Ch. 4- Adjustments, Financial Statements, and Financial Results
Accumulated Amortization
*Credit Balance sheet
Amortization Expense
*Debit Income statement
Adjustments are needed to ensure...
- Revenue recognition principle (revenues recorded when earned) - Expense recognition "matching" principle (expenses recorded in the same period as the revenues to which they relate) - Assets are reported at amounts representing economic benefits that remain at the end of the current period - Liabilities are reported at amounts owed at the end of the current period that will require a future sacrifice of resources
Deferral Adjustments
- Used to decrease balance sheet accounts and increase corresponding income statement accounts - Previously deferred amounts are adjusted and transferred to the income statement using a deferral adjustment - Each deferral adjustment involves one asset and one expense account, or one liability and on revenue account Ex. Supplies --> Supplies Expense Ex. Prepaid rent --> Rent Expense Ex. Unearned Revenue --> Sales/Service Revenue
Adjustment Steps:
1. Analyze necessary adjustments 2. Record using adjusting journal entries 3. Summarize in accounts
2 Categories of Adjustments
1. Deferrals 2. Accruals
Order of statement preparation....
1. Income 2. Retained Earnings 3. Balance 4. Cash flows and notes
Dividends
1. have a normal debit balance 2. are closed into retained earnings by crediting Dividends 3. are closed into retained earnings by debiting retained earnings
2 Effects of Deferral Adjustments:
1. reduce the carrying value of assets on the balance sheet 2. transfer the amount of the reductions to related expense accounts on the income statement
After posting the adjusting entry to record revenues earned but not yet collected, which account will be increased?
Accounts Receivable
How do accrual adjustments affect liabilities and expenses?
Accrual adjustments can increase liabilities and increase expenses OR increase assets and increase revenues
Carrying value
Amount at which an asset or liability is reported ("carried") in the financial statements Also known as... - Net book value - Book value
Amortization
Applies to using up long-term assets that lack physical substance and have a limited period of usefulness - Deferral adjustment to report amortization as an expense on the income statement and accumulate it in a contra-asset account on the balance sheet
Accumulated Depreciation
Balance sheet account - increase over time, as it accumulates the depreciation of each period *Credit
Interest
Cost of interest relates to the current period only thus, when a Note Payable and Interest is due next year, the Interest Expense should be increased
The adjusting entry for supplies used during the period requires a _____________ (debit/credit) to Supplies and a _______________ (debit/credit) to Supplies Expense
Credit to Supplies Debit to Supplies Expense
The adjusting entry to record salaries and wages owed to employees at the end of the accounting period includes a debit to "Salaries and Wages __________" and a credit to "Salaries and Wages ________"
Debit to "salaries and wages expense" Credit to "Salaries and Wages Payable"
Adjustments
Entries made at the end of every accounting period to report revenues and expenses in the proper period and assets and liabilities at appropriate amounts - involve both income statement and balance sheet acounts
Depreciation Expense
Income statement account - will include only the depreciation of the current accounting year *Debit
Gift cards are an example of a transaction in which a company receives payment in advance of fulfilling a sale or performing a service. This type of transaction will result in an increase to an asset account (cash) and a _____________ to a ____________ account
Increase to a liability account
___________ expense accumulates or accrues throughout the accounting period on Notes Payable.
Interest accumulates throughout the accounting period on Notes Payable
Why aren't adjustments made on a daily basis?
It is more efficient to do them all at once at the end of each period
Closing process
Last step of the accounting cycle, performed only at the end of the year, after the financial statements have been prepared
Contra-account
Like a negative asset account... An account that is an offset to, or reduction of, another account while maintaining a record of the original cost for long-lived asset accounts The normal balance in a contra-account is always the opposite of the account it offsets
Accrual Adjustments
Needed when a company has earned revenue or incurred an expense in the current period but has not yet recorded it because the related cash will not be received or paid until a later period *unlike "deferral" adjustments, accrual adjustments pair one asset and one revenue or one liability and one expense
Will adjusting entires reduce cash?
No, adjusting entries adjust balances based on internal events and the passage of time. They do not involve the exchange of cash.
Where is account Dividends reported?
Only on the statement of retained earnings
Adjusted Trial Balance
Prepared to check that the accounting records are still in balance, after having posted all adjusting entries to the t-accounts
Depreciation
Process of allocating the cost of buildings, vehicles, and equipment to the accounting periods in which they are used - "Depreciation expense" NOT taken directly out of the asset's account (ex. Equipment) Rather, a contra-account is created to keep track of all the depreciation recorded against the equipment
Adjusting journal entries (AJEs)
Record the effects of each period's adjustments in a debits-equal-credits format
The amount coming from the adjusted trial balance is the beginning-of-year balance for ____________________
Retained Earnings *Doesn't yet include revenues, expenses and dividends for the current period because they've been recorded in their own separate accounts
True or False: Supplies is an asset account because it contains the value of supplies that have NOT been used, but still remain an economic resource for the co.
True *Supplies Expense reports the amount of supplies that have been used during that period
Key starting point for adjustments...
Unadjusted trial balance, because it presents the unadjusted balances for every account
Income Tax
always calculate income tax expense after taking into account all revenue and expense adjustments Company's adjusted income (before income tax expense) [X] Company's tax rate
Adjusting entires always include one ________ sheet and one ______________ statement account.
balance sheet, income statement account
Adjusting journal entries never involve ________________.
cash
The adjusting entry to record services earned but not yet billed requires ______________
debit to Accounts Receivable and credit to Service Revenue
Post-closing trial balance
final check on credits-equals-debits and all temp. accounts have been closed