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16/08/2016

CHAPTER 4
Adjusting the Accounts and
Preparing Financial Statements

Accounting Fundamentals In Society ACCY111


Lecture 4
Dr Sanja Pupovac

TEMPORARY AND PERMANENT


ACCOUNTS

MEASUREMENT OF PROFIT

Temporary (Nominal) Accounts


Income Statement Accounts

Cash Basis

Reduced to zero balance at the end of each


accounting period (closed)
Reset the business stopwatch

Income is recorded when cash is received


Expenses are recorded when cash is paid

Accrual Basis
Income recognised when the anticipated inflow of
economic benefit can be reliably measured

Permanent (Real) Accounts


Balance Sheet Accounts

Expenses recognised when the consumption of


benefits can be reliably measured

Ending balances carried forward to next


accounting period

EXPANDED ACCOUNTING CYCLE


INCLUDING ADJUSTING ENTRIES
1. Recognise & record
transactions

2. Journalise transaction

EXPANDED ACCOUNTING CYCLE


INCLUDING ADJUSTING ENTRIES

Source
documents

5. Determine adjusting

General journal

6. Post adjusting entries

General ledger
(Accounts Adjusted)

7. Prepare adjusted trial

Trial balance
(Adjusted)

entries and journalise

General journal

to general ledger

3. Post to ledger accounts

General ledger

balance

4. Prepare unadjusted trial

balance of general ledger

Trial balance
(unadjusted)

Continued Next Slide

8. Prepare financial
6

statements

Work
sheet

Financial
Statements

16/08/2016

THE NEED FOR ADJUSTING ENTRIES

CLASSIFICATION OF ADJUSTING
ENTRIES

In many cases the period in which cash is paid or received


does not coincide with period in which expense and income
are recognised
Therefore, in order for our statements to reflect what has
actually happened, some accounts must be adjusted on
the last day of the accounting period to correctly
recognise income and expenses not reflected in cash
receipts or payments

Deferrals
(Prepayments)

Accruals
(Unrecorded)
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Unearned
Revenue

Prepaid
Expense

Revenues that are


collected or
received but not
yet earned

Costs/expenses
paid before they
are consumed

Accrued
Revenue

Accrued
Expense

Revenue earned
but not yet
received

Expenses incurred
but not yet paid

THE RULES OF ADJUSTING ENTRIES


Attempting to account for the timing difference
between receipt/payment of cash, and recognition of
income/expense
One side of the entry affects an income statement
account
That is revenue or expense

ADJUSTING ENTRIES
Revenue
Unearned revenue

Accrued revenue

Revenues collected in
advance, but not yet earned
e.g. magazine subscription
received in advance

Revenues earned, but not yet


received in cash or entered
e.g. interest earned on a bank
term deposit but not paid

The other side of the entry affects an account


reported in the balance sheet
That is asset or liability

$$$

Cash is never adjusted!

Revenue

Last Year

Revenue

$$$
Next Year

Current Year

prepared by Phil Johnson

ADJUSTING ENTRIES
Expenses

DEFERRALS: PREPAID EXPENSES

Prepaid expenses

Accrued expenses

Expenses paid for before they are


consumed
e.g. Insurance premium paid 12
months in advance

Expenses incurred, but not yet


paid for or entered
e.g. wages earned by
employees, but not yet paid

$$$
Last Year

Expense

Expense

Current Year

Cash paid before benefits are consumed


Initially recorded as assets when paid
At the end of the period the amount consumed/expired
is expensed.

ASSET ACCOUNT
Prepaid Expense

$$$

Initial Cost
Debit

Next Year

Adjusting
Entry
Credit

EXPENSE ACCOUNT
Adjusting
Entry
Debit

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Costs consumed or expired

prepared by Phil Johnson

16/08/2016

EXAMPLE: PREPAID RENT

EXAMPLE: PREPAID RENT


On 1 June the following entry was made to record $1200 rent
covering the period of 3 months:

On 30 June only one month of rent has expired ($1,200 3


months = $400)

General Journal
Jun Rent Expense
30

General Journal
Jun 1 Prepaid Rent

1 200

Cash at Bank

400

Prepaid Rent

1 200

400

(Adjusting entry for rent)

(Payment of rent for 3 months)

Rent Expense

Prepaid Rent
Initial Entry
1 200
13

Adjusting
Entry
400

Adjusting
Entry
400

14

Costs expired and allocated to current period

EXAMPLE: DEPRECIATION

DEFERRALS: UNEARNED REVENUE

Depreciation = Allocation of the historic cost of an asset (less


any residual value) over the useful life of that asset

Cash received in advance for services that are to be


preformed in the future
Initially recorded as liability when received

Non-Current Asset

Recognised as revenue as earned

Initial Cost
Debit
Contra-Asset Account
Accumulated
Depreciation
Adjusting
Entry
Credit

LIABILITY ACCOUNT
Unearned Revenue
Depreciation Expense
Adjusting
Entry
Debit

15

Adjusting
Entry
Debit
16

On 8 September a monthly magazine publisher received


$264 for a 1 year subscription beginning October

Adjusting
Entry
Credit

Cash Receipt

Revenue earned during the current period

Costs consumed and allocated to current period

EXAMPLE: SUBSCRIPTIONS

INCOME ACCOUNT

EXAMPLE: SUBSCRIPTIONS
On 31 December 3 months of revenue has been earned
(3/12 x $264= $66)

General Journal
Dec Unearned Subscriptions Revenue
31
Subscriptions Revenue

66
66

(Adjusting entry for subscriptions


earned)
Unearned Subscriptions
Revenue

17

Adjusting
Entry
66
18

Subscriptions Revenue

Cash
264

Adjusting
Entry
66

Revenue earned during the current period

16/08/2016

ACCRUALS: ACCRUED EXPENSES

EXAMPLE: ACCRUED SALARIES

Expenses that have been consumed but have not


been recorded because payment has not yet been
made
Expense must be recognised along with a liability for
future payment

LIABILITY ACCOUNT
Expense Payable
Adjusting
Entry
Credit
19

EXPENSE ACCOUNT
Adjusting
Entry
Debit
20

Expenses Incurred

EXAMPLE: ACCRUED SALARIES


On 30 June an adjusting entry is required to correctly determine
Junes expenses

General Journal
Jun Salaries Expense
30

EXAMPLE: ACCRUED SALARIES


The liability is eliminated on 6 July when the next payment
is made to employees

3 980

General Journal

Salaries Payable

3 980

Jul 6 Salaries Payable


Salaries Expense

(Adjusting entry for salaries


payable)
Salaries Payable
Adjusting
Entry
3 980

3 980
3 420

Cash at Bank

7 400

(Payment of salaries earned 23


June to 6 July)

Salaries Expense
Adjusting
Entry
3 980

21

22

Expenses Incurred

ACCRUALS: ACCRUED REVENUE

EXAMPLE: MARKETING SERVICES

Usually recorded when service is performed


No adjusting entry would be necessary

Any unrecorded revenue earned needs to be recorded

On 1 June an agreement was signed to provide marketing


services for a monthly fee of $800. By 30 June, the full fee
of $800 is receivable

General Journal
ASSET ACCOUNT
Accounts Receivable
Adjusting
Entry
Debit
23

Jun Accounts Receivable


30

INCOME ACCOUNT
Revenue

Marketing Services Revenue

Adjusting
Entry
Credit
Revenue earned but not yet received

800
800

(Marketing services fee receivable


for June)
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16/08/2016

ADJUSTED TRIAL BALANCE


Same accounting process applied
Unadjusted trial balance used as starting point
Adjusting entries are posted to the general
ledger
An adjusted trial balance can then be prepared
Debits must still equal credits
Adjusting entries always affect an Income
Statement and a Balance Sheet account

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