1. Adjusting Accounts for Financial Statement

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4. 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.

5. Review: Time period concept
Definition: the continued life of a business is divided into time periods of equal length.
This year income
statement
Next year income
Last year income statement
Past period
Current period
Future period
Dec. 31, B/S date
going concern
(business will not stop)

6. Review: Revenue Recognition Principle
Revenue is recorded at the time it is earned regardless of whether cash or another asset has been exchanged.

7. Review: Matching Principle
Expenses are to be matched in the same accounting period as the revenues they helped to earn.

8. 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.

9. Adjust: A Step in Accounting cycle
1. Analyze Transactions
2. Journalize
3. Post
4. Unadjusted trial balance
5. Adjust
6. Adjusted trial balance
7. Prepare finance statements
8.Close
Now that we have
covered the trial
balance, let’s
discuss adjusting
entries.

10. 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.

11. Why Need to Adjust
Adjustments are based on three generally accepted accounting principles:
Time period principle.
Revenue recognition principle.
Matching principle.

12. Type of Adjusting Entries
Accruing unrecorded
revenues
Converting liabilities to
expenses
Converting assets to

13. Adjusting Entries – Accruals
Accruals occur when revenues have been earned or expenses incurred but no cash has been exchanged.
Example: interest revenue earned during the period but not received until the next period.
End of
accounting period.
Cash received
Revenues earned

14. 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, On December 31, 2004, Smith, Inc. need to make the following entry for the interest earned so far.

15. Adjusting Entries – Accrued
Unrecorded expenses incurred
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.

16. 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.

17. Adjusting Entries – Deferrals
Prepaid expense is used up
Paid cash for
12 month’s rent
< from July 2004 to June 2005 >
7/1/04
12/31/04
Year end
6/30/05

18. 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.

19. Adjusting Entries – Deferrals
Converting liabilities to revenues:
End of
accounting period.
Cash received
Revenues earned
Example: service revenue received in advance.

20. 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.

21. 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.

22. 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.

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24. Asset Cost - Salvage Value
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
Useful Life
Straight-Line
Amortization
Expense =
$ $5,000
5 years
= $19000/year

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

26. 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:

27. Adjusted Trial Balance

28. Adjusted trial balance

29. 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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CONTACT:
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