3 CHAPTER Adjusting Accounts for Financial Statements.
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Transcript of 3 CHAPTER Adjusting Accounts for Financial Statements.
3CHAPTER
Adjusting Accounts for Financial Statements
Start upTime period concept
• Definition: The life of a business is divisible into time periods of equal length– Annual financial reports once a year – Interim financial reports
–monthly, quarterly or semi-annually
• Annual accounting periods are the norm• Fiscal year – any 12 consecutive months
• Calendar year – 12 months ending December 31• Natural business year – ends when inventories and business activities
are at their lowest point
Period 1Period 1 Period 2Period 2 Period 3Period 3
Cash CollectedServices Performed- recognize revenue
Match Expenses
OrderTaken
Revenue
Need for adjustment at the end of the period
• Purpose – makes the information on the accounting statements comparable
from period to period
• The revenue recognition principle – requires that revenue be assigned to the accounting period in which it
is earned, rather than the period in which it is collected in cash
• The matching principle – requires that expenses be matched to the period the revenue was
earned
Accrual Basis Revenues are
recognized when earned and
expenses are recognized when
incurred.
Cash BasisRevenues are
recognized when cash is received and expenses recorded when cash is paid.
Accounting
Accrual Basis Vs. Cash Basis
Accrual Basis Revenues are
recognized when earned and expenses are recognized when
incurred.
Cash BasisRevenues are
recognized when cash is received and expenses recorded when cash is paid.
Accounting
Accrual Basis Vs. Cash Basis
Not GAAPNot GAAP
Time Passes
Assets are used up, consumed or expire
Need for adjustment at the end of the period
• Unadjusted trial balance– some balances are incorrect for financial statement
purposes, not through error but due to the passage of time
– accountants must record internal economic events such as the use of an asset
– these internal transactions are not evidenced by business papers as were the transactions presented in previous chapters.
Framework for Adjustments
PrepaidExpenses
Amortization UnearnedRevenues
AccruedExpenses
AccruedRevenues
Adjustments
Transactions where cash is paid orreceived after a related expense
or revenue is recognized.
Exhibit 4.5
An adjusting entry is recorded to bring an asset or liability account balance to its proper amount.
Adjusting Accounts
Transactions where cash is paid orreceived before a related expense
or revenue is recognized.
BAT Entertainment• The Gr. 12 BAT class has decided to enter into an
employment venture and we started our own entertainment business. We offer many services: catering, DJ, consulting, photography, etc.
• We rented office space downtown and have started to incur expenses and earn revenue since our opening on October 1st, 2011. Since we are accounting experts from Ms. Delorme’s accounting class we have decided to keep our own records. We are doing our month end recording and there are some transactions that we need to make adjustments for using the appropriate GAAPs. They are as follows:
Paid for in advance of receiving benefits.
Here is the chequefor my first
6 months’ rent.
Prepaid Expenses
Prepaid asset Expense
UnadjustedBalance
CreditAdjustment
DebitAdjustment
Adjusting Prepaid Expenses
As time goes by, a prepaid asset will be consumed or will expire and its cost will become an expense. This adjusting entry records the amount of the prepaid asset that has been consumed or that has expired as an expense and reduces the
prepaid asset account accordingly.
E.g. Prepaid Rent• On Oct. 1st, we prepaid for 6 months of our office space
downtown. The monthly rent is $2000. Therefore we prepaid $12,000 and the entry was:
Prepaid Rent 12000
Cash 12000
By Oct. 31st, one month’s rent is used and must be recorded:
Rent Expense 2000
Prepaid Rent 2000
Amortization is the process of computing expense from allocating the cost of capital assets over
their expected useful lives.
Straight-LineAmortizationExpense
= Asset Cost - Salvage Value
Useful Life
Amortization
Accumulated Amortization
Amortization Expense
CreditAdjustment
DebitAdjustment
Adjusting for Amortization
As a capital asset wears out over time, an expense is recorded to match the cost of the asset over the periods benefited. This
adjusting entry uses a contra account called Accumulated Amortization. This account would be subtracted from the
capital asset account to which it related on the balance sheet.
e.g. Amortization of our DJ equipment
On Oct. 1st BAT Entertainment purchased $18,000 of DJ equipment:Equipment 18000
Cash 18000The cost of the equipment needs to be amortized
(we are going to use straight-line) – estimated life is 3 years and salvage value is $5,000 – the adjustment for one month on Oct. 31st is:Amortization exp, equip. 361
Accumulated amortiz., equip. 361
Calculation: 18,000 – 5000/36 = 361
Cash received in advance of providing products or services.
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Unearned Revenue
Unearned Revenue
Consulting Revenue
UnadjustedBalance
DebitAdjustment
CreditAdjustment
Adjusting Unearned Revenue
Unearned revenue is a liability account because the company has an obligation to supply future services. As these services
are provided, an unearned revenue will become an earned revenue. This adjusting entry records the amount of unearned
revenue that later becomes earned.
e.g. Unearned photography consulting revenue
On Oct. 16th, BAT Entertainment agreed to do some consulting for an upcoming wedding. On the same day we were paid $4,200 to provide these services:Cash 4200
Unearned consulting rev. 4200On Oct. 31st, we had provided one day of the two days of
service so we recorded the adjustment as follows:Unearned consulting Rev. 2100
Consulting Rev. 2100