HFT 2403 Chapter 3 Accounting Adjustments

The Need for Adjustments The life of an enterprise is divided into equal segments of time The life of an enterprise is divided into equal segments of time The income statement shows operations of the business enterprise – revenues & expenses The income statement shows operations of the business enterprise – revenues & expenses The balance sheet reports the financial position at the end of the accounting period The balance sheet reports the financial position at the end of the accounting period Adjusting entries – “fine tuning” the books Adjusting entries – “fine tuning” the books Matching principle requires the need for adjusting entries Matching principle requires the need for adjusting entries

Common to Every Adjusting Entry Every entry involves a balance sheet account and an income statement account Every entry involves a balance sheet account and an income statement account No adjusting entry involves cash No adjusting entry involves cash

Cash Basis versus Accrual Accounting Cash Basis – Recognizes an accounting transaction at the point of cash inflow or outflow. Does not require adjustments at the end of an accounting period Cash Basis – Recognizes an accounting transaction at the point of cash inflow or outflow. Does not require adjustments at the end of an accounting period Accrual Basis – Based on the matching principle. Recognizes expenses when they are incurred and revenue when it is earned. Accrual Basis – Based on the matching principle. Recognizes expenses when they are incurred and revenue when it is earned.

Classification of Adjusting Entries Deferred Items Deferred Items Previously recorded assets become expense Previously recorded assets become expense Previously recorded liabilities become revenue Previously recorded liabilities become revenue Accrued Items Accrued Items Assets and revenues not previously reported Liabilities and expenses not recorded

Deferral Adjustments Prepaid Insurance / Insurance Expense Prepaid Insurance / Insurance Expense Accumulated Depreciation / Depreciation Expense Accumulated Depreciation / Depreciation Expense Straight Line = C – SV / N Straight Line = C – SV / N Unearned Revenues Unearned Revenues

Accrual Adjustments Accrued Wages Payable / Salary Expense Accrued Wages Payable / Salary Expense Accrued Utilities / Utility Expense Accrued Utilities / Utility Expense Accrued Assets Accrued Assets

Impact of Failing to prepare Adjustments Failing to prepare adjustments affects both the balance sheet and the income statement Failing to prepare adjustments affects both the balance sheet and the income statement See p. 89, exhibit 1 for complete list See p. 89, exhibit 1 for complete list

Examples Depreciation – Overstates assets, understates expenses, overstates equity, overstates net income, no effect on revenue or liabilities Depreciation – Overstates assets, understates expenses, overstates equity, overstates net income, no effect on revenue or liabilities Wages accrual – Understates liabilities, overstates equity, understates expenses, overstates net income, no effect on revenue or assets Wages accrual – Understates liabilities, overstates equity, understates expenses, overstates net income, no effect on revenue or assets

Homework Assignment Problem 8 Problem 8 Problem 10 Problem 10 Problem 11 Problem 11 Problem 13 Problem 13