topic 6 - recording year end adjustments

© The McGraw-Hill Companies, Inc., 2007

Recording Year End Adjustments and

Preparing Financial Statements

Topic

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Adjustments??


Learning ObjectivesLearning Objectives

Explain the importance of periodic reporting and the time period principle

Identify the types of adjustments and their purpose Prepare and explain adjusting entries Explain and prepare an adjusted trial balance Prepare financial statements from an adjusted trial

balance Describe and prepare closing entries Explain and prepare a post-closing trial balance Explain and prepare a classified balance sheet


1 2 3 4 5 6 7 8 9 10 11 12

1 2 3 4

Annual

1 2

Monthly

Quarterly

Semiannual

The Accounting PeriodThe Accounting Period

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec


The Accounting PeriodThe Accounting Period

Calendar year- reporting period of 12 months covering from 1 January to 31 December

Fiscal year- reporting period consisting of any 12 consecutive months, in which the starting month is not necessarily beginning from 1 January. Eg. 1 April 2005 to 31 March 2006


Accounting

Accrual Basis vs. Cash BasisAccrual Basis vs. Cash Basis

Accrual Basis

Revenues are recognized when

earned and expenses are recognized when

incurred.

Cash Basis

Revenues are recognized when

cash is received and expenses recorded when cash is paid.

Not GAAPNot GAAPNot GAAPNot GAAP•Revenue Recognition•Matching


SourceDocuments

Journal

LedgerTrial BalanceAdjustments

AdjustedTrial Balance

Financial Statements

Closing Entries

The Accounting CycleThe Accounting Cycle


AdjustmentsAdjustments

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

Adjusting AccountsAdjusting Accounts

Paid (or received) cash before expense (or revenue) recognizedPaid (or received) cash before

expense (or revenue) recognizedPaid (or received) cash after

expense (or revenue) recognizedPaid (or received) cash after

expense (or revenue) recognized

Prepaid (Deferred) expenses*

Prepaid (Deferred) expenses*

Unearned (Deferred) revenues

Unearned (Deferred) revenues

AccruedexpenseAccruedexpense

AccruedrevenuesAccruedrevenues

Framework for Adjustments

*including depreciation


Here is the checkfor my first

6 months’ rent.

Here is the checkfor my first

6 months’ rent.

1. Adjusting Prepaid (Deferred) Expenses


Resources paid for prior to receiving the

actual benefits.

Resources paid for prior to receiving the

actual benefits.




Asset Expense

UnadjustedBalance

CreditAdjustment

DebitAdjustment

Dec 31 Expense Acc xx

Asset Acc xx

Journal:


Ex:Prepaid InsuranceEx:Prepaid Insurance

On 1 December 2006, Suria Company paid RM12,000 to cover rent for December 2006 through May 2007. Scott recorded the expenditure as Prepaid Insurance

on 1 December. What adjustment is required?

On 1 December 2006, Suria Company paid RM12,000 to cover rent for December 2006 through May 2007. Scott recorded the expenditure as Prepaid Insurance

on 1 December. What adjustment is required?

RM12,000 – insurance for 6 month

So, insurance for December 2006?


Ex:Prepaid InsuranceEx:Prepaid Insurance

Dec. 31 Insurance Expense 2,000 Prepaid Insurance 2,000

To record first month's expired insurance

Dec. 1 12,000 Dec. 31 2,000Bal. 10,000

Prepaid Insurance 637

Dec. 31 2,000Insurance Expense 128


Straight-LineDepreciationExpense

= Asset Cost - Salvage Value

Useful Life

Adjusting for DepreciationAdjusting for Depreciation

Depreciation is the process of computing expense from allocating the cost of plant and equipment over their

expected useful lives.


Ex: Adjusting for DepreciationEx: Adjusting for Depreciation

On 1 January 2006, Sykt Batik purchased equipment for RM62,000 cash. The equipment has an

estimated useful life of 5 years and Barton expects to sell the equipment at the end of its life for

RM2,000 cash.Let’s record depreciation expense for the year ended

31 December 2006.

2006Depreciation

Expense= RM62,000 - RM2,000

5= RM12,000


Ex: Adjusting for DepreciationEx: Adjusting for Depreciation

Dec. 31 Depreciation Expense 12,000 Accumulated Depreciation - Equipment 12,000

To record equipment depreciation

Accumulated depreciation isa contra asset account.

Accumulated depreciation isa contra asset account.


Equipment Depreciation Expense

1/1 62,000 31/12 12,000

Accumulated Depreciation31/12 12,000

Ex: Adjusting for DepreciationEx: Adjusting for DepreciationDec. 31 Depreciation Expense 12,000

Accumulated Depreciation - Equipment 12,000 To record equipment depreciation


Adjusting for DepreciationAdjusting for Depreciation

Equipment is shown net of accumulated depreciation.

RM


Buy your season tickets forall home basketball games NOW!

2. Adjusting Unearned (Deferred) Revenues


Cash received in advance of

providing products or services.

Cash received in advance of

providing products or services.

Liability RevenueUnadjusted

BalanceCredit

AdjustmentDebit

Adjustment




Journal:

Dec 31 Unearned Revenue Acc xxRevenue Acc xx


Ex:Adjusting Unearned (Deferred) Revenues

Ex:Adjusting Unearned (Deferred) Revenues

On 1 October 2006, Universiti Utama(UU) sold 1,000 season tickets to its 20 home basketball games for

RM100 each. UU makes the following entry:

Oct. 1 Cash 100,000 Unearned Revenue 100,000

Basketball revenue received in advance

Oct. 1 100,000Unearned Revenue


Ex: Adjusting Unearned (Deferred) Revenues

Ex: Adjusting Unearned (Deferred) Revenues

On 31 December, UU has played 10 of its regular home games, winning 2 and losing 8.

Dec. 31 Unearned Revenue 50,000 Basketball Revenue 50,000

To recognized 10-game basketball revenue

Dec 31 50,000 Oct. 1 100,000Bal. 50,000

Unearned RevenueDec. 31 50,000

Basketball Revenue


We’re about one-halfdone with this job and

want to be paid forour work!

We’re about one-halfdone with this job and

want to be paid forour work!

Costs incurred in a period that are

both unpaid and unrecorded.

Costs incurred in a period that are

both unpaid and unrecorded.

3. Adjusting for Accrued Expenses


Expense LiabilityCredit

AdjustmentDebit

Adjustment




Journal:

Dec 31 Expense Acc xx

Liability Acc xx


1/12/06 31/12/06Year end

Last paydate

26/12/06

Next paydate

2/01/07

Record adjustingjournal entry.

Record adjustingjournal entry.

Ex:Adjusting for Accrued Expenses

Ex:Adjusting for Accrued Expenses

Sykt Beras pays its employees every Friday. Year-end, 31/12/06, falls on a Wednesday. As of 31/12/06, the employees have earned salaries of RM47,250 for Monday through Wednesday of the week ended

2/01/07.

Sykt Beras pays its employees every Friday. Year-end, 31/12/06, falls on a Wednesday. As of 31/12/06, the employees have earned salaries of RM47,250 for Monday through Wednesday of the week ended

2/01/07.


Ex: Adjusting for Accrued Expenses

Ex: Adjusting for Accrued Expenses

Sykt. Beras pays its employees every Friday. Year-end, 31/12/06, falls on a Wednesday. As of 31/12/06, the employees have earned salaries of RM47,250 for Monday through Wednesday of the week

ended 2/01/07.

Sykt. Beras pays its employees every Friday. Year-end, 31/12/06, falls on a Wednesday. As of 31/12/06, the employees have earned salaries of RM47,250 for Monday through Wednesday of the week

ended 2/01/07.

Dec. 31 Salaries Expense 47,250 Salaries Payable 47,250

To accrue 3-days' salary

Other salaries657,500

Dec. 31 47,250Bal. 704,750

Salaries Expense

Dec. 31 47,250Salaries Payable


Yes, I’ve completed yourtax return, but have not had

time to bill you yet.

Yes, I’ve completed yourtax return, but have not had

time to bill you yet.

4. Adjusting Accrued Revenues


Revenues earned in a period that

are both unrecorded and not yet received.

Revenues earned in a period that

are both unrecorded and not yet received.

Asset Revenue

CreditAdjustment

DebitAdjustment




Journal:

Dec 31 Asset Acc xx

Revenue Acc xx


Ex:Adjusting for Accrued Revenues

Ex:Adjusting for Accrued Revenues

Kamal Amin, CA(M), had RM31,200 of work completed but not yet billed to clients. Let’s make

the adjusting entry necessary on 31 December 2006, the end of the company’s fiscal year.

Kamal Amin, CA(M), had RM31,200 of work completed but not yet billed to clients. Let’s make

the adjusting entry necessary on 31 December 2006, the end of the company’s fiscal year.

Dec. 31 Accounts Receivable 31,200 Service Revenue 31,200

To accrue revenue earned

Other receivables

1,325,268

Dec. 31 31,200Bal. 1,356,468

Accounts ReceivableOther revenues

6,589,500

Dec. 31 31,200Bal . 6,620,700

Service Revenue


Type

Balance Sheet Account

Income Statement Account Adjusting Entry

Prepaid Asset Expense Dr. ExpenseExpenses Overstated Understated Cr. Asset

Unearned Liability Revenue Dr. LiabilityRevenues Overstated Understated Cr. Revenue

Accrued Liability Expense Dr. ExpenseExpenses Understated Understated Cr. Liability

Accrued Asset Revenue Dr. AssetRevenues Understated Understated Cr. Revenue

Before Adjustment

Summary of Adjustments and Financial Statement Links

Links to Financial StatementsLinks to Financial Statements


SourceDocuments

Journal




Closing Entries



Adjusted Trial BalanceAdjusted Trial Balance

List of accounts and balances prepared after adjusting entries have been recorded and posted to the ledger.

Use a work sheet to prepare adjusted trial balance & financial statement (as a tool)


Benefits of a Work SheetBenefits of a Work Sheet

Aids the preparation of

financial statements.

Aids the preparation of


Reduces possibility of

errors.

Reduces possibility of

errors.

Assists in planning and organizing an

audit.

Assists in planning and organizing an

audit.

Helps in preparing

interim financial statements.

Helps in preparing

interim financial statements.

Shows the effects of proposed

transactions.

Shows the effects of proposed

transactions.

Not a required report.

Links accounts and their

adjustments.

Links accounts and their

adjustments.


SYKT MAJUTRIAL BALANCE

31 DECEMBER 2006

First, the initial

unadjusted amounts are added to the worksheet.

First, the initial

unadjusted amounts are added to the worksheet.

$

$

$$


Next, Sykt Maju’s

adjustments are added. (pg96-102)

Next, Sykt Maju’s

adjustments are added. (pg96-102)

SYKT. MAJUTRIAL BALANCE

31 DECEMBER 2006

$

$

$$

$$

$$


SYKT MAJUTRIAL BALANCE

31 DECEMBER 2006Finally, the totals are determined.

Finally, the totals are determined.

$

$

$$

$$

$$

$

$

$$


SourceDocuments

Journal




Closing Entries



FastForwardWork Sheet

For Month Ended December 31, 2004

Sort adjusted trial balance amounts to financial statements.

Sort adjusted trial balance amounts to financial statements.


FastForwardWork Sheet

For Month Ended December 31, 2004

Total statement columns, compute income or loss, and balance columns.

Total statement columns, compute income or loss, and balance columns.


Prepare the IncomeStatement.

Prepare the Financial StatementsPrepare the Financial Statements

A work sheet does not substitute for


A work sheet does not substitute for



Prepare the Statement of Changes in Owner’s Equity.


SYKT MAJUBALANCE SHEET

31 DECEMBER 2006

Non-current assetsEquipment $ 26,000Less: accum. depr. 375 $25,625Current assetsCash 3,950Accounts receivable 1,800Supplies 8,670Prepaid insurance 2,300

Total assets $42,345

EquityC. Taylor, Capital $33,185

Current liabilitiesAccounts payable 6,200Salaries payable 210Unearned consulting revenues 2,750Total equity and liabilities $42,345

SYKT MAJUBALANCE SHEET

31 DECEMBER 2006

Non-current assetsEquipment $ 26,000Less: accum. depr. 375 $25,625Current assetsCash 3,950Accounts receivable 1,800Supplies 8,670Prepaid insurance 2,300

Total assets $42,345

EquityC. Taylor, Capital $33,185

Current liabilitiesAccounts payable 6,200Salaries payable 210Unearned consulting revenues 2,750Total equity and liabilities $42,345

Prepare the Balance Sheet.


SourceDocuments

Journal




Closing Entries



Resets revenue, expense and withdrawal account balances to zero at the end of the period.

Helps summarize a period’s revenues and expenses in the Income Summary account.

Identify accounts for closing.

Record and post closing entries.

Prepare post-closing trial balance.

Closing ProcessClosing Process


Temporary Accounts

Revenues

Income Summary

Exp

ense

s

With

draw

als

Permanent Accounts

Assets

Lia

bili

ties

Ow

ner’s

Cap

ital

The closing process applies only to

temporary accounts.

The closing process applies only to

temporary accounts.



Let’s see how the closing process

works!

Recording Closing EntriesRecording Closing Entries

Close Revenue accounts to Income Summary.

Close Expense accounts to Income Summary.

Close Income Summary account to Owner’s Capital.

Close Withdrawals to Owner’s Capital.

Close Revenue accounts to Income Summary.

Close Expense accounts to Income Summary.

Close Income Summary account to Owner’s Capital.

Close Withdrawals to Owner’s Capital.


Balances before closing.

Income Summary

Owner's Capital30,000

30,000

Revenue Accounts25,000

25,000

Withdrawals Account5,000

5,000

Expense Accounts10,000

10,000



Income Summary25,000

25,000

Close Revenue accounts to Income

Summary.

Owner's Capital30,000

30,000

Revenue Accounts25,000 25,000

-


5,000

Expense Accounts10,000

10,000



Income Summary10,000 25,000

15,000 Owner's Capital30,000

30,000


-


5,000

Close Expense accounts to Income

Summary.

Expense Accounts10,000 10,000

-


The balance in Income Summary equals profit

for the period

The balance in Income Summary equals profit

for the period


Owner's Capital30,000 15,000

45,000


45,000


5,000


5,000

Close Income Summary to

Owner’s Capital.


-


-

Income Summary10,000 25,000 15,000

-




45,000


15,000

40,000


5,000

Withdrawals Account5,000 5,000

-


-


-

Income Summary10,000 25,000 15,000

-


Close Withdrawals account to Owner’s

Capital.


Using the adjusted trial balance, let’s prepare the

closing entries for

FastForward.


Close Revenue accounts to

Income Summary.


Close Revenue Accounts to Income Summary


Dec. 31 Consulting revenue 7,850 Rental revenue 300

Income summary 8,150

Dec. 31 Consulting revenue 7,850 Rental revenue 300

Income summary 8,150

Now, let’s look at the ledger accounts after posting this closing entry.




Consulting Revenue7,850 7,850

-

Rental Revenue300 300

-

Income Summary7,850

300


Close Expense accounts to

Income Summary.



Close Expense Accounts to Income Summary


Dec. 31 Income summary 4,365Depreciation expense-Equipment 375Salaries expense 1,610Insurance expense 100Rent expense 1,000Supplies expense 1,050Utilities expense 230


Income Summary4,365 7,850

300 3,785

Utilities Expense230 230

-

Rent Expense1,000 1,000

-

Profit for the period

Close Expense Accounts to Income Summary Close Expense Accounts to Income Summary



Supplies Expense1,050 1,050

-

Depreciation Expense- Eq.

375 375 -

Salaries Expense1,610 1,610

-

Insurance Expense100 100

-


Close Income Summary to

Owner’s Capital.



Close Income Summary to Owner’s Capital


Dec. 31 Income summary 3,785C. Taylor, Capital 3,785


C. Taylor, Capital30,000 3,785

33,785

Close Income Summary to Owner’s Capital Close Income Summary to Owner’s Capital



Income Summary4,365 7,850 3,785 300

-


Close Withdrawals to

Owner’s Capital.



Close Withdrawals to Owner’s Capital


Dec. 31 C. Taylor, Capital 600C. Taylor, Withdrawals 600


C. Taylor, Capital600 30,000

3,785

33,185

C. Taylor, Withdrawals

600 600

-




Let’s look at FastForward’s

post-closing trial balance.

Post-Closing Trial BalancePost-Closing Trial Balance

List of permanent accounts and their balances after posting closing entries.

Total debits and credits must be equal.

List of permanent accounts and their balances after posting closing entries.

Total debits and credits must be equal.


Post-Closing Trial BalancePost-Closing Trial Balance


Categories of a Classified Balance SheetAssets Liabilities and Equity

Current Assets Current LiabilitiesNoncurrent Assets Noncurrent Liabilities

Long-Term Investments EquityFixed AssetsIntangible Assets

Current items are those expected to come due (both collected and owed) within the longer of one year or

the company’s normal operating cycle.

Classified Balance SheetClassified Balance Sheet


SNOWBOARDING COMPONENTSBALANCE SHEET

AS AT 31 JANUARY 2006Non-current assets Store equipment $33,200 Less accumulated depreciation 8,000 $25,200 Buildings 170,000 Less accumulated depreciation 45,000 125,000 Land 73,200

223.400$ Long-term investments Notes receivable 1.500 Investments in stocks and bonds 18.000 Land held for future expansion 48.000 Total investments 67.500 Intangible assets 10.000 Total non-current assets 300.900$

Cash $6,500 Short-term investments 2,100 Accounts receivable 4,400 Merchandise inventory 27,500 Prepaid expenses 2,400

$42,900

Current Assets

Current assets are expected to be sold, collected, or used within one year or the company’s operating

cycle.


SNOWBOARDING COMPONENTSBALANCE SHEET31 JANUARY 2006

Non-current assets Store equipment $33,200 Less accumulated depreciation 8,000 $25,200 Buildings 170,000 Less accumulated depreciation 45,000 125,000 Land 73,200

$223,400Long-term investments Notes receivable 1,500 Investments in stocks and bonds 18,000 Land held for future expansion 48,000 Total investments 67,500Intangible assets 10.000 Total assets $300.900

Current Assets Cash 6.500 Short-term investments 2.100 Accounts receivable 4,400 Merchandise inventory 27,500

Long-term investments are expected to be held for the longer of one year or the operating cycle.




$223,400Long-term investments Notes receivable 1.500 Investments in stocks and bonds 18.000 Land held for future expansion 48.000 Total investments 67.500Intangible assets 10.000

$300,900Current assets Cash $6,500 Short-term investments 2,100 Accounts receivable 4,400

Fixed assets are tangible long-lived assets used to produce or sell

products and services.




$223,400Long-term investments Notes receivable $1,500 Investments in stocks and bonds 18,000 Land held for future expansion 48,000

$67,500Intangible assets 10.000

$300.900

Current Assets Cash 6.500

Intangible assets are long-term resources used to produce or sell

products and services and that lack physical form.


Current liabilities are obligations due within the longer of one year or the

company’s operating cycle.


AS AT 31 JANUARY 2006Current liabilities Accounts payable 15.300$ Wages payable 3.200 Notes payable 3.000 Current portion of long-term liabilities 7.500 Total current liabilities $29,000



AS AT 31 JANUARY 2006

Equity and liabilitiesT.Hawk, Capital $164,800

Non-current liabilities Notes payable (net of current portion) $150,000

Current liabilities

Long-term liabilities are obligations not due within the longer of one year

or the company’s operating cycle.