February 1, 2016ADJUSTING ENTRIES (Ch 3) and RECORDING BUSINESS TRANSACTIONS (Ch 2) ADJUSTING ENTRIESAccrual basis accounting: required by GAAPRevenue recognitionRecord revenue when EARNED, not based on when cash is receivedMatching principleAttempt to record expense in same period as the revenue that the expense helped generateAccrual basis – requires adjusting entries to ensure that all revenues and expensesare correctly recorded (on Income Statement) and that all Assets and Liabilities are correctly stated (on Balance Sheet).Adjusting entries:- Recorded as of the last day of the accounting cycle- Each adjusting entry affects one income statement account and one balance sheet account- Do NOT affect cashCash should already be doneWhen all adjusting entries have been recorded, the adjusted trial balance, or trial balance after adjustments, is prepared. The account balances from the adjusted trial balance, are used to prepare the financial statements.February 1, 2016Adjusting entries fall into two major categories, deferrals and accruals. Deferrals – adjustments needed to update prepaid expenses and unearned revenues. Adjustments are needed to record the portion of the expense incurred or revenue earned in the current accounting period.Accruals – revenues earned or expenses incurred that have not yet been recorded. Adjustments are needed to record the revenue or expense so that it will be included in the current financial statements.Example: Adjusting entries(chart below)Reliable Cleaning Service was organized in September, 2015; the company actuallybegan operations in October of that year. The company’s October 1 account balances are shown on the transactions grid at the end of these notes; transactions for October follow:October1 RCS purchased cleaning equipment, paying $1,450 cash2 Paid office rent for the period Oct 1 – Dec 31, $1,2002 Purchased cleaning supplies on account, $5203 Received $1,800 cash in advance from customers for cleaning services that Will be provided during the period Oct 3 – Dec 315 Provided cleaning services for cash customers, $2,67520 Paid wages, $88029 Billed customers for cleaning services provided during October, $2,26029 Paid for the supplies purchased previously30 Received Cash, $1,200, from customers billed previouslyAdditional information- Supplies on hand as of October 31, $210- Wages earned by company employees from October 21 – 30, $300; these wages will be paid in November- The note payable account pertains to a one year note dated September 30; principal and 6% interest will be paid on September 30, 2016o I = PRTFebruary 1, 2016o Interest = 12,000 x .06 x 1/12o = 60 dollars- Of the cleaning services for which customers had paid in advance, 1/3 of the work was completed during Octobero 1800 prepaido 1800 x 1/3 = 600o Adjust for 600 dollarso Subtract un rev by 600o Increase revenue by 600- Equipment is expected to be useful for 6 years, then scrappedo Depreciationo Equipment = 1450o Use for 6 yearso 1450 / 6 = 241.67 per yearo 241.67 / 12 = 20.14 per montho Go with 20 dollars a month that the equip depreciateso But, your asset doesn’t really decrease because it is just an estimateo That is why you set up a team account to calculate thiso Accumulated Depreciation is the account that tracks the depreciationo Decrease the account by 20 / month when adjustingo Then you can count it as a depreciation expense and decrease the expense account by 20 dollarsRequired:1. Using the transactions grid at the end of these notes, record the October transactions for RCS.2. Using the transactions grid and additional information, record the required adjusting entries.3. Prepare October financial statements for RCS.4. For each of the adjusting entries, determine the effect on the income statement and the balance sheet if the adjustment IS NOT recorded.If adjustment is NOT recorded:Adjusting entry Income BalanceFebruary 1, 2016Statement SheetFor supplies used during October Expense toolowNet Income too highAssets never reduced and are high & equity too highFor accrued wages Expense toolow and netincome too highLiability too low & equity too lowFor accrued interest Net income too highLiability too lowFor unearned revenue now earned Revenue too low & net income too lowLiability too highFor prepaid rent Expenses too low andnet income too high Assets too highSupplies- supplies down & expense upWages- liability up & expense up Interest- liability up & expense upUnearned Revenue- liability down & revenue upRent- assets down & expenses upFebruary 1, 2016THE RECORDING PROCESSTransaction analysis using the accounting equation shows the effect of each transaction on the company’s balance sheet. However, because of the number of accounts and the number of transactions most companies must record, recording transactions using the accounting equation method demonstrated earlier is too cumbersome for most companies to use. Instead, most companiesuse a system of journals and ledgers to collect and process information. The system may be maintained manually, but most companies use a computerized system.Define the following termsAccount – an accounting form used to record the dollar amount of increases and decreases and the balance of each element of the financial statements; a simplified version of an account is often presented in the shape of the letter T and is called a “T account”- Companies make as many accounts as they need to be useful- Categories!Chart of accounts – a list of all the accounts of a firm; usually listed in the following order: Assets, Liabilities, Equity, Revenue, and ExpenseGeneral journal – the book of original entry, provides a chronological record of each transaction for a firm- Start with journal and transfer to the ledger- The transfer process to the ledger is called posting- Organized by complete transactionsGeneral ledger – the collection of all accounts for a firmFebruary 1, 2016- Before computers they used notebooks and every page was an account with the account name at the top and a big T down the middle- Left debit side, right credit side- Ledgers have the same information as the journals, but it is organizeddifferently- It is organized BY ACCOUNTDebit – the lef side of a T account- For all asset accounts increase the debit side- LOOK BELOWCredit – the right side of a T account Trial balance – a list of all accounts of a firm with their balances, used to