The Adjusting Process PDF

THE ADJUSTING PROCESS What is the Adjusting Process? A process in which adjusting entries are made at the end of an accounting period to rectify errors, record unaccounted income or expenses, and maintain the integrity of financial records in accordance with the Gener...

THE ADJUSTING PROCESS What is the Adjusting Process? A process in which adjusting entries are made at the end of an accounting period to rectify errors, record unaccounted income or expenses, and maintain the integrity of financial records in accordance with the Generally Accepted Accounting Principles (GAAP). Importance of adjusting Adjustments are needed to ensure that the recognition and derecognition principles are followed thus resulting in financial statements reporting the effects of all transactions at the end of the period. RECOGNITION DERECOGNITION The process of including an item in a The removal of all or a part of a financial statement when it meets the recognized asset or liability from an definition of an element of a financial entity’s statement of financial position. statement such as an asset, liability, It normally occurs when that item no equity, income, or expense. longer meets the definition of an asset or of a liability. Importance of adjusting When one fails to include the proper adjusting entries, the resulting financial statements will inaccurately reflect the financial position and the performance of the entity. Inaccuracies in one accounting period can cause further inaccuracies in the statements of subsequent periods. types of accounting adjustments 1. DEFERRALS The postponement of the recognition of “an expense already paid but not yet incurred” or of “revenue already collected but not yet earned” This adjustment decreases a balance sheet account and increases an income statement account. 2. ACCRUALS The recognition of “an expense already incurred but unpaid” or “revenue earned but uncollected.” This adjustment increases both a balance sheet and an income statement account. types of accounting adjustments 3. ESTIMATES Approximations made by management when precise data is unavailable or difficult to determine. Ex. accounts receivable and inventory, bad debts, taxes. As actual transactions occur or additional information is known, a company will adjust its financial position. 4. DEPRECIATION AND AMORTIZATION Both are methods of allocating the cost of an asset over its useful life, but they apply to different types of assets. Depreciation Amortization applied to tangible fixed assets applied to intangible fixed assets types of accounting adjustments 1. PREPAID EXPENSES 2. UNEARNED REVENUES 3. ACCRUED REVENUES 4. ACCRUED EXPENSES 5. DEPRECIATION EXPENSE PrepaId expense By: Alarcon, Alcazar, Altarejos & Añonuevo PREPAID EXPENSE What is Prepaid Expense?  PREPAID EXPENSE A prepaid expense is an expense that has been paid for in advance but has yet to be used or incurred. Prepaid expenses are recorded as assets on the balance sheet because they represent future benefits. As time goes by and you use up these benefits, a portion of the prepaid expense is gradually moved from the balance sheet to the income statement as an expense.  PREPAID EXPENSE How does it work? 1. Initial Payment: You pay a sum of money upfront for a service or good that will be used over time. 2. Asset Recognition: This payment is initially recorded as an asset on the balance sheet. 3. Expense Recognition: As time passes and you use up the service or good, a portion of the asset is gradually recognized as an expense on the income statement. Common Examples of Prepaid Expenses: Insurance: Paying for a year's worth of insurance upfront. Rent: Paying rent for multiple months or a year in advance. Office Supplies: Buying a large quantity of supplies to last several months.  IMPORTANCE Accurate Financial Reporting Improved Cash Flow Management Budget Forecasting Compliance with Accounting Standards  example If $12,000 is paid for a year of rent, the monthly expense is $1,000. After four months, an adjusting entry would debit rent expense for $4,000 and credit prepaid rent, reflecting the used portion of the asset.  example Company ABC purchases insurance for the upcoming 12-month period. It pays $120,000 upfront for the insurance policy. Company ABC will initially book the full $120,000 as a debit to prepaid insurance, an asset on the balance sheet, and a credit to cash.  example Each month, an adjusting entry will be made to expense $10,000 (1/12 of the prepaid amount) to the income statement through a credit to prepaid insurance and a debit to insurance expense. In the 12th month, the final $10,000 will be fully expensed and the prepaid account will be zero. Unearned revenue By: Araña and Aperin UNEARNED REVENUE What is Unearned Revenue? UNEARNED REVENUE Unearned revenue is money received by a company for goods or services that have not yet been delivered or performed. It represents a liability for the company because it owes the customer the goods or services in the future.  IMPORTANCE Unearned revenue is important for businesses because it shows money received before delivering goods or services. This advance payment helps companies with cash flow, allowing them to invest in their operations. It also indicates customer trust and demand for future services.  EXAMPLE Liability method vs. Income method 1. A business rents out its building to various tenants. On April 1,the business receives one-year rent in advance of P120,000 im one of its tenants. Rent per month is P10,000.  EXAMPLE LIABILITY METHOD INCOME METHOD April 1 20x1 April 1 20x1 Cash 120,000 Cash 120,000 Unearned Rent 120,000 Rent Income 120,000 to record receipt of 1-year rent in to record receipt of 1-year rent advance. in advance. A. Earned portion ('used up') - pertains to the first 9 B.Unearned portion (unused'). - pertains to the remaining months of the 1-year rent in advance covering the months covering January 1 to March 31, 20x2. This months of April 1 to December 31, 20x1. portion computed as follows: This portion is computed as follows: (10,000 rent per month x 3 months) = 30,000; or (10,000 rent per month x 9 months) - 90,000; or (120,000 x 3 mos./12 mos. It will on (120,000 x 9 mos./12 mos.) = 90,000. The earned portion is recognized as income for the period (i.e., 20x1). THE ADJUSTING ENTRIES OF DECEMBER ARE AS FOLLOWS: LIABILITY METHOD INCOME METHOD December31, 2023 December31, 2023 Unearned Rent 90,000 Rent Income 30,000 Rent Income 90,000 Unearned Rent 30,000 to recognize the earned portion to recognize the earned portion of the 1 year rent in advance. of the 1 year rent in advance. accrued Revenue by: Aycardo and Baloloy ACCRUED REVENUE What is Accrued Revenue? Accrued Revenue Accrued revenue is revenue that has been earned by providing a good or service, but for which no cash has been received. They are recorded as receivables on the balance sheet to reflect the amount of money that customers owe the business for the goods or services they purchased. Accrued Revenue Accrued revenue is a key concept for accounting and financial analysis, as it measures the revenue that a company expects to receive in the future while also providing a way to track the performance of a business over time.  Example A company might provide consulting A SaaS company may acquire a customer who needs services to a client in December, but not a service for the next six months. Under the contract issue an invoice until January of the terms, the business may agree to deliver the service at following year. In this case, the the price of $1,000 and send an invoice at the end of company would record the revenue as the month, which is payable on the 15th of the next “accrued” in December and recognize it month. From that point until the end of the contract, as “received” in January, when the the SaaS company will have $1000 in accrued revenue from that particular customer. invoice is paid.  IMPORTANCE Consistency- Ensuring financial reporting consistency over time. Accuracy- This is vital for not exaggerating or diminishing a company’s financial position.  IMPORTANCE Factual data- It ensures that revenue is recognized when earned, not just when cash is received, allowing financial statements to truly reflect a business’s performance.  IMPORTANCE Transparency- Offering a realistic view of cash flow to investors and lenders. Deicision Making- Assisting in identifying and addressing potential financial challenges.  STEPS 1. Identify the revenue: Identify the revenue that the business has earned but for which it has not yet received payment. 2. Create a balance sheet entry: Once you have identified the revenue, record the revenue in a balance sheet entry.  STEPS 3. Update the financial statements: The new balance sheet entry will update the balance sheet to reflect the accrued revenue and will also update the income statement to reflect the revenue earned. 4. Invoice the customer: After recording the accrued revenue, invoice the customer for the service or product provided.  STEPS 5. Record the payment: Once you receive payment from the customer, you recognize the revenue as received. Record the payment in a new balance sheet entry, which usually involves debiting the cash account and crediting the accrued revenue account. accrued expense By: Barquilla, Banday, Barnedo Accrued expense What is Accrued Expense?  Accrued expense These are expenses that have been incurred but have yet to be recorded or paid (e.g. interest payable, wages payable).  MATCHING PRINCIPLE key component of accrual accounting that requires expenses to be recorded in the same period as the revenues they help to generate.  Example Jake owns a restaurant. In June, he received a If a business sells products in December delivery of fresh produce worth 2,500 but but pays a commission to sales staff in planned to pay the supplier in July. For his Jan. the commission expense should be June financial records, he would record an recorded in December to match the accrued expense of 2,500 for the produce, revenue generated by those sales. even though the payment will be made in the next month.  IMPORTANCE Accuracy- it ensures that financial statements accurately recognize expenses when they are incurred rather than when they are paid.  IMPORTANCE Transparency- This helps in providing a more accurate and clearer picture of a company's financial situation in terms of health and financial obligations.  IMPORTANCE Compliance- it helps companies to comply with accounting standards and principles Decision making- accurate financial statements aid in better business decisions, budgeting, and forecasting.  REPORTING CONSIDERATIONS Accuracy of Estimation - Oftentimes, accrued expenses require estimation, which impacts the overall financial reporting. Timing of Recognition - The recognition must follow the accrual accounting period, which means that accrued expenses are recorded on the period which they are incurred.  REPORTING CONSIDERATIONS Monitoring and Disclosure Requirements - The entity must develop a robust system to monitor the accrued expenses, ensuring that all are tracked, reported, updated, and up to standards.  STEPS 1. Identify the Expense: Determine what the expense is for and when it was incurred. 2. Estimate the Amount: Calculate the estimated amount of the expense.  STEPS 3. Journal Entry: Make a journal entry that debits the appropriate expense account and credits an accrued liability account. 4. Adjust for Actual Amount: When the actual bill arrives, adjust the accrual to match the exact amount and pay it off. EXample Of AdjustIng the actual amount Jake recorded an accrued expense of 2,000 for electricity at the end of March. When the actual bill arrives in April, it turns out to be 2, 100. Here's how we adjust for the actual amount: 1. March Entry: Record the initial accrued expense: Debit: Electricity Expense 2,000 Credit: Accrued Expenses 2,000 2. April Adjustment: Adjust for the actual amount when the bill arrives: Debit: Electricity Expense 100 Debit: Accrued Expenses 2.000 Credit: Accounts Payable 2,100 ACCRUED EXPENSES VS ACCOUNTS PAYABLE Accrued Expenses vs Accounts Payable Accrued Expenses are recognized when the expense is incurred and impacts the current period’s financial condition. Accounts payable are recognized when the invoice is received and reflects specific liabilities for previously incurred transactions. ACCRUED EXPENSES VS ACCOUNTS PAYABLE Accrued Expenses vs Accounts Payable Accrued Expenses are expenses that a company has incurred during an accounting period but has not been billed for and paid. Accounts Payables are amounts that an entity owes for goods or services that the entity received and was invoiced for. THANK YOU