1. The Adjustment Process
8.1

2. In this unit we will focus on financial statements prepared at the end of a fiscal period or year.
When preparing these financial statements, the accountants must ensure that all:
accounts are brought up to date
late transactions are taken into account
calculations have been made correctly
accounting principles and standards have been met.

3. Accounting Principles & Standards
The International Financial Reporting Standards identifies quality characteristics that all financial statements should have.
They should:
Be relevant - readers of financial statements want a current picture of a business’ important features.
Be reliable - The financial figures should be based on solid evidence.
Be comparable - be able to make meaningful comparisons of dollar amounts - from one year to the next, from business to business, etc.

4. Accrual Accounting
Accounting clerks do not wait until cash is received before recording revenue.
Revenue and expenses are recorded as they occur.
Accountants and accounting clerks must be aware of all revenue and expenses even if they are not recorded.

5. Adjusting the Accounts
Senior accountants take action at the end of the fiscal period to adjust the accounts.
This happens by making journal entries.
An adjusting entry is a journal entry that assigns an amount of revenue or expense to the appropriate accounting period.
It also brings the balance sheet account to its true value.

6. Income Statement Perspective VS. Balance Sheet Perspective

7. Adjusting Entries for Supplies
Supplies are used regularly in a business. It is too difficult to record their usage regularly.
Adjusting Entries for Supplies
Supplies #120
6000
4000
3000
2000
15000
The balance of $15000 is too high.
No Credits??

8. From the balance sheet perspective we know this amount is too high.
From the income statement perspective we know that the supplies used is an expense, but no expenses have been recorded.
To find the true value, someone would have to count the remaining inventory of supplies. If the remaining inventory is $3000 what is the amount to be credited??

9. Supplies Expense #545
Supplies #120
6000
4000
3000
2000
15000
12000
12000
12000
3000
Now on the balance sheet the true value is correct and on the income statement the cost of using supplies is also accurate.

10. Adjusting Entries for Prepaid Expenses
Some expenses (insurance) are prepaid and extend past the fiscal period.
Prepaid expenses are items paid for in advance, but where the benefits extend into the future.
Prepaid Insurance #115
A 1 year insurance policy is prepaid on September 1.
These have value and are considered an ASSET.
1800

11. This insurance policy is for 12 months.
Simply take the amount paid and divide by 12.
1800/12 = 150
From September to December only 4 months value will be used up for the insurance.
Therefore 4 months x $150 = $600

12. Insurance Expense #525
Prepaid Insurance #115
600
1800
600
600
1200
This shows that $600 was “used up” (expense) for the fiscal period. $1200 carries forward (FORWARDED) to the following year.

13. Adjusting Entry for Late-Arriving Purchase Invoices
Bills for some purchases may not arrive until the next fiscal period but they should be recorded in the period same period as the revenue they helped earn.
Financial statements are usually not prepared until 2-3 weeks after the fiscal-year end leaving time for late arriving invoices.

14. Telephone Expense #555 Utilities Expense #570 212 315
Accounts Payable #205
If these were not recorded liabilities would be understated and net income would be overstated
212
315
527
A bill for telephone & utilities has arrived in January 2014 for the 2013 fiscal year.

15. Adjusting Entry for Unearned Revenue
Sometimes you may be paid in advance for a service you will be completing later.
If you are paid $5000 for work to be completed in January you would debit Bank and credit Fees Earned. However, this violates the revenue recognition principle.

16. Fees Earned #401 Unearned Revenue #235 5000 (1) 5000 5000
(1) 5000
5000
To correct this you would have to debit Fees Earned so this Revenue does not show up for the previous fiscal period. You would credit unearned revenue until the following year when the service is completed.

17. Adjusting Entries in the Journal
All the entries that were adjusted are recorded as journal entries on page 275 of your textbook.

18. Adjusting Entries and the Work Sheet 8.2

19. Adjusting Entries and the Work Sheet
The first place that adjusting entries are recorded is on the work sheet.
As the work sheet is prepared, adjusting entries are calculated and recorded in a section headed Adjustments. 20

20. The physical inventory
of supplies at Dec. 31
totaled $526.
What adjusting entry
is required?
954.90 1
An analysis of prepaid
insurance determined
that the balance at
Dec. 31 should
be $4,070.
What adjusting entry
is required? 2
626.00 3
85.00 3
45.00 3
496.00 3
A clerk discovered
three “late” purchase
invoices belonging to
2007…telephone $45,
truck repair $496 &
printer repair $85.
Supplies Expense
954.90 1
Insurance Expense 2

21. Balance the Adjustments Columns.
Balancing the Work Sheet …
total each of the last four columns
Balance the Adjustments Columns.
Extending the Work Sheet … add or subtract the adjustments
from the trial balance and record in the last four columns.
Balancing the Work Sheet … determine the diff. between the
two income statement columns the two balance sheet columns 1 2 3 1 2 3 1 2 3 1 2 3
526.00
4,070.00
3,136.00
Net Income

22. Journalize Adjusting Entries
So far, the adjusting entries have been recorded only on the work sheet
Once the work sheet is complete / balanced, the adjusting entries must be recorded in the books of accounts.
Journalize and post all entries that appear in the adjustments section of the work sheet. 23

23. Journalize Adjusting Entries24

24. Closing Entries
8.3

25. Closing Entries Concepts
The Time Period Concept states that financial reporting, or net income in particular, is done in equal period of time.
After you do your adjusting entries and prepare your formal income statements, the accounts must be made ready for the next accounting cycle. 27

26. Closing Entries Concepts
Determine which accounts have balances that continue from one period to the next and which do not.
There are two types of accounts … real accounts and nominal accounts.
All asset and liability accounts, as well as the owner’s capital account, are considered to be real accounts. 28

27. Closing Entries Concepts
Real accounts have balances that continue into the next fiscal period.
Nominal accounts (revenue, expense and drawings accounts) have balances that do not continue into the next fiscal period.
Nominal accounts, with the exception of drawings, are related to the income statement. 29

28. Closing Entries Concepts
A special nominal account, called the Income Summary account, is used only during the closing entry process.
Once the income statement for a period has been completed, the balances in the nominal accounts are no longer useful … their balance must be taken to zero in preparation for the next accounting cycle. 30

29. Closing Entries Concepts
Closing an account means to cause it to have no balance.
Any changes in equity during the period are contained in the Revenue, Expense, and Drawings accounts.
Closing these nominal accounts moves the values collected in these accounts into the one real equity account, the Capital account. 31

30. Complete Accounting Cycle
Performed by
accounting
clerks
Performed
daily
Transactions occur.
Source documents.
Accounting entries
recorded in the journal.
Journal entries posted
to the ledger accounts.
Performed
monthly
Ledger balanced by
means of a trial balance.
Work sheet prepared.
Performed by
accountants
Performed
at end of
each fiscal
period
Formal income stmt. &
balance sheet prepared.
Adjusting entries
journalized & posted.
Closing entries
journalized & posted.
Post-closing
trial balance.

31. Journalizing and Posting the Closing Entries

32. Closing Entry 1: transfer the balances in the revenue
account(s) to a new nominal account called Income Summary. 1 2 3
Net Income

33. Closing Entry 2: transfer the balances in the expense
accounts to the Income Summary account. 1 2 3
Net Income

34. Closing Entry 3: transfer the balances in Income Summary
Account to the owner’s Capital account. 1 2 3
Net Income

35. Closing Entry 4: transfer the balances in Drawings
account to the owner’s Capital account. 1 2 3
Net Income

36. Summary of Closing Entries

37. Post-Closing Trial Balance
Lastly, a post-closing trial balance is completed to check the accuracy of the ledger.
On page 290 of your textbook you will see that the nominal accounts have zero balances after taking off the post-closing trial balance.

38. Post-Closing Trial Balance
Balancing the Work Sheet …
total each of the last four columns
Balance the Adjustments Columns.
Extending the Work Sheet … add or subtract the adjustments
from the trial balance and record in the last four columns.
Post-Closing Trial Balance 1 2 3 1 2 3 1 2 3 1 2 3
526.00
4,070.00
3,136.00

39. Calculating your Post-Closing Balance
Capital Account
Calculating your Post-Closing Balance
P. Marshall, Capital
$42,000.00 4
$28,895.42
66,836.09 3
$42,000.00
$95,731.51
$53,731.51 39

40. Post-Closing Trial Balance
P. Marshall, Capital
$28,895.42
66,836.09
$95,731.51
$53,731.81
$42,000.00 40

41. Adjusting for Depreciation 8.4

42. Adjusting for Depreciation
Assets that are used to produce revenue over several fiscal periods are known as fixed assets.
Fixed assets are also known as “long- lived assets”, “capital equipment”, and “plant and equipment”.
Except for land, all fixed assets will be used up in the course of time and activity. 43

43. Adjusting for Depreciation
Fixed assets decrease or depreciate in value.
Depreciation refers to an allowance made for the decrease in value of an asset over time.
It is not possible to calculate depreciation until the end of the asset’s life … only then, can you say how many years it was used and determine its final worth. 44

44. Adjusting for Depreciation
The matching principle dictates that depreciation must be included on every year-end income statement.
To do this, accountants must estimate depreciation while the asset is still in use.
The two most common methods of calculating depreciation are the: Straight-Line method and Declining-balance method. 45

45. Straight-Line Depreciation
The simplest way to estimate depreciation.
The Straight-Line method of depreciation divides up the net cost of the asset equally over the years of the asset’s life.
Straight-Line Depreciation for one year =
Original Cost of Asset -
Estimated Salvage Value
Estimated Number of Periods in the Life of the Asset 46

46. Straight-Line Depreciation
You purchased a truck for $78,000 on January 1, It is estimated that the truck will be used for six years, and at the end of that time, could be sold for $7,800. What is the annual depreciation?
Straight-Line Depreciation for one year =
Original Cost of Asset -
Estimated Salvage Value
Estimated Number of Periods in the Life of the Asset =
$78,000 -
$7,800 6 =
$11,700 47

47. Straight-Line Depreciation
You purchased furniture for $5,120 on January 1, It is estimated that the furniture will be used for 10 years, and at the end of that time, could be sold for $ What is the annual depreciation?
Straight-Line Depreciation for one year =
Original Cost of Asset -
Estimated Salvage Value
Estimated Number of Periods in the Life of the Asset =
$5,120 -
$500 10 =
$462 48

48. Adjusting Depreciation
When adjusting for depreciation you would expect to DR Depreciation Expense CR Asset
In order to show the value of the Asset at cost, you would not CR Asset for the depreciation … rather you CR Accumulated Depreciation. 49

49. Accumulated Depreciation
Accumulated depreciation is a valuation or contra account.
A contra account is one that is displayed alongside an associated account and has a balance that is opposite to the account it is associated with.
Accumulated depreciation is also known as a valuation account … an account that is used, together with an asset account, to show the true net value (or net book value) of the asset. 50

50. Adjusting Entry for Depreciation
In the truck example, the adjusting entry would be:
DR Depreciation Expense 11,700
CR Accumulated Depreciation 11,700
In the furniture example, the adjusting entry would be:
DR Depreciation Expense
CR Accumulated Depreciation 51

51. Financial Statement Presentation
Income Statement
Depreciation expense is shown on the income statement.
Each depreciation expense item is shown separately (e.g. Depreciation Expense – Truck).
Balance Sheet
Accumulated depreciation is deducted from its respective fixed asset account on the balance sheet.
Each asset, with its related accumulated depreciation, is shown separately. For example: Truck $78, Less: Accumulated Depreciation ,700 $66,300 52

52. Depreciation for Part Year
Sometimes an asset is used for only part of a year.
For example, you purchase a building on May 1, 2007 for $120,000. The building is expected to be used for 30 years, after which it will be worth $30,000. Your company issued financial statements quarterly (i.e. every 3 months).
Annual depreciation = (120,000 – 30,000) / = $3,000
Monthly depreciation = 3,000 / 12 = $250 per month
The depreciation expense would be 1st quarter $ 0 and (Jan-Mar)
2nd quarter $500 (Apr-Jun) 53

53. Declining-Balance Depreciation
The declining-balance method is an alternative to the straight-line method of calculating depreciation.
The declining-balance method is common because the government of Canada requires a variation of this method for income tax purposes.
This method calculates the annual depreciation by multiplying the remaining undepreciated cost (i.e. net book value) by a fixed percentage. 54

54. CRA Rates of Depreciation
Some of the percentage rates set by the government are as follows:
Class
Description
Rate 1
Most buildings acquired after 1987 4% 3
Most buildings acquired before 1988 5% 8
Office furniture and equipment
20% 10
Automobiles and other motor vehicles
30% 12
Most computer software
100% 50
Most computer equipment
55% 55

55. Declining-Balance Depreciation
Example: you purchase computers on January 1, 2011 for $22,000. The rate, per the previous slide, is 55%.
Depreciation expense would be calculated as follows:
2011: Original Cost $22, Less: Depreciation ($22,000 x 55%) , Undepreciated cost (net book value) $9,900
2012: Undepreciated Cost $9, Less: Depreciation ($9,900 x 55%) Undepreciated cost (net book value) $4455 56

56. Tax Regulations
Canada Customs and Revenue Agency (CCRA) requires businesses to use the declining-balance method when calculating depreciation for tax purposes.
In addition, the CCRA generally allows 50% of the asset’s cost to be eligible for depreciation in its first year of use … regardless of the month it was purchased.
The CCRA refers to this as the “50% Rule” 59

57. Tax Regulations
How would the “50% Rule” look? 60

58. Comparison of the Two Methods of Depreciation
For straight-line, assume the computers have an 8 year life with an ending value of $2,000.
The straight-line
method produces
depreciation figures
that are the same each year.
The net book value (NBV)
or undepreciated cost
gradually reduces until
it reaches the estimated
Salvage value.
$22,000 - $2,000 8
= $2,500 / year 57

59. Comparison of the Two Methods of Depreciation
The declining-
balance method
produces depreciation
figures that are the larger in
the early years and smaller
in the later years. The
estimated final value is
ignored using this
method. 58