Lesson Notes
Lesson 4 Adjusting Accounts for Financial Statement
Learning objectives
Describe the purpose of adjusting accounts at the end of the period.
Prepare and explain adjusting entries for prepaid expenses,amortization,unearned revenues,accrued expenses,and accrued revenues.
Explain how accounting adjustments link to financial statements.
4,Explain and prepare an adjusted trial balance.
Teaching hours
Students major in accounting,3 hours
Others,3 hours
Teaching contents:
Need for adjustments at the end of an accounting period
Some events are not evidenced by the obvious documents,They may not recorded and related accounts will not be up-to-date and therefore do not provide a fair presentation of the accounts on the financial statements,Adjustment are necessary to record internal economic events such as the expiration of cost.
Before financial statements are prepared at the end of an accounting period,it is necessary to adjust the account balances that are not up-to-date,The purpose of making adjustments is to ensure that the information on the accounting statement is comparable from period to period.
Related GAAP
Adjustments are based on three generally accepted accounting principles:
Time period principle,The continued life of a business is divided into time periods of equal length,Annual Financial reports are prepared at the end of each fiscal period.
Revenue recognition principle,The revenue is recognized in the period in which it is earned regardless the cash is received or not,
Matching principle,Matching principle requires that revenues and expenses be matched,All expenses incurred in earning revenues must be deducted from the revenues in determining net income.
So,Adjustments are required to match:
Associated revenues with their related costs
Revenues and expenses to their appropriate time periods
Accrual and cash basis of accounting
The accrual basis of accounting matches revenues earned with expenses incurred.
The cash basis matches revenues received with expenses paid,It is not satisfactory for most businesses because it results in financial statements that are not comparable from period to period,except when the amounts of prepaid,unearned,and accrued items are not material,
Cash basis accounting does not make adjustments for prepaid expenses,accrued expenses,unearned revenues,and accrued revenues,Only accrual accounting,with its emphasis on matching,and hence the need for adjustments,is acceptable under GAAP.
Type of Adjusting Entries
There are four types of adjustment:
Accruing unrecorded revenues
Converting liabilities to revenues
Accruing unrecorded expenses
Converting assets to expenses
Accruing unrecorded revenues is to accrue revenues and record the related assets,Since the revenues are earned in one period and cash received in the other period so adjustment is necessary.
Example,On Jun 1,2004,Smith Inc,invests $100,000 for a bonds which pays 5% interest per year,Smith Inc,will not receive the interest until March 31,2005,On December 31,2004,Smith,Inc,need to make the following entry for the interest earned already
The adjusting try for the adjustment will be,
Dr,Interest Receivable 2916.67
Cr,Interest Revenue 2916.67
Accruing unrecorded expenses is to accrue incurred expenses and record the related liabilities,
Example,On the year-end,Dec,31,2004,Smith Inc.’s employees have earned total wages of $35,000 for the Monday,but Smith Inc,will not pay the wages until 5th of next month,So at the end of the accounting period,Smith need to make the following entries to accrued the wage expenses.
The adjusting entry will be,
Dr,Wages Expense 35000
Cr,Wages Payable 35000
Converting liabilities to revenues is to recognize as revenues the earned portion of unearned revenue liabilities.
Example,On Oct,1,2004,Smith Inc,signed a contract for providing a special service to Cone,Smith received $50000 for the service to be provided,At the end of 2004 half of the services have been proved to Cone,Smith should make the following entries to record earned revenue,
The adjusting entry will be:
Dr,Unearned Revenue 25000
Cr,Service Revenue 25000
Converting assets to expenses is to charge the expired portion of prepaid expenses to expense.
Example,On July 1,2004,Smith Inc,paid $20000 for whole year’s rent covered from 1stof July to 30th of June,At the end of 2004,$10000 of rent expenses have occurred so Smith Inc,need to make the following entries to transfer the deferrals to expenses.
The adjusting entry will be:
Dr,Rent Expense 10000
Cr,Prepaid Rent 10000
Amortization is also belongs to this type of adjustment,because Amortization is to convert the cost of fix asset to amortization expense.
Example,On January 1,2004,a company purchased a piece of equipment for $100,000,The equipment is expected to have a useful life of five years and have a salvage value of $5000.Asume the company use the straight-line method.
We can calculated that the annual amortization value is 19000,[(100000-5000)/5],the adjusting entry will be,
Dr,Amortization Expense 19000
Cr,Accumulated Amortization 19000
Adjusted Trial Balance
The adjusted trial balance is used to check if there are any mistakes in preparing and posting the adjusted accounts and it is used for the financial statement,
Adjustments & Financial Statements
Adjusting entries bring the accounts up-to-date.
Adjustments are only made when financial statements are prepared.
Adjust entries will affect both the income statement and the balance sheet.
Adjustment will not affect the cash flow of the company.
Key points
Identify and analyze the events needed to adjust;
The preparation of adjusting entries.
Reference
Philip E,Fess and Carl S,Warren,Accounting Principles,South-Western Publishing Co.,1987.
Burrowes,Ashley W,Core Concepts of Accounting Information Systems,Issues in Accounting Education,May2005,Vol,20 Issue 2.
Sutton,Steve G.,The role of AIS research in guiding practice.,International Journal of Accounting Information Systems,Mar2005,Vol,6 Issue 1.
Hutchison,Paul D.,White,Craig G.,and Daigle,Ronald J.,Advances in Accounting Information Systems and International Journal of Accounting Information Systems,first ten volumes (1992–2003).,International Journal of Accounting Information Systems,Oct2004,Vol,5 Issue 3.
Lin,Fengyi,A Unified Accounting Information Framework To Modeling Bank Accounting Systems,Journal of Applied Business Research,Fall2004,Vol,20 Issue
Lesson 4 Adjusting Accounts for Financial Statement
Learning objectives
Describe the purpose of adjusting accounts at the end of the period.
Prepare and explain adjusting entries for prepaid expenses,amortization,unearned revenues,accrued expenses,and accrued revenues.
Explain how accounting adjustments link to financial statements.
4,Explain and prepare an adjusted trial balance.
Teaching hours
Students major in accounting,3 hours
Others,3 hours
Teaching contents:
Need for adjustments at the end of an accounting period
Some events are not evidenced by the obvious documents,They may not recorded and related accounts will not be up-to-date and therefore do not provide a fair presentation of the accounts on the financial statements,Adjustment are necessary to record internal economic events such as the expiration of cost.
Before financial statements are prepared at the end of an accounting period,it is necessary to adjust the account balances that are not up-to-date,The purpose of making adjustments is to ensure that the information on the accounting statement is comparable from period to period.
Related GAAP
Adjustments are based on three generally accepted accounting principles:
Time period principle,The continued life of a business is divided into time periods of equal length,Annual Financial reports are prepared at the end of each fiscal period.
Revenue recognition principle,The revenue is recognized in the period in which it is earned regardless the cash is received or not,
Matching principle,Matching principle requires that revenues and expenses be matched,All expenses incurred in earning revenues must be deducted from the revenues in determining net income.
So,Adjustments are required to match:
Associated revenues with their related costs
Revenues and expenses to their appropriate time periods
Accrual and cash basis of accounting
The accrual basis of accounting matches revenues earned with expenses incurred.
The cash basis matches revenues received with expenses paid,It is not satisfactory for most businesses because it results in financial statements that are not comparable from period to period,except when the amounts of prepaid,unearned,and accrued items are not material,
Cash basis accounting does not make adjustments for prepaid expenses,accrued expenses,unearned revenues,and accrued revenues,Only accrual accounting,with its emphasis on matching,and hence the need for adjustments,is acceptable under GAAP.
Type of Adjusting Entries
There are four types of adjustment:
Accruing unrecorded revenues
Converting liabilities to revenues
Accruing unrecorded expenses
Converting assets to expenses
Accruing unrecorded revenues is to accrue revenues and record the related assets,Since the revenues are earned in one period and cash received in the other period so adjustment is necessary.
Example,On Jun 1,2004,Smith Inc,invests $100,000 for a bonds which pays 5% interest per year,Smith Inc,will not receive the interest until March 31,2005,On December 31,2004,Smith,Inc,need to make the following entry for the interest earned already
The adjusting try for the adjustment will be,
Dr,Interest Receivable 2916.67
Cr,Interest Revenue 2916.67
Accruing unrecorded expenses is to accrue incurred expenses and record the related liabilities,
Example,On the year-end,Dec,31,2004,Smith Inc.’s employees have earned total wages of $35,000 for the Monday,but Smith Inc,will not pay the wages until 5th of next month,So at the end of the accounting period,Smith need to make the following entries to accrued the wage expenses.
The adjusting entry will be,
Dr,Wages Expense 35000
Cr,Wages Payable 35000
Converting liabilities to revenues is to recognize as revenues the earned portion of unearned revenue liabilities.
Example,On Oct,1,2004,Smith Inc,signed a contract for providing a special service to Cone,Smith received $50000 for the service to be provided,At the end of 2004 half of the services have been proved to Cone,Smith should make the following entries to record earned revenue,
The adjusting entry will be:
Dr,Unearned Revenue 25000
Cr,Service Revenue 25000
Converting assets to expenses is to charge the expired portion of prepaid expenses to expense.
Example,On July 1,2004,Smith Inc,paid $20000 for whole year’s rent covered from 1stof July to 30th of June,At the end of 2004,$10000 of rent expenses have occurred so Smith Inc,need to make the following entries to transfer the deferrals to expenses.
The adjusting entry will be:
Dr,Rent Expense 10000
Cr,Prepaid Rent 10000
Amortization is also belongs to this type of adjustment,because Amortization is to convert the cost of fix asset to amortization expense.
Example,On January 1,2004,a company purchased a piece of equipment for $100,000,The equipment is expected to have a useful life of five years and have a salvage value of $5000.Asume the company use the straight-line method.
We can calculated that the annual amortization value is 19000,[(100000-5000)/5],the adjusting entry will be,
Dr,Amortization Expense 19000
Cr,Accumulated Amortization 19000
Adjusted Trial Balance
The adjusted trial balance is used to check if there are any mistakes in preparing and posting the adjusted accounts and it is used for the financial statement,
Adjustments & Financial Statements
Adjusting entries bring the accounts up-to-date.
Adjustments are only made when financial statements are prepared.
Adjust entries will affect both the income statement and the balance sheet.
Adjustment will not affect the cash flow of the company.
Key points
Identify and analyze the events needed to adjust;
The preparation of adjusting entries.
Reference
Philip E,Fess and Carl S,Warren,Accounting Principles,South-Western Publishing Co.,1987.
Burrowes,Ashley W,Core Concepts of Accounting Information Systems,Issues in Accounting Education,May2005,Vol,20 Issue 2.
Sutton,Steve G.,The role of AIS research in guiding practice.,International Journal of Accounting Information Systems,Mar2005,Vol,6 Issue 1.
Hutchison,Paul D.,White,Craig G.,and Daigle,Ronald J.,Advances in Accounting Information Systems and International Journal of Accounting Information Systems,first ten volumes (1992–2003).,International Journal of Accounting Information Systems,Oct2004,Vol,5 Issue 3.
Lin,Fengyi,A Unified Accounting Information Framework To Modeling Bank Accounting Systems,Journal of Applied Business Research,Fall2004,Vol,20 Issue
