12-1 Chapter 12 Skyline College. 12-2 system of accounting by which all revenues and expenses are matched and reported on financial statements for the.

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Chapter

12

Skyline College

12-2

system of accounting by which all revenues and expenses are matched and reported on financial statements for the applicable period.

The Accrual Basis of Accounting

Financial statements usually are prepared using the accrual basis of accounting.

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Revenue is recognized when earned, regardless when the cash is received.

Revenue is recognized when the sale is complete.

A sale is complete when title to the goods passes to the customer or when the service is provided.

For sales on account, revenue is recognized when the sale occurs even though the cash is not collected immediately.

Revenue Recognition

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Expenses are recognized when incurred or used, not necessarily when cash is paid.

Each expense is assigned to the accounting period in which it helped to earn revenue for the business, regardless when paid.

This is often referred to as matching revenues and expenses.

The Matching Principle

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An asset account for merchandise inventory is maintained in the general ledger.

Inventory

All purchases of merchandise are debited to the Purchases account.

All sales of merchandise are credited to the revenue account Sales.

Purchases

Sales

Adjustment for Merchandise Inventory

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Notice that no entries are made directly to the Merchandise Inventory account during the accounting period.

when the trial balance is prepared at the end of the period, the Merchandise Inventory account still shows the beginning inventory for the period.

Merchandise Inventory Purchases Sales

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Adjustment for Merchandise Inventory

The first step in determining the ending inventory is to count the number of units of each type of item on hand.

As the merchandise is counted, the quantity on hand is entered on an inventory sheet.

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Simpson Antiques needs to adjust the Merchandise Inventory account to reflect the balance at the end of the year.

The adjustment is made in two steps.

Each step needs two general ledger accounts:

Based on a count taken on December 31, merchandise inventory for Simpson Antiques totaled $47,000.

Merchandise Inventory Income Summary

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The first step is to remove beginning inventory from the books.

Simpson Antiques began the year with $52,000 in inventory.

the amount of the first inventory adjustment

BeginningInventory

$52,000

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Income Summary

(a) 52,000

Merchandise Inventory

+Bal. 52,000

Adjustment for Beginning Inventory

-52,000 (a)

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The next step is to place ending inventory on the books.

Simpson Antiques ended the year with $47,000 in inventory.

the amount of the next inventory adjustment

EndingInventory

$47,000

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Merchandise Inventory

+(b) 47,000

Income Summary

Adjustment for Ending Inventory

47,000 (b)

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Credit sales are made with the expectation that the customers will pay the amount due

Sometimes the account receivable is never collected.

Losses from uncollectible accounts are classified as operating expenses.

Adjustment for Losses from Uncollectible

Accounts

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Under accrual accounting, the expense for uncollectible accounts is recorded in the same period as the related sale (matching principle).

The expense is estimated because the actual amount of uncollectible accounts is not known until later periods.

The estimated expense is debited to an account named Uncollectible Accounts Expense.

Uncollectible Accounts Expense

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In the percentage of net credit sales methodThe rate used is based on the company's past experience with uncollectible accounts and management's assessment of current business conditions.

Percentage of Sales Method

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Simpson Antiques estimates that 0.80 percent of net credit sales will be uncollectible.

Net credit sales for the year were $100,000.

The estimated expense for uncollectible accounts is $800 ($100,000 x 0.0080).

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Accounts Receivable $32,000

Allowance for Doubtful Accounts <1,050>

The entry to record the expense for uncollectible accounts includes a credit to a contra asset account, Allowance for Doubtful Accounts. This account appears on the balance sheet as follows.

Net Accounts Receivable $30,950

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Adjustment for Uncollectible Accounts

Uncollectible Accounts Expense

+© 800

Allowance for Doubtful Accounts

+250 BEG BAL

©008

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Why doesn’t Uncollectible Accounts Expense increase when a customer’s account is written off?

Because the expense was already recorded based on the estimate.

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Property, plant, and equipment are long-term assets that are used in the operation of a business. Plant & Equipment are subject to depreciation.

Adjustments for Depreciation

Land (property) is not depreciated.

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Accrued expenses are expense items that relate to the current period but have not yet been paid and do not yet appear in the accounting records.

Adjustments for Accrued Expenses

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Simpson Antiques makes adjustments for three types of accrued expenses:

Because accrued expenses involve amounts that must be paid in the future, the adjustment for each item is a debit to an expense account and a credit to a liability account.

Accrued salaries (f) Accrued payroll taxes (g) Accrued interest on notes payable (i)

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From December 28 to January 3, the firm hired several part-time clerks for the year-end sale.

The part-time salaries expense has not been recorded because the employees will not be paid until January 3, 2008.

Adjustment for Accrued Salaries

Through December 31, 2007, these employees earned $1,200.

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Salaries Expense – Sales

+(f) 1,200

Salaries Payable

+1,200 (f)

Adjustment for Accrued Salaries

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Accrued Payroll TaxesAccrued Payroll Taxes

Payroll taxes are not legally owed until the salaries are paid.

Businesses that want to match revenue and expenses in the appropriate period make adjustments to accrue the employer's payroll taxes even though the taxes are technically not yet due.

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Accrued Payroll TaxesAccrued Payroll Taxes

None of the part-time clerks employed by Simpson Antiques have reached the social security wage base limit.

The entire $1,200 of accrued salaries is subject to the employer's share of social security and Medicare taxes.

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Social security tax $1,200 x 0.0620 = $ 74.40

Medicare tax 1,200 x 0.0145 = 17.40

Total accrued payroll taxes $91.80

The accrued employer's payroll taxes are:

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+74.40 (g)

Adjustment for Accrued Payroll Taxes

Payroll Taxes Expense

+(g) 91.80

Medicare Tax Payable Social Security Tax Payable

+17.40 (g)

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Federal unemployment tax $1,200 x 0.008 = $ 9.60

State unemployment tax $1,200 x 0.054 = 64.80

Total accrued taxes $ 74.40

The accrued unemployment taxes are:

The entire $1,200 is also subject to unemployment taxes.

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+9.60 (h)

Payroll Taxes Expense

+74.40 (h)

SUTA Payable FUTA Payable

+64.80 (h)

Adjustment for Accrued Payroll Taxes

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Accrued Interest on Notes PayableAccrued Interest on Notes Payable

On December 1, 2007, Simpson Antiques issued a two-month note for $2,000, with annual interest of 12 percent.

Simpson Antiques will pay the interest when the note matures on February 1, 2008.

However, the interest expense is incurred day by day and should be allocated to each fiscal period involved in order to obtain a complete and accurate picture of expenses.

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Principal x Rate x Time

$2,000 x 0.12 x 1/12 = $20

The fraction 1/12 represents one month, which is 1/12 of a year.

The accrued interest expense amount is determined by using the interest formula:

Date of note: December 1, 2007

Expense for 2007 = 1 month (Dec.1 - 31)

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Interest Expense

+(i) 20

Interest Payable

+ 20 (i)

Adjustment for Accrued Interest on Notes Payable

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Prepaid expenses (also called deferred expenses) are expenses that are paid for and recorded before they are used, such as rent or insurance.

Adjustments for Prepaid Expenses

Simpson Antiques makes adjustments for three types of prepaid expenses:

Prepaid supplies

Prepaid insurance

Prepaid interest on notes payable

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On November 1, 2007, Simpson Antiques

borrowed $9,000 from its bank and signed a three-month note at an annual interest rate of 10 percent. The bank deducted the entire amount of interest in advance.

Adjustment for Prepaid Interest on Discounted Notes Payable

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the amount of interest prepaid for three months = $225

$9,000 x 0.10 x 3/12Principal x Rate x Time

Adjustment for Prepaid Interest on Discounted Notes Payable

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The interest expense for 1 month is $75:$225 3 months = $75

OR

$9,000 x 10% x 1/12 = $75

the interest expense for 2007

$ 75

X 2

$150

2 months (November and December)

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Interest Expense

+(i) 150

Prepaid Interest

-150 (i)

+Bal. 225

Adjustment for Prepaid Interest on Discounted Notes Payable

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Accrued income is income that has been earned but not yet received and recorded.

Adjustments for Accrued Income

On December 31, 2007, Simpson Antiques had two types of accrued income:

Accrued interest on notes receivable

Accrued commission on sales tax

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On November 1, 2007, Simpson Antiques accepted from a customer a four-month, 12.5 percent note for $1,200.

The interest income is recorded when it is received, which is normally when the note matures.

However, interest income is earned day by day.

At the end of the period, an adjustment is made to recognize accrued interest income earned but not yet received or recorded.

Accrued Interest on Notes Receivable

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The amount of earned interest income is determined by using the interest formula:

Date of note: November 1, 2007

Income for 2007 = 2 months (Nov.1 – Dec. 31)

Principal x Rate x Time

$1,200 x 0.125 x 2/12 = $30

The fraction 1/12 represents one month, which is 1/12 of a year.

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Interest Receivable

+(i) 30

Interest Income

(i) 30

+Bal. 136

Adjustment for Accrued Interest on Notes Receivable

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Unearned income (also called unearned revenue or advances from customers) is income received before it is earned.

Adjustments for Unearned Income

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Under the accrual basis of accounting, only income that has been earned appears on the income statement.

Simpson Antiques has no unearned income.

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Unearned Income Items include:Unearned Income Items include:

Subscription income

Management fees

Rental income

Legal fees

Architectural fees

Construction fees

Advertising income

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The Adjusted Trial Balance section of the worksheet is completed as follows.

1. Combine the amount in the Trial Balance section and the Adjustments section for each account.

2. Enter the results in the Adjusted Trial Balance section.

The accounts that do not have adjustments are simply extended from the Trial Balance section to the Adjusted Trial Balance section.

The accounts that are affected by adjustments are recomputed. Follow these rules to combine amounts on the worksheet.

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ACCOUNT NAMEDEBIT CREDIT DEBIT CREDIT DEBIT CREDIT

1 Cash 13,136.00 13,136.002 Petty Cash Fund 100.00 100.003 Notes Receivable 1,200.00 1,200.004 Accounts Receivable 32,000.00 32,000.005 Allowance for Doubtful Accounts 250.00 ( c) 750.00 1,050.006 Interest Receivable (m) 24.00 24.007 Merchandise Inventory 51,500.00 (b) 46,000.00 (a) 51,500.00 46,000.008 Prepaid Insurance 7,200.00 (k) 3,600.00 3,600.009 Prepaid Interest 225.00 (l) 150.00 75.00

10 Supplies 6,300.00 (j) 4,975.00 1,325.0011 Store Equipment 20,000.00 20,000.0012 Accumulated Depr.- Store Equip. (d) 2,250.00 2,400.0013 Office Equip. 7,000.00 7,000.0014 Accumulated Depr.- Office Equip. (e) 1,200.00 700.0015 Notes Payable- Trade 2,000.00 2,000.0016 Notes Payable- Bank 9,000.00 9,000.0017 Accounts Payable 24,129.00 24,129.0018 Interest Payable (i) 20.00 20.0019 Social Security Tax Payable 1,084.00 (g) 93.00 1,177.0020 Medicare Tax Payable 250.00 (g) 21.75 271.7521 Employee Income Taxes Payable 990.00 990.0022 Federal Unemployment Tax Payable (h) 12.00 12.0023 State Unemployment Tax Payable (h) 64.80 64.8024 Salaries Payable (f) 1,500.00 1,200.0025 Sales Tax Payable 7,200.00 (n) 144.00 7,056.0026 Sonia Sanchez, Capital 61,221.00 61,221.0027 Sonia Sanchez, Drawing 27,600.00 27,600.0028 Income Summary (a) 52000.00 (b) 47,000.00 52,000.00 47,000.0029 Sales 559,650.00 559,650.0030 Sales Returns and Allowances 12,500.00 12,500.0031 Interest Income 136.00 (m) 30.00 160.0032 Miscellaneous Income 366.00 (n) 216.00 510.0033 Purchases 320,500.00 320,500.0034 Freight In 8,800.00 8,800.0035 Purchases Returns and Allowances 3,050.00 3,050.0036 Purchase Discounts 3,130.00 3,130.0037 Salaries Expense- Sales 78,490.00 (f) 1500.00 79,990.00

ADJUSTED TRIAL BALANCE

Year Ended December 31, 2004

TRIAL BALANCE ADJUSTMENTS

Worksheet Simpson Antiques

Year Ended December 31, 2007

Notice that the debit and credit amounts in Income Summary are not combined in the Adjusted Trial Balance section.

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Preparing the Income Statement Columns

The Income Summary debit and credit amounts are also entered in the Income Statement section of the worksheet.

Carry both debit and credit amounts in the Income Summary account to the Income Statement section. (Do not combine them.)