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ACC101 – CHAPTER 3
Preparing Financial Statements
Key Terms and Concepts to Know
Accounting Period: Time Period Principle Calendar vs. Fiscal Year
Accounting Cycle: Know the steps in order. Use the steps as a reference to insure that journal entries, trial balances and financial statements are prepared in the proper order.
Accrual Basis Accounting: Accrual vs. Cash Basis Accounting Revenue Recognition Principle requires that revenues are reported in the period in which they are earned, regardless of when payment is received. Matching Principle requires that all expenses incurred (whether paid or not) are recorded in the same accounting period as the revenues earned as a result of these expenses. Therefore, adjusting entries may be required to record internal transactions and to bring assets and liability accounts to their proper balances.
Adjusting Entries: Adjusting entries always affect one income statement account (revenue or expense) and one balance sheet account (asset or liability).
There are two basic types of adjusting entries: Deferrals and Accruals
Deferrals occur when cash changes hands prior to the revenue is earned or expense is incurred. Recording the revenue or expense is postponed or deferred until a subsequent economic event has occurred which causes revenue to be earned or expense to be incurred.
Accruals occur when revenue is earned or expense is incurred prior to the cash changing hands. Deferred revenues and deferred expenses have not been recorded prior to preparing and recording the adjusting entry.
Deferred Expenses (also referred to as prepaid expenses) are initially recorded as assets and adjusted at the end of the period for the portion that has been used up or expired.
Closing process involves four steps:
- Zeroing-out the balance in each revenue account and transferring the total revenues to the Income Summary account as a credit.
- Zeroing-out the balance in each expense account and transferring the total revenues to the Income Summary account as a debit.
- Zeroing-out the balance in Income Summary, the net income (credit) or net loss (debit) for the period, to the Retained Earnings account.
- Zeroing-out the balance in each dividend account and transferring the total dividends directly into retained earnings as a debit. Income Summary is not used because dividends are not used to determine Net Income. After closing only asset, liability and permanent stockholders’ equity accounts should have balances.
Trial Balances: Unadjusted, adjusted and post-closing are all necessary and important. Know when to prepare each of them and the purpose of each one.
Classified Balance Sheet: Divides assets and liabilities into Current and Non-Current based on the company’s operating cycle (typically one year). Current Assets are cash and other assets expected to be converted to cash or sold within one year through normal operations of the business. Current Liabilities are debts due within one year or less that will be paid out of current assets. Non-Current Assets – include fixed assets such as plant and equipment, which are depreciated over time, property or land and investments expected to be owned after one year. Non-current (Long-term) Liabilities are debts due after one year.
Profit Margin ratio and Current ratio
Example #1:
- Journalize the adjusting entries and label them as accruals or deferrals, adding accounts as needed.
- Determine the adjusted balances of the accounts and prepare an adjusted trial balance.
a. Unexpired insurance at December 31, $1,500. b. Supplies on hand at December 31, $400. c. Depreciation of building for the year, $1,750. d. Depreciation of equipment for the year, $5,800. e. Revenue unearned at December 31, $2,000. f. Accrued salaries and wages at December 31, $2,300. g. Fees earned but unbilled on December 31, $4,850.
Forever Green Lawn Care, Inc. Trial Balance December 31, 20-- Cash 8, Accounts Receivable 20, Prepaid Insurance 4, Supplies 1, Land 45, Building 134, Accumulated Depreciation-Bldg
Equipment 80, Accumulated Depreciation-Equip.
Accounts Payable 7, Unearned Revenue 6, Capital Stock 15, Retained Earnings 54, Dividends 8, Fees Earned 199, Salaries and Wages Expense
Utilities Expense 23, Advertising Expense 18, Repairs Expense 11, Miscellaneous Expense 4, Totals 430,200 430,
Forever Green Lawn Care, Inc. Adjusted Trial Balance December 31, 20-- Cash 8, Accounts Receivable 25, Prepaid Insurance 1, Supplies 400 Land 45, Building 134, Accumulated Depreciation- Bldg
Equipment 80, Accumulated Depreciation- Equip.
Accounts Payable 7, Salaries & Wages Payable 2, Unearned Revenue 2, Capital Stock 15, Retained Earnings 54, Dividends 8, Fees Earned 208, Salaries and Wages Expense
Utilities Expense 23, Advertising Expense 18, Repairs Expense 11, Depreciation Expense- Equipment
Depreciation Expense-Bldg 1, Miscellaneous Expense 4, Insurance Expense 2, Supplies Expense 1,
Totals 444,900 444,
Practice Problem #1:
- Journalize the adjusting entries and label them as accruals or deferrals.
- Update the account balances of the selected accounts given below.
a. Supplies on hand on August 31, $ b. Depreciation of equipment during the year, $3, c. Rent expired during the year, $11, d. Wages accrued, but not paid at August 31, $2, e. Unearned fees at August 31, $1, f. Unbilled fees at August 31, $5,
Selected Account Balances
Current Balance
Adjustm ent
Adjusted Balance
Debit Credit (+ / - ) Debit Credit
Accounts Receivable 12, Supplies 1, Prepaid Rent 20, Equipment 73, Accumulated Depreciation- Equipment
Capital Stock 20, Dividends 2, Unearned Fees 7, Fees Earned 99, Wages Expense 42, Rent Expense Depreciation Expense Supplies Expense
Adjusting Entries and Errors
Failure to record adjusting entries at the end of the period will cause several financial statement items to be misstated. Consider the following:
Company A failed to record accrued wages of $5,000 at the end of the period.
The entry should have been:
Wages Expense 5, Wages Payable 5,
Net Total Total Total Stock- Income Assets Liabilities holder’s Equity Reported Balance $102,500 $228,750 $60,500 $168, Corrections: Adjustment (a) -800 -800 --- - Adjustment (b) -3,000 -3,000 --- -3, Adjustment (c) +1,200 +1,200 --- +1, Adjustment (d) -500 ----------- +500 - Corrected Balance $ 99,400 $ 226,150 $ 61,000 $ 165,
Practice Problem # At the end of January, the first month of operations, the following selected data were taken from the financial statements of Wanda’s Car Wash: Net Income for January $88, Total Assets at January 31 276, Total Liabilities at January 31 77, Total Stockholders’ Equity at January 31 198,
The following adjusting entries were omitted at the end of the month: a. Unbilled fees earned at January 31, $2, b. Supplies used during January 31, $1, c. Depreciation of equipment for January, $7, d. Accrued wages at January 31, $1,
Required: 1) Journalize the entries to record the omitted adjustments.
- Determine the correct amounts for Net Income, Total Assets, Total Liabilities, and Total Stockholders’ Equity as of January 31.
Closing Entries The next step in the accounting cycle is to journalize the closing entries to prepare the temporary accounts to gather data for the next accounting period. The following closing entries are based on the previous worksheet. There are four closing entries that are numbered below.
Fees Revenue 190, Rent Revenue 2, Income Summary 192,
(#1: close all revenue accounts to Income Summary)
Income Summary 201, Salaries and Wages Expense 102, Advertising Expense 58, Utilities Expense 19, Repairs Expense 11, Miscellaneous Expense 4, Insurance Expense 800 Supplies Expense 700 Depreciation Expense-Bldg 1, Depreciation Expense-Equipment 3,
(#2: close all expense account to Income Summary)
(Balance of Income Summary = Net Income)
Retained Earnings 9, Income Summary 9,
(#3: close Income Summary to RE)
Retained Earnings 10, Dividends 10,
(#4: close Dividend account to RE)
Practice Problem # For each of the following accounts indicate whether it is: (IS) – closed to Income Summary (RE) – closed to Retained Earnings (P) – a permanent account and not closed
- Accounts Payable
- Accounts Receivable
- Fees Earned
- Dividends
- Insurance Expense
- Accumulated Depreciation-Bldg
- Prepaid Advertising
- Wages Payable
- Unearned Fees
- Supplies
- Prepaid Insurance
- Salary Expense
Post-Closing Trial Balance
A trial balance is taken after the closing entries have been posted. This trial balance should contain only permanent accounts as all temporary accounts have been closed.
- The balance in the prepaid rent account before adjustment at the end of the year is $18,000, which represents three months’ rent paid on December 1. The adjusting entry required on December 31 is: a. Debit Rent Expense, $6,000; credit Prepaid Rent, $6, b. Debit Prepaid Rent, $6,000; credit Rent Expense, $6, c. Debit Rent expense, $12,000; credit Prepaid Rent, $12, d. Debit Prepaid Rent, $12,000; credit Rent expense, $12,
- At the end of the fiscal year, the usual adjusting entry for accrued salaries owed to employees was omitted. Which of the following statements is true? a. Stockholders’ equity at the end of the year was overstated b. Salary Expense for the year was overstated c. The total of the liabilities at the end of the year was overstated d. Net Income for the year was understated
- What is the proper adjusting entry at June 30, the end of the fiscal year, based on a supplies account balance before adjustment, $7,200, and supplies inventory on June 30, $1,200? a. Debit Supplies, $1,200; credit Supplies Expense, $1, b. Debit Supplies Expense, $1,200; credit Supplies, $1, c. Debit Supplies Expense, $6,000; credit Supplies, $6, d. Debit Supplies, $6,000; credit Supplies Expense, $6,
- A business enterprise pays weekly salaries of $45,000 on Friday for a five-day week ending on that day. The adjusting entry necessary at the end of the fiscal period ending on Thursday is: a. Debit Salaries Payable, $36,000; credit Cash, $36, b. Debit Salary Expense, $36,000; credit Dividends, $36, c. Debit Salary Expense, $36,000; credit Salaries Payable, $36, d. Debit Dividends, $36,000; credit Cash, $36,
- At the end of the fiscal year, May Company omitted the usual adjusting entry for depreciation on equipment. Which of the following statements is true? a. Total assets will be understated at the end of the current year. b. The balance sheet, income statement, and retained earnings statement will be misstated for the current year. c. Expenses will be overstated at the end of the current year. d. Net income will be understated for the current year.
- Data for an adjusting entry described as “accrued wages, $800” means to debit: a. Capital Stock and credit Wages Payable b. Wages Expense and credit Wages Payable c. Wages Payable and credit Wages Expense d. Accounts Receivable and credit Wages Expense
- Supplies are recorded as assets when purchased. Therefore, the credit to supplies in the adjusting entry is for the amount of supplies: a. Purchased b. Used c. Either used or remaining d. Remaining
- If cash is received in advance from a customer, then a. Assets will decrease. b. Retained earnings will increase. c. Liabilities will increase. d. Stockholders’ equity will decrease.
- Which of the following appears on the Balance Sheet? a. Unearned Fees b. Supplies Expense c. Service Revenue d. Fees Earned
- Which of the following does not appear on the Income Statement? a. Service Revenue b. Prepaid Insurance c. Wages Expenses d. Rent Income
- When preparing the retained earnings statement, the beginning retained earnings balance can always be found: a. In the Income Statement columns of the worksheet b. By subtracting expenses from revenue c. In the general journal d. In the general ledger
- Depreciation Expense appears on the a. Balance Sheet b. Retained Earnings Statement c. Statement of Cash Flows d. Income Statement
- Accumulated Depreciation appears on the: a. Balance Sheet in the Fixed Asset section b. Balance Sheet in the Current Assets section c. Balance Sheet in the Long-Term Liabilities section d. Income Statement as an Operating Expense
- The ability of a company to pay its debts is called a. Solvency b. Working capital c. Current ratio d. Net worth
- A current ratio of 5.6 means that a. There is $5.60 in current assets available to pay each dollar of current liabilities b. The company cannot pay its debts as they come due c. There is $5 in current assets for every $6 in current liabilities d. There is $6 in current assets for every $5 in current liabilities
- Receipt of an unearned revenue a. Increases an asset; increases a liability. b. Increases an asset; increases a revenue. c. Decreases a liability; increases stockholders’ equity. d. Decreases a revenue; increases stockholders’ equity.
- If revenues are recognized only when a customer pays, what method of accounting is being used? a. Accrual basis b. Recognition basis c. Cash basis d. Matching basis
- Which of the following is not a typical example of a prepaid expense? a. Supplies b. Insurance c. Rent d. Wages
- Payments received in advance of services provided are recorded as a. Revenues b. Equity c. Expenses d. Liabilities
- If the adjusting entry is not made for unearned revenues the result will be to a. Overstate assets and understate liabilities. b. Overstate liabilities and understate revenues. c. Understate net income and overstate retained earnings d. Understate retained earnings and overstate revenues.
- Greenland Property Management Co. received a check for $30,000 on October 1 which represents a one year advance payment of rent on an office it rents to a client. Unearned Rental Revenue was credited for the full $30,000. Financial statements are prepared on December 31. The appropriate adjusting journal entry to make on December 31 would be a. Debit Rental Revenue $2,500; credit Unearned Rental Revenue $2,500. b. Debit Unearned Rental Revenue $7,500; credit Rental Revenue $7, c. Debit Unearned Rental Revenue $22,500; credit Rental Revenue $22, d. Debit Rental Revenue $22,500; credit Unearned Rental Revenue $22,
- On July 1, East Lake, Inc. purchased a 3-year insurance policy for $12,600. Prepaid Insurance was debited for the entire amount. On December 31, when the annual financial statements are prepared, the appropriate adjusting journal entry would be a. Debit Prepaid Insurance $2,100; credit Insurance Expense $2, b. Debit Insurance Expense $10,500; credit Prepaid Insurance $10, c. Debit Prepaid Insurance $10,500; credit Insurance Expense $10, d. Debit Insurance Expense $2,100; credit Prepaid Insurance $2,
Practice Problem #
a. Accounts Receivable 2, Fees Earned 2, b. Supplies Expense 1, Supplies 1, c. Depreciation Expense-Equip. 7, Accum. Depr.-Equip. 7, d. Wages Expense 1, Wages Payable 1,
Net Total Total Total Stock- Income Assets Liabilities holders’ Equity Reported Balance $88,450 $276,000 $77,800 $198, Corrections: Adjustment (a) +2,200 +2,200 ----- +2, Adjustment (b) -1,800 -1,800 ----- -1, Adjustment (c) -7,500 -7,500 ----- -7, Adjustment (d) -1,500 ---------- +1,500 -1, Corrected Balance $79,850 $268,900 $79,300 $189,
Practice Problem #
- P
- P
- IS
- RE
- IS
- P
7. P
8. P
9. P
10. P
11. P
12. IS
Post-Closing Trial Balance
Accumulated
- Practice Problem #
- a. Deferred Expense: Supplies Expense 1, 1) Journalize the adjusting entries and label them as accruals or deferrals. - Supplies 1,
- b. Deferred Expense: Depreciation Expense-Equip. 3, - Accum. Depr.-Equip. 3,
- c. Deferred Expense: Rent Expense 11, - Prepaid Rent 11,
- d. Accrued Expense: Wages Expense 2, - Wages Payable 2,
- e. Deferred Revenue: Unearned Fees 6, - Fees Earned 6,
- f. Accrued Revenue: Accounts Receivable 5, - Fees Earned 5,
- Accounts Receivable 12,350 +5,260 17, Debit Credit (+ / - ) Debit Credit
- Supplies 1,980 -1,180
- Prepaid Rent 20,000 -11,000 9,
- Equipment 75,800 ----- 75, - 24, Equipment - +3,400 0 28,
- Capital Stock 20,480 0 20,
- Wages Payable 0 +2,500 0 2,
- Unearned Fees 7,500 -6,000 0 1,
- Fees Earned 99,650 +11,260 0 110,
- Wages Expense 42,200 +2,500 44,700
- Rent Expense +11,000 11,000
- Depreciation Expense +3,400 3,400
- Supplies Expense +1,180 1,180
- 152,330 152,330 163,490 163,
- Practice Problem #
- Fees Earned 110,
- Income Summary 60,
- Wages Expense 44,
- Rent Expense 11,
- Depreciation Expense 3,
- Supplies Expense 1,
- Income Summary 50,
- Retained Earnings 2,
- Accounts Receivable 17,
- Supplies
- Prepaid Rent 9,
- Equipment 73, - 28, Depreciation-Equip
- Capital Stock 20,
- Wages Payable 2,
- Unearned Fees 1,
- Retained Earnings 48,