Topic 6 - Recording Year End Adjustments

Topic

6

Recording Year End Adjustments and Preparing Financial Statements 100 Shares

Adjustments?? $1 par value

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Learning Learning Objectives Objectives  Explain the importance of periodic reporting and the time period principle  Identify the types of adjustments and their purpose  Prepare and explain adjusting entries  Explain and prepare an adjusted trial balance  Prepare financial statements from an adjusted trial balance  Describe and prepare closing entries  Explain and prepare a post-closing trial balance  Explain and prepare a classified balance sheet

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The The Accounting Accounting Period Period Annual 1

2

Semiannual 1

2

3

4

Quarterly 1

Jan

2

3

4

Feb

Mar

Apr

5

6

7

May Jun Jul

8

9

10

Aug Sep Oct

Monthly

11

12

Nov Dec

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The The Accounting Accounting Period Period  Calendar year- reporting period of 12 months covering from 1 January to 31 December  Fiscal year- reporting period consisting of any 12 consecutive months, in which the starting month is not necessarily beginning from 1 January. Eg. 1 April 2005 to 31 March 2006

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Accrual Accrual Basis Basis vs. vs. Cash Cash Basis Basis Accrual Basis

Cash Basis

Revenues are recognized when earned and expenses are recognized when incurred.

Revenues are recognized when cash is received and expenses recorded when cash is paid.

•Revenue Recognition •Matching

Not GAAP

Accounting

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The Accounting Cycle Closing Entries Financial Statements

Journal

Adjusted Trial Balance

Adjustments

Source Documents

Trial Balance

Ledger © The McGraw-Hill Companies, Inc., 2007

Adjusting Adjusting Accounts Accounts An adjusting entry is recorded to bring an asset or liability account balance to its proper amount.

Framework for Adjustments Adjustments Paid Paid (or (or received) received) cash cash before before expense expense (or (or revenue) revenue) recognized recognized

Prepaid Unearned Prepaid Unearned (Deferred) (Deferred) (Deferred) (Deferred) expenses* revenues expenses* revenues *including depreciation

Paid Paid (or (or received) received) cash cash after after expense expense (or (or revenue) revenue) recognized recognized

Accrued Accrued expense expense

Accrued Accrued revenues revenues © The McGraw-Hill Companies, Inc., 2007

1. 1. Adjusting Adjusting Prepaid Prepaid (Deferred) (Deferred) Expenses Expenses Resources paid for prior to receiving the actual benefits.

Here is the check for my first 6 months’ rent.

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1. 1. Adjusting Adjusting Prepaid Prepaid (Deferred) (Deferred) Expenses Expenses Expense

Asset Unadjusted Balance

Credit Adjustment

Journal: Dec 31 Expense Acc Asset Acc

Debit Adjustment

xx xx

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Ex:Prepaid Ex:Prepaid Insurance Insurance On 1 December 2006, Suria Company paid RM12,000 to cover rent for December 2006 through May 2007. Scott recorded the expenditure as Prepaid Insurance on 1 December. What adjustment is required?

RM12,000 – insurance for 6 month So, insurance for December 2006?

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Ex:Prepaid Ex:Prepaid Insurance Insurance Dec. 31 Insurance Expense Prepaid Insurance

2,000 2,000

To record first month's expired insurance

637

128

Pre © The McGraw-Hill Companies, Inc., 2007

Adjusting Adjusting for for Depreciation Depreciation Depreciation is the process of computing expense from allocating the cost of plant and equipment over their expected useful lives. Straight-Line Asset Cost - Salvage Value Depreciation = Useful Life Expense

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Ex: Ex: Adjusting Adjusting for for Depreciation Depreciation On 1 January 2006, Sykt Batik purchased equipment for RM62,000 cash. The equipment has an estimated useful life of 5 years and Barton expects to sell the equipment at the end of its life for RM2,000 cash. Let’s record depreciation expense for the year ended 31 December 2006. 2006 Depreciation Expense

RM62,000 - RM2,000 =

=

RM12,000

5

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Ex: Ex: Adjusting Adjusting for for Depreciation Depreciation D e c . 3 1D e p re c i a tio n E x p e n se 1 2 ,0 0 0 A c c u m u la te d D e p re c ia tio n - E q u ip m e n t1 2 , 0 0 0 T o r eco r d eq u i p m en t d ep r eci a ti o n

Accumulated Accumulated depreciation depreciation is is aa contra contra asset asset account. account.

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Ex: Ex: Adjusting Adjusting for for Depreciation Depreciation Dec. 31 Depreciation Expense Accumulated Depreciation - Equipment

12,000 12,000

To record equipment depreciation

Equipment 1/1 62,000

Depreciation Expense 31/12 12,000

Accumulated Depreciation 31/12 12,000

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Adjusting Adjusting for for Depreciation Depreciation

RM

Equipment is shown net of accumulated depreciation.

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2. 2. Adjusting Adjusting Unearned Unearned (Deferred) (Deferred) Revenues Revenues Cash Cash received received in in advance advance of of providing providing products products or or services. services.

Liability Debit Adjustment

Unadjusted Balance

Buy your season tickets for all home basketball games NOW!

Revenue Credit Adjustment

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2. 2. Adjusting Adjusting Unearned Unearned (Deferred) (Deferred) Revenues Revenues Journal: Dec 31

Unearned Revenue Acc Revenue Acc

xx xx

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Ex:Adjusting Ex:Adjusting Unearned Unearned (Deferred) (Deferred) Revenues Revenues On 1 October 2006, Universiti Utama(UU) sold 1,000 season tickets to its 20 home basketball games for RM100 each. UU makes the following entry: Oct. 1

Cash

100,000 Unearned Revenue

100,000

Basketball revenue received in advance

Unearned Revenue Oct. 1 100,000

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Ex: Ex: Adjusting Adjusting Unearned Unearned (Deferred) (Deferred) Revenues Revenues On 31 December, UU has played 10 of its regular home games, winning 2 and losing 8. Dec. 31 Unearned Revenue 50,000 Basketball Revenue

50,000

To recognized 10-game basketball revenue

Unea rned Reve nue De c 31 50,000Oct. 1 100,000 Bal. 50,000

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3. 3. Adjusting Adjusting for for Accrued Accrued Expenses Expenses Costs Costs incurred incurred in in aa period period that that are are both both unpaid unpaid and and unrecorded. unrecorded.

Expense Debit Adjustment

We’re about one-half done with this job and want to be paid for our work!

Liability Credit Adjustment

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3. 3. Adjusting Adjusting for for Accrued Accrued Expenses Expenses Journal: Dec 31 Expense Acc Liability Acc

xx xx

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Ex:Adjusting Ex:Adjusting for for Accrued Accrued Expenses Expenses Sykt Sykt Beras Beras pays pays its its employees employees every every Friday. Friday. Year-end, Year-end, 31/12/06, 31/12/06, falls falls on on aa Wednesday. Wednesday. As As of of 31/12/06, 31/12/06, the the employees employees have have earned earned salaries salaries of of RM47,250 RM47,250 for for Monday Monday through through Wednesday Wednesday of of the the week week ended ended 2/01/07. 2/01/07. Last pay date 26/12/06 1/12/06

Next pay date 2/01/07 31/12/06 Year end

Record Record adjusting adjusting journal journal entry. entry. © The McGraw-Hill Companies, Inc., 2007

Ex: Ex: Adjusting Adjusting for for Accrued Accrued Expenses Expenses Sykt. Sykt. Beras Beras pays pays its its employees employees every every Friday. Friday. Year-end, Year-end, 31/12/06, 31/12/06, falls falls on on aa Wednesday. Wednesday. As As of of 31/12/06, 31/12/06, the the employees employees have have earned earned salaries salaries of of RM47,250 RM47,250 for for Monday Monday through through Wednesday Wednesday of of the the week week ended ended 2/01/07. 2/01/07.

Dec. 31 Salaries Expense Salaries Payable

47,250 47,250

To accrue 3-days' salary Salaries Expense Other salaries 657,500 Dec. 31 47,250 Bal. 704,750

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4. 4. Adjusting Adjusting Accrued Accrued Revenues Revenues Revenues earned in a period that are both unrecorded and not yet received.

Asset Debit Adjustment

Yes, I’ve completed your tax return, but have not had time to bill you yet.

Revenue Credit Adjustment

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4. 4. Adjusting Adjusting Accrued Accrued Revenues Revenues Journal:

Dec 31 Asset Acc Revenue Acc

xx xx

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Ex:Adjusting Ex:Adjusting for for Accrued Accrued Revenues Revenues Kamal Kamal Amin, Amin, CA(M), CA(M), had had RM31,200 RM31,200 of of work work completed completed but but not not yet yet billed billed to to clients. clients. Let’s Let’s make make the the adjusting adjusting entry entry necessary necessary on on 31 31 December December 2006, 2006, the the end end of of the the company’s company’s fiscal fiscal year. year. Dec. 31 Accounts Receivable Service Revenue

31,200 31,200

To accrue revenue earned

Accounts Receivable Other receivables 1,325,268

Dec. 31 31,200 Bal. 1,356,468

Service Revenue Other revenues 6,589,500

Dec. 31 Bal .

31,200 6,620,700

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Links Links to to Financial Financial Statements Statements Summary of Adjustments and Financial Statement Links Before Adjustment Income Balance Statement Sheet Account Account Type Adjusting Entry Prepaid Asset Expense Dr. Expense Expenses Overstated Understated Cr. Asset Unearned Liability Revenue Dr. Liability Revenues Overstated Understated Cr. Revenue Accrued Liability Expense Dr. Expense Expenses Understated Understated Cr. Liability Accrued Asset Revenue Dr. Asset Revenues Understated Understated Cr. Revenue

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The Accounting Cycle Closing Entries Financial Statements

Journal

Adjusted Trial Balance

Adjustments

Source Documents

Trial Balance

Ledger © The McGraw-Hill Companies, Inc., 2007

Adjusted Adjusted Trial Trial Balance Balance  List of accounts and balances prepared after adjusting entries have been recorded and posted to the ledger.  Use a work sheet to prepare adjusted trial balance & financial statement (as a tool)

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Benefits Benefits of of aa Work Work Sheet Sheet Aids Aidsthe the preparation preparationof of financial financial statements. statements. Reduces Reduces possibility possibilityof of errors. errors.

Links Linksaccounts accounts and andtheir their adjustments. adjustments.

Assists Assistsinin planning planningand and organizing organizingan an audit. audit.

Not a required report.

Helps Helpsinin preparing preparing interim interimfinancial financial statements. statements. Shows Showsthe the effects effectsof of proposed proposed transactions. transactions. © The McGraw-Hill Companies, Inc., 2007

SYKT MAJU TRIAL BALANCE 31 DECEMBER 2006

$

$

$

First, First, the the initial initial unadjusted unadjusted amounts amounts are are added added to to the the worksheet. worksheet.

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SYKT. MAJU TRIAL BALANCE 31 DECEMBER 2006

$ $ $

$

$

$

$

Next, Next, Sykt Sykt Maju’s Maju’s adjustments adjustments are are added. added. (pg96-102) (pg96-102)

$ © The McGraw-Hill Companies, Inc., 2007

SYKT MAJU TRIAL BALANCE 31 DECEMBER 2006

Finally, Finally, the the totals totals are are determined. determined.

$

$

$ $ $ $

$

$

$

$

$

$

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The Accounting Cycle Closing Entries Financial Statements

Journal

Adjusted Trial Balance

Adjustments

Source Documents

Trial Balance

Ledger © The McGraw-Hill Companies, Inc., 2007

FastForward Sort trial balance Sort adjusted adjusted trial Work Sheet balance amounts to financial statements. For Month December 31, 2004 amounts toEnded financial statements.

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FastForward Total compute income or loss, and Total statement statement columns, columns, compute income or loss, and Work Sheet balance columns. For Month Ended December 31, 2004 balance columns.

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Prepare Prepare the the Financial Financial Statements Statements Prepare the Income Statement. A A work work sheet sheet does does not not substitute substitute for for financial financial statements. statements. © The McGraw-Hill Companies, Inc., 2007

Prepare the Statement of Changes in Owner’s Equity.

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Prepare the Balance Sheet. SYKT MAJU BALANCE SHEET 31 DECEMBER 2006

Non-current assets Equipment Less: accum. depr. Current assets Cash Accounts receivable Supplies Prepaid insurance

$

26,000 375

$25,625 3,950 1,800 8,670 2,300

Total assets Equity

$42,345

C. Taylor, Capital

$33,185

Current liabilities Accounts payable Salaries payable Unearned consulting revenues Total equity and liabilities

6,200 210 2,750 $42,345

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The Accounting Cycle Closing Entries Financial Statements

Journal

Adjusted Trial Balance

Adjustments

Source Documents

Trial Balance

Ledger © The McGraw-Hill Companies, Inc., 2007

Closing Closing Process Process  Resets revenue, expense and withdrawal account balances to zero at the end of the period.  Helps summarize a period’s revenues and expenses in the Income Summary account.

Identify accounts for closing.

Record and post closing entries.

Prepare post-closing trial balance. © The McGraw-Hill Companies, Inc., 2007

Closing Closing Process Process

Income Summary

Liabilities

Permanent Accounts

Owner’s Capital

Temporary Accounts

Assets

Withdrawals

Expenses

Revenues

The The closing closingprocess process applies applies only onlyto to temporary temporaryaccounts. accounts. © The McGraw-Hill Companies, Inc., 2007

Recording Recording Closing Closing Entries Entries  Close Close Revenue Revenue accounts accounts to to Income Income Summary. Summary.  Close Close Expense Expense accounts accounts to to Income Income Summary. Summary.

Let’s see how the closing process works!

 Close Close Income Income Summary Summary account account to to Owner’s Owner’s Capital. Capital.  Close Close Withdrawals Withdrawals to to Owner’s Owner’s Capital. Capital. © The McGraw-Hill Companies, Inc., 2007

Closing Closing Process Process Expense Accounts 10,000

Revenue Accounts 25,000

10,000

25,000

Income Summary

Withdrawals Account 5,000

Owner's Capital 30,000

30,000

Balances before closing.

5,000

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Closing Closing Process Process Expense Accounts 10,000

10,000

Close Revenue accounts to Income Summary.

Revenue Accounts 25,000 25,000

-

Income Summary 25,000

Owner's Capital 30,000

30,000

25,000

Withdrawals Account 5,000

5,000

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Closing Closing Process Process Expense Accounts 10,000 10,000

Close Expense accounts to Income Summary.

Revenue Accounts 25,000 25,000

-

-

Income Summary 10,000 25,000

Owner's Capital 30,000

30,000

15,000

The Thebalance balancein inIncome Income Summary Summaryequals equalsprofit profit for forthe theperiod period

Withdrawals Account 5,000

5,000

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Closing Closing Process Process Expense Accounts 10,000 10,000

Close Income Summary to Owner’s Capital.

Revenue Accounts 25,000 25,000

-

-

Income Summary 10,000 25,000 15,000 Owner's Capital 30,000 30,000 15,000 45,000

-

Withdrawals Account Withdrawals Account 5,000 5,000 5,000

5,000

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Closing Closing Process Process Expense Accounts 10,000 10,000

Revenue Accounts 25,000 25,000

-

Income Summary 10,000 25,000 15,000 -

Owner's Capital 5,000 30,000 15,000 45,000 40,000

Withdrawals Account 5,000 5,000

Close Withdrawals account to Owner’s Capital.

5,000 -

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Using the adjusted trial balance, let’s prepare the closing entries for FastForward.

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Close Revenue accounts to Income Summary.

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  Close Close Revenue Revenue Accounts Accounts to to Income Income Summary Summary D e c . 3 C1 o n su l ti n g r e v e n u e R e n ta l r e v e n u e I n c o m e su m m a r y

7,850 300 8,150

Now, let’s look at the ledger accounts after posting this closing entry.

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  Close Close Revenue Revenue Accounts Accounts to to Income Income Summary Summary Consulting Revenue 7,850 7,850

Income Summary 7,850 300

Rental Revenue 300 300

-

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Close Expense accounts to Income Summary.

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  Close Close Expense Expense Accounts Accounts to to Income Income Summary Summary Dec. 31 Income summary Depreciation expense-Equipment Salaries expense Insurance expense Rent expense Supplies expense Utilities expense

4,365 375 1,610 100 1,000 1,050 230

Now, let’s look at the ledger accounts after posting this closing entry. © The McGraw-Hill Companies, Inc., 2007

 Close Expense Accounts to Income  Close Expense Accounts to Close Expense Accounts to Income  Close Expense Accounts toIncome Income Summary Summary Summary Summary Depreciation Expense- Eq. 375 375 -

Rent Expense 1,000 1,000 -

Salaries Expense 1,610 1,610 -

Supplies Expense 1,050 1,050 -

Insurance Expense 100 100 -

Utilities Expense 230 230 -

Income Summary 4,365 7,850 300 3,785

Profit for the period

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Close Income Summary to Owner’s Capital.

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  Close Close Income Income Summary Summary to to Owner’s Owner’s Capital Capital Dec.

31 Income summary C. Taylor, Capital

3,785 3,785

Now, let’s look at the ledger accounts after posting this closing entry.

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 Close Income Summary to Owner’s  Close Income Summary to Close Income Summary to Owner’s  Close Income Summary toOwner’s Owner’s Capital Capital Capital Capital

C. Taylor, Capital 30,000 3,785

Income Summary 4,365 7,850 3,785 300 -

33,785

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Close Withdrawals to Owner’s Capital.

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  Close Close Withdrawals Withdrawals to to Owner’s Owner’s Capital Capital Dec.

31 C. Taylor, Capital 600 C. Taylor, Withdrawals

600

Now, let’s look at the ledger accounts after posting this closing entry.

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  Close Close Withdrawals Withdrawals to to Owner’s Owner’s Capital Capital C. Taylor, Withdrawals 600 600

-

C. Taylor, Capital 600 30,000 3,785 33,185

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Post-Closing Post-Closing Trial Trial Balance Balance  List List of of permanent permanent accounts accounts and and their their balances balances after after posting posting closing closing entries. entries.

Let’s look at FastForward’s post-closing trial balance.

 Total Total debits debits and and credits credits must must be be equal. equal.

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Post-Closing Post-Closing Trial Trial Balance Balance

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Classified Classified Balance Balance Sheet Sheet Categories of a Classified Balance Sheet Assets Liabilities and Equity Current Assets Current Liabilities Noncurrent Assets Noncurrent Liabilities Long-Term Investments Equity Fixed Assets Intangible Assets Current items are those expected to come due (both collected and owed) within the longer of one year or the company’s normal operating cycle. © The McGraw-Hill Companies, Inc., 2007

SNOWBOARDING COMPONENTS BALANCE SHEET AS AT 31 JANUARY 2006 Non-current assets Store equipment $33,200 Less accumulated depreciation 8,000 $25,200 Buildings 170,000 Less accumulated depreciation 45,000 125,000 Land 73,200

223.400 Current assets are expected to$ be Long-term investments sold, collected, or used within Notes receivable 1.500 one Investments stockscompany’s and bonds 18.000 year orinthe operating Land held for future expansion 48.000 cycle. Total investments 67.500 Intangible assets Total non-current assets Current Assets Cash Short-term investments Accounts receivable Merchandise inventory

10.000 $ 300.900 $6,500 2,100 4,400 27,500

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SNOWBOARDING COMPONENTS BALANCE SHEET 31 JANUARY 2006 Non-current assets Store equipment $33,200 Less accumulated depreciation 8,000 $25,200 Buildings 170,000 Less accumulated depreciation 45,000 125,000 Land 73,200 $223,400 Long-term investments Notes receivable Investments in stocks and bonds Land held for future expansion Total investments Intangible assets Total assets

1,500 18,000 48,000

Long-term investments are 67,500 10.000 expected to be held for the longer $300.900 of one year or the operating cycle.

Current Assets Cash Short-term investments

6.500 2.100

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SNOWBOARDING COMPONENTS BALANCE SHEET 31 JANUARY 2006 Non-current assets Store equipment $33,200 Less accumulated depreciation 8,000 $25,200 Buildings 170,000 Less accumulated depreciation 45,000 125,000 Land 73,200

$223,400 Fixed assets are tangible long-lived Long-term investments assets sell Notes receivableused to produce or 1.500 Investments in stocks and bonds 18.000 products and services. Land held for future expansion Total investments Intangible assets Current assets Cash Short-term investments Accounts receivable

48.000

67.500 10.000 $300,900 $6,500 2,100 4,400

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SNOWBOARDING COMPONENTS BALANCE SHEET 31 JANUARY 2006 Non-current assets Store equipment $33,200 Less accumulated depreciation 8,000 $25,200 Buildings 170,000 Less accumulated depreciation 45,000 125,000 Land 73,200 $223,400 Long-term investments Notes receivable Investments in stocks and bonds Land held for future expansion

$1,500 18,000 48,000

Intangible assets are long-term $67,500 Intangible assets 10.000 resources used to produce or sell $300.900 products and services and that Current Assets lack physical form. 6.500 Cash © The McGraw-Hill Companies, Inc., 2007

SNOWBOARDING COMPONENTS BALANCE SHEET AS AT 31 JANUARY 2006 Current liabilities Accounts payable $ 15.300 Wages payable 3.200 Notes payable 3.000 Current portion of long-term liabilities 7.500 Total current liabilities $29,000

Current liabilities are obligations due within the longer of one year or the company’s operating cycle. © The McGraw-Hill Companies, Inc., 2007

SNOWBOARDING COMPONENTS BALANCE SHEET AS AT 31 JANUARY 2006

Equity and liabilities T.Hawk, Capital Non-current liabilities Notes payable (net of current portion)

$164,800

$150,000

Current liabilities

Long-term liabilities are obligations not due within the longer of one year or the company’s operating cycle. © The McGraw-Hill Companies, Inc., 2007