Accounting Chapter 4 Preparing the Annual Report Public owned companies - those with shares listed on a stock exchange

have to release annual and quarterly information to their stockholders and to the public. These companies dont prepare only financial statements but they have to publish annual reports. An annual reports consists of financial statements, other information about companys financial position. Before issuance of financial reports these reports are audited by certified public accountants (CPAs). Copies of annual reports are sent to stockholders and also available to public. Adjusting Entries For the measurement of income and preparation of financial statements, the life of a business is divided into a series of accounting periods. This practice enables decision makers to compare the financial statement of successive periods and to identify significant trends. Measurement of income of short periods raise a problem. Some transactions affect the revenue or expenses of more than one period. So adjusted entries are needed at the end of each accounting period. Adjusting entries are needed whenever transactions affect the revenue or expenses of more than one accounting period. These entries assign revenues to the periods in which they are earned, and expenses to the periods in which the related goods or services are used. Thus the adjusting accounts is an end of the period procedure associated with the preparation of financial statements. Types of Adjusting Entries The exact number of adjustments depends on the nature of the companys business activities. However adjusting entries fall in the following 4 general categories. Entries to apportion recorded costs A cash expenditure that will benefit more than one accounting period usually is recorded by debiting an asset account e.g. supplies, unexpired insurance etc.) and by crediting cash. Entries to apportion unearned revenue A business may collect cash for the services to be provided in the future. These transactions are recorded by debiting cash and by crediting liability account. In the period that services are rendered, an adjusting entry is made to record the portions of revenue actually earned during the period. The adjusting entry is recorded by debiting unearned revenue and by crediting revenue earned for the value of the services rendered. Entries to apportion unrecorded expenses An expense may be incurred in the current accounting period even though no bill has been received and no cash payment will occur until a future period. These accrued expenses are recorded by an adjusting entry made at the end of the accounting period. The adjusting entry is recorded by debiting the appropriate expense account and by crediting the related liability. The Challengers National University of Modern Languages Ready for Challenge 1

Accounting Chapter 4 Entries to apportion unrecorded revenue Revenue may be earned during the current period but not collected or recorded in the accounting records. Revenue earned, for which no cash has been collected, is recorded by an adjusting entry made at the end of accounting period. The adjusting entry is recorded by debiting account receivable and by crediting revenue earned. Characteristic of Adjusting Entries Two important characteristics First, adjusting entries recognize revenue or expense. Revenue and expenses show changes in owners equity. However owners equity cannot change itself, there must be a corresponding change is assets or liability account. Every adjusting entry affect both income statement and balance sheet. Second, adjusting entries are based on the concepts of accrual accounting, not upon monthly bills or month-end transactions. We must be aware of the need to estimate and record the depreciation expenses if we have to measure net income properly for the period. It requires a greater understanding of accrual accounting instead of recording routine business transactions. Apportioning Recorded Costs When a business make an expenditure that will benefit more than one accounting period, the amount is usually debited to an asset account. At the end of each accounting period benefit from this expenditure. An adjusting entry is made to transfer an appropriate portion of the cost from the asset account to an expense account. This adjusting entry reflects the fact that part of the assets has been used up or become expense during the current accounting period. An adjusting entry to apportion previously recorded cash expenditure consists of a debit to an expense account and a credit to an asset account (or contra-assets account). Prepaid Expenses Payments in advance are made for such items as insurance, rent and office supplies. If the advance payment will benefit more than just the current accounting period, the cost represents an assets rather than an expense. The cost of this asset will be allocated to expense in the accounting periods in which the services or the supplies are used. In summary, prepaid expenses are assets, they become expenses only as the goods or services are used up.

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