Chpater 03. Reporting and Preparing Financial Statements

ACCT 201
Reporting and
3
Chapter
Preparing Financial
Statements
ACCT 201
UAA ACCT 201

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Principles of Financial
Accounting
Dr. Fred Barbee
ACCT 201 ACCT 201 ACCT 201
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What Have We Learned?
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I have
some bad
news . . .
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Dr. Fred Barbee 3

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What Have We Learned?
I have
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some good
news . . .
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Dr. Fred Barbee 4

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We Have Learned . . .
The basic accounting equation

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- and the definition of each of

its components
Assets =
Liabilities +
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Owners Equity
Dr. Fred Barbee 5
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Double-entry accounting
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Assets = Liabilities + Owners

Equity
Debits=Credits
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Dr. Fred Barbee 6

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The debit/credit rules and how

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each impacts accounting.

ncrease
Debit = Left
side of an account ebits
- Nothing more,
xpenses
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nothing less.
Acronym:
ssets
Dr. Fred Barbee 7

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The debit/credit rules and how

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each impacts accounting.

evenue
quity Credit = Right
side of an account
iabilities - Nothing more,
nothing less.
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ncrease
Acronym:
redits
Dr. Fred Barbee 8

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Income Net Income

Statement
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Retained
Stmt of Earnings
Retained
Earnings
About the
basic financial Balance
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statements and how Sheet

they interrelate.
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The first five
steps in the
accounting
Prepare
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cycle. Trial Balance

Post Transactions
Record Transactions
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Analyze Transactions
Examine Source Documents

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Preparing Financial Statements
Financial
Prepare
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Statements
Trial Balance
Post Transactions
Record Transactions
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Analyze Transactions
Examine Source Documents

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Problems in Accounting
Measurements
The identification of the

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accounting period.
The proper point in time to

recognize revenue.
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The appropriate moment to

record an expense.
Dr. Fred Barbee 13
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Identification of the
Accounting Period
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Time Period Principle
For reporting purposes, an

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organizations life can be divided

into separate accounting periods
months,
quarters,
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years, etc.
Dr. Fred Barbee 15

Time Period Principle
Discrete (separate) accounting
B periods.
E E
G N
I 96 97 98 99 00 01 02 03 04 05 D
N I
N Life of the Firm N
I G
N
G
Exh.
3.1
The Accounting Period
Annual
1 2
Semiannual
1 2 3 4
Quarter
1 2 3 4 5 6 7 8 9 10 11 12
Month
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The proper point in time

to recognize revenues.
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Revenue Recognition . . .
Revenues are recorded when two

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main criteria have been met:

The earnings process is
substantially complete (a sale has
taken place or service has been
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rendered); and
An exchange has taken place.

Dr. Fred Barbee 19
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Revenue Recognition . . .
Revenue is generally recognized

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At the time services are

performed; or
When goods are sold and delivered
to a customer.
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Dr. Fred Barbee 20

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The proper point in time

to recognize expenses.
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The Matching Principle
The matching principle requires

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that all expenses incurred to

generate the revenues
recognized in an accounting
period be matched with those
revenues.
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Dr. Fred Barbee 22

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Another view . . .
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Let the expense follow the revenue.

First the revenue . . .
Then the expense.
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Sometimes referred to as The

Expense Recognition Principle.
Dr. Fred Barbee 23
Accounting
Accrual Basis
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Revenue
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Accrual Basis
Recognition
Accounting
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Matching
Principle
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Yikes!! What
is Accrual
Basis
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Accounting?
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Accrual Basis Accounting
Revenues are recognized

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(recorded) when earned, without

regard to when cash is received;
Expenses are recorded as
incurred without regard to when
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they are paid.
Dr. Fred Barbee 28

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The time period principle
Gives rise to the need for
The Revenue Recognition

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Principle and the Matching

Principle
Resulting in . . .
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The accrual basis of

accounting
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Whoa! Lets
back up a bit
here -- this
really does
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make sense?
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Assumption
96 97 98 99 00 01 02 03 04 05
Periodicity
? ? ? ? ? ?
How do we recognize revenues?

ThePrinciple
Revenue Recognition
How do we recognize expenses?

Accrual Basis Accounting
Accrual Accounting . . .
BOP EOP
Recognized
Revenues
Matched
Expenses
Recognized Matched Accrual Net

Revenues Expenses Income
Bertha, are
there any other
bases for
accounting?
Yikes! I dont
know Claude. We
probably better
ask the professor!
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Absolutely.
You dont
think we
would make it
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that easy, do
you?
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Accounting
Cash Basis
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Cash Basis Accounting
With the cash basis . . .

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Revenues are recognized in the

period cash is received; and
Expenses are recognized in the

period when cash is paid out.
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Dr. Fred Barbee 36

Cash Basis Accounting . . .
BOP EOP
Revenue (Cash)
Expenses (Cash)
Revenue Expenses Cash Basis

(Cash) (Cash) Net Income
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Ahhh, but
there is yet
another one!
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Fun! Fun!
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Modified Cash
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Basis Accounting
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Modified Cash Basis
Accounting
With the Modified Cash Basis . . .

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Current period revenues and

expenses are treated exactly as in
the cash basis;
Expenses covering more than one
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accounting period are allocated

over the useful life of the asset.
Dr. Fred Barbee 40
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Exh.
3.4
Adjusting Accounts
An adjusting entry is recorded to

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bring an asset or liability account

balance to its proper amount.
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Dr. Fred Barbee 42

Exh.
3.4
Framework for Adjustments

F r a m e w o r k f o r A d ju s tm e n ts
A d ju s tm e n ts
P r e p a id D e p r e c ia tio n U n e a rn e d A c c ru e d A c c ru e d
E xp en ses R even u es E xp en ses R even u es
Transactions where cash is paid or

received before a related expense
or revenue is recognized.
Transactions where cash is paid or

received after a related expense
or revenue is recognized.
Exh.
3.4

A d ju s tm e n ts
Transaction where cash is paid

before a related expense is
recognized.
Adjusting Prepaid Expenses
Resources paid Here is the check
for my first
for prior to 6 months rent.
receiving the
actual benefits.
Asset Expense
Unadjusted Credit Debit
Balance Adjustment Adjustment
On December 1, 2001, Scott Company
paid $12,000 to cover rent for
December 2001 through May 2002.
Lets look at the adjusting journal
entry needed on December 31, 2001.
GENERAL JOURNAL Page 34

Date Description PR Debit Credit
Dec. 31 Rent Expense 2,000
Prepaid Rent 2,000
to r ecord monthl y rent
After posting, the accounts involved
look like this:
Prepaid Rent Rent Expense

12/1 $12,000 12/31 $2,000 12/31 $2,000
Exh.
3.4

A d ju s tm e n ts

before a related expense is
recognized.
Adjusting for Depreciation
Depreciation is the process of
computing expense from allocating the
cost of plant and equipment over its
expected useful lives.
Asset Cost Salvage Value

Straight-Line
=
Depreciation Useful Life
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On January 1, 2002, Monroe, Inc.

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purchased oil pumping equipment for

$62,000 cash.
The equipment has an estimated
useful life of 5 years.
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Monroe expects to sell the equipment

at the end of its life for $2,000 cash.
Dr. Fred Barbee 51
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Lets compute depreciation expense

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for the year ended December 31,

2002.
2002 $62,000 - $2,000

Depreciation =
5
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Expense
= $12,000
Dr. Fred Barbee 52

Prepare the journal entry.

Dec. 31 Depreciation Exp. 12,000
Accum. Depreciation 12,000
To record a nnua l depreci a ti on
Accumulated depreciation is
a contra asset account.

look like this:
Equipment Depreciation Expense
1/1 $62,000 12/31 $12,000
Accumulated Depreciation
12/31 $12,000
The
equipment
account is
shown on
the balance
sheet like
this.
Exh.
3.4

A d ju s tm e n ts
Transaction where cash is

received before a related
revenue is recognized.
Adjusting Unearned Revenue
Cash received in
advance of Buy your season tickets for
providing all home basketball games NOW!
products or
services. GO SEAWOLVES
Liability Revenue
Debit Unadjusted Credit
Adjustment Balance Adjustment
On October 1, 2002, UAA sold 1,000
season tickets to its 20 home basketball
games for $100 each. UAA makes the
following entry:

Oct. 1 Cash 100,000
Unearned Basketball Revenue 100,000
Recei pts for 1,000 sea son ti ck ets
On December 31, UAA has played 10 of its regular

home games, winning 8 and losing 2.

Dec. 31
Prepare
Preparethe
theappropriate
appropriateAdjusting
Adjusting
Entry
Entryon
onDecember
December31
31
On December 31, UAA has played 10 of its regular

home games, winning 8 and losing 2.

Dec. 31 Unearned Basketball Revenue 50,000
Basketball Revenue 50,000
to recogni ze ba sk etba l l revenue
look like this
Unearned Basketball
Revenue Basketball Revenue
12/31 $50,000 10/1 $100,000 12/31 $50,000
Exh.
3.4

A d ju s tm e n ts

after a related expense is
recognized.
Adjusting for Accrued Expenses
Were about one-half
Costs incurred in a done with this job and
period that are want to be paid!
both unpaid and
unrecorded.
Expense Liability
Debit Credit
Adjustment Adjustment
Denton, Inc. pays its employees every Friday.
Year-end, 12/31/02, falls on a Wednesday. As of
12/31/02, the employees have earned salaries of
$47,250 for Monday through Wednesday of the
week ended 1/02/03.
Last pay Next pay

date date
12/26/02 1/2/03
12/1/02 12/31/02 Record adjusting

Year end journal entry.
Denton, Inc. pays its employees every Friday.
Year-end, 12/31/02, falls on a Wednesday. As of
12/31/02, the employees have earned salaries of
$47,250 for Monday through Wednesday of the
week ended 1/02/03.

Dec. 31 Salaries Expense 47,250
Salaries Payable 47,250
to record sa l a ry a ccrua l
will look like this . . .
Salaries Expense Salaries Payable
12/31 $47,250 12/31 $47,250
Exh.
3.4

A d ju s tm e n ts
Transaction where cash is

received after a related
revenue is recognized.
Adjusting for Accrued Revenues
Revenues earned Yes, you can pay me
for your tax return
in a period that
when I finish the work.
are both
unrecorded and
not yet received.
Asset Revenue
Debit Credit
Adjustment Adjustment
Smith & Jones, CPAs, had $31,200 of work completed but
not yet billed to clients. Lets make the adjusting entry
necessary on December 31, 2002, the end of the
companys fiscal year.

Dec. 31 Accounts Receivable 31,200
Service Revenues 31,200
Revenues ea rned but not recei ved
will look like this . . .
Accounts Receivable Service Revenue

12/31 $31,200 12/31 $31,200
Exhibit 3.18
Exh.
3.18
Summary of Adjustments and

Before Adjusting
Adjusting
Category Financial
B/S
Statement
I/S
Links Entry
Dr. Expense
Prepaid Expense Asset Expense
Cr. Asset
Dr. Liability
Unearned Revenue Liability Revenue
Cr. Revenue
Dr. Expense
Accrued Expenses Liability Expense
Cr. Liability
Dr. Asset
Accrued Revenues Asset Revenue
Cr. Revenue
Overstated
Understated
FastForward Exh.
3.19
Trial Balance
December 31, 2001
First,
First, the
the
initial
initial
unadjusted
unadjusted
amounts
amounts are are
added
added to to the
the
worksheet.
worksheet.
FastForward Exh.
3.19
Trial Balance
December 31, 2001
Next,
Next,
FastForwards
FastForwards
adjustments
adjustments
are
areadded.
added.
Finally, FastForward
Finally,the
thetotals
Exh.
totals Trial Balance 3.19
are
aredetermined.
determined. December 31, 2001
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Preparing Financial
Statements
Lets use
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FastForwards
adjusted trial
balance to prepare
the companys
financial
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statements.
Dr. Fred Barbee 77
Exh.
3.20
Step One:
Prepare the Income
Statement.
Exh.
Step Two: 3.20
Prepare the Statement

of Retained Earnings.
Note: The Net Income

from the Income
Statement carries to the
Statement of Retained
Earnings.
Exh.
FastForward 3.20
Balance Sheet
December 31, 2001
Assets
Cash $ 3,950
Accounts receivable 1,800
Supplies 8,670
Prepaid insurance 2,300
Equipment 26,000
Less: accum. depr. (375) 25,625
Total assets $ 42,345
Liabilities
Accounts payable $ 6,200
Salaries payable 210
Unearned revenue 2,750
Total liabilities $ 9,160
Owner's Equity
Common Stock 30,000
Retained Earnings 3,185
Total liabilities and equity $ 42,345
Step Three:
Prepare the Balance
Sheet.

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ACCT 201

UAA ACCT 201

Dr. Fred Barbee 3

Dr. Fred Barbee 4

The basic accounting equation

- and the definition of each of

Assets = Liabilities + Owners

Dr. Fred Barbee 6

The debit/credit rules and how

each impacts accounting.

Dr. Fred Barbee 7

The debit/credit rules and how

each impacts accounting.

Dr. Fred Barbee 8

Income Net Income

statements and how Sheet

cycle. Trial Balance

Examine Source Documents

Examine Source Documents

The identification of the

The proper point in time to

The appropriate moment to

For reporting purposes, an

organizations life can be divided

Dr. Fred Barbee 15

The Accounting Period

The proper point in time

Revenues are recorded when two

main criteria have been met:

An exchange has taken place.

Revenue is generally recognized

At the time services are

Dr. Fred Barbee 20

The proper point in time

The matching principle requires

that all expenses incurred to

Dr. Fred Barbee 22

Let the expense follow the revenue.

Sometimes referred to as The

Revenues are recognized

(recorded) when earned, without

they are paid.

Dr. Fred Barbee 28

The Revenue Recognition

Principle and the Matching

The accrual basis of

How do we recognize revenues?

How do we recognize expenses?

Recognized Matched Accrual Net

With the cash basis . . .

Revenues are recognized in the

Expenses are recognized in the

Dr. Fred Barbee 36

Revenue Expenses Cash Basis

With the Modified Cash Basis . . .

Current period revenues and

accounting period are allocated

An adjusting entry is recorded to

bring an asset or liability account

Dr. Fred Barbee 42

Framework for Adjustments

Transactions where cash is paid or

Transactions where cash is paid or

Framework for Adjustments