The Matching Concept And The Adjusting Process

Chapter 3 The Matching Concept and the Adjusting Process Accounting, 21st Edition Warren Reeve Fess

PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

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Some Some of of the the action action has has been been automated, automated, so so click click the themouse mouse when when you you see see this this lightning lightning bolt bolt in in the thelower lower right-hand right-hand corner corner of of the the screen. screen. You You can can point point and and click click anywhere anywhere on on the the screen. screen.

Objectives Objectives 1. Explain how the matching concept relates to the accrual basis of accounting. After After studying studying this this 2. Explain why adjustments are necessary and list the chapter, you should chapter, you should characteristics of adjusting entries. able be able to: to: 3. Journalize entries for be accounts requiring adjustment. 4. Summarize the adjustment process and prepare an adjusted trial balance. 5. Use vertical analysis to compare financial statement items with each other and with industry averages.

The Matching Concept

Reporting Revenue and Expenses TWO METHODS Cash Basis of Accounting Accrual Basis of Accounting

Under the cash basis for the accounting period concept, revenues and expenses are reported in the income statement in the period in which cash is received or paid.

Under the accrual basis for the accounting period concept, revenues are reported in the income statement in the period in which they are earned.

Accrual Basis of Accounting  Revenue Revenue reported reported when when earned earned  Expense Expense reported reported when when incurred incurred  Properly Properly matches matches revenues revenues and and expenses expenses in in determining determining net net income income  Requires Requires adjusting adjusting entries entries at at end end of of period period

The The matching matching concept concept supports supports reporting reporting revenues revenues and and related related expenses expenses in in the the same same period. period.

Paid $10,000 for an advertising campaign for a $10,000 product thataswill recorded an be introduced asset in 2003. 2005. 2004

Sold the advertised $10,000 product. expensed in 2005 to match revenues 2005

NetSolutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense

Unadjusted Unadjusted trial trial balance balance

2 2 2 2 20 1

065 220 000 400 000 800

00 00 00 00 00 00 900 00 360 00 25 000 00

4 000 00 16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00 42 600 00

NetSolutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense

2 2 2 2 20 1

065 220 000 400 000 800

00 00 00 00 00 00 900 00 360 00 25 000 00

Assets Assets

4 000 00 16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00 42 600 00

NetSolutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense

2 2 2 2 20 1

065 220 000 400 000 800

00 00 00 00 00 00 900 00 360 00 25 000 00

4 000 00

Liabilities Liabilities

16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00 42 600 00

NetSolutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense

2 2 2 2 20 1

065 220 000 400 000 800

00 00 00 00 00 00 900 00 360 00 25 000 00

4 000 00 16 340 00

Owner’s Owner’s Equity Equity

4 275 00 1 600 00 985 00 800 00 455 00 42 600 00 42 600 00

NetSolutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense

2 2 2 2 20 1

065 220 000 400 000 800

00 00 00 00 00 00 900 00 360 00 25 000 00

4 000 00 16 340 00

Revenue Revenue

4 275 00 1 600 00 985 00 800 00 455 00 42 600 00 42 600 00

NetSolutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense

2 2 2 2 20 1

Expenses Expenses

065 220 000 400 000 800

00 00 00 00 00 00 900 00 360 00 25 000 00

4 000 00 16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00 42 600 00

NetSolutions Chart of Accounts Balance Sheet 1. 11 12 14 15 17 18 19 2. 21 22 23

Assets Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accumulated Depreciation19 Accumulated Depreciation Liabilities Accounts Payable Wages Payable Unearned Rent

3. Owner’s Equity 31 Chris Clark, Capital 32 Chris Clark, Drawing

Income Statement 4. Revenue 41 Fees Earned 42 Rent Revenue 5. 51 52 53 54 55 56 59

Expenses Wages Expense Rent Expense Depreciation Expense Utilities Expense Supplies Expense Insurance Expense Miscellaneous Expense

Deferred Expenses (Prepaid Expenses)

NetSolutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense

2 065 00 2 220 00 2 000 00 2 400 00 Some Some of of these these supplies supplies have00 20 have 000 1 800 00 been 31, been used. used. On On December December 31,

aa count count reveals reveals that that $760 $760 of of supplies supplies are are on on hand. hand.

900 00 360 00 25 000 00

4 000 00 16 340 00

4 275 00 1 600 00 985 00 800 00 455 00 42 600 00 42 600 00

Supplies (balance on trial balance) Supplies on hand, December 31 Supplies used 2005

1 Dec. 31 Supplies Expense Supplies 2

55 14

$2,000 – 760 $1,240

1 240 00 1 240 00

3 4

Bal.

Supplies Expense Supplies 14 2,000 Dec. 31 1,240 Bal. 800 Dec. 31 1,240 760 2,040

55

NetSolutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense

2 2 2 2 20 1

065 220 000 400 000 800

00 00 00 00 00 00

The The prepayment prepayment for for 24 24 months months900 360 of of insurance insurance does does not not reflect reflect that that 25 000 December’s December’s insurance insurance has 4 000 has 00 16 340 theoretically theoretically expired. expired. 4 275 00 1 600 985 800 455 42 600

00 00 00 00

00 00 00 00 00 42 600 00

4 5

31 Insurance Expense

56

Prepaid Insurance

100 00

15

100 00

6 7

Prepaid Insurance Bal. 2,400 Dec. 31 2,300

15

100

Insurance Expense Dec. 31 100

Note: Note: You You probably probably have have the the idea idea of of how how posting posting flows, flows, so so the the rest rest of of the the slides slides will will omit omit the the arrows. arrows.

56

Effect Effect of of Omitting Omitting Adjustment Adjustment

Deferred Revenue (Unearned Revenue)

NetSolutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense

2 2 2 2 20 1

065 220 000 400 000 800

00 00 00 00 00 00

Three Three months’ months’ rent, rent, $360, $360, was was received received on on December December 1. 1. As As of of December December 31, 31, only only $120 $120 has has 900 360 been been earned. earned. 25 000

00 00 00

4 000 00 16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00 42 600 00

7 8

31 Unearned Rent

23

Rent Revenue

120 00 120 00

42

9 10

Unearned Rent Dec. 31 120 Bal.

23

360 240

Rent Revenue Dec. 31

42

120

Effect Effect of of Omitting Omitting Adjustment Adjustment

Accrued Expenses (Accrued Liabilities)

NetSolutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense

25

2 065 00 2 220 00 accrued At At the the end end of of December, December, accrued 2 000 00 wages amounted to $250. wages amounted 2 400to00$250. Currently, Expense isis 20 000 00 Currently, Wages Wages Expense 1 800 00 is no understated and there understated and there is no 900 00 liability liability shown shown for for these these wages. wages. 360 00 25 000 00 4 000 00 16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00 42 600 00

10 11

31 Wages Expense

51

Wages Payable

250 00 250 00

22

12 13

Wages Payable Dec. 31

22 250

Wages Expense Bal. Dec. 31

4,275 250

51

Effect Effect of of Omitting Omitting Adjustment Adjustment

Accrued Revenues (Accrued Expenses)

NetSolutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense

29

2 065 00 2 220 00 2 000 00 2$500 400 00 NetSolutions provided NetSolutions provided20$500 000 00 in 1 800 00 in services services during during December December

for for which which the the customer customer has has not not been been billed. billed.

900 00 360 00 25 000 00

4 000 00 16 340 00 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00 42 600 00

13 14

31 Accounts Receivable Fees Earned

12 41

500 00 500 00

15 16

Accounts Receivable 12 Bal. 2,220 Dec. 31 500 2,720

Fees Earned 41 Bal. 16,340 Dec. 31 500 16,840

Effect Effect of of Omitting Omitting Adjustment Adjustment

Fixed Assets

Land Land

Land has an infinite life; therefore, it does not depreciate.

Building Building

A building has a limited life, so it must be depreciated. The contra account used in the adjusting entry is Accumulated Depreciation—Building

Equipment Equipment

Because equipment has a limited life, it depreciates. The contra account used is Accumulated Depreciation—Equipment

NetSolutions NetSolutions estimates estimates the the depreciation depreciation on on its its office office equipment equipment to to be be $50 $50 for for the the month month of of December. December. 16 17 18 19

31 Depreciation Expense

53

50 00

Accumulated Depreciation— 19

Office Equipment

Accumulated Depreciation— Office Equipment

19

Dec. 31

50

50 00

Depreciation Expense 53 Dec. 31 50

NetSolutions’ NetSolutions’ balance balance sheet sheet would would show show the the office office equipment equipment at at cost, cost, less less the the accumulated accumulated depreciation. depreciation.

Office equipment Less accumulated depreciation

$1,800 50 $1,750

Book value

Effect Effect of of Omitting Omitting Adjustment Adjustment

Summary Summary of of Basic Basic Adjustments Adjustments

NetSolutions’ Adjusted Trial Balance for December 31, 2005

41

NetSolutions Adjusted Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accumulated Depreciation Accounts Payable Wages Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Rent Revenue Wages Expense Rent Expense Utilities Expense

2 065 00 2 720 00 760 00 2 300 00 20 000 00 1 800 00 50 900 250 240 25 000

00 00 00 00 00

4 000 00 16 840 00 120 00 4 525 00 1 600 00 985 00

Continued

NetSolutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Utilities Expense Supplies Expense Insurance Expense Miscellaneous Expense

42

2 065 00 2 720 00 760 00 2 300 00 20 000 00 1 800 00 985 00 2 040 00 100 00 455 00 43 400 00 43 400 00

Vertical Analysis and Interpretation

J. Holmes, Attorney-at-Law Income Statements For the Years Ended December 31, 2005 and 2006

Fees earned Operating expenses: Wages expense Rent expense Utilities expense Supplies expense Miscellaneous exp. Total operating expenses Net income

2006 2005 Amount Percent Amount Percent $187,500 $150,000 $60,000 15,000 12,500 2,700 2,300

$45,000 12,000 9,000 3,000 1,800

$92,500 $95,000

$70,800 $79,200

2006 2005 Amount Percent Amount Percent Fees earned $187,500 100.0% Operating expenses: Wages expense $60,000 Rent expense 15,000 Utilities expense 12,500 Supplies expense 2,700 Miscellaneous exp. 2,300 Total operating expenses $92,500 Net income $95,000

$150,000 100.0% $45,000 12,000 9,000 3,000 1,800 $70,800 $79,200

2006 2005 Amount Percent Amount Percent Fees earned $187,500 100.0% Operating expenses: Wages expense $60,000 32.0% Rent expense 15,000 38.0% Utilities expense 12,500 Supplies expense 2,700 Miscellaneous exp. 2,300 Total operating expenses $92,500 Net income $95,000

$150,000 100.0% $60,000 $60,000 $45,000 $187,500 $15,000 $187,500 $15,000 12,000 $187,500 $187,500 9,000 3,000 1,800 $70,800 $79,200

2006 2005 Amount Percent Amount Percent Fees earned $187,500 100.0% Operating expenses: Wages expense $60,000 32.0% Rent expense 15,000 38.0% Utilities expense 12,500 6.7% Supplies expense 2,700 1.4% Miscellaneous exp. 2,300 1.2% Total operating expenses $92,500 49.3% Net income $95,000 50.7%

$150,000 100.0% $45,000 12,000 9,000 3,000 1,800

30.0% 8.0% 6.0% 2.0% 1.2%

$70,800 $79,200

47.2% 52.8%

Chapter 3 The The End End