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Adjustments, Financial Statements, and Adjustments, Financial Statements, and the Quality of Earningsthe Quality of Earnings
Chapter 4
McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.
Accounting Cycle
Prepare financial statements.
Disseminate statements to users.
Prepare financial statements.
Disseminate statements to users.
Close revenues, gains, expenses, and losses to Retained Earnings.
Close revenues, gains, expenses, and losses to Retained Earnings.
During the period: Analyze transactions. Record journal entries. Post amounts to general
ledger.
During the period: Analyze transactions. Record journal entries. Post amounts to general
ledger.
At the end of the period: Adjust revenues and
expenses.
At the end of the period: Adjust revenues and
expenses.
Start of Period
McGraw-Hill/Irwin Slide 3
Types of AdjustmentsThere are four types of adjustments.
ExpensesExpensesExpensesExpenses
3. Prepaid Expenses.
4. Accrued Expenses.
3. Prepaid Expenses.
4. Accrued Expenses.
RevenuesRevenuesRevenuesRevenues
1. Unearned Revenues.
2. Accrued Revenues.
1. Unearned Revenues.
2. Accrued Revenues.
McGraw-Hill/Irwin Slide 4
End of accounting period.
Cash received. Revenues earned.
Example includes rent received in Example includes rent received in advance (an unearned revenue).advance (an unearned revenue).
Example includes rent received in Example includes rent received in advance (an unearned revenue).advance (an unearned revenue).
Unearned Revenues
McGraw-Hill/Irwin Slide 5
End of accounting period.
Cash receivedRevenues earned
Example includes interest earned during the period (accrued revenue).
Example includes interest earned during the period (accrued revenue).
Accrued Revenue
McGraw-Hill/Irwin Slide 6
End of accounting period.
Cash paid.
Examples include prepaid rent, Examples include prepaid rent, advertising, and insurance.advertising, and insurance.
Examples include prepaid rent, Examples include prepaid rent, advertising, and insurance.advertising, and insurance.
Prepaid Expenses
Expense incurred.
McGraw-Hill/Irwin Slide 7
Accrued Expenses
As of 12/27/09, Denton, Inc. had already paid $1,900,000 in As of 12/27/09, Denton, Inc. had already paid $1,900,000 in wages for the year. Denton pays its employees every wages for the year. Denton pays its employees every
Friday. Year-end, 12/31/09, falls on a Wednesday. The Friday. Year-end, 12/31/09, falls on a Wednesday. The employees have earned total wages of $50,000 for employees have earned total wages of $50,000 for
Monday through Wednesday of the week ending 1/02/10. Monday through Wednesday of the week ending 1/02/10.
Certain circumstances require adjusting entries to record accounting estimates.
Examples include . . .DepreciationBad debts Income taxes
Certain circumstances require adjusting entries to record accounting estimates.
Examples include . . .DepreciationBad debts Income taxes
Accrued Expenses Involving Estimates
The income statement contains
revenues and expenses.
The income statement contains
revenues and expenses.
Earnings Per Earnings Per Share (EPS) must Share (EPS) must
be reported on be reported on the income the income statement.statement.
Earnings Per Earnings Per Share (EPS) must Share (EPS) must
be reported on be reported on the income the income statement.statement.
McGraw-Hill/Irwin Slide 10
Statement of Stockholders’ EquityNet income appears on the statement of stockholders’
equity as an increase in Retained Earnings.
From theIncome
Statement
McGraw-Hill/Irwin Slide 11
Balance Sheet – Liabilities & Stockholders’ Equity
From the From the Statement of Statement of Stockholders’ Stockholders’
Equity.Equity.
From the From the Statement of Statement of Stockholders’ Stockholders’
Equity.Equity.
McGraw-Hill/Irwin Slide 12
Closing the Books
Even though the balance sheet account balances
carry forward from period to period, the
income statement accounts do not.
Closing entries:Closing entries:1.1. Transfer net income (or loss) Transfer net income (or loss)
to Retained Earnings.to Retained Earnings.2.2. Establish a zero balance in Establish a zero balance in
each of the each of the temporarytemporary accounts to start the next accounts to start the next accounting period.accounting period.
Closing entries:Closing entries:1.1. Transfer net income (or loss) Transfer net income (or loss)
to Retained Earnings.to Retained Earnings.2.2. Establish a zero balance in Establish a zero balance in
each of the each of the temporarytemporary accounts to start the next accounts to start the next accounting period.accounting period.
McGraw-Hill/Irwin Slide 13
Closing the Books
Two steps are used in the Two steps are used in the closing process . . .closing process . . .
1.1. Close revenues and gains to Close revenues and gains to Retained Earnings.Retained Earnings.
2.2. Close expenses and losses to Close expenses and losses to Retained Earnings.Retained Earnings.
McGraw-Hill/Irwin Slide 14
Post-Closing Trial Balance
After all temporary accounts have been closed, we After all temporary accounts have been closed, we prepare a post-closing trial balance. Only assets, prepare a post-closing trial balance. Only assets,
liabilities, and stockholders’ equity accounts will appear. liabilities, and stockholders’ equity accounts will appear. All revenue, expense, gain and loss accounts will have a All revenue, expense, gain and loss accounts will have a
zero balance. zero balance.
