Adjusting Entries & Income Statements

COMM 3110

What are Adjusting Entries?

adjustments to the accounting system for items that weren’t previously recorded.

Recording is not triggered by a source document/specific external transaction

WHY are adjusting entries important?

more susceptible to human error and biases in judgement

3 categories of adjusting entries

1. Prepayments & Deferrals: prepaid expenses & unearned revenues

2. accruals: Accrued Revenues & Accrued Expenses

3. estimates: Depreciation & Bad Debt Expense

Prepayments & Deferrals: prepaid expenses

expenses paid in cash BEFORE they are used/consumed

Prepayments & Deferrals: Unearned revenues

cash received before services are performed; company now has a performance obligation

Accrued revenues

services has been performed but we have not yet received in cash/recorded

Accrued expenses

expenses paid but not yet in cash/recorded

What are deferrals:

expenses/revenues that are recognized at a date after the cash was exchanged

Special Rule About deferrals

Adjusting entries has no effect on cash flows

Prepaid Expenses Before Adjustment:

Assets = Overstated

Expenses = Understated

Reason for adjusting prepaid expenses

Prepaid expenses originally recorded in asset accounts have been used up

Unearned Revenues Before Adjustment

liabilities = overstated

revenues = understated

Reason for Adjustment

Unearned revenues recorded in liability accounts are now recognized as revenues for services performed.

Accrued Revenues Before Adjustment

Assets = Understated

Revenues = Understated

Accrued Revenues Reason for Adjustment

Services performed but not yet received in cash or recorded

Accrued Expenses Reason for Adjustment

Expenses have been incurred but not yet paid in cash or recorded

Accrued Expenses Before Adjustment

Expenses = understated

Liabilities = understated

Adjusting Entry for Prepaid Expenses

Debit: Expenses

Credit: Asset/Contra Asset

Adjusting Entry for Unearned Revenues

Debit: Liabilities

Credit: Revenues

Adjusting Entry for Accrued Revenues

Debit: Assets

Credit: Revenues

Adjusting Entry for Accrued Expenses

Debit: Expenses

Credit: Liabilities

Permanent Account DEF

balance sheet accounts, not automatically closed at the end of each accounting period

Temporary Account

Income statement accounts, automatically closed at the end of each accounting period

5 things that make up the other comprehensive income

1. Decrease in Adjustments to Investments (net of tax)

2. Decrease in Adjustments to Pensions (net of tax)

3. Decrease in Adjustments to Derivatives (net of tax)

4. Decrease in Adjustments to Foreign Currency Translation (net of tax)

5. Decrease in Adjustments to Other than temporary impairments for Debt Securities (net of tax)

Instructors Print Doodles, friends Cheat, Teachers observe

Earnings Quality

ability of reported earnings to predict a company's future earnings.

Formula for basic EPS earnings per share

(Net income - preferred stock dividends) / Weighted Average Common Shared Outstanding 

Income Smoothing

Good performance —> management overestimates Bad Debt expense.

Next year, you don’t have to recognize as much BDE —> makes financial growth look more stable and hides volatility

Classification Shifting

classifying operating expenses as non-operating expenses; so expenses seems less important

What is excluded when predicting future earnings?

1. Restructuring Costs

2. Impairment of long-term assets (goodwill & intangibles)

What are Restructuring Costs?

costs included in management’s plan to materially change the scope of business operations

often a one-time expense

What is Impairement of long-term assets (goodwill intangibles_

any long-lived assets should be reduced if there is significant impairment of value

Non-operating income includes

gains, losses, interest income & interest expense

non-GAAP earnings

management’s opinion of “permanent earnings“

this type of reporting minimizes effect of larger one-time costs (i.e. restructuring costs)

3 reasons they are controversial

1. subject to manipulation

2. lack of regulation or scrutiny

3. lack of comparability/consistency

Discontinued Operations are….

component of the entity that has been sold or disposed of. strategic shift that will have major effects on the company’s operations and financial results.

Comprehensive Income DEF

all changes in equity from non-owner sources (not stock transactions or dividends)

Formula for Comprehensive Income

Comprehensive Income = Net Income + OCI

OCI - Other Comprehensive Income DEF

captures gains/losses from non-owner transactions that aren’t reported in the income statement

Comprehensive Income is reported

Net of tax

• Accumulated OCI on Balance sheet under SE (credit account)

• consolidated statements of comprehensive Income