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Lesson 4 Adjusting Accounts for Financial Statement. Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University. Outline. Describe the purpose of adjusting accounts at the end of the period.

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Lesson 4 adjusting accounts for financial statement l.jpg

Lesson 4Adjusting Accounts for Financial Statement

Task Team of

FUNDAMENTAL ACCOUNTING

School of Business, Sun Yat-sen University


Outline l.jpg
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.


Review time period concept l.jpg

Dec. 31, B/S date

Dec. 31, B/S date

Last year income statement

This year income

statement

Next year income

statement

Past period

Current period

Future period

going concern

(business will not stop)

Review: Time period concept

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


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Review: Revenue Recognition Principle

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


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Review: Matching Principle

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


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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 l.jpg

Now that we have

covered the trial

balance, let’s

discuss adjusting

entries.

1. Analyze Transactions

2. Journalize

3. Post

4. Unadjusted trial balance

5. Adjust

6. Adjusted trial balance

7. Prepare finance statements

8.Close

Adjust: A Step in Accounting cycle


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Why Need to Adjust

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


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Why Need to Adjust

  • Adjustments are based on three generally accepted accounting principles:

    • Time period principle.

    • Revenue recognition principle.

    • Matching principle.


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Accruing unrecorded

revenues

Converting liabilities to

revenues

Adjusting

entries

Converting assets to

expenses

Accruing unrecorded

expenses

Type of Adjusting Entries


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Cash received

Revenues earned

End of

accounting period.

Adjusting Entries – Accruals

  • Accruals occur when revenues have been earned or expenses incurred but no cashhas been exchanged.

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


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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.


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End of

accounting period.

Cash paid

Expense incurred

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

Adjusting Entries – Accrued

  • Unrecorded expenses incurred


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Adjusting Entries – Accrued

  • 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.


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Paid cash for

12 month’s rent

< from July 2004 to June 2005 >

7/1/04

12/31/04

Year end

6/30/05

Adjusting Entries – Deferrals

  • Prepaid expense is used up


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Adjusting Entries – Deferrals

  • 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.


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End of

accounting period.

Cash received

Revenues earned

Adjusting Entries – Deferrals

  • Converting liabilities to revenues:

Example: service revenue received in advance.


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Adjusting Entries – Deferrals

  • 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.


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Adjust: Allocating the Costs oflong-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.


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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 andrationalallocation of cost of a long-lived asset to the periods during which it is used to generate revenue.


  • Amortization21 l.jpg

    Asset Cost - Salvage Value

    Useful Life

    Straight-Line

    Amortization

    Expense

    =

    $100000 - $5,000

    5 years

    =

    = $19000/year

    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.


    Amortization22 l.jpg
    Amortization

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


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    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:




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    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.



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