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Chapter 5 Accrual Accounting Adjustments: Discussion Questions

The purpose of accrual accounting adjustments is to record revenue earned and expenses incurred during an accounting period, regardless of the timing of cash receipts and payments. Key adjustments include accruing unpaid expenses, deferring unearned revenue, and allocating prepaid expenses over multiple periods. Accrual accounting provides a more accurate picture of financial performance compared to cash-based accounting alone. However, some objectivity is lost due to the need to estimate accruals and deferrals.

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382 views7 pages

Chapter 5 Accrual Accounting Adjustments: Discussion Questions

The purpose of accrual accounting adjustments is to record revenue earned and expenses incurred during an accounting period, regardless of the timing of cash receipts and payments. Key adjustments include accruing unpaid expenses, deferring unearned revenue, and allocating prepaid expenses over multiple periods. Accrual accounting provides a more accurate picture of financial performance compared to cash-based accounting alone. However, some objectivity is lost due to the need to estimate accruals and deferrals.

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kiet
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter 5 Accrual accounting adjustments

Discussion questions

In a cash accounting system, an occurrence is recognized as a transaction only if it involves an


immediate cash inflow or outflow. In a system employing accrual accounting, the basis of
recognition is extended to include a variety of non-cash transactions. These usually involve
credit extended to or by the entity.
Cash flows are easy to recognize but do not provide a satisfactory measure of the performance of
most organizations. Accrual accounting employs wider criteria to decide whether revenue has
been realized or expense has been incurred. This provides more informative results, which are
more useful to those using accounting reports. Because tests other than cash flows are less easy
to define precisely, some certainty and objectivity is lost.

The purpose of accrual accounting adjustments is to make the financial statements as reliable as
possible. The intention is to identify for each accounting period the revenue earned in that
period, and to determine the expenses associated with generating the period’s revenue. The
difference between the revenue and expense for the period then represents the profit or loss for
the period. Thus, the adjustments augment the cash-based figures to implement accrual
accounting.

At the time customers pay for the flights this is recorded as a liability, because the airline has an
obligation to make a future sacrifice of economic benefits. When the flight has been made this is
transferred to revenue. Profit is increased by the amount of revenue less costs incurred in
providing the service.

The mining company has the advantage of the use of cash until the contractors submit their bills.
At year end, this does mean that the company must record the liability for unpaid accounts. In
many cases, it is necessary for the company to make an estimate of the value of work undertaken
to date.

Problem
PROBLEM 5.1
Cash versus accrual accounting
Penshurst Ltd began business on 1 July 2018 with each of the two owners contributing $25 000
cash. The company paid $2200 in advance for a two-year lease of its retail premises. Inventory
worth $3500 was purchased in the first month of operation; by 30 June 2019, $1200 of that
inventory remained. Sales revenue of $9500 was invoiced during the year, although $2000 of this
amount is yet to be collected.
During the year, wages totaling $1300 were paid to employees and $900 was paid for various
administrative expenses. The company received an advertising invoice for $1100 as well as a
utilities bill for $385; these are yet to be paid as at 30 June 2019.
1 Prepare a cash-basis income statement for Penshurst Ltd for the year ended 30 June
2019.
2 Prepare an accrual-basis income statement for Penshurst Ltd for the year ended 30 June
2019.
PROBLEM 5.8
Adjustments
The financial year-end for Jannali Ltd is 30 June.
a. Prepaid insurance as at 1 July 2018 was $6000. This represents the cost of an
insurance policy that expires on 1 March 2019.
b. Jannali was entitled to a dividend revenue of $4000 which will not be received until
mid-July.
c. Commissions to sales personnel for the five-day working week ending 2 July 2019,
totaling $9600, will be paid on 2 July.
d. Sales revenue for the year included $5700 of customer deposits for products that have
not yet been shipped to them.
e. A total of $900 worth of stationery was charged to the office supplies expense during
the year. On 30 June, $490 worth of stationery is still considered useful for next year.
f. The company has a bank loan and pays interest annually (in arrears). The estimated
interest cost for the calendar year ended 30 June 2019 is $5000. The interest will be paid
in July.
Required:
1. Show the effect of each of the above on the accounting equation at 30 June 2019.
2. Give the adjusting journal entry for each of the above situations on 30 June 2019.
PROBLEM 5.12
Adjustments entries
Forbes Ltd ’ s annual accounting year ends on 30 June. It is 30 June 2019 and all of the 2019
entries except the following adjusting entries have been made.
a. On 1 April 2019 the company borrowed $80 000 from a local bank at 5 per cent per
annum interest. The principal and interest are payable on 30 June 2020. The borrowing
was correctly recorded but no adjustment has been made for interest.
b. On 1 March 2019 Forbes collected six months ’ rent of $18 000. At that date Forbes
debited Cash and credited Unearned rent revenue for $18 000.
c. On 1 October 2018 Forbes paid a one-year premium for fire insurance, $18 000, for
coverage starting on that date. Cash was credited and Prepaid insurance was debited for
this amount.
d. At 30 June 2019 wages earned by employees totalled $43 000. The employees will be
paid in July 2019.
c. On 30 June 2019 the company estimated it owed $7000 for 2019 electricity costs. The
amount will be paid when the invoice is received in July 2019.
f. Office supplies on hand at 30 June 2018 totalled $1000. Additional office supplies
costing $2400 were purchased and debited to Office supplies (asset account). The count
of supplies on hand at year-end was $800.
Required:
1. Using the following headings, indicate the effect of each adjusting entry and the
amount of the effect. Use + for increase, − for decrease and NE for no effect.
2. Prepare the adjusting journal entries.

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