Reporting and

Preparing Financial
Statements

Principles of Financial Accounting

We Have Learned . . .

The basic accounting equation - and

the definition of each of its
components
Assets =
Liabilities +
Owners’ Equity
3
We Have Learned . . .

Double-entry accounting
Assets = Liabilities + Owners’ Equity

Debits=Credits

4
We Have Learned . . .

The debit/credit rules and how each

impacts accounting.
ncrease
Debit = “Left”
side of an account ebits
- Nothing more,
nothing less. xpenses
Acronym:
ssets

5
We Have Learned . . .

The debit/credit rules and how each

impacts accounting.
evenue
quity Credit = “Right”
side of an account
iabilities - Nothing more,
nothing less.
ncrease
Acronym:
redits

6
We Have Learned . . .

Income Net Income

Statement
Retained
Stmt of Earnings
Retained
Earnings
About the basic
financial statements and Balance
how they interrelate. Sheet
We Have Learned . . .
The first five
steps in the
accounting
Prepare
cycle. Trial Balance
Post Transactions

Record Transactions

Analyze Transactions

Examine Source Documents

Preparing Financial Statements

Financial
Statements Prepare
Trial Balance
Post Transactions

Record Transactions

Analyze Transactions

Examine Source Documents

Problems in Accounting
Measurements
The identification of the
accounting period.

The proper point in time to

recognize revenue.

The appropriate moment to

record an expense.
10
Identification of the
Accounting Period
Time Period Principle

For reporting purposes, an

organization’s life can be divided
into separate accounting periods
months,
quarters,
years, etc.

12
 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
The proper point in time
to recognize revenues.
Revenue Recognition . . .

Revenues are recorded when two

main criteria have been met:
The earnings process is
substantially complete (a sale has
taken place or service has been
rendered); and

An exchange has taken place.

16
Revenue Recognition . . .

Revenue is generally recognized

At the time services are
performed; or
When goods are sold and delivered
to a customer.

17
The proper point in time
to recognize expenses.
The Matching Principle

The matching principle requires

that all expenses incurred to
generate the revenues
recognized in an accounting
period be matched with those
revenues.

19
The Matching Principle

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

Sometimes referred to as “The

Expense Recognition Principle.”
20
Accrual Basis
Accounting
 Revenue Revenue recognition is an accounting principle that outlines

Recognition
the specific conditions under which revenue is recognized. In
theory, there is a wide range of potential points at which
revenue can be recognized. This guide addresses
recognition principles for both IFRS and U.S. GAAP.

Accrual Basis
Accounting

Matching The matching principle is one of the basic underlying

guidelines in accounting. The matching principle directs a
company to report an expense on its income statement in the
Principle period in which the related revenues are earned.
Yikes!! What
is Accrual
Basis
Accounting?
Accrual Basis Accounting

Revenues are recognized

(recorded) when earned, without
regard to when cash is received;
Expenses are recorded as
incurred without regard to when
they are paid.

25
The time period principle
Gives rise to the need for

The Revenue Recognition

Principle and the Matching
Principle
Resulting in . . .

The accrual basis of accounting

Whoa! Let’s
back up a bit
here -- this
really does
make sense?
 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?

 The Matching Principle
Accrual Basis Accounting
 Accrual Accounting . . .
BOP (Balance of payment) EOP (End of Payment)

Recognized
Revenues

Matched
Expenses

Recognized
Revenues
 Matched
Expenses  Accrual Net
Income
Cash Basis Accounting
Cash Basis Accounting

With the cash basis . . .

Revenues are recognized in the
period cash is received; and

Expenses are recognized in the

period when cash is paid out.

Dr. Fred Barbee 31

Cash Basis Accounting . . .
BOP EOP

Revenue (Cash)

Expenses (Cash)

Revenue
(Cash)
 Expenses
(Cash)  Cash Basis
Net Income
Modified Cash Basis
Accounting
Modified Cash Basis
Accounting

With the Modified Cash Basis . . .

Current period revenues and
expenses are treated exactly as in
the cash basis;
Expenses covering more than one
accounting period are allocated
over the useful life of the asset.
34
 Exh.
3.4

Adjusting Accounts

An adjusting entry is recorded to

bring an asset or liability account
balance to its proper amount.

36
 Exh.
3.4

Framework for Adjustments

F ra m e w o rk f o r A d justm e nts

Adju stm e n ts

Pre p a id D e p re c ia tio n U ne a rn e d Ac c ru e d Ac c ru e d
E x p e nse s R e ve n ue s E x pe n se s R e ve n ue s

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

Framework for Adjustments

F ra m e w o rk f o r A d justm e nts

Adju stm e n ts

Pre p a id D e p re c ia tio n U ne a rn e d Ac c ru e d Ac c ru e d
E x p e nse s R e ve n ue s E x pe n se s R e ve n ue s

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
 Adjusting Prepaid Expenses
On December 1, 2001, Scott Company
paid $12,000 to cover rent for
December 2001 through May 2002.
Let’s 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
 Adjusting Prepaid Expenses
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

Framework for Adjustments

F ra m e w o rk f o r A d justm e nts

Adju stm e n ts

Pre p a id D e p re c ia tio n U ne a rn e d Ac c ru e d Ac c ru e d
E x p e nse s R e ve n ue s E x pe n se s R e ve n ue s

Transaction where cash is paid

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
Adjusting for Depreciation

On January 1, 2002, Monroe, Inc.

purchased oil pumping equipment for
$62,000 cash.
The equipment has an estimated
useful life of 5 years.
Monroe expects to sell the equipment
at the end of its life for $2,000 cash.
45
Adjusting for Depreciation

Let’s compute depreciation expense

for the year ended December 31,
2002.
$62,000 - $2,000
2002
Depreciation =
Expense 5
= $12,000

46
 Adjusting for Depreciation
Prepare the journal entry.

GENERAL JOURNAL Page 2

Date Description PR Debit Credit
Dec. 31 Depreciation Exp. 12,000
Accum. Depreciation 12,000
To record annua l depreci a ti on

Accumulated depreciation is
a contra asset account.
 Adjusting for Depreciation

After posting, the accounts involved

look like this:
Equipment Depreciation Expense
1/1 $62,000 12/31 $12,000

Accumulated Depreciation
12/31 $12,000
Adjusting for Depreciation

The
equipment
account is
shown on
the balance
sheet like
this.
 Exh.
3.4

Framework for Adjustments

F ra m e w o rk f o r A d justm e nts

Adju stm e n ts

Pre p a id D e p re c ia tio n U ne a rn e d Ac c ru e d Ac c ru e d
E x p e nse s R e ve n ue s E x pe n se s R e ve n ue s

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
 Adjusting Unearned Revenue
On October 1, 2002, UAA sold 1,000
season tickets to its 20 home basketball
games for $100 each. UAA makes the
following entry:

GENERAL JOURNAL Page 34

Date Description PR Debit Credit
Oct. 1 Cash 100,000
Unearned Basketball Revenue 100,000
Recei pts for 1,000 sea son ti ck ets
 Adjusting Unearned Revenue

On December 31, UAA has played 10 of its

regular home games, winning 8 and
losing 2.

GENERAL JOURNAL Page 34

Date Description PR Debit Credit
Dec. 31
Prepare the appropriate Adjusting
Entry on December 31
 Adjusting Unearned Revenue

On December 31, UAA has played 10 of its

regular home games, winning 8 and
losing 2.

GENERAL JOURNAL Page 34

Date Description PR Debit Credit
Dec. 31 Unearned Basketball Revenue 50,000
Basketball Revenue 50,000
to recogni ze ba sk etba l l revenue
Adjusting Unearned Revenue
After posting, the accounts involved
look like this

Unearned Basketball
Revenue Basketball Revenue
12/31 $50,000 10/1 $100,000 12/31 $50,000
 Exh.
3.4

Framework for Adjustments

F ra m e w o rk f o r A d justm e nts

Adju stm e n ts

Pre p a id D e p re c ia tio n U ne a rn e d Ac c ru e d Ac c ru e d
E x p e nse s R e ve n ue s E x pe n se s R e ve n ue s

Transaction where cash is paid

after a related expense is
recognized.
Adjusting for Accrued Expenses
We’re 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
Adjusting for Accrued Expenses
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.
Adjusting for Accrued Expenses
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.

GENERAL JOURNAL Page 34

Date Description PR Debit Credit
Dec. 31 Salaries Expense 47,250
Salaries Payable 47,250
to record sa l a ry a ccrua l
Adjusting for Accrued Expenses
After posting, the accounts involved
will look like this . . .
Salaries Expense Salaries Payable
12/31 $47,250 12/31 $47,250
 Exh.
3.4

Framework for Adjustments

F ra m e w o rk f o r A d justm e nts

Adju stm e n ts

Pre p a id D e p re c ia tio n U ne a rn e d Ac c ru e d Ac c ru e d
E x p e nse s R e ve n ue s E x pe n se s R e ve n ue s

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
Adjusting for Accrued Revenues
Smith & Jones, CPAs, had $31,200 of work completed but
not yet billed to clients. Let’s make the adjusting entry
necessary on December 31, 2002, the end of the
company’s fiscal year.

GENERAL JOURNAL Page 34

Date Description PR Debit Credit
Dec. 31 Accounts Receivable 31,200
Service Revenues 31,200
Revenues ea rned but not recei ved
Adjusting for Accrued Revenues
After posting, the accounts involved
will look like this . . .

Accounts Receivable Service Revenue

12/31 $31,200 12/31 $31,200
 Exh.
Exhibit 3.18 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.
Trial Balance 3.19
December 31, 2001

First, the
initial
unadjusted
amounts are
added to the
worksheet.
 FastForward Exh.
Trial Balance 3.19
December 31, 2001

Next,
FastForward’s
adjustments
are added.
Finally, the totals FastForward Exh.
Trial Balance 3.19
are determined. December 31, 2001
Preparing Financial
Statements

Let’s use
FastForward’s
adjusted trial
balance to prepare
the company’s
financial
statements.
71
 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.