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ยป HI, EVERYBODY.
MICHAEL GOUGH HERE AGAIN.
IN THIS PART OF CHAPTER 3, WE'RE GOING TO FOCUS ON
THE ACTUAL ADJUSTING ENTRIES, THEN WE'RE GOING
TO MOVE ON THE NEXT STEP IN THE ACCOUNTING CYCLE;
THAT IS, THE ADJUSTED TRIAL BALANCE, WHAT
HAPPENS ONCE THE ENTRIES HAVE BEEN ENTERED INTO THE
ACCOUNTING SYSTEM, AND WE'RE ABLE TO PUT THOSE
FORWARD SO WE CAN SUMMARIZE THE EFFECTS ON
ALL OF THE ACCOUNTS.
THAT'S WHAT WE'RE GOING TO DO HERE, SO FOLLOW ALONG.
SO OUR NEXT OBJECTIVE HERE IS TO JOURNALIZE ENTRIES
FOR ACCOUNTS REQUIRING ADJUSTMENT.
SO YOU MIGHT REMEMBER OUR UNADJUSTED TRIAL BALANCE
FOR NETSOLUTIONS, AND AGAIN, REMEMBER THIS COMES
AFTER WE'VE JOURNALIZED AND POSTED AND THEN TAKEN
THE ENDING BALANCE FROM ALL THE LEDGER ACCOUNTS
BEFORE WE'VE DONE THE ADJUSTING ENTRIES.
SO NETSOLUTIONS' SUPPLIES ACCOUNT HAS A BALANCE OF
$2,000 ON THE UNADJUSTED TRIAL BALANCE.
SOME OF THESE SUPPLIES HAVE BEEN USED.
AN ACCOUNT REVEALS THE AMOUNT OF SUPPLIES ON
HAND, THE $760.
SO WHAT THAT MEANS IS, IS THAT WE ACTUALLY USED UP
$1,240.
IF I HAD $2,000 WORTH OF SUPPLIES, I HAVE $760
REMAINING.
THAT MEANS $1,240 WAS USED UP.
AS A RESULT OF THAT, OUR ENTRY IS GOING TO BE DEBIT
SUPPLY EXPENSE $1,240, AND CREDIT SUPPLIES $1,240.
SO THE IDEA IS, WE RECOGNIZE AN EXPENSE THAT
WILL CAUSE NET INCOME TO GO DOWN, AND OUR ASSET
GOES DOWN AT THE SAME TIME.
NOW, THEN THE DEBIT BALANCE OF $2,400 IN THE
PREPAID INSURANCE REPRESENTS A DECEMBER 1ST
PREPAYMENT OF INSURANCE FOR 12 MONTHS.
SO WE TAKE A LOOK AT THIS AND WE SAY, OKAY.
IF I TAKE $2,400, DIVIDE IT BY 12 MONTHS, THAT'S
$200 A MONTH.
SO AS A RESULT OF THAT, I'M GOING TO RECOGNIZE
$200 IN INSURANCE EXPENSE AND CREDIT PREPAID
INSURANCE, SO DEBIT INSURANCE EXPENSE, $200,
CREDIT PREPAID INSURANCE FOR THE SAME AMOUNT.
NOW, IF I DON'T DO THIS, WHAT'S GOING TO HAPPEN IS
THAT I'M GOING TO UNDERSTATE MY EXPENSES,
AND IF I UNDERSTATE MY EXPENSES, I'M GOING TO
OVERSTATE MY NET INCOME, AND THEN MY ASSETS WILL BE
OVERSTATED AS WELL.
SO AS A RESULT OF THAT, IF WE DON'T DO OUR ADJUSTING
ENTRIES, WE'LL FIND THAT WE CAN'T RELY ON OUR
FINANCIAL STATEMENTS.
AND THIS IS ONE OF THE REASONS WHEN CERTIFIED
PUBLIC ACCOUNTANTS AUDIT THE BOOKS OF PUBLIC
COMPANIES, THEY WANT TO LOOK AT THE ADJUSTING
ENTRIES VERY CLOSELY BECAUSE, IN FACT, IF WE'RE
NOT CAREFUL OR IF WE'RE LESS THAN HONEST, THAT'S A
GOOD PLACE TO HIDE INCOME, AS IT WERE.
OKAY.
PREPAID INSURANCE IN THIS EXAMPLE HAD A BEGINNING
BALANCE OF $6,400 AND WAS DEBITED FOR $3,600 OF
PREMIUMS DURING THE YEAR.
JOURNALIZE THE ENTRY AT THE END OF THE YEAR, GIVEN
THAT THE UNEXPIRED INSURANCE IS $3,250.
SO WE TAKE A LOOK AT THIS AND WE SAY, OKAY.
$6,400 PLUS THE $3,600, THAT'S A TOTAL OF $10,000
MINUS THE $3,250 THAT REMAINS.
THAT MEANS WE DEBIT INSURANCE EXPENSES $6,750,
AND CREDIT PREPAID INSURANCE $6,750.
IT'S VERY COMMON FOR COMPANIES TO HAVE SEVERAL
INSURANCE POLICIES AND TO PAY THEM AHEAD AND THEN TO
RECOGNIZE THE EXPENSE AT THE END OF A QUARTER OR
THE END OF THE YEAR, SOMETHING ALONG THOSE
LINES.
OKAY.
THE CREDIT BALANCE OF $360 IN NETSOLUTIONS' UNEARNED
RENT ACCOUNT REPRESENTS THE RECEIPT OF THREE
MONTHS' RENT ON DECEMBER 1 FOR DECEMBER, JANUARY, AND
FEBRUARY.
SO WE'VE EARNED ONE MONTH'S WORTH OF RENT
HERE.
SO WE ARE GOING TO DEBIT UNEARNED RENT $120 AND
CREDIT RENT REVENUE FOR THE SAME AMOUNT.
THAT'S $360 DIVIDED BY 3.
SO IN THIS EXAMPLE, WHAT WE SEE IS THAT OUR
LIABILITIES ARE GOING DOWN AND OUR REVENUES HAVE GONE
UP.
SO IF WE DON'T RECOGNIZE THIS, WE'RE GOING TO
UNDERSTATE OUR REVENUES.
AND AS A RESULT, WE'LL UNDERSTATE OUR NET INCOME
AS WELL, AND OUR BALANCE SHEET WILL OVERSTATE OUR
LIABILITIES.
SO THE IDEA IS ADJUSTING ENTRIES TEND TO ALWAYS
AFFECT THE INCOME STATEMENT AND THE BALANCE
SHEET.
THAT'S ONE OF THE DEFINITIONS OF AN
ADJUSTING ENTRY.
SO IN THIS EXAMPLE, WE SAY THE BALANCE IN THE
UNEARNED RENT ACCOUNT BEFORE ADJUSTMENT WAS
$44,900.
JOURNALIZING THE ADJUSTING ENTRY IF THE UNEARNED FEES
AT THE END OF THE YEAR IS $22,300.
SO WE SAY $44,900 MINUS $22,300 MEANS WE DEBIT
UNEARNED FEES OF $22,600, AND CREDIT FEES EARNED,
$22,600.
NOW WE SEE NETSOLUTIONS SIGNED AN AGREEMENT WITH
DANKER ON DECEMBER 15 TO PROVIDE SERVICES AT $20 AN
HOUR.
AS OF DECEMBER 31, THEY'VE PROVIDED 25 HOURS OF
SERVICES, AND THE REVENUE WILL BE BILLED ON JANUARY
15.
SO WHAT'S GOING TO HAPPEN IS, WE'RE GOING TO TAKE 25
TIMES 20.
THAT MEANS THEY OWE US 500 BUCKS, SO WE ARE GOING TO
DEBIT $500 TO ACCOUNTS RECEIVABLE.
CREDIT FEES EARNED FOR THE SAME AMOUNT.
SO THE IDEA HERE IS, IS THAT WE HAVE AN INCREASE
TO OUR ASSETS AND AN INCREASE IN REVENUE.
AND IF THERE'S A MISSTATEMENT THERE, WE
WOULD HAVE UNDERSTATED OUR REVENUE, UNDERSTATED OUR
NET INCOME.
WE WOULD HAVE UNDERSTATED OUR ASSETS AS WELL.
AND HERE AT THE END OF THE YEAR, $13,680 IN FEES HAVE
BEEN EARNED, BUT NOT BILLED TO CLIENTS.
SO WE'RE GOING TO JOURNALIZE THAT, SO WE'RE
SIMPLY GOING TO DEBIT ACCOUNTS RECEIVABLE
$13,680 AND CREDIT FEES EARNED FOR THE SAME
AMOUNT.
NOW, ONE OF THE THINGS WE FIND IS IS THAT YEARS
TYPICALLY DON'T END ON FRIDAYS, DO THEY?
AS A RESULT OF THAT, IN DECEMBER, IN THIS EXAMPLE,
WE SEE THAT THE YEAR ENDS ON DECEMBER 31ST.
SO THAT MEANS WHATEVER WAGES THAT ARE OWED, THE
30TH AND 31ST BELONG IN DECEMBER EXPENSES, AND
WHATEVER'S EARNED FOR THE 1ST, 2ND, AND 3RD BELONG
IN THE JANUARY EXPENSES.
THE PROBLEM IS, IF YOU'RE A COMPANY THAT PAYS ITS
SALARY ONCE A WEEK ON FRIDAY, YOU HAVE TO MAKE
SURE THAT YOU SPLIT THAT.
YOU HAVE TO DO AN ADJUSTING ENTRY.
SO THE NETSOLUTIONS PAYS ITS EMPLOYEES BIWEEKLY.
DURING DECEMBER, NETSOLUTIONS PAY WAGES OF
$950 ON DECEMBER 13 AND $1,200 ON DECEMBER 27.
AS OF DECEMBER 31ST, THERE ARE $250 OF WAGES FOR
MONDAY, TUESDAY -- MONDAY AND TUESDAY, RATHER,
DECEMBER 30TH AND 31TH.
SO THERE WE ARE GOING TO DEBIT WAGE EXPENSE $250,
CREDIT WAGES PAYABLE FOR THE SAME AMOUNT.
SO THE IDEA IS, IS THAT THIS IS MONEY THAT HAS TO
BE RECOGNIZED FOR DECEMBER, NOT FOR JANUARY.
THE IDEA IS WE DON'T WANT TO UNDERSTATE OUR EXPENSES
FOR DECEMBER, BECAUSE THAT WOULD BE A PROBLEM.
NOW, NETSOLUTIONS PAYS WAGES OF $1,275 ON JANUARY
10TH, AND THAT INCLUDES THE 250 BUCKS OF ACCRUED
WAGES, SO WHAT WE'RE GOING TO DO IS A COMPOUND ENTRY
FOR THAT TRANSACTION.
WE DEBIT WAGE EXPENSE $1,025.
THAT'S FOR JANUARY.
AND THEN WE DEBIT WAGES PAYABLE, THOSE FOR
DECEMBER, IN THE AMOUNT OF $250, AND CREDIT CASH FOR
$1,275.
THAT'S HOW WE CLEAN THINGS UP.
AND AGAIN, HAD WE NOT PUT THIS ENTRY IN, WE WOULD
HAVE UNDERSTATED OUR EXPENSES AND THEREFORE
OVERSTATED OUR NET INCOME.
SO THE IDEA IS THAT, AGAIN, WE WOULD HAVE HAD
AN EFFECT ON BOTH THE INCOME STATEMENT AND THE
BALANCE SHEET.
FIXED ASSETS, OR PLANT ASSETS, ARE PHYSICAL
RESOURCES OWNED, USED BY A BUSINESS, AND ARE
PERMANENT OR HAVE A LONG LIFE.
AND AS TIME PASSES, THEY BEGIN TO LOSE THEIR VALUE,
AND WE CALL THIS DEPRECIATION.
NOW, ALL FIXED ASSETS EXCEPT FOR LAND -- AND
THAT'S IMPORTANT.
YOU NEVER DEPRECIATE LAND -- LOSE THEIR USEFULNESS,
AND SO WE DEPRECIATE THEM.
AND AS FIXED ASSETS DEPRECIATE, WE RECOGNIZE
THIS DEPRECIATION EXPENSE.
NOW WE'VE A SPECIAL ACCOUNT CALLED THE
ACCUMULATED DEPRECIATION.
RATHER THAN BUY A TRUCK FOR $20,000 AND BASICALLY
REDUCE THE TRUCK FROM $20,000 TO $19,000, WHAT
WE DO IS WE HAVE A SPECIAL ACCOUNT CALLED A CONTRA
ACCOUNT, ACCUMULATED DEPRECIATION THAT STAYS
WITH THE TRUCK ACCOUNT.
SO AS A RESULT OF THAT, THIS ACCUMULATED
DEPRECIATION ACCOUNT IS AN ACCOUNT WE'RE GOING TO
BECOME VERY FAMILIAR WITH.
WE THINK THIS TO BE IMPORTANT FOR OUR
INVESTORS AND MANAGERS.
SO THE IDEA IS LAND DOESN'T HAVE A CONTRA
ASSET ACCOUNT, BUT WE'LL FIND THAT BUILDINGS HAVE
ACCUMULATED DEPRECIATION ASSOCIATED WITH BUILDINGS,
STORE EQUIPMENT, ACCUMULATED DEPRECIATION,
STORE EQUIPMENT, OFFICE EQUIPMENT, THE SAME THING.
SO NETSOLUTIONS ESTIMATES THE DEPRECIATION ON ITS
OFFICE EQUIPMENT TO BE 50 BUCKS FOR THE MONTH OF
DECEMBER.
SO WE GO AHEAD, DEBIT DEPRECIATION EXPENSE 50,
CREDIT ACCUMULATED DEPRECIATION OFFICE
EQUIPMENT 50.
SO THE IDEA IS, YOU'LL NOTICE THAT WE HAVE OFFICE
EQUIPMENT OF $1,800.
THAT DOESN'T CHANGE.
BUT OUR ACCUMULATED DEPRECIATION FOR THE
OFFICE EQUIPMENT DOES, AND THEN OF COURSE WE
RECOGNIZE THE $50 DEPRECIATION EXPENSE.
NOW, THE DIFFERENCE BETWEEN THE ORIGINAL COST
OF THE OFFICE EQUIPMENT AND THE BALANCE IN THE
ACCUMULATED DEPRECIATION IS CALLED THE BOOK VALUE.
OKAY?
AND IT'S COMPUTED JUST LIKE THIS.
WE TAKE THE BOOK VALUE OF AN ASSET, AND THAT'S EQUAL
TO THE COST OF THE ASSET MINUS THE ACCUMULATED
DEPRECIATION OF THE ASSET.
OKAY?
SO FOR THE OFFICE EQUIPMENT, THE COST OF THE
OFFICE EQUIPMENT MINUS THE ACCUMULATED DEPRECIATION
OF THE OFFICE EQUIPMENT.
SO THE OFFICE EQUIPMENT IS NOW SITTING AT $1,750.
COST WAS $1,800.
WE'VE TAKEN A TOTAL OF $50 DEPRECIATION EXPENSE, SO
THE BOOK VALUE IS $1,750.
AT THE END OF NEXT YEAR, IT WILL BE $1,700.
THAT IS, $50 DEPRECIATION WILL BE RECOGNIZED, OR FOR
DEPRECIATING ON A MONTHLY BASIS, $1,700 AT THE END
OF THE NEXT MONTH.
NOW, IF WE DON'T DO OUR DEPRECIATION, WE'RE GOING
TO UNDERSTATE OUR EXPENSE, OVERSTATE OUR NET INCOME,
AND WE'RE GOING TO OVERSTATE OUR ASSETS.
NOW, LET'S SUMMARIZE THE ADJUSTMENT PROCESS.
SO THE IDEA IS, IS THAT SUPPLIES OF PREPAID
INSURANCE, THOSE GET ADJUSTED SO WE CAN UPDATE
THEM.
SO TYPICALLY WE DEBIT THE EXPENSE AND CREDIT THE
ASSET.
OKAY?
SO WE HAVE SUPPLY EXPENSE AND INSURANCE EXPENSE.
AND THAT AFFECTS BOTH THE INCOME STATEMENT AND THE
BALANCE SHEET.
THEN WE HAVE UNEARNED REVENUES.
THAT'S A LIABILITY.
AND SO THERE TYPICALLY WE DEBIT UNEARNED RENT,
CREDIT RENT REVENUE OR DEBIT UNEARNED FEES AND
CREDIT EARNED FEES.
SO THE IDEA IS THIS AFFECTS BOTH THE INCOME
STATEMENT AND THE BALANCE SHEET FROM A PROFITABILITY
AND FROM AN ASSET AND A LIABILITY PERSPECTIVE.
THEN THERE ARE ACCRUED REVENUES.
THIS IS WHERE WE'VE PERFORMED WORK.
WE'RE OWED THE MONEY.
WE HAVE TO RECOGNIZE THE REVENUE.
DEBIT ACCOUNTS RECEIVABLE, CREDIT FEES EARNED.
AND THEN ACCRUED EXPENSES, WHERE WE'VE INCURRED
EXPENSES THAT HAVE TO BE PAID, BUT WE WANT TO
ASSOCIATE THEM WITH THE CURRENT PERIOD.
SO THERE WE WOULD DEBIT WAGE EXPENSE AND CREDIT
WAGES PAYABLE, IN THAT REGARD.
DEPRECIATION.
THIS IS WHERE WE RECOGNIZE THE DEPRECIATION EXPENSE
ON A REGULAR BASIS FOR OUR ASSETS.
SO THERE WE DEBIT DEPRECIATION EXPENSE AND
CREDIT ACCUMULATED DEPRECIATION, THAT CONTRA
ASSET ACCOUNT.
SO THESE ADJUSTING ENTRIES THAT WERE DONE FOR
NETSOLUTIONS, DEBIT SUPPLY EXPENSE, CREDIT SUPPLIES,
DEBIT INSURANCE EXPENSE, CREDIT PREPAID INSURANCE,
DEBIT UNEARNED RENT, CREDIT RENT REVENUE, DEBIT
ACCOUNTS RECEIVABLE, CREDIT FEES EARNED, DEBIT
WAGE EXPENSE, CREDIT WAGES PAYABLE, AND DEBIT
DEPRECIATION EXPENSE, CREDIT ACCUMULATED
DEPRECIATION-OFFICE EQUIPMENT.
AND SO THE IDEA IS THAT THEN WE'RE ABLE TO UPDATE
OUR LEDGER ACCOUNTS, BECAUSE THIS ALL HAS TO
GET POSTED, DOESN'T IT?
AND SO ULTIMATELY THE LEDGER GETS FULLY
ADJUSTED.
OKAY?
AND THEN WHAT HAPPENS IS, IS YOU TAKE THOSE
ADJUSTMENTS AND YOU SAY, OKAY, NOW I'M READY FOR AN
ADJUSTED TRIAL BALANCE.
BECAUSE THE TRIAL BALANCE HAS CHANGED, HASN'T IT?
SO AS A RESULT OF THAT, WHAT WE'RE TRYING TO DO IS
WE WANT TO MAKE SURE THAT OUR DEBITS AND CREDITS ARE
EQUAL, THAT WE'VE RECORDED EVERYTHING PROPERLY.
SO AS A RESULT OF THAT, NOW WE HAVE THE ADJUSTED
TRIAL BALANCE.
YOU'LL NOTICE THAT CASH IS THE SAME, BUT ACCOUNTS
RECEIVABLE HAS CHANGED.
SUPPLIES HAVE CHANGED.
PREPAID INSURANCE HAS CHANGED.
WAGES PAYABLE, UNEARNED RENT, AND SO FORTH.
SO THE IDEA IS, SEVERAL OF THE ACCOUNTS CHANGED IN
THE ADJUSTED TRIAL BALANCE.
OKAY.
NOW, THEN WE CAN USE VERTICAL ANALYSIS TO
EVALUATE A COMPANY'S FINANCIAL CONDITION USING
THESE AMOUNTS.
OKAY.
NOW, WHAT'S GOING TO HAPPEN IS, AFTER WE HAVE
THE ADJUSTED TRIAL BALANCE, THEN WE CAN PUT
TOGETHER AN UPDATED INCOME STATEMENT, STATEMENT OF
OWNER'S EQUITY, AND BALANCE SHEET.
AND WE'VE PUT THAT TOGETHER AS QUICKLY AS
POSSIBLE, SO MANAGERS AND INVESTORS WILL HAVE THAT
DATA AS EARLY AS POSSIBLE SO THEY CAN MAKE GOOD
DECISIONS.
NOW, WHEN WE COMPARE EACH ITEM IN A FINANCIAL
STATEMENT WITH THE TOTAL AMOUNT FROM THE SAME
STATEMENT, IT'S REFERRED TO AS VERTICAL ANALYSIS.
SO HERE WE HAVE AN EXAMPLE AGAIN OF J.
HOLMES, ATTORNEY AT LAW.
AND WHAT WE SEE IS, WE SEE THAT UTILITY EXPENSE HAS
CHANGED BY ABOUT $3,500.
THAT IS FROM $9,000 TO $12,500.
WE SEE THAT FEES EARNED HAVE GONE UP, AND SO
FORTH.
SO THE IDEA IS, IS THAT WE TAKE A LOOK AT OUR
PERCENT'S CHANGE YEAR OVER YEAR, AND THEN OUR
PERCENT'S CHANGE BEING IN TERMS OF TOTAL REVENUE.
SO FOR INSTANCE, IN 2011, UTILITIES REPRESENTED 6%
OF REVENUES, WHEREAS IN 2012 IT REPRESENTS 6.7% OF
REVENUES.
THIS IS GOOD INFORMATION, BECAUSE IT TELLS US, ARE
WE RUNNING THE BUSINESS WELL?
DO WE NEED TO MAKE CHANGES?
OR SOMETHING ALONG THOSE LINES.
HERE WE SEE AN EXAMPLE WHERE SUPPLY EXPENSE HAVE
GONE FROM $3,000 TO $2,700.
AND AS A PERCENT, IT'S GONE FROM 2% TO 1.4%.
SO THE IDEA IS, IS THAT WE'RE IN A BETTER SPACE IN
TERMS OF USING OUR SUPPLIES.
OKAY.
SO LET'S DO VERTICAL ANALYSIS HERE FOR FORSON
COMPANY -- OR FORTSON COMPANY, RATHER -- WHERE
WE'LL TAKE A LOOK AND SEE HOW WE'RE DOING.
SO THE IDEA IS, IS THAT 56% OF OUR REVENUES WERE
OPERATING EXPENSES IN 2011, BUT 62% IS WHAT
WE'RE SEEING IN 2012, SO OBVIOUSLY OUR OPERATING
EXPENSES HAVE GONE UP.
NOW, THE GOOD NEWS IS, IS THAT OUR REVENUES HAVE
GONE UP, BUT THE BAD NEWS IS OUR PROFITABILITY HAS
NOT.
SO THAT TELLS US OUR OPERATING EXPENSES ARE
RUNNING HIGH.
SO THIS ALLOWS US TO ASK THE QUESTION, WHY DID THIS
HAPPEN?
WHAT IS THE PURPOSE IN THAT REGARD?
NOW, WE FINISH UP CHAPTER 3, SO THE QUESTIONS YOU
NEED TO ASK YOURSELF AT THIS POINT IS, CAN YOU
PREPARE A TRIAL BALANCE PROPERLY, AN UNADJUSTED
TRIAL BALANCE?
SO CAN YOU JOURNALIZE, POST TO THE LEDGER, AND DO
A TRIAL BALANCE?
THAT'S NUMBER 1.
THEN DO YOU KNOW THE DIFFERENCE BETWEEN A TRIAL
BALANCE, A BALANCE SHEET, AND AN INCOME STATEMENT?
AND THEN, CAN YOU DO ADJUSTING ENTRIES IN
PROPER FORM AND ADJUST THEM ACCORDINGLY?
AND THEN, CAN YOU DO AN ADJUSTED TRIAL BALANCE?
AND DO YOU UNDERSTAND THAT, AND CAN YOU EXPLAIN
IT TO SOMEONE ELSE?
IF YOU CAN, THEN YOU'RE READY FOR CHAPTER 4.
IF YOU CAN'T, THEN YOU NEED TO GO BACK TO CHAPTER
3 AND GO THROUGH THOSE ADJUSTING ENTRIES AND MAKE
SURE YOU UNDERSTAND ALL THOSE CONCEPTS IN THAT
REGARD.
SO AS IS ALWAYS THE CASE, I ENCOURAGE YOU TO STAY
WITH IT, TAKE A LOT OF NOTES, TAKE YOUR TIME, AND
YOU'LL PROBABLY JUST FINE.
UNTIL NEXT TIME, I WISH YOU WELL.