Professional Documents
Culture Documents
Session4:IIMCPGP201719
AccountingMechanics
1
LearningGoals
AdjustmentEntries
DeferralsandAccruals
PreparinganAdjustedTrialBalance
PreparingFinancialStatements
ClosingEntries
PreparingaPostClosingTrialBalance
AssignmentProblems
2
TrialBalance
Each
accountis
analyzedto
determine
whetheritis
completeand
uptodate.
3
AccrualConcept
Problem:
Revenues canbeearnedinaperiodotherthantheoneinwhich
cashisreceived
Expenses canbeincurredinaperiodotherthantheonein
whichcashispaid
Solution:
Transactionsrecordedintheperiodsinwhichtheeventsoccur
Recognizerevenuesintheaccountingperiodinwhichthe
goodsaresoldorservicesarerendered(evenifcashwasnot
received
Recognizeexpensesintheaccountingperiodinwhichthey
areusedtogeneraterevenues(evenifcashwasnotpaid)
4
RevenueRecognitionandExpenseRecognition
RevenueRecognitionPrinciple:
Companiesrecognizerevenueintheaccountingperiodinwhichthe
performanceobligationissatisfied
ExpenseRecognition:
Expensesneedtobematchedwiththerevenueintheperiodwhen
thecompanymakeseffortstogeneratethoserevenues
Lettheexpensesfollowtherevenues
AlsoreferredtoasMatchingPrinciple
Accrualbasisofaccountinghelpstoapplythematchingprinciple
Thedifficultyofassigningrevenuesandexpensestothe
appropriateaccountingperiod isaddressedsothatnetincome
ismeasuredaccurately
5
AssumptionsandMatchingRule
GoingConcern,
AccrualsBasis
Matching
Principle Let the expenses
follow the
revenues.
Sometransactionsspanmorethanoneaccountingperiod 6
AdjustingEntries
Adjustingentriesneeded toensurethat
Transactionsthatspanmorethanoneperiodareadjustedattheendof
anaccountingperiod ApplyingAccrualBasis
Revenuerecognition&Expenserecognitionprinciples arefollowed
Adjustingentriesmakeitpossibletoreport
correctamounts onthebalancesheetandincomestatement.
Acompanymustmakeadjustingentries
everytime itpreparesfinancialstatementsattheendofaperiod
AdjustmentEntrymust:
IncludeatleastoneincomestatementA/c
IncludeatleastonebalancesheetA/c
Donotaffectcashflowsincurrentperiod,neveraffectCashA/c
InvolvesJudgment:Potentialforabuse(Ethics)
7
TypesofAdjustingEntries
Deferrals:CashExchangedinAdvance ofafutureRevenueorExpense
1. Prepaidexpenses: RecognitionofExpenseisDeferred
Expensesalreadypaidincashandrecordedasassets
before theyareusedorconsumed.
RecognitionofRevenueisDeferred
3. Unearnedrevenues:(Prereceived/Receivedinadvance)
Cashreceivedinadvanceandreportedasliabilities
before revenueisearned.
9
DEFERRALS
(Type1and3)
10
AdjustmentEntries Deferrals:PrepaidExpense(Type1)
PrepaidExpense:Expensespaidinadvancethathavenotyetexpired
CashPayment Before Expensesarerecorded(Supplies,PrepaidRent,Plant)
Recordedcoststobeallocatedbetweentwoormoreaccountingperiods
AtthetimeofPayment:Serviceorbenefitisyettobereceived
DebitedtoanAsseta/c RecognitionofExpenseisDeferred
AttheendofAccountingPeriod:AcertainportionExpires(withpassageof
timeorUse)
ExpiredportiontobetransferredtoanExpenseA/c AdjustmentEntry
AdjustingentrytorecordtheEXPENSEthathasbeenincurredandtothe
ASSETthatremains.Resultsin
anincreasetoanexpenseaccount(Dr.)and
adecreasetoanassetaccount(Cr.)
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PrepaidExpense
Whenpaymentwasmade
Recognitionofexpensewaspostponedandassetrecorded
Ifadjustmententryisnotpassedattheendoftheaccountingperiod,
eventhoughtheassethasbeenused/consumed
Assetswillbeoverstated
Expenseswillbeunderstated
Netincomewillbeoverstated
Stockholdersequitywillbeoverstated
12
AdjustmentEntry(Type1):PrepaidRentAdjustment
OnJuly3,MillerDesignStudiopaidtwomonthsrentinadvancefor$3,200.
TheamountwasrecordedinthePrepaidRentaccount.
Dr. Cr.
July3PrepaidRent 3,200
Cash 3,200
ByJuly31,halfoftheprepaidrenthasexpiredandshouldbetreated
Dr. Cr.
asanexpense July31RentExpense 1,600
PrepaidRent 1,600
AdjustmentJuly31:Prepaidrentof$1,600hasexpiredforJuly.
AdjustaccountbyallocatingtheamounttotheRentExpenseaccount.
PrepaidRent RentExpense
July33,200 1,600July31July311,600
Bal.1,600
The account now reflects the The account now reflects the
prepaid August amount July rent expense amount
13
Adjustment Entry(Type1):PrepaidInsurance
Illustration: OnOctober4,SierraCorporationpaid$600foraoneyearfire
insurancepolicy.CoveragebeganonOctober1.Sierrarecordedthe
paymentbyincreasing(debiting)PrepaidInsurance.Thisaccountshowsa
balanceof$600intheOctober31trialbalance(ifnotadjusted).
Insuranceof$50($600 12)expireseachmonth.
Oct.31 InsuranceExpense 50
PrepaidInsurance 50
14
AdjustmentEntry(Type1):Supplies
Illustration: SierraCorporationpurchasedsuppliescosting$2,500on
October5.Sierrarecordedthepurchasebyincreasing(debiting)theasset
Supplies.Thisaccountshowsabalanceof$2,500intheOctober31trial
balance (ifnotadjusted).
AninventorycountatthecloseofbusinessonOctober31revealsthat
$1,000ofsuppliesarestillonhand.
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Plant,DepreciationExpense,AccumulatedDepreciation
Purchaseofalongtermassetisadeferralofanexpense
Thecostoftheassetmustbeallocatedoveritsestimatedusefullife.
Theamountallocatedtoanyoneperiodiscalleddepreciation.
Depreciationexpense
Incurredduringanaccountingperiodtoproducerevenue,mustbeestimated
Basedon:Costoftheasset,itsestimatedusefullife(numberofmethods)
Depreciationexpensedoesnotreducetheassetaccountdirectly,butisrecorded
inaContraAccount,calledAccumulatedDepreciation
Aseparateaccount,shownasadeductionfromtherelatedassetaccount
Contraaccountisusedto
Recognizethatdepreciationisanestimate,Preservesoriginalcostoftheasset
Incombinationwiththeassetaccount,itshows
Howmuchoftheassethasbeenallocatedasanexpense
Thebalancelefttobedepreciated
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AdjustingEntry(Type1):PrepaidExpense(Asset,Depreciation)
Depreciationistheprocessofallocatingcostofanassettoexpenseoveritsusefullife
Depreciationdoesntattempttoreportactualchangeinthevalueoftheasset
ForSierraCorporation,assumethatdepreciationontheofficeequipmentis$480
ayear,or$40permonth.
Oct.31 DepreciationExpense 40
AccumulatedDepreciation Equipment 40
17
PrepaidExpenseandUnearnedRevenue
Mr. A records Mr. B records
Prepaid Expense (A) Cash (A) (Dr.)
Cash (A) (Cr.) Unearned Revenue (L)
Advance payment today
Service Tomorrow
18
AdjustmentEntries DeferredorUnearnedRevenue(Type3)
UnearnedRevenue(Prereceived/Receivedinadvance)
CashReceiptBefore Revenueearnedorrecognized
(AirlineTickets,MagazineSubscription,Rent,Customerdeposits)
Recordedunearnedrevenuetobeallocatedbetweentwoormore
accountingperiods
Atthetimeofcashreceipt: Service(goods)yettoberendered(delivered)
Creditedtoa LiabilityA/c RecognitionofRevenueisDeferred
Attheendoftheaccountingperiod:ServiceRendered(orGoodsdelivered)
AmountEarnedistransferredtoaRevenueA/c AdjustmentEntry
AdjustingentrytorecordtheREVENUEthathasbeenearnedandtoshow
theLIABILITYthatremains.Resultsin:
adecreasetoaliabilityaccount(Dr.)and
anincreasetoarevenueaccount(Cr.)
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UnearnedRevenue
Whenpaymentwasreceived
RecognitionofrevenuewaspostponedandLIABILITYrecorded
Ifadjustmententryisnotpassedattheendoftheaccountingperiod,
eventhoughtheREVENUEhasbeenEarned
LIABIITIESwillbeoverstated
REVENUESwillbeunderstated
NetincomewillbeUnderstated
StockholdersequitywillbeUnderstated
20
AdjustmentEntries(Type3)UnearnedRevenue
OnJuly19,MillerDesignStudioreceived$1,400asanadvancepaymentforbrochuresto
bepreparedforaclient.Bytheendofthemonth,$800ofthebrochureswerecompleted
andacceptedbytheclient.
Whenthepaymentwasoriginallyreceived,itwasrecordedasaliability.
Dr.Cr.
July19 Cash 1400
Unearned DesignRevenue1400
$800oftheadvancepaymenthasbeenearnedinJuly Dr. Cr.
July31UnearnedDesignRevenue 800
DesignRevenue 800
AdjustmentJuly31:Recognize$800oftheunearnedrevenueasearnedinJuly.
Assets =Liabilities+ StockholdersEquity
UnearnedDesignRevenue DesignRevenue
July31800 July191,400 July102,800
July159,600
Bal. 600 July31800
The account now reflects a The account now reflects the total
balance that is unearned revenue revenue applicable to July
21
AdjustmentEntries(Type3)UnearnedRevenue
Illustration: SierraCorporationreceived$1,200onOctober2fromR.Knox
forguideservicesformultidaytripsexpectedtobecompletedby
December31.UnearnedServiceRevenueshowsabalanceof$1,200inthe
October31trialbalance.
FromanevaluationoftheserviceSierraperformedforKnoxduring
October,thecompanydeterminesthatithasearned$400inOctober.
22
ACCRUALS
(Type2and4)
23
AdjustmentEntries AccruedExpense(Type2)
AccruedExpensesorOutstandingExpenses
ExpensesIncurredduringtheperiod,butnotyetrecorded nocashpaidyet
(Rent,Interest,Wages,Taxes,Utilities) Expensesarisen,notyetrecorded
AttheendoftheAccountingPeriod:Amountthathasbeenincurredis
RecognizedasanExpense,and AdjustmentEntry
RecordedasaLiability. Astheexpenseaccumulates,
itissaidtoaccrue
AdjustmentEntryresultsin
Increasesanexpenseaccount(Dr.)and
Increasesaliabilityaccount(Cr.)
24
AdjustmentEntry(Type2):AccruedWages
MillerDesignStudiopaysitsemployeeseverytwoweek$2400:On12th and26th of
everymonth.ThelastpayperiodendedonJuly26.ThesecretaryworkedJuly29
31,butwillnotbepaiduntiltheregularpaydayinAugust(12th).
TheunrecordedwagesforJuly29 31areanexpenseofJulyeventhoughthey
July
willnotbepaiduntilAugust.
Dr.Cr.
July31WagesExpense 720
WagesPayable 720
AdjustmentJuly31:Accruetheunrecordedwages.Thesecretaryearns$2,400everytwo
weeks.($2,400/10workingdays=$240/dayx3days=$720)
WagesPayable WagesExpense
July31720 July264,800
July31720
Bal.5,520
The account now reflects the The account now reflects the
liability applicable to July total July wages expense
25
AdjustmentEntry(Type2):AccruedInterest
26
AdjustmentEntry(Type2):AccruedWages
Illustration: SierraCorporationlastpaidsalariesonOctober26;thenextpaymentof
salarieswillnotoccuruntilNovember9.Theemployeesreceivetotalsalariesof$2,000
forafivedayworkweek,or$400perday.
Thus,accruedsalariesatOctober31are$1,200($400x3days).
Hired:9thOct,
Workstarted:15thOct,
Wagespayable:
Every2weeks
FirstWagePaid:26th Oct
27
AdjustmentEntries AccruedRevenue(Type4)
AccruedRevenueorReceivables
Revenueearnedduringtheperiod,butnotyetrecorded:nocashreceipts
yet Revenuearisen,notyetrecorded
(Rent,Interest,Serviceperformed,Revenuesearnedonoperations)
AttheendoftheAccountingPeriod:AmountthathasbeenEarnedis
RecognizedasanREVENUE,and AdjustmentEntry
RecordedasanASSET(AccountsReceivable) amountduetothe
companyforservicesperformed(orgoodsdelivered)
Astherevenueaccumulates,
AdjustmentEntryresultsin itissaidtoaccrue
Increasesanassetaccount(debits)and
Increasesarevenueaccount(credits)
28
AdjustmentEntries AccruedRevenue(Type4)
InJuly,MillerDesignStudioagreedtodesignawebsiteforMarshTireCompanywith
thefirstsectionoperationalbyJuly31.Thefeeforthissectionis$400.
Thefeehasbeenearnedbytheendofthemonth,buthasnotbeenrecorded
July31AccountsReceivable 400
DesignRevenue 400
AdjustmentJuly31:Recognize$400asrevenueearnedinJuly
AccountsReceivable DesignRevenues
July159,600 July225,000 July102,800
July31400 July169,600
Bal.5,000 July31800
July31400
The account now reflects all The account now reflects the total
receivables for July revenue applicable to July
29
AdjustmentEntries AccruedRevenue(Type4)
Illustration: InOctober,SierraCorporationperformedguideservices
for$200thatwerenotbilledtoclientsbeforeOctober31.
30
AdjustingEntries Accruals
WithoutAdjustmentforAccruedExpenses ExpensesandLiabilitieswill
beunderstated:NI,ShareholdersEquitywillbeOverstated
WithoutAdjustmentforAccruedRevenues RevenuesandAssetswillbe
understated:NI,ShareholdersEquitywillbeUnderstated
BalanceSheetandIncomeStatementwouldbeincorrect
Mr XsAccruedExpenses(A/P)wouldbeMr.YsAccruedRevenue(A/R)
31