Completing the Accounting Cycle

The Adjustment Process  At the end of a fiscal period, we have to make sure that all our financial statements are 100% accurate.  We need to finalize our accounts.  When accountants prepare the financial statements, they have to make sure that: -Accounts are brought up to date, -Late transactions are taken into account, -Calculations have been made correctly, and -Accounting principles and standards have been followed.

Accounting Principles and Standards  Our financial statements need to be correct in both MATH and??  The theory.  IFRS and ASPE requires that our financial statements be relevant, reliable, and comparable.  Relevant : We need a good “picture” of the business’ important features.  Reliable: These need to be based on good evidence.  Comparable: We need to be able to look at old information and compare. With other companies too.

Accrual Accounting  Accrue means to add over time.  Both revenues and expenses accrue over time.  We do not wait until cash is received to record revenue; we do not wait until cheques are written before recording expenses. They write them in the accounts as they happen.  This is called accrual accounting.  Time is important. We cannot wait for all cash before entering transactions, we cannot always record revenues and expenses as they happen.

Financial Statement Comparability  We need to have standard fiscal periods so we can compare information.  This is a problem sometimes though. Some expenses/revenues do not occur right in line with our periods.  At the end of a period, an accountant must step in and deal with the revenues and expenses that have been accruing but haven’t been recorded yet. LETS LOOK AT THAT.

ADJUSTING THE ACCOUNTS  This is what accountants do at the end of a fiscal period.  We want to make sure that the accounts actually have what they should.  We use adjusting entries to do this.  We need to be concerned about both the income statement and the balance sheet when we do this.

Adjusting Entries for Supplies  Lets look at the Supplies account for Markell Company.  What do these numbers mean?

Adjusting Entries for Supplies  So…balance sheet problems? Is $15,000 accurate?  What about Income Statement problems? -What would be wrong about the income statement? -What would this do to the business?

Adjusting Entries for Supplies  There is a very easy solution.  We would know right away that there is a mistake with the Supplies account. SO…we “take inventory.”  So we have to adjust the new account by creating a credit. What is it for this example?  What is the debit that goes along with this credit?

Adjusting Entries for Supplies

Adjusting Entries for Prepaid Expenses  Sometimes businesses buy things in advance. There is no problem if the item falls entirely in a fiscal period.  Some things are in more than one period.  Prepaid expenses are things paid for in advance, but the benefits extend into the future.  Insurance is the most common of these.  So let’s pretend that Markell Company purchased a one year policy for $1800.  We would credit bank and debit the insurance expense.

Adjusting Entries for Prepaid Expenses  To adjust this kind of account, it is similar to the supplies account.  Need to figure out value, and make credits and debits.  We cannot do an “inventory” like we did with supplies. We need to do math.  The policy was for 12 months. By Dec. 31, 4 months have expired, 8 months are still prepaid. What is the true value then?

Adjusting Entries for Prepaid Expenses

Adjusting Entry for Late-Arriving Purchase Invoices  Often, businesses will buy goods or services near the end of a period. Sometimes, these things do not arrive until the next period.  Now, Revenue Recognition Principles say that we have to put expenses and revenue together in the same period.  Accountants need to make sure that the books ACCURATELY show these revenues and expenses.  Financial Statements are usually prepared after the period ends, so there is time to correct these mmistakes.

Adjusting Entry for Late-Arriving Purchase Invoices  For Markell Company, let us assume that the Senior Accountant waited until January for late-arriving invoices.  Let’s pretend that two show up. A phone bill $212, and utilities bill for $315.  These two invoices show costs that the business had in 2013.

Adjusting Entry for Unearned Revenue  We have only looked at expenses so far. Sometimes though, we have to adjust revenue.  Let’s pretend Markell Company deposited a cheque for $5000 on December 23,  The cheque was to pay for services that will be done in January and February The clerk debited bank $5000 and credited fees earned.  The Accountant saw this, realized a mistake was made and had to fix it.

Review of Adjusting Entries  We looked at adjusting entries for supplies, prepaid expenses, late-arriving invoices, and unearned revenue.  No matter how complicated the adjustment is, use COMMON SENSE.  Now…we adjust everything using T-Accounts. We now need to do journal entries. Let’s have a look at the entries we’ve seen so far.

Work:  Exercises #1, 3, 4, 5