1、Measuring Business Income:The Adjusting Process,Chapter 3,Distinguish accrual accounting from cash-basis accounting.,Objective 1,Accrual-basis: Transactions are recorded when revenues are earned or expenses are incurred.,Cash-basis: Transactions are recorded when cash is paid or cash is received.,Th

2、e Two Bases of Accounting:,Accrual Versus Cash Example,In January 2002, Prensa Insurance sells a three-year health insurance policy to a business client. The contract specifies that the client had to pay $150,000 in advance. Yearly expenses amount to $20,000. What is the income or loss?,Accrual Vers

3、us Cash Example,Accrual-Basis Accounting,200220032004,(000 omitted),Revenues$50$50$50 Expenses 20 20 20 Net income (loss)$30$30$30,Accrual Versus Cash Example,Cash-Basis Accounting,200220032004,(000 omitted),Cash inflows$150$ 0$ 0 Cash outflows 20 20 20 Net income (loss)$130($20)($20),Managers adopt

4、 an artificial period of time to evaluate performance.,Accounting Period,Monthly,Quarterly,Semi-annually,Interim Period Statements,Apply the revenue andmatching principles.,Objective 2,Revenue Principle,When is revenue recognized? When it is deemed earned. Recognition of revenue and cash receipts do

5、 not necessarily occur at the same time.,The Matching Principle,What is the matching principle? It is the basis for recording expenses. Expenses are the costs of assets and the increase in liabilities incurred in the earning of revenues. Expenses are recognized when the benefit from the expense is r

6、eceived.,Matching Expenses with Revenues Example,Parker Floor sells a wood floor for $15,000 on the last day of May. The wood was purchased from the manufacturer for $8,000 in March of the same year. The floor is installed in June. When is income recognized?,Revenues$15,000 Cost of goods sold 8,000

7、Net income$ 7,000,May,Matching Expenses with Revenues Example,Interacts with the revenue principle and the matching principle,Requires that income be measured accurately each period,The Time Period Concept,It requires that accounting information be reported at regular intervals.,Make adjusting entri

8、es.,Objective 3,Adjusting Entries,Assign revenue to the period earned. Assign expenses to the period incurred. Bring related asset and liability accounts into correct balance.,Prepaids or Deferrals,Accruals,Two Types OfAdjusting Entries,Prepaid expenses,Depreciation,Accrued expenses,Accrued revenues

9、,Unearned revenues,Five Categories OfAdjusting Entries,24,000,Cash,Prepaid Insurance,24,000,Prepaid Insurance Example,On January 2, 2005, Parker Floor paid $24,000 for a two-year health insurance policy.,Prepaid Insurance Example,What is the journal entry on December 31, 2005? Dec. 31, 2005 Insuranc

10、e Expense 12,000 Prepaid Insurance 12,000 To record insurance expense,Time,Prepaid Insurance Example,What was the determining factor in matching this expense?,Supplies Example,Wood Enterprise started business the beginning of the month. $800 worth of office supplies were purchased on November 15, 20

11、04, for cash.,Office Supplies,Cash,800,800,An inventory at month end indicated that $200 in office supplies remained. What is the supplies expense?,Supplies Example,Usage,Supplies Expense,600,Supplies,800 600 Bal. 200,Supplies Example,What was the determining factor in matching this expense?,Depreci

12、ation Example,On January 2, Wood Enterprise purchased a truck for $30,000 cash. The truck is expected to last for 3 years.,Depreciation Example,The cost of the truck must be matched with the accounting periods in which it was used to earn income. What is the journal entry for the year ended December

13、 31, 2005?,Dec. 31, 2005 Depreciation Expense 10,000 Accumulated Depreciation 10,000 To record depreciation on truck,Depreciation Example,A contra account has a companion account.,A contra accounts normal balance is opposite that of the companion account.,Accumulated depreciation is a contra account

14、 to plant assets.,Contra Accounts,Wood Enterprise Example,Partial Balance Sheet December 31, 2005,Plant assets: Machinery$30,000 Less: Accumulated depreciation 10,000 Total$20,000,Contra account,Book value,Accruals,What is an accrual? It is the recognition of an expense or revenue that has arisen bu

15、t has not yet been recorded. Expenses or revenues are recorded before the cash settlement.,Accrued Expenses Example,Employees at Mary Business Services are paid every Friday. Weekly salaries total $30,000. The business is closed on Saturday and Sunday. The employees were last paid on April 26, which

16、 was a Friday. They will be paid on May 3.,April,May,26 27,28 29 30,1 2 3,Accrued Expenses Example,Accrued Expenses Example,What is the adjusting entry on April 30? They worked April 29 and 30. $30,000 5 = $6,000 per day $6,000 2 days = $12,000 April 30, 2002 Salaries Expense 12,000 Salaries Payable

17、 12,000 To accrue salary expense,Accrued Revenues Example,During the month of April, Mary Business Services rendered services to customers totaling $15,000. At the end of April, the customers have not as yet been billed.,Accrued Revenues Example,What is the April 30 adjusting entry? April 30, 2005 A

18、ccounts Receivable 15,000 Service Revenue 15,000To accrue service revenue,Performance,Accrued Revenues Example,What is the determining factor in recognizing this service revenue?,Unearned or Deferred Revenue Example,In January 2005, Prensa Insurance received $150,000 from a business client to provid

19、e health insurance coverage for three years. January 2, 2005 Cash 150,000 Unearned Revenue 150,000 Received revenue in advance,Correct liability $100,000,Total accounted for $150,000,Correct revenue $50,000,Unearned or Deferred Revenue Example,What is the journal entry on December 31, 2005? Unearned

20、 revenue 50,000 Revenue 50,000 To record revenue collected in advance,Notice,Adjusting entries always have. one income statement account and. one balance sheet account. Adjusting entries never involve cash.,Prepare an adjusted trial balance.,Objective 4,Adjusted Trial Balance,The adjusting process s

21、tarts with the unadjusted trial balance. Adjusting entries are made at the end of the accounting period and then an adjusted trial balance is prepared. The adjusted trial balance serves as the basis for the preparation of the financial statements.,Prepare the financial statements from the adjusted t

22、rial balance.,Objective 5,Financial Statements,Financial statements have two parts: The first part includes the following: name of the entity title of the statement date or period covered The second part is the body of the statement.,Financial Statements Example,Revenue from insurance services$50,000 Less:Salaries expense 14,275 Supplies expense 250 Rent expense 3,600 Utilities expense 625 Interest expense 600 Depreciation 650 Net income$30,000,Prensa Insurance Income Statement Year Ended December 31, 2005,Prens