Kế toán tài chính 2 - Chapter 3: Measuring business income

Measuring Business IncomeMultimedia Slides by: Gail A. Mestas, MAcc, New Mexico State UniversityChapter 3Learning ObjectivesDefine net income and its two major components, revenues and expenses.Explain how the income measurement issues of accounting period, continuity, and matching are resolved.Define accrual accounting and explain two broad ways of accomplishing it.2Copyright © Houghton Mifflin Company. All rights reserved.Learning Objectives (cont’d)State four principal situations that require adjusting entries and prepare typical adjusting entries.Prepare financial statements from an adjusted trial balance.Supplemental ObjectiveAnalyze cash flows from accrual-based information.3Copyright © Houghton Mifflin Company. All rights reserved.Profitability Measurement: The Role of Business IncomeObjective 1Define net income and its two major components, revenues and expenses4Copyright © Houghton Mifflin Company. All rights reserved.Profitability is the ability to earn enough income to attract and hold investment capitalProfitability is a major goal of a businessFor a business to survive, it must earn a profitThe term profit has many meanings depending on who is interpreting itEconomistsLawyersAccountantsAccountants prefer to use the term net income5Copyright © Houghton Mifflin Company. All rights reserved.Net Incomeis the increase in owner's equity that results from the operations of a companyNet Income = Revenues – ExpensesWhen expenses exceed revenues a net loss occurs6Copyright © Houghton Mifflin Company. All rights reserved.RevenuesIncreases in owner's equity resulting from Selling goodsRendering servicesPerforming other business activitiesNot all increases in owner's equity arise from revenuesIncreases resulting from owner's investments do not represent revenueWhen a company earns revenue, it usually receives Cash A promise to be paid in the near futureRecorded in either Accounts Receivable or Notes Receivable7Copyright © Houghton Mifflin Company. All rights reserved.Revenues (cont’d)Liabilities are usually not affected by revenuesTransactions that increase cash and other assets but are not revenuesA bank loanIncreases liabilities and cashCollection of accounts receivableIncreases cash and decreases accounts receivableRevenue was previously recorded when the sale took place8Copyright © Houghton Mifflin Company. All rights reserved.ExpensesDecreases in owner's equity resulting from costs ofSelling goodsRendering servicesPerforming other business activitiesAlso called the cost of doing businessInclude costs ofGoods soldActivities necessary to carry on a businessAttracting and serving customers9Copyright © Houghton Mifflin Company. All rights reserved.Expenses (cont’d)Transactions that decrease cash and other assets but are not expensesCash payments to reduce liabilitiesDecrease cash and decrease a liabilityThe expense was recorded when the purchase took placeOwner withdrawalsDecrease cash and decrease owner’s equityWithdrawals is an owner's equity account, not an expense account10Copyright © Houghton Mifflin Company. All rights reserved.Prepaid Expenses and Plant AssetsTwo steps required before an expenditure of cash becomes an expensePrepaid expenses and plant assets are recorded as assets when acquiredTheir cost is allocated to expenses as their usefulness expires Expenses are also called expired costs11Copyright © Houghton Mifflin Company. All rights reserved.DiscussionWhy does the accountant use the term net income instead of profit?Profit has many meaningsNet income is more accurateNet income is the net increase in owner's equity produced by business operationsNet income = Revenues – Expenses(when revenues exceed expenses)12Copyright © Houghton Mifflin Company. All rights reserved.Income Measurement IssuesObjective 2Explain how the income measurement issues of accounting period, continuity, and matching are resolved13Copyright © Houghton Mifflin Company. All rights reserved.Income Measurement IssuesAccounting period issueContinuity issueMatching issue14Copyright © Houghton Mifflin Company. All rights reserved.The Accounting Period IssueAddresses the difficulty of assigning revenues and expenses to a short period of timeProblem:Some transactions have effects that extend over long periods of time (more than one accounting period)Solution:Make an assumption about periodicityThe net income for any period of time less than the life of the business, although tentative, is still a useful estimate of the entity’s profitability for the period15Copyright © Houghton Mifflin Company. All rights reserved.The Accounting PeriodA specific length of time during which the financial results of business transactions are recorded and measuredTime periods are of equal length to make comparisons easierFinancial statements may be prepared for any time period16Copyright © Houghton Mifflin Company. All rights reserved.The Accounting Period (cont’d)Fiscal yearTwelve-month accounting period used by an organizationBusinesses can use the calendar yearOr, their fiscal year can correspond to the yearly activity of the business cycleThe fiscal year used should always be noted in the financial statements Interim periodAccounting periods of less than one yearUsually a month or a quarter17Copyright © Houghton Mifflin Company. All rights reserved.The Continuity IssueThe issue that arises when it is difficult to know how long a business entity will surviveProblem:Certain revenue and expense transactions must be allocated over several accounting periodsUncertainty exists about whether the business will continue to operate in the futureSolution:The accountant assumes the business is a going concernThe business will continue to operate indefinitely, unless there is evidence to the contrary18Copyright © Houghton Mifflin Company. All rights reserved.Assumption of ContinuityJustification for all the techniques of income measurement is based on the assumption of continuity (that a business is a going concern)This allows the cost of certain assets to be held on the balance sheet until a future year, when they will become expenses on the income statementThe value of assets is recorded at cost and does not change for a going concernFor a business facing bankruptcy, there is no assumption of continuity, and assets may be reported at liquidation value (what they will bring in cash if sold)19Copyright © Houghton Mifflin Company. All rights reserved.The Cash Basis of AccountingRevenues are recorded when cash is receivedExpenses are recorded when cash is paidProblems associated with cash accountingRevenues can be earned in a period other than the one in which cash is receivedExpenses can be incurred in an accounting period other than the one in which cash is paid20Copyright © Houghton Mifflin Company. All rights reserved.The Matching IssueThe difficulty of assigning revenues and expenses to the appropriate accounting period so that net income is measured accuratelyProblem:Revenues can be earned in a period other than the one in which cash is receivedExpenses can be incurred in a period other than the one in which cash is paidSolution:The matching ruleAssign revenues to the accounting period in which the goods are sold or services are renderedAssign expenses to the accounting period in which they are used to produce income21Copyright © Houghton Mifflin Company. All rights reserved.The Matching RuleApplying the matching rule solves the problems associated with cash basis accountingRevenues and related expenses are recognized in the same accounting periodA building is converted from an asset to an expense by allocating its cost over the years the company benefits from its useThe cost of the building is expensed over a number of accounting periods, thereby matching its cost for each period with the revenues produced during each of those periods22Copyright © Houghton Mifflin Company. All rights reserved.DiscussionWhy does the need for an accounting period cause problems?Any measurement of net income over a short period of time is tentativeNot all transactions can be easily assigned to specific periodsIt is necessary to recognize that net income for any period less than the life of the business is a useful approximation of the net income for the period23Copyright © Houghton Mifflin Company. All rights reserved.Accrual AccountingObjective 3Define accrual accounting and explain two broad ways of accomplishing it24Copyright © Houghton Mifflin Company. All rights reserved.Accrual Accounting is the attempt to record the financial effects of transactions and other events in the periods in which they occur rather than only in the periods in which cash is received or paid 25Copyright © Houghton Mifflin Company. All rights reserved.Accrual Accounting (cont’d)Developed to apply the matching rule byRecording revenues when earnedRecording expenses when incurredAdjusting the accounts26Copyright © Houghton Mifflin Company. All rights reserved.Revenue RecognitionThe process of determining when revenue is earned and when it should be recordedFour criteria for revenue recognition established by the Securities and Exchange Commission (SEC)Persuasive evidence of an arrangementDelivery has occurred or services have been renderedThe seller’s price to the buyer is fixed or determinableReasonable assurance that the amount is collectable27Copyright © Houghton Mifflin Company. All rights reserved.Revenue Recognition ExampleJoan Miller Advertising Agency bills a customer for placing an advertisementIt is agreed customer owes for serviceServices have been renderedThe seller’s price to the buyer is fixed or determinableCollectibility is reasonably assuredThe transaction should be recorded as revenue even though cash has not been received because all four criteria have been metRecord byDebiting Accounts ReceivableCrediting Advertising Fees Earned28Copyright © Houghton Mifflin Company. All rights reserved.Recognizing Expenses When IncurredSame criteria apply as for revenue recognitionCriteria for recognizing expensesAn agreement exists to purchase a product or serviceThe product has been delivered or services renderedA price is established or can be determinedThe product or service has been used to produce revenue29Copyright © Houghton Mifflin Company. All rights reserved.Example of Recognizing an Expense Joan Miller Advertising Agency receives its telephone billIt is agreed that Joan Miller Advertising owes for the serviceServices have been renderedA price is established or can be determinedThe service has been used to produce revenueThe transaction should be recorded as an expense even though cash has not yet been paid because all four criteria have been metRecord byDebiting Telephone ExpenseCrediting Accounts Payable30Copyright © Houghton Mifflin Company. All rights reserved.Adjusting the AccountsAlthough operating a business is a continuous process, there must be a cutoff point for periodic reports Reports are prepared at the end of an accounting periodBalance sheet must list all assets and liabilities at the end of the accounting periodIncome statement must list all revenues and expenses applicable to the accounting periodSome transactions span more than one accounting periodThese transactions require adjustments31Copyright © Houghton Mifflin Company. All rights reserved. Adjusting the Accounts (cont.) Some accounts in the end-of-period trial balance for Joan Miller Advertising Agency do not show the correct balances for preparing the financial statementsThe balance in Prepaid Rent represents rent for July and August. An adjustment is needed to reflect the proper balance of $800 and to allocate $800 to rent expense32Copyright © Houghton Mifflin Company. All rights reserved.Accrual Accounting and Performance MeasuresImportance of adjustmentsThey are necessary for determining key profitability performance measures because they affectNet income on the income statementProfitability comparisons from one period to anotherAssets and liabilities on the balance sheetProvide information about a company’s future cash inflows and outflowsInformation needed to assess management’s short-term goal of liquidity so that there is enough cash to pay bills33Copyright © Houghton Mifflin Company. All rights reserved.Adjusting EntriesNever affect the Cash accountTherefore, they never affect cash flows in the current periodThey do provide information about future cash flowsAccounts Receivable indicates expected future cash inflowsAccounts Payable indicates expected future cash outflowsConsiderable judgment underlies the application of adjusting entriesTherefore, the potential for abuse existsMisuse can result in misleading performance measures34Copyright © Houghton Mifflin Company. All rights reserved.Prepaid RentJuly 2 1,600July 31: Prepaid rent of $800 has expired. Adjust account by allocating $800 of prepaid rent to rent expenseJoan Miller Advertising Agency’s July 31 trial balance showed a balance of $1,600 in the Prepaid Rent accountJuly 2: Paid $1,600 rent in advance for July and August Rent ExpenseBal. 800July 31 800July 31 800The correct account balance of $800 will now be reflected on the balance sheetThe correct account balance of $800 will now be reflected on the income statementIf this adjustment was not made, assets on the balance sheet would be $800 too high and expenses on the income statement would be $800 too low Adjustment’s Effect on the Income Statement and Balance Sheet35Copyright © Houghton Mifflin Company. All rights reserved.DiscussionWhy don’t adjustments ever involve the Cash account?Adjustments involve deferrals and accrualsDeferrals are the recognition of an expense already paid or a revenue received in advance Cash was recorded in a previous transaction when the cash was paid or receivedAccruals are the recognition of revenues or expenses that have arisen but have not yet been recorded because the related cash has not been received or paidCash will be recorded in a future transaction when it is received or paid36Copyright © Houghton Mifflin Company. All rights reserved.The Adjustment ProcessObjective 4State four principal situations that require adjusting entries and prepare typical adjusting entries37Copyright © Houghton Mifflin Company. All rights reserved.Adjusting Entries are used to apply accrual accounting to transactions that span more than one accounting periodEach adjusting entry mustInclude at least one balance sheet accountInclude at least one income statement accountNever include the Cash account38Copyright © Houghton Mifflin Company. All rights reserved.When to Make AdjustmentsAdjusting entries are required whenRecorded costs are allocated between two or more accounting periodsExpenses are incurred but not yet recordedRecorded unearned revenues are allocated between two or more accounting periodsRevenues are earned but not yet recorded39Copyright © Houghton Mifflin Company. All rights reserved. Four Types of Adjustments Examples of recorded costs:Prepaid RentPrepaid InsuranceSuppliesEquipmentBuildingRecorded costs are assetsThey represent expenses paid in advance that have not expired yet(Deferred Expenses)Once a recorded cost expires it becomes an expenseThe adjusting entry involves an asset account and an expense accountAlso called deferred expenses or prepaid expenses40Copyright © Houghton Mifflin Company. All rights reserved. Four Types of Adjustments Example: Wages earned by employees in the current accounting period but after the last pay periodAlso called accrued expenses(Accrued Expenses)These expenses have been incurred and must be recorded as liabilities to the companyThe adjusting entry involves an expense account and a liability account(Deferred Expenses)41Copyright © Houghton Mifflin Company. All rights reserved. Four Types of Adjustments Recorded unearned revenues are liabilitiesAn example of recorded unearned revenue is Unearned Art Fees(Accrued Expenses)(Deferred Expenses)(Deferred Revenues)It represents fees that have been received and recorded for services not yet providedOnce earned, recorded unearned revenue becomes revenueThe adjusting entry involves a liability account and a revenue accountAlso called deferred revenues42Copyright © Houghton Mifflin Company. All rights reserved. Four Types of Adjustments Example:Advertising services that have been performed but no fees have been collected and the customer has not yet been billedThese revenues have been earned and must be recorded as assets to the companyThe adjusting entry involves an asset account and a revenue account(Accrued Expenses)(Deferred Expenses)(Accrued Revenues)(Deferred Revenues)Also called accrued revenues43Copyright © Houghton Mifflin Company. All rights reserved. Four Types of AdjustmentsNotice that each adjusting entry involves one balance sheet accountand one income statement account (Accrued Expenses)(Deferred Expenses)(Accrued Revenues)(Deferred Revenues)44Copyright © Houghton Mifflin Company. All rights reserved.DeferralsA deferral is the postponement ofThe recognition of an expense already paidType 1 adjustmentThe recognition of a revenue received in advanceType 3 adjustment45Copyright © Houghton Mifflin Company. All rights reserved.AccrualsAn accrual is the recognition ofA revenue that has arisen but has not yet been recorded Cash will be received in a future periodType 4 adjustment An expense that has arisen but has not yet been recorded Cash will be paid in a future periodType 2 adjustment46Copyright © Houghton Mifflin Company. All rights reserved.Deferred ExpensesThe postponement of the recognition of expenses already paid Require allocating recorded costs between two or more accounting periodsRecorded costsExpenditures that benefit more than one accounting periodUsually debited to an asset accountAt the end of the accounting period the amount that has been used is transferred to an expense accountPrepaid expenses and depreciation of plant and equipment are two types of adjustments involving deferred expenses47Copyright © Houghton Mifflin Company. All rights reserved.Prepaid ExpensesExpenses paid in advance that have not yet expiredAre recorded as assetsA certain portion expires at the end of an accounting periodAn adjusting entry is made to reduce the asset and increase the expenseThe amount of the adjustment equals the cost of goods or services used up or expiredIf adjustments for prepaid expenses are not made at the end of the accounting periodAssets will be overstatedExpenses will be understatedOwner's equity will be overstatedNet income will be overstated48Copyright © Houghton Mifflin Company. All rights reserved.July 31: Prepaid rent of $800 has expired for July. Adjust account by allocating $800 of Prepaid Rent to Rent ExpenseJuly 2: Joan Miller Advertising Agency paid $1,600 rent in advance for July and August As each day of the month passes, part of the asset, prepaid rent, expires and becomes an expenseBy July 31, half of the prepaid rent has expired and should be treated as an expensePrepaid RentJuly 2 1,600Prepaid Rent49Copyright © Houghton Mifflin Company. All rights reserved.Step 3RecordStep 2Apply rulesDebits decrease owner's equity (increase Rent Expense)Credits decrease assets (Prepaid Rent)Step 1AnalyzeDecrease in owner's equity (increase in expenses) Decrease in assetsAdjusting Transaction July 31: Expiration of one month’s rent, $800Prepaid RentRent Expense July 2 1,600July 31 800 July 31 800The Prepaid Rent account now reflects $800 of rent paid in advance for AugustThe Rent Expense account now reflects $800 of rent expense for JulyBal. 800Balance sheet accountIncome statement accountPrepaid Rent50Copyright © Houghton Mifflin Company. All rights reserved.July 31: Prepaid insurance of $80 has expired for July. Adjust the account by allocating $80 of Prepaid Insurance to Insurance ExpenseJuly 8: The Agency purchased a one-year life insurance policy in advance, $960 As each day of the month passes, part of the asset, prepaid insurance, expires and becomes an expenseBy July 31, one month, or one-twelfth, of the prepaid rent has expired and should be treated as an expensePrepaid InsuranceJuly 8 960Prepaid Insurance51Copyright © Houghton Mifflin Company. All rights reserved.Step 2Apply rulesDebits decrease owner's equity (increase Insurance Expense)Credits decrease assets (Prepaid Insurance)Prepaid InsuranceStep 3RecordStep 1AnalyzeDecrease in owner's equity (increase in expenses) Decrease in assetsAdjusting TransactionJuly 31: Expiration of one month’s life insurance, $80Insurance Expense July 31 80 July 31 80The Prepaid Insurance account now reflects $880 of insurance paid in advance for 11 monthsThe Insurance Expense account now reflects $80 of insurance expense for JulyBal. 880Prepaid InsuranceJuly 8 960Balance sheet accountIncome statement account52Copyright © Houghton Mifflin Company. All rights reserved.Art and Office SuppliesEarlier in the month, Joan Miller Advertising Agency purchased art suppliesAs advertising designs for clients were prepared, art supplies were consumedInventory is taken at the end of the month to determine supplies on handThe amount of art supplies consumed during the month is calculated and an adjustment is madeRepeat procedure to determine office supplies expense53Copyright © Houghton Mifflin Company. All rights reserved.Art SuppliesJuly 31: Art supplies worth $500 were consumed during July. Adjust account by allocating $500 of Art Supplies to Art Supplies ExpenseJuly 6: The Agency purchased $1,800 of art suppliesEnding inventory shows $1,300 of art supplies still on handThis means that of the $1,800 of art supplies originally purchased, $500 worth were consumed (became an expense)Art SuppliesJuly 6 1,800Bal. 1,30054Copyright © Houghton Mifflin Company. All rights reserved.Step 2Apply rulesStep 3RecordDebits decrease owner's equity (increase Art Supplies Expense)Credits decrease assets (Art Supplies)Art SuppliesStep 1AnalyzeDecrease in owner's equity (increase in expenses) Decrease in assetsAdjusting TransactionJuly 31: Consumption of $500 worth of art suppliesArt Supplies Expense July 31 500 July 31 500The Art Supplies account now reflects $1,300 of art supplies still on handThe Art Supplies Expense account now reflects the $500 of art supplies consumed during JulyBal. 1,300Art SuppliesJuly 6 1,800Balance sheet accountIncome statement account55Copyright © Houghton Mifflin Company. All rights reserved.Office SuppliesJuly 31: Office supplies worth $200 were consumed during July. Adjust account by allocating $200 of Office Supplies to Office Supplies ExpenseJuly 6: The Agency purchased $800 of office suppliesEnding inventory shows $600 of office supplies still on handThis means that of the $800 of office supplies originally purchased, $200 worth were consumed (became an expense)Office SuppliesJuly 6 800Bal. 60056Copyright © Houghton Mifflin Company. All rights reserved.Step 2Apply rulesStep 3RecordDebits decrease owner's equity (increase Office Supplies Expense)Credits decrease assets (Office Supplies)Office SuppliesStep 1AnalyzeDecrease in owner's equity (increase in expenses) Decrease in assetsAdjusting TransactionJuly 31: Consumption of $200 worth of office suppliesOffice Supplies Expense July 31 200 July 31 200The Office Supplies account now reflects $500 of art supplies still on handThe Office Supplies Expense account now reflects the $200 of office supplies consumed during JulyBal. 600Office SuppliesJuly 6 800Balance sheet accountIncome statement account57Copyright © Houghton Mifflin Company. All rights reserved.Depreciation is the periodic allocation of the cost of a tangible asset over its estimated useful lifeWhen a long-term asset is purchased, the company is paying in advance for the usefulness of the asset for as long as it benefits the companyThis purchase of an asset is a deferral of an expenseThe cost of the asset must be allocated over its estimated useful lifeThe amount allocated to any one period is called depreciation, or depreciation expense58Copyright © Houghton Mifflin Company. All rights reserved.Depreciation (cont’d)Is an expenseIs incurred during an accounting period to produce revenueMust be estimatedThe useful life of the asset is estimatedThe cost of the asset and its estimated useful life are used to determine the amount expensed each monthA number of methods exist for determining depreciationDepreciation expense does not reduce the asset account directly, but is recorded in a contra account59Copyright © Houghton Mifflin Company. All rights reserved.Contra AccountA separate account paired with the asset accountUsed to show the accumulated amount of depreciation expensed for the related assetThe balance in the contra account is shown on the financial statements as a deduction from the related asset accountContra accounts are used toRecognize that depreciation is an estimatePreserve the original cost of the assetIn combination with the asset account, they showHow much of the asset has been allocated as an expenseThe balance left to be depreciated60Copyright © Houghton Mifflin Company. All rights reserved.Depreciation of Art EquipmentJuly 31: Depreciate art equipment for July. Record $70 of depreciation expenseJuly 3: Joan Miller Advertising Agency paid $4,200 for art equipmentAs each day of the month passes, the asset, art equipment, is used to produce revenueAs a result, part of its cost expires and becomes an expenseBy July 31, $70 of its cost should be treated as an expenseArt EquipmentJuly 3 4,200Because depreciation is recorded in a contra account, the adjusting entry to record depreciation will not involve the Art Equipment account61Copyright © Houghton Mifflin Company. All rights reserved.Step 2Apply rulesStep 3RecordDebits decrease owner's equity (increase Depreciation Expense, Art Equipment)Credits decrease assets (increase Accumulated Depreciation, Art Equipment)Depreciation of Art EquipmentStep 1AnalyzeDecrease in owner's equity (increase in expenses) Decrease in assets (increase in contra asset)Adjusting TransactionJuly 31: Record depreciation expense for art equipment, $70Accum. Depreciation, Art Equip. The Accumulated Depreciation account now reflects the accumulated amount that the art equipment has been depreciatedDeprecation Exp., Art Equip.July 31 70July 31 70Income statement accountBalance sheet accountThe Depreciation Expense account now reflects $70 of the cost of Art Equipment that has been expensed for July62Copyright © Houghton Mifflin Company. All rights reserved.Depreciation of Office EquipmentJuly 31: Depreciate office equipment for July. Record $50 of depreciation expenseJuly 5: Joan Miller Advertising Agency paid $3,000 for office equipmentAs each day of the month passes, the asset, office equipment, is used to produce revenueAs a result, part of its cost expires and becomes an expenseBy July 31, $50 of its cost should be treated as an expenseOffice EquipmentJuly 5 3,000Because depreciation is recorded in a contra account, the adjusting entry to record depreciation will not involve the Office Equipment account63Copyright © Houghton Mifflin Company. All rights reserved.Step 2Apply rulesStep 3RecordDebits decrease owner's equity (increase Depreciation Expense, Office Equipment)Credits decrease assets (increase Accumulated Depreciation, Office Equipment)Depreciation of Office EquipmentStep 1AnalyzeDecrease in owner's equity (increase in expenses) Decrease in assets (increase in contra asset)Adjusting TransactionJuly 31: Record depreciation expense for office equipment, $50Accum. Depreciation, Office Equip. The Accumulated Depreciation account now reflects the accumulated amount that the office equipment has been depreciatedDeprecation Exp., Office Equip.July 31 50July 31 50Income statement accountBalance sheet accountThe Depreciation Expense account now reflects $50 of the cost of Office Equipment that has been expensed for July64Copyright © Houghton Mifflin Company. All rights reserved.Carrying Value of AssetsAccum. Depreciation, Art Equip. July 31 70Art EquipmentJuly 3 4,200Carrying value is the portion of the cost of an asset that has not yet expired (been expensed)Also called book valueCarrying value = Cost – Accumulated DepreciationCarrying value = $4,200 – $70 = $4,130 At the end of August, depreciation expense of $70 will be recorded again Aug 31 70Bal. 140Compute the carrying value of art equipment for Joan Miller Advertising AgencyCarrying value = $4,200 – $140 = $4,060 65Copyright © Houghton Mifflin Company. All rights reserved.Accrued ExpensesExpenses that are incurred but not yet recordedAt the end of the accounting period the amount that has been incurred is recorded in An expense accountThe corresponding liability accountAs the expense and liability accumulate, they are said to accrueCommon unrecorded (accrued) expensesInterestTaxesWagesUtilities66Copyright © Houghton Mifflin Company. All rights reserved.Accrued WagesJulyThe pay period for the secretary at Joan Miller Advertising Agency is biweekly (every two weeks)The last pay period ended July 26At the end of business on July 31, the secretary has earned 3 days wages but will not be paid until the next payday in AugustThese wages are an expense for July and should be recorded as a liability to the company SuMTuWThFSa12345678910111213141516171819202122232425262728293031Calculating Accrued WagesThe secretary’s wage rate is equal to $1,200 every two weeksCalculate wages payable as of July 3168Copyright © Houghton Mifflin Company. All rights reserved.Step 2Apply rulesStep 3RecordDebits decrease owner's equity (increase Wages Expense)Credits increase liabilities (Wages Payable)Accrued WagesStep 1AnalyzeIncrease in liabilitiesDecrease in owner's equity (increase in expenses) Adjusting TransactionJuly 31: Accrual of unrecorded wages expense for July of $360Wages PayableThe Wages Payable account now reflects the liability that exists to pay wages for JulyWages ExpenseJuly 31 360July 31 360Income statement accountBalance sheet accountThe Wages Expense account now reflects $360 of accrued wages for July69Copyright © Houghton Mifflin Company. All rights reserved.Estimated Income TaxesJoan Miller Advertising Agency is a corporation subject to federal income taxesActual amount owed will not be known until the end of the yearIncome tax expense for each month is estimatedJoan Miller estimates that July’s share of federal income taxes for the year is $40070Copyright © Houghton Mifflin Company. All rights reserved.Step 2Apply rulesStep 3RecordDebits decrease owner's equity (increase Income Taxes Expense)Credits increase liabilities (Income Taxes Payable)Estimated Income TaxesStep 1AnalyzeIncrease in liabilitiesDecrease in owner's equity (increase in expenses) Adjusting TransactionJuly 31: Accrual of estimated income taxes for July, $400Income Taxes PayableThe Income Taxes Payable account now reflects the liability that exists to pay income taxes for JulyIncome Taxes ExpenseJuly 31 400July 31 400Income statement accountBalance sheet accountThe Income Taxes Expense account now reflects $400 of accrued income taxes for July71Copyright © Houghton Mifflin Company. All rights reserved.Deferred RevenuesThe postponement of the recognition of revenues already received Require allocating recorded unearned revenues between two or more accounting periodsRecorded unearned revenueRevenues that are received in advance (creating a liability)Deferred revenues are credited to a liability accountAt the end of the accounting period the amount that has been earned is transferred to a revenue account72Copyright © Houghton Mifflin Company. All rights reserved.Unearned Art FeesJuly 31: Services for which payment was received in advance were partially performed. The revenue has been earned and must be recognizedJuly 15: The Joan Miller Advertising Agency received payment in advance for advertising designs for another agency, $1,000 By the end of July, $400 worth of designs had been finished and accepted by the other agencyUnearned Art FeesJuly 15 1,00073Copyright © Houghton Mifflin Company. All rights reserved.Step 2Apply rulesStep 3RecordDebits decrease liabilities (Unearned Art Fees)Credits increase stockholder’s equity (Art Fees Earned)Unearned Art FeesStep 1AnalyzeDecrease in liabilitiesIncrease in owner's equityAdjusting TransactionJuly 31: Performance of services paid for in advance, $400Art Fees EarnedThe Art Fees Earned account now reflects the revenue that was earned for JulyUnearned Art FeesJuly 15 1,000July 31 400Balance sheet accountIncome statement accountThe Unearned Art Fees account now reflects $600 of unearned art fees that remain at the end of JulyJuly 31 400Bal. 60074Copyright © Houghton Mifflin Company. All rights reserved.Accrued RevenuesRevenues earned but not yet recordedAt the end of the accounting period, record the amount that has been earned inA revenue accountTo record the amount of revenue that has been earnedThe Accounts Receivable account (an asset account)To record amounts due to the company for services performed75Copyright © Houghton Mifflin Company. All rights reserved.Step 2Apply rulesStep 3RecordDebits increase assets (Accounts Receivable)Credits increase owner's equity (Advertising Fees Earned)Accrued Advertising FeesStep 1AnalyzeIncrease in assetsIncrease in owner's equityAdjusting TransactionJuly 31: Accrual of unrecorded revenue for July of $200Advertising Fees EarnedThe Advertising Fees Earned account now reflects the revenue that was earned for JulyAccounts ReceivableJuly 31 200July 31 400Income statement accountBalance sheet accountThe Accounts Receivable account now reflects $200 of accrued advertising fees for July76Copyright © Houghton Mifflin Company. All rights reserved.DiscussionWhat do plant and equipment, office supplies, and prepaid insurance have in common?They are all assets Their cost must be allocated to expenses as they are used over timeThey all require adjusting entries at the end of the accounting period77Copyright © Houghton Mifflin Company. All rights reserved.Using the Adjusted Trial Balance to Prepare Financial StatementsObjective 5Prepare financial statements from an adjusted trial balance78Copyright © Houghton Mifflin Company. All rights reserved.Adjusted Trial BalanceA trial balance prepared after all adjusting entries have been recorded and posted to the accountsTotal debits = total creditsThe financial statements can easily be prepared from the adjusted trial balance79Copyright © Houghton Mifflin Company. All rights reserved.Sequence for Preparing Financial StatementsIncome statement Uses revenue and expense accounts from adjusted trial balanceStatement of owner’s equityUses Capital account balance from adjusted trial balance Uses net income from the income statement Balance sheetUses balance sheet accounts from adjusted trial balanceUses end of period balance in Capital account from statement of owner’s equity80Copyright © Houghton Mifflin Company. All rights reserved.Sequence for Preparing Financial StatementsThe Capital account balance on the adjusted trial balance is the beginning of period balance — the end of period balance is calculated in the statement of owner’s equity81Copyright © Houghton Mifflin Company. All rights reserved.DiscussionWhere does unearned revenue appear on the balance sheet?Unearned revenue appears as a liability on the balance sheet82Copyright © Houghton Mifflin Company. All rights reserved.Cash Flows from Accrual-Based InformationSupplemental Objective 6Analyze cash flows from accrual-based information83Copyright © Houghton Mifflin Company. All rights reserved.Cash Flows from Accrual-Based InformationEvery revenue or expense account on the income statement has one or more related accounts on the balance sheetThese accounts are related through adjusting entriesAdjusting entries are based on accrual accountingCash flows generated or paid by company operations can be determined by analyzing these relationships84Copyright © Houghton Mifflin Company. All rights reserved.Determining Cash FlowsGeneral RuleNote: The general rule does not apply to depreciation85Copyright © Houghton Mifflin Company. All rights reserved.Applying the General RuleApplication of the general rule varies with the type of asset or liability accountFor deferralsPrepaid expensesEnding Balance + Expense for the Period – Beginning BalanceUnearned revenuesEnding Balance + Revenue for the Period – Beginning BalanceFor accrualsAccrued expensesBeginning Balance + Expense for the Period – Ending BalanceAccrued revenuesBeginning Balance + Revenue for the Period – Ending Balance86Copyright © Houghton Mifflin Company. All rights reserved. Cash Payments for Insurance 310 310 Deferred expenseGeneral rule for deferred expensesCash payments for expenses Jun 30 670CashPrepaid InsuranceInsurance Expense120May 31 480 120The beginning balance is deducted because it was paid in a prior periodAnother Example of Determining Cash Flows from Accrual-Based InformationDetermine Joan Miller Advertising Agency’s cash payments for wages for the month of July88Copyright © Houghton Mifflin Company. All rights reserved. Cash Payments for WagesAccrued expenseGeneral rule for accrued expensesCash payments for expenses 26 1,200CashWages PayableJuly 12 1,20031 360July 31 360Wages ExpenseJuly 12 1,20031 360July 31 2,76026 1,2002,4002,400The ending balance is deducted because it has not yet been paidThe beginning balance is zero because July is the first month of operationDiscussionWhy is the income statement the first statement prepared from the adjusted trial balance?The net income figure is needed to complete the statement of retained earningsThe end of period balance for retained earnings is then needed to prepare the owner's equity section of the balance sheet90Copyright © Houghton Mifflin Company. All rights reserved.Time for ReviewDefine net income and its two major components, revenues and expensesExplain how the income measurement issues of accounting period, continuity, and matching are resolvedDefine accrual accounting and explain two broad ways of accomplishing it91Copyright © Houghton Mifflin Company. All rights reserved.And FinallyState four principal situations that require adjusting entries and prepare typical adjusting entriesPrepare financial statements from an adjusted trial balanceAnalyze cash flows from accrual-based information92Copyright © Houghton Mifflin Company. All rights reserved.