A Why Adjustments Are Needed Chapter 4 Handout 1 Adjustments Entries necessary at the end of each accounting period to report revenues and expenses in the proper period and assets and liabilities at appropriate amounts also called adjusting journal entries 2 Adjustments always include both income statement and balance sheet accounts They are needed to ensure quarter year period a Revenues are recorded in the period earned b Expenses are recorded in the period incurred they occur at the end of a time period e g month c Assets are reported at amounts representing the economic benefits that remain at the end of the d Liabilities are reported at amounts owed at the end of the period 3 Adjustments NEVER involve cash 4 Adjustments are grouped into two categories deferral and accrual B Prepare adjustments needed at the end of the period 1 Accruals money earned or owed has not been exchanged transactions in which the company has generated revenue or incurred an expense but the a Involves one asset and one revenue account or one liability and expense account b Creates receivables or payables in October c We provided 3 250 of consulting services to our clients in September with payment to be received Date 9 30 Account Accounts Receivable A Debit Credit 3 250 Service Revenue R SE 3 250 d On November 1 we loaned 18 000 to XYZ Co and issued a 1 year 10 note Interest earned by Dec 31 amounts to 300 Account Debit Credit Interest Receivable Interest Revenue 300 300 e The company owes 1 950 of wages to employees for work done in the last six days of December at a cost of 325 per day this amount will not be paid until January Account Debit Credit Salaries and Wages Expense E SE 1 950 Salaries and Wages Payable L 1 950 Date 12 31 Date 12 31 f On November 1 we borrowed 18 000 from the bank and issued a 1 year 10 note Interest owed by Dec 31 amounts to 300 Date 12 31 Account Interest Expense E SE Interest Payable L Debit Credit 300 g The Company pays income tax at an average rate equal to 20 of the company s income before taxes which is 1 000 this period 1000 x 20 Account Debit Credit Income Tax Expense E SE 200 Income Tax Payable L 2 Deferrals revenue has been postponed transactions in which the money has been exchanged but the reporting of an expense or a Updates Prepaid or Unearned Deferred b Involves one asset and one expense account or one liability and revenue account c The company counts its supplies on hand at December 31 Of the supplies previously purchased for 600 only 250 are now on hand Account Debit Credit d Three months of rent were prepaid on December 1 for 7 200 but one month has now expired leaving only two months prepaid at December 31 Account Debit Credit Supplies Expense E SE Supplies A Rent Expense E SE Prepaid Rent A 350 2 400 e On May 1 we purchased a 2 year insurance policy for 4 800 No adjustments were made prior to December 31 4 800 24 mths 200 mths x 8 May 1 Dec 31 1 600 Account Debit Credit Insurance Expense E SE 1 600 Prepaid Insurance A 1 600 f On September 1 we collected one year s rent in advance of 3 600 No adjustments were made prior to December 31 3 600 12 300 x 4 mths Sept 1 Dec 31 1 200 Account Debit Credit Deferred Revenue L 1 200 Rent Revenue R SE 1 200 Date 12 31 Date 12 31 Date 12 31 Date 12 31 Date 12 31 300 200 350 2 400 g Depreciation expense is recorded for use of equipment which is the company s estimate of the proportion of a fixed asset s cost that should be allocated each year over the asset s expected useful life i Accumulated Depreciation is the contra account balance sheet account a Running total of depreciation for an asset It will increase each period until the asset is fully depreciated b Normal balance in a contra account is always the opposite of the account it offsets c Accumulated Depreciation is recorded with a credit because the account that it offsets Equipment is previously recorded with a debit ii Depreciation Expense is an income statement account a Includes only the depreciation of the current accounting year b The amount of depreciation depends on the method used for determining it Depreciation methods and their formulas will be discussed in Chapter 9 h On January 1 we purchased a piece of equipment for 500 It had an estimated useful life of 5 years 500 5 years 100 each year Date 12 31 Account Debit Credit Depreciation Expense E SE 100 Accumulated Depreciation xA A 100 Company Name Inc Balance Sheet At December 31 XXXX Assets Equipment Accumulated Depreciation Equipment Net of Acc Dep 500 Original Cost of Equipment 100 Running total of depreciation 400 Carrying Value Book Value i Amortization is recorded for use of an intangible asset i Similar to depreciation amortization is the concept that applies to using up long term assets that lack physical substance and have a limited period of usefulness ii The long term asset declines in usefulness over time causing a reduction in the value of the asset which creates an expense j The software developed for the company estimated to have three years of usefulness has now been used for one month at an estimated expense of 250 9 000 36 250 Date 12 31 Account Debit Credit Amortization Expense E SE 250 Accumulated Amortization xA A 250 C Prepare an adjusted trial balance 1 A list of all accounts and their adjusted balances to check on the equality of recorded debits and credits lists accounts in the order A L SE R E 2 The only difference between an adjusted trial balance and an unadjusted trial balance is that the adjusted trial balance is prepared after all adjustments have been posted D Prepare Financial Statements E Closing Process 1 In Order 1 Income Statement 2 Statement of Owners Equity 3 Balance Sheet 4 Statement of Cash Flows 1 Close temporary accounts at the end of the year after all transactions and adjustments are recorded 2 These transfer the balances of all temporary accounts to the balance of retained earnings a Temporary accounts track financial results for a limited period of time Revenue Expenses and b Permanent accounts track results from year to year Assets Liabilities and Equity 3 Closing entries occur at year end the balance of all temporary accounts is ZERO after closing entries a Debit Revenue accounts credit Expense accounts and Debit or credit the difference to Retained Dividends Earnings b Credit Dividends Declared and debit Retained Earnings Cash Prepaid Insurance Equipment Accumulated Depreciation Deferred Revenue Notes Payable Salary Payable Interest Payable Common