned revenues are received a revenue account is cred- ited. 19. The alternative treatment of prepaid expenses and unearned revenues has the same effect on the financial statements as the procedures described in the chapter. 20. When a prepaid expense is initially debited to an expense account, a. No adjusting entry will be required if the prepayment is fully expired or consumed before the next financial statement date. b. If the prepayment is not fully expired or consumed, an adjusting entry is required. c. Prior to adjustment an expense account is overstated and an asset account is un- derstated. d. The adjusting entry results in a debit (increase) to an asset account and a credit (de- crease) to an expense account. e. To illustrate the adjusting entry, assume Gonzalez Company purchases P1,200 of sup- plies and debits Office Supplies Expense. At the next financial statement date, P300 of supplies are on hand. The adjusting entry is: Office Supplies........................................................... 300 Office Supplies Expense..................................... 300 21. When an unearned revenue is initially credited to a revenue account, the procedures are similar to those described above for prepaid expenses. In this case, however, a. Prior to adjustment, a revenue account is overstated and a liability account is un- derstated. b. The adjusting entry results in a debit to a revenue account and a credit to a liability account. Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 11 Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 12 Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations 20 MINUTE QUIZ Circle the correct answer. True/False 1. Since companies find it desirable and necessary to report the results of their activities fre- quently, the time period assumption assumes that the economic life of a business can be divided into artificial time periods. True False 2. The revenue recognition principle dictates that revenue be recognized in the period in which it was received rather than when it was earned. True False 3. Monthly and quarterly time periods are commonly referred to as fiscal periods. True False 4. Payments of expenses that will benefit more than one accounting period are referred to as prepaid expenses. True False 5. Cost less accumulated depreciation is a measurement of the current value of an asset such as equipment or a building. True False 6. Depreciation is the allocation of the cost of an asset to expense over its useful life in a rational and systematic manner. True False 7. The adjusting entry for unearned revenues results in a debit to an asset account and a credit to a revenue account. True False 8. A contra-asset account is an account whose balance is deducted from a related asset in the financial statements. True False 9. When accrual basis accounting is applied, adjusting entries are not necessary. True False Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 13 Accounting 11A Financial Accounting and Reporting Accounting Process for Service Operations 10. Adjustments for accrued expenses are necessary to record the obligations that exist at the balance sheet date and to recognize the expenses that are applicable to the current ac- counting period. True False Multiple Choice 1. The recording of wages earned but not yet paid is an example of an adjustment that a. recognizes an accrued expense. b. recognizes an unrecorded revenue. c. apportions revenues between two or more periods. d. apportions costs between two or more periods. 2. A list of the accounts and their balances after all adjustments have been made is known as a. adjusting entries. b. adjusted trial balance. c. book values. d. accrued accounts. 3. Prior to recording of adjusting entries, revenues exceed expenses by P40,000. Adjusting entries for accrued wages of P5,000 and depreciation expense of P5,000 were made. Net income for the year would be a. P40,000. b. P35,000. c. P30,000. d. none of the above. 4. The adjustment for depreciation is an example of a. recognizing an accrued expense. b. apportioning costs between two or more periods. c. apportioning revenues between two or more periods. d. recognizing an unrecorded revenue. 5. Most businesses choose fiscal years which correspond to a. the calendar year. b. any twelve-month period. c. their natural business year. d. any of the above. Content is adopted from Warren, Reeve, Duchac (2009). Accounting. South-western Cengage Learning. Rey Joseph M. Redoblado | 14