page 1 adjusting accounts for financial statement

Adjusting Accounts for Financial Statement

JOIN KHALID AZIZ

• MA ECONOMICS EXTERNAL COACHING CLASSES.

• MICRO ECONOMICS, STATISTICS & MACRO ECONOMICS.

• GUESS PAPERS AND NOTES ARE AVAILABLE

• 0322-3385752

JOIN KHALID AZIZ

• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.

• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.

• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.

• CONTACT:• 0322-3385752• R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,

KARACHI, PAKISTAN.

Outline

• 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.

• Explain and prepare an adjusted trial balance.

• Definition: the continued life of a business is divided into time periods of equal length.

Review: Time period concept

This year incomeThis year incomestatementstatement

Next year incomeNext year incomestatementstatement

Last year income Last year income statementstatement

Past Past period period

Current Current periodperiod

Future Future periodperiod

Dec. 31, B/S dateDec. 31, B/S dateDec. 31, B/S dateDec. 31, B/S date

going concerngoing concern

(business will not stop)(business will not stop)

Review: Revenue Recognition Principle

• Revenue is recorded at the time it is earned regardless of whether cash or another asset has been exchanged.

Review: Matching Principle

• Expenses are to be matched in the same accounting period as the revenues they helped to earn.

Accrual and cash basis

• 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.

Adjust: A Step in Accounting cycle

1. Analyze Transactions1. Analyze Transactions

2. Journalize2. Journalize

3. Post 3. Post

4. 4. Unadjusted trial balanceUnadjusted trial balance

5. Adjust 5. Adjust

6. Adjusted trial balance6. Adjusted trial balance

7. Prepare finance statements7. Prepare finance statements

8.Close 8.Close

Now that we havecovered the trial

balance, let’sdiscuss adjusting

entries.

Why Need to Adjust

• Some events are not evidenced by the obvious Some events are not evidenced by the obvious documents. the effects of these events are documents. the effects of these events are recorded at the end of the accounting period by recorded at the end of the accounting period by means of adjusting entries.means of adjusting entries.

• The purpose of adjusting the accounts at the end of period is to make the accounting information comparable from period to period.

Why Need to Adjust

• Adjustments are based on three generally accepted accounting principles:– Time period principle.– Revenue recognition principle.– Matching principle.

Type of Adjusting Entries

AdjustingAdjustingentriesentries

AdjustingAdjustingentriesentries

Accruing unrecordedAccruing unrecorded revenuesrevenues

Accruing unrecordedAccruing unrecorded revenuesrevenues

Converting liabilities toConverting liabilities to revenuesrevenues

Converting liabilities toConverting liabilities to revenuesrevenues

Accruing unrecordedAccruing unrecordedexpensesexpenses

Accruing unrecordedAccruing unrecordedexpensesexpenses

Converting assets toConverting assets to expensesexpenses

Converting assets toConverting assets to expensesexpenses

Adjusting Entries – Accruals

• Accruals occur when revenues have been earned or expenses incurred but no cashno cash has been exchanged.

End of End of accounting period.accounting period.

Cash receivedCash receivedRevenues earnedRevenues earned

Example: interest revenue earned during the Example: interest revenue earned during the period but not received until the next period.period but not received until the next period.Example: interest revenue earned during the Example: interest revenue earned during the period but not received until the next period.period but not received until the next period.

Adjusting Entries – Accruals

• 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 so far.

Adjusting Entries – Accrued

• Unrecorded expenses incurred

End of End of accounting periodaccounting period..

Cash paidCash paidExpense incurredExpense incurred

Example: wages should be paid to employees during this Example: wages should be paid to employees during this period but not paid until the next period.period but not paid until the next period.

Example: wages should be paid to employees during this Example: wages should be paid to employees during this period but not paid until the next period.period but not paid until the next period.

Adjusting Entries – Accrued

Example: On the year-end, Dec. 31, 2004, Smith Inc.’s Example: On the year-end, Dec. 31, 2004, Smith Inc.’s employees have earned total wages of $35,000 for the employees have earned total wages of $35,000 for the Monday, but Smith Inc. will not pay the wages until 5Monday, but Smith Inc. will not pay the wages until 5thth of of next month. So at the end of the accounting period, Smith next month. So at the end of the accounting period, Smith need to make the following entries to accrued the wage need to make the following entries to accrued the wage expenses.expenses.

Adjusting Entries – Deferrals

• Prepaid expense is used up

Paid cash forPaid cash for12 month’s rent12 month’s rent

< from July 2004 to June 2005 >< from July 2004 to June 2005 >

7/1/047/1/04 12/31/0412/31/04Year endYear end

6/30/056/30/05


• 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.


End of End of accounting period.accounting period.

Cash receivedCash received Revenues earnedRevenues earned

Example: service revenue received in advance.Example: service revenue received in advance.

Converting liabilities to revenues:Converting liabilities to revenues:


• 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.

Adjust: Allocating the Costs of

long-term assets • Certain circumstances require adjusting

entries to record accounting estimates. Amortization is an example.

• Amortization is the process of allocating the costs of assets over their useful lives.

Amortization

Companies acquire capital assets such as equipment, buildings, vehicles, and patents to generate revenues.

These assets are expected to provide benefits for more than one period.

• The accounting concept of amortization involves the systematic and rational allocation of cost of a long-lived asset to the periods during which it is used to generate revenue.

JOIN KHALID AZIZ

• MA ECONOMICS EXTERNAL COACHING CLASSES.

• MICRO ECONOMICS, STATISTICS & MACRO ECONOMICS.

• GUESS PAPERS AND NOTES ARE AVAILABLE

• 0322-3385752

Amortization

• 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.

Asset Cost - Salvage Value Asset Cost - Salvage Value

Useful LifeUseful Life

Straight-LineStraight-LineAmortizationAmortizationExpenseExpense

==

== $100000 - $5,000 $100000 - $5,000

5 years5 years

= $19000/year= $19000/year

Amortization

• The required journal entry includes a debit to Amortization expense and a credit to an account called accumulated amortization.

Adjusted Trial Balance

• The adjusted trial balance is used to check if there are any mistakes in the adjusted accounts and it is used for the financial statement.

• Assume that Smith Inc. has the following unadjusted trial balance:

Adjusted Trial Balance

Adjusted trial balance

Debi t Credi t Debi t Credi t Debi t Credi tCash 171000 171000

Short-term i nvestment 100000 100000Accounts Recei vabl e 36000 36000I nterest recei vabl e 2916. 67 2916. 67

Prepai d Expense 20000 10000 10000I nventory 20000 20000

Pl ant and Equi pmemt 250000 250000Accumul ated Depreci ati on 2600 2600Accounts Payabl e 50000 50000

Wages payabl e 35000 35000Unearned Revenue 50000 25000. 00 25000. 00

Pai d Capi tal 500000 500000Sal es Revenue 36000 25000 61000

I nterest Revenue 2916. 67 2916. 67Cost of Sal es 30000 30000

Operati ng expenses 9000 47600. 00 56600. 00total 636000 636000 75516. 67 75516. 67 676516. 67 676516. 67

for the year ended Dec.31Adj usti ng Entri es

SMI TH I nc.

Adj usted tri al bal anceAccounts

unadj usted tri al bal ance

Debi t Credi t Debi t Credi t Debi t Credi tCash 171000 171000

Short-term i nvestment 100000 100000Accounts Recei vabl e 36000 36000I nterest recei vabl e 2916. 67 2916. 67

Prepai d Expense 20000 10000 10000I nventory 20000 20000

Pl ant and Equi pmemt 250000 250000Accumul ated Depreci ati on 2600 2600Accounts Payabl e 50000 50000

Wages payabl e 35000 35000Unearned Revenue 50000 25000. 00 25000. 00

Pai d Capi tal 500000 500000Sal es Revenue 36000 25000 61000

I nterest Revenue 2916. 67 2916. 67Cost of Sal es 30000 30000

Operati ng expenses 9000 47600. 00 56600. 00total 636000 636000 75516. 67 75516. 67 676516. 67 676516. 67

for the year ended Dec.31Adj usti ng Entri es

SMI TH I nc.

Adj usted tri al bal anceAccounts

unadj usted tri al bal ance

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.• Will not affect the cash flow of the company.

JOIN KHALID AZIZ

• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.

• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.

• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.

• CONTACT:• 0322-3385752• R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,

KARACHI, PAKISTAN.

page 1 adjusting accounts for financial statement

Documents

end of period

unrecorded revenues

unrecorded expenses

accrued revenues

accrued expenses

adjusting entries accruals

time period principle

unearned revenues