Financial Accounting Week 9: Adjusting Process PDF

LO 6 – BASIC CONCEPTS (Economic) Entity - an organization that stands apart from other organizations and individuals as a separate economic unit – The first line in the statements’ headings – Personal transactions are not recorded by a business...

LO 6 – BASIC CONCEPTS (Economic) Entity - an organization that stands apart from other organizations and individuals as a separate economic unit – The first line in the statements’ headings – Personal transactions are not recorded by a business entity Stable Monetary Unit – Currency is used to measure events – Its purchasing power is assumed to be stable (low inflation) over time © 2012 Pearson Education Introduction to Financial Accounting, 10/e 1 of 35  LO 6 – BASIC CONCEPTS Going concern (continuity) – Reporting entity will continue to exist indefinitely, i.e. can use historical costs to measure long-lived assets – If liquidation is in sight, assets should be revalued to their current market value Materiality – If it makes a difference to a decision maker, information should be separately identifiable – Immaterial – combine with other information © 2012 Pearson Education Introduction to Financial Accounting, 10/e 2 of 35  LO 6 – BASIC CONCEPTS Reliability – Management prepares and is rewarded by the content of financial statements (possible bias) – Independent auditors, in theory, add quality to those statements by offering three opinions “Fair” presentation (unqualified) Prepared according to the relevant accounting standards Adequacy of internal controls – Higher quality statements makes them more reliable (useful) in decision making © 2012 Pearson Education Introduction to Financial Accounting, 10/e 3 of 35 Exhibit 1-3 | Conceptual Foundation of Accounting 1-4 © 2012 Pearson Education Introduction to Financial Accounting, 10/e  LO 8 – TRADE-OFFS Trying to make the information provided to Decision Makers (DM) useful Relevance – Will it make a difference to the DM? – Predictive Value (helps predict the future) – Confirmatory value (confirms/refutes expectations) – E.g. Present value of an asset - Land Faithful Representation - is what happened – Free of bias, material errors and is neutral – E.g. Historical cost of an asset – land Trade-off – Land at what value? Cost or value © 2012 Pearson Education Introduction to Financial Accounting, 10/e 5 of 35  LO 8 – TRADE-OFFS Characteristics that enhance relevance and faithful representation – Comparability – consistent use of same measures – Verifiability – able to be checked for accuracy – Timelines – reach DM in time to be useful – Understandability – clear and consistent information that avoids undo complexity © 2012 Pearson Education Introduction to Financial Accounting, 10/e 6 of 35  Financial Accounting WEEK 9: ADJUSTING PROCESS 3-7  Apply the Revenue and Expense Recognition Principles The Revenue Principle Deals with two issues: When to record (recognize) revenue What amount of revenue to record Revenue is recognized when the business transfers promised goods or services to a customer in an amount that reflects the cash (or fair market value of other consideration) that the entity expects to receive in exchange for those goods or services. 3-8  Apply the Revenue and Expense Recognition Principles The Expense Recognition Principle Includes two steps: Identify all expenses incurred during the period Measure the expenses and recognize them in the same period in which any related revenues are earned To recognize an expense along with related revenues means to subtract expenses from related revenues to compute net income or net loss. 3-9  Exhibit 3-2 | The Expense Recognition Principle 3- 10  Adjusting Entries Prepared at end of an accounting period Assign: Revenues to the period when earned Expenses to the period when incurred Update asset and liability accounts Need to properly measure: Net Income Assets & Liabilities 11  Adjusting Entry Rules Either increase Never involve revenue or cash increase an expense “Accrued” means amount must be recorded 12  Categories of Adjusting Entries The two basic categories of adjustments are prepaids and accruals. In a prepaid adjustment, the cash payment occurs before an expense is recorded. Accrual adjustments are the opposite. An accrual records an expense before the cash payment. 3- 13  Types of Adjusting Entries Prepaid Deprecia expense tion s Accrued Accrued expense revenues s Unearne d revenues 14  Prepaid Expenses Advance payments of expenses Examples: Rent Insurance Supplies Recorded as an asset Adjusting entry records amount used as an expense 15 Prepaid Expenses Example  On March 2, PelCustoms bought office supplies from Kipa for 500 TL. (as paper, printer cartridges, and folders ) on account.  PelCustoms will pay Kipa on May 2.  During March, PelCustoms used these supplies to conduct business.  The cost of the supplies used = Supplies expense.  Supplies on hand on March 31 cost 400 TL.  The updated Supplies account is shown by the adjusting entry. Depreciation  Plant assets Long-lived tangible assets used in business operations  Examples: Land, buildings, equipment, and furniture  Depreciation Allocation of a plant asset’s cost to expense over its useful life As a business uses the assets, their value and usefulness declines. The decline in usefulness of a plant asset is an expense, and it is systematically spread the asset’s cost over its useful life. Land is not depreciated  Depreciation Entry GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT 12 31 Depreciation expense $$$$ Accumulated depreciation $$$$ Amount Contra-asset calculated account based on depreciation method 18  Accumulated Depreciation  Contra asset account an asset account with Normal credit balance Always paired with related account  A contra account has two main characteristics: (1) A contra account is paired with and follows its related account. (2) A contra account’s normal balance (debit or credit) is the opposite of the balance of the related account.  Holds sum of all depreciation recorded on a plant asset  Book value: Cost minus accumulated depreciation 19 Question 1**** On April 3 Cookie Lapp Travel purchased furniture for $18,000. Cookie Lapp believes the furniture will remain useful for 5 years and then be worthless. Record the depreciation expense for April, May, and June. What is the book value of the furniture in June? Question 2**** On January 1, 2024, A Company purchased a truck that cost $30,000. The company depreciates the asset $3,000 per year. What is the truck’s book value at December 31, 2025? What is the truck’s book value at December 31, 2026?  Accrued Expenses  Businesses often incur expenses before paying for them. The term accrued expense refers to an expense of this type. Consider an employee’s salary. The salary expense grows as the employee works, so the expense is said to accrue. Another accrued expense is interest expense on a note payable. Interest accrues as time passes on the note. An accrued expense always creates a liability.  Expenses incurred before payment is made  Results in a liability  Opposite of a prepaid expense  Examples:  Salaries  Interest 23  Accrued Expense Entries GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT Dec 31 Salaries expense $$$$ Salaries payable $$$$ To record accrued salaries 24  Accrued Revenues Revenue earned before cash is received Results in a receivable Similarly, businesses can earn revenue before they receive the cash. This calls for an accrued revenue, which is a revenue that has been earned but not yet collected in cash. GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT Dec 31 Accounts receivable $$$$ Service revenue $$$$ To record accrued revenues 25  Unearned Revenue Cash is collected before revenue is earned Results in a liability as the company owes a product or service or they will have to give the money back Also called deferred revenue BEFORE 26  UnearnedGENERAL Revenue JOURNAL Entries DATE DESCRIPTION REF DEBIT CREDIT Dec 1 Cash $$$$ Unearned revenue $$$$ To record cash received before service is provided GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT Dec 31 Unearned revenue $$$$ Service revenue $$$$ To record earned portion of unearned revenue 27  Adjusted Trial Balance Prepared after adjusting entries are posted Useful step in preparing financial statements Often appears on a work sheet Tool we use at the end of period 28  Any Company Worksheet December 31, 2010 Adjusted Trial Balance Adjustments Trial Balance Account Title Dr. Cr. Dr. Cr. Dr. Cr. Cash 5,400 Supplies 700 a. 500 200 Equipment 17,000 b. Accum. depr. - Equip. 1,000 2,000 1,000 Accounts payable 200 Interest payable c. 100 100 Note payable 9,000 9,000 Josie Smith, Capital 6,000 6,000 Josie Smith, W/D 1,000 1,000 Service revenue 12,000 12,000 Rent expense 4,000 4,000 Supplies expense a. 500 500 b. Depreciation expense 1,000 1,000 Interest expense 100 c. 100 200 Totals 27,200 27,200 1,600 1,600 28,300 28,300 Example: Adjusted Trial Balance Make the adjustment entries and prepare the adjusted trial balance according to the information of April: Prepare the financial statements from the adjusted trial balance First prepare the income statement Then the statement of owner’s equity Last is the Balance Sheet reporting the financial position