CorporateFinancialReporting

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.

Accruals:CashtobeExchanged Later foracurrentRevenueorExpense

2.Accruedexpenses:
Expensesincurred Expensesarisen,notyetrecorded
butnotyetpaid incashorrecorded.
4.Accruedrevenues: Revenuearisen,notyetrecorded
Revenuesearned
butnotyetreceived incashorrecorded
8
 FourTypesofAdjustments
Cashexchanged BALANCESHEET
BEFORE recognition
Assets Liabilities

1. Recorded costs are 2. Expenses are

Expense allocated between incurred but not yet
Note:Each
adjustingentry
INCOME STATEMENT

two or more recorded

accounting periods involvesone
(Accrued Expenses) balancesheet
(Deferred Expenses) account&one
incomestatement
4. Revenues are 3. Recorded unearned account
Revenue earned but not yet revenues are
recorded allocated between
two or more
accounting periods
(Accrued Revenues)
(Deferred Revenues)
Cashtobeexchanged
AFTER recognition

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.)

11
 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.

Oct.31 SuppliesExpense 1,500

Supplies 1,500
($2,500 1,000=$1,500)

15
 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
16
 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

Mr. A (Tenant) Mr. B (Landlord)

Service Tomorrow

Mr.Arecords: Mr. B records

RentExpense(E)(Dr.), UnearnedRevenue(L)(Dr.),
PrepaidRent(A)(Cr.) RentRevenue(R)(Cr.)

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.)

19
 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.

Oct.31 UnearnedServiceRevenue 400

ServiceRevenue 400

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

Illustration: Sierra Corporation signed a three-month note

payable in the amount of $5,000 on October 1. The note
requires Sierra to pay interest at an annual rate of 12%.

Oct. 31 Interest Expense 50

Interest Payable 50

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

Oct.31 SalariesandWagesExpense 1,200

SalariesandWagesPayable 1,200

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.

Oct.31 AccountsReceivable 200

ServiceRevenue 200

30
 AdjustingEntries Accruals

WithoutAdjustmentforAccruedExpenses ExpensesandLiabilitieswill
beunderstated:NI,ShareholdersEquitywillbeOverstated
WithoutAdjustmentforAccruedRevenues RevenuesandAssetswillbe
understated:NI,ShareholdersEquitywillbeUnderstated
BalanceSheetandIncomeStatementwouldbeincorrect
Mr XsAccruedExpenses(A/P)wouldbeMr.YsAccruedRevenue(A/R)
31