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Accounting Chapter 3- Adjusting Accounts & Preparing Financial Statements

by: Katie Mulliken

Accounting Chapter 3- Adjusting Accounts & Preparing Financial Statements ACCT2101

Marketplace > University of Georgia > Accounting > ACCT2101 > Accounting Chapter 3 Adjusting Accounts Preparing Financial Statements
Katie Mulliken
GPA 3.91

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Accounting Chapter 3- Adjusting Accounts & Preparing Financial Statements. The accounting cycle, accrual vs. cash basis accounting, revenues and expenses, adjusting accounts, classified balance sh...
Intro to Accounting 1
Class Notes
adjusting accounts and preparing financial statements, Accounting cycle, accrual vs cash basis accounting
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This 6 page Class Notes was uploaded by Katie Mulliken on Tuesday April 5, 2016. The Class Notes belongs to ACCT2101 at University of Georgia taught by Bhandarkar in Spring 2016. Since its upload, it has received 17 views. For similar materials see Intro to Accounting 1 in Accounting at University of Georgia.


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Date Created: 04/05/16
Accounting 2101 Bhandarkar Katie Mulliken Chapter 3—Adjusting Accounts & Preparing Financial Statements The Accounting Cycle — refers to the steps in preparing financial statements  The events /transactions that a business completes in an accounting period o Analyze and Journalize transactions into journal o Post o Prepare unadjusted trial balance o Adjust!!! Journalize and post the adjustments o Prepare adjusted trial balance o Prepare financial statements o Journalize and post closing entries o Prepare post-closing trial balance o Reverse (optional)  Annual Financial Statements typical reporting/accounting period is 1 year (fiscal year)  Interim Financial Statements—can be prepared for more frequent/short periods (more accurate statement of financial standing)  Natural Business Year companies’ w seasonal variations in sales. End when sales are lowest for whole year  Worksheet— a form of working papers used by accountants (internally) that organizes financial data to help in preparing financial statements. o When used to prepare financial statements, its constructed at the end of period o Includes: list of accounts, account balances, & adjustments sorted into columns (ex: columns may include a trial balance column, adjusted trial balance column, income statement column, or a balance sheet column). Steps::: 1) Enter unadjusted trial balance 2) Enter adjustments 3) Prepare adjusted trial balance 4) Sort adjusted trial balance amounts into financial statements 5) Total financial statement columns 6) Find the net income/loss and add to the balance sheet columns Accrual vs. Cash Basis Accounting Accrual Basis—Revenue recognized when earned, expense recognized when incurred o Large firms use bc better reflects performance & increases statement comparability o Uses the adjusting process to recognize (record) revenues & expenses to match Cash Basis—Revenue recognized when cash received, expenses recorded when cash paid… (Not consistent with GAAP) o More likely to be used by a small business with more cash receipts/payments Accounting 2101 Bhandarkar Katie Mulliken Accrual Basis—Revenues o Accrued revenues or accrued assets—revenues earned in a period that are unrecorded and not yet received in cash. Arise from services, products, interest o Revenue Recognition Principle— goal of adjusting is to have revenue reported in the time period it was earned, whether or not cash is received.  The revenues earned when products delivered/services are performed.  Ex: Plumber bills customers after the job is done. If he completes 1/3 of the job at the end of a period, the plumber records 1/3 of expected revenue at the end of a period. The adjusting entry: accrued increase revenue, increase assets (asset—debit adjustment) (adjusted revenue— credits)  Accrual Basis—Expenses o Accrued expenses or accrued liabilities—costs that are incurred in a period but are both unpaid & unrecorded.  Must be reported on an income statement for the period it was incurred  Include: salaries payable, interest payable, rent payable, taxes payable  Adjusting entry for recording accrued expenses: expenses liabilities o Matching Principle/Expense Recognition Principle—aims to record expenses in the same accounting period as revenues earned as a result of these expenses  Expense recognition—records expenses that were incurred to generate the revenues recorded in the accounting period  Recording revenue early overstates the current period revenue/ income. Recording late understands current revenue/ income  Recording expenses early overstates the current period expenses and understates the current-period income (visa versa) Adjusting Accounts  Adjusting Entry—made at the end of an accounting period to reflect a transaction or event that has not yet been recorded o Each adjustment affects 1+ income statement accounts & 1+ balance sheet assets but never cash accounts o Recorded to bring an asset or liability account balance to its proper amount and ensure that the revenue recognition and matching principle are followed o Any change in the ledger must be changed in the journal first (adjusting journal entries) before preparing financial statements o Steps in Adjusting Account Entries: 1) Prepare unadjusted trial balance 2) Journalize and post the adjusting entries 3) Prepare an adjusted trial balance 4) Prepare financial statements Accounting 2101 Bhandarkar Katie Mulliken 4 types of adjusting entries: 1) Prepaid Expenses— (deferred expense) cash is paid before expense is recorded , this includes depreciation  Resources paid for before receiving benefits= prepaid asset. When used= expense  Straight-Line Depreciation – process of computing expense by allocating the cost of plant & equipment assets over their expected useful lives. It does not necessarily measure a decline in market value  Book Value—an assets acquisition cost – accumulated depreciation o The difference between an assets original value & value now after use o The cost principle requires an asset to be initially recorded at acquisition cost. Depreciation causes assets’ book value to decline o Book Value = Cost – Accumulated Depreciation  Straight-Line Depreciation Expense= [Asset Cost – Salvage Value] ÷ [Useful Life] o Ex: prepaid insurance, prepaid rent, prepaid subscriptions, supplies 2) Unearned Revenues— (deferred revenue) cash is received before revenue is recorded. This is a liability; you’re obligated to provide goods or service.  Once they’re provided, unearned revenue earned revenue 3) Accrued Expenses—(liabilities) cash is paid after expenses is recognized  Expenses incurred in a period that are both unpaid and unrecorded  Ex: a company pays its employees every Friday. The year-end is on a Wednesday, so you make an account payable 4) Accrued Revenues—(assets) cash is received after revenue is recognized  Revenues earned in a period that are both unrecorded & not yet received o Ex: Interest receivable, rent receivable, accounts receivable, etc. o Ex: Service provided not yet billed/ recorded at the end of a period. Adjusting entry: Debit Accounts Receivable, Credit Service Revenue  Summary of Adjustments & Effects of Omitting o Summary of Adjustments Effect of Omitting Adjustment Type Adjusting Entry Balance Sheet Account Income Statement Account Adjusted Trial Balance —list of account & balances prepared after adjusting entries recorded and posted to the ledger used to prepare financial statements… o Financial Statements prepared in order:  Income statement – reports businesses’ revenues & expenses for a certain period Accounting 2101 Bhandarkar Katie Mulliken  Statement of retained earnings  Balance sheet – reports a businesses’ assets, liabilities & equity on a specific date  Statement of cash flow—reports inflows/ outflows of cash during a certain period o Income Statement & Statement of Retained Earnings  Tells profitability of an account  Net income from income statement carries to statement of retained earnings  Net Income = Revenue – Expenses  Classified Balance Sheet o Gives information about a company’s financial position o Header: ~Company Name ~ ~Balance Sheet Name~ ~Date~ o ‘Report Form’ when all iterms listed in one form o Organized assets & liabilities into subgroups (unclassified is a more general list) o Current items are those expected to come due (either collected or owed) within one year or the company’s operating cycle (whichever is longer)  Current Assets: cash, or an asset easily convertible to cash in 1 year period  Noncurrent Assets: Long-term investments o Notes receivable/ stock investments held for 1+ years o Ex: land owned for future expansion not in current use  Plant assets—special category of prepaid expense, eventually depreciates & become expenses. (Original cost – salvage value) is expended over useful life o Expected to provide benefits for more than 1 period o Long-term tangible assets used to produce & sell products o Ex: buildings, land, etc. Intangible assets  Good-will, copyrights, trademarks, traditions, patients  Liabilities & Equity o Current liabilities — obligations due to be paid within 1-years time  Reported in the order of those to be settled first (usually w cash)  Unearned revenue, accounts payable o Noncurrent liabilities (long-term)—not expected to settle debt in 1 year o Equity  Temporary (nominal) Accounts— accumulate data related to one accounting period o Temp accounts ‘closed’ at end of period to get ready for next accounting period o Temporary because the accounts are opened at the beginning of a period, used to record transactions & events for that period, then closed at period end.  Income statement accounts  Dividend accounts  Income summary accounts  Ex: Service revenue, etc.  Permanent (real) Accounts— report activities related to 1+ future accounting periods. Accounting 2101 Bhandarkar Katie Mulliken o Carry ending balances to the next accounting period and are not ‘closed’  Asset accounts  Liability accounts  Common stock accounts  Retained earnings accounts  Ex: Accumulated depreciated, unearned rent The Closing Process  Recording Closing Entries o Close revenue accounts (income statement credits balances) o Close expense accounts (income statement debits balances) o Close income summary accounts (temporary account) o Close dividend accounts  Close—after financial statements have been completed o Prepare accounts for recording the transactions and events for the next period o Purpose:  To summarize a periods’ revenue and expenses  Reset revenue, expense, & dividend account balances to 0 at period end o The Closing Process is similar to the statement of retained earnings, but instead of a ‘statement’, it formulizes  3 steps to closing process: 1) Identify accounts for closing 2) Record and post closing entries 3) Prepare a post-closing trial balance  To close accounts, balances are transferred to income summary account (temporary, and only used during the closing process) o Sum of all revenues are credited o Sum of all expenses are debited  Ex: credit expense accounts during closing bc they have debit balances Debit income summary to transfer expense balances to income summary o Balance of income summary = Net income/loss o ^^^ Transferred to retained earnings account o Transfer Dividend account balance to retained earnings  Put Revenue & Expense accounts into the income summary o Transfer income summary balance to retained earnings acct (permanent storage)  Put Dividend account into retained earnings account as a ‘permanent storage’ o Closing the dividend account  Debit retained earnings, credit dividends Accounting 2101 Bhandarkar Katie Mulliken  Post-Closing Trial Balance o A list of permanent accounts & balances from the ledger after all closing entries have been journalized & posted o Lists balances for all accounts not closed o Purpose: to ensure that all nominal (temporary) accounts have been closed o Only accounts on this trial balance should be assets, liability & equity accounts


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