Page 131 - Accounting Principles (A Business Perspective)

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Bal. after adjustment 3,780
(Dr.) Salaries Payable (Cr.)
2010 180 Increased by
Dec. 31 Adjustment 8 $180
Failure to Recognize Effect on Net Income Effect on Balance Sheet Items
1. Consumption of the benefits of an asset Overstates net income Overstates assets Overstates retained earnings
(prepaid expense)
2. Earning of previously unearned revenues Understates net income Overstates liabilities Understates retained
earnings
3. Accrual of assets Understates net income Understates assets Understates retained
earnings
4. Accrual of liabilities Overstates net income Understates liabilities Overstates retained
earnings
Exhibit 18: Effects of failure to recognize adjustments

The debit in the adjusting journal entry brings the month’s salaries expense up to its correct USD 3,780 amount
for income statement purposes. The credit to Salaries Payable records the USD 180 salary liability to employees.
The balance sheet shows salaries payable as a liability.
Another example of a liability/expense adjustment is when a company incurs interest on a note payable. The
debit would be to Interest Expense, and the credit would be to Interest Payable. We discuss this adjustment in
Chapter 9.

Effects of failing to prepare adjusting entries
Failure to prepare proper adjusting entries causes net income and the balance sheet to be in error. You can see

the effect of failing to record each of the major types of adjusting entries on net income and balance sheet items in
Exhibit 18.
Using MicroTrain Company as an example, this chapter has discussed and illustrated many of the typical entries
that companies must make at the end of an accounting period. Later chapters explain other examples of adjusting
entries.
Analyzing and using the financial results—trend percentages

It is sometimes more informative to express all the dollar amounts as a percentage of one of the amounts in the
base year rather than to look only at the dollar amount of the item in the financial statements. You can calculate
trend percentages by dividing the amount for each year for an item, such as net income or net sales, by the
amount of that item for the base year:

Current year amount
Trend percentage=
Base year amount
To illustrate, assume that ShopaLot, a large retailer, and its subsidiaries reported the following net income for
the years ended 2001 January 31, through 2010. The last column expresses these dollar amounts as a percentage of
the 2001 amount. For instance, we would calculate the 125 per cent for 2002 as:

[(USD 1,609,000/USD 1,291,000)5 100]
Dollar Amount
of Net Income Percentage of
(millions) 1991 Net Income
1991 $1,291 100 %
1992 1.609 125
1993 1,995 155
1994 2,333 181
1995 2,681 208
1996 2,740 212
1997 3,056 237

Accounting Principles: A Business Perspective 132 A Global Text