Adjustments, Financial Statements, and the Quality of Earnings

Chapter 4

PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Understanding the Business

Management is responsible for preparing . . .

Financial Statements

High Quality = Relevance + Reliability

. . . useful to investors and creditors.

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Accounting Cycle
Start of Period
During the period: Analyze transactions. Record journal entries. Post amounts to general ledger.

Close revenues, gains, expenses, and losses to Retained Earnings.

At the end of the period: Adjust revenues and expenses.

Prepare financial statements. Disseminate statements to users.

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Unadjusted Trial Balance

A listing of individual accounts, usually

in financial statement order. Ending debit or credit balances are listed in two separate columns. Total debit account balances should equal total credit account balances.

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Partial Trial Balance

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Partial Trial Balance

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Purpose of Adjustments
Revenues are recorded when earned. Expenses are recorded when incurred.

Matching Principle
Because transactions occur over time, ADJUSTMENTS are required at the end of each fiscal period to get the revenues and expenses into the right period.

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Types of Adjustments

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Adjustment Process

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Prepaid Expenses
Property and equipment are assets that have a normal debit balance. Depreciation is the allocation of the cost of an asset over its estimated useful life to the company. Depreciation is an expense with a normal debit balance. When we record depreciation we credit a contra asset account called Accumulated Depreciation. Contra-accounts are accounts that are directly linked to another account, but with an opposite balance. We subtract accumulated depreciation from the cost of our property and equipment to arrive at net book value.

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Ethics and Adjusting Entries

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Preparing Financial Statements

Before we prepare a complete set of financial statements, lets update the trial balance to reflect the adjustments and provide us with adjusted balances for the statements. 1. Income statement, 2. Statement of stockholders equity, 3. Balance sheet, and 4. Statement of cash flows.
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Financial Statement Relationships

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Income Statement
This is the income statement drawn from the adjusted trial balance. Refer back to the adjusted trial balance and trace the income statement numbers forward. Notice that gains and losses are reported in the Other Items section of the statement.

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Closing the Books

Here is an example of the closing process using an illustration with just a few accounts.

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End of Chapter 4

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