ACCT 110

Chapter 3: Adjusting the accounts

-Time period assumption: Accountants divide the economic life of a business into artificial
time periods.

Fiscal and calendar years:

-Accounting time periods are generally a month, a quarter, or a year.
-Interim periods: Monthly and quarterly time periods.
-Fiscal year: An accounting time period that is one year in length.

Accrual-versus cash basis accounting:

-Accrual-basis accounting → companies record transactions that change a company’s
financial statements in the periods in which the events occur.
-Cash-basis accounting → companies record revenue when they receive cash. They record
an expense when they pay out cash.

-Accrual-basis accounting is therefore in accordance with IFRS.

Revenue recognition principle:

-Performance obligation → when a company agrees to perform a service or sell a product to
a customer.
-Revenue recognition principle: requires that companies recognize revenue in the
accounting period in which the performance obligation is satisfied.

Expense recognition principle:

-Expense recognition is tied to revenue recognition.

-Expense recognition principle (matching principle): match expenses with revenues in the
period when the company makes efforts to generate those revenues.

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The basic of adjusting entries:
-Adjusting entries: Ensure that the revenue recognition and expense recognition principles
are followed.
-Adjusting entries are necessary because of the trial balance.
-Adjusting entries are requires every time a company prepares financial statements.

-Every adjusting entry will include one income statement account and one statement of
financial position account.
-Types of adjusting entries:

• Deferrals.
• Accruals.

Deferrals → prepaid expenses, unearned revenues.

-Prepaid expenses: expenses paid in cash before they are used or consumed.
-Unearned revenues: cash received before services are performed.

Accruals → accrued revenues, accrued expenses.

-Accrued revenues: revenues for services performed but not yet received in cash or
recorded.

-Accrued expenses: expenses incurred but not yet paid in cash or recorded.

Adjusting entries for deferrals:

-deferrals: expenses or revenues that are recognized at a date later than the point when
cash was originally exchanged.

Depreciation:
-Useful life: the period of service of the asset.
-Depreciation: The process of allocating the cost of an asset to expense over its useful life.
-Depreciation is an allocating concept, not a valuation concept.
-Depreciation allocates an asset’s cost to the periods in which it is used.
-Depreciation does not attempt to report the actual change in the value of the asset.

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-Accumulated depreciation is called a contra asset account.
-Accumulated depreciation: keeps track of the total amount of depreciation expense taken
over the life of the asset.
-All contra accounts have increase, decrease, and normal balances opposite to the account
to which they relate.

-Book value: the difference between the cost of any depreciable asset and its related
accumulated depreciation.

Unearned revenues:
-Unearned revenues are the opposite of prepaid expenses.

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Adjusting entries for accruals:
-The adjusting entry for accruals will increase both a statement of financial position and an
income statement account.

Accrued revenues:
-Accrued revenues: Revenues for services performed but not yet recorded at the statement
date.

Accrued expenses:
-Accrued expenses: Expenses incurred but not yet paid or recorded at the statement date.
-In computing interest, we express the time period as a fraction of a year.

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The adjusted trial balance and financial statements:
-Adjusted trial balance: Shows the balances of all accounts, including those adjusted, at the
end of the accounting period.
-The purpose of an adjusted trial balance is to prove the equality of the total debit balances
and the total credit balances in the ledger after all adjustments.
-The adjusted trial balance is the primary basis for the preparation of financial statements.

Preparing financial statements:

-Companies can prepare financial statements directly from the adjusted trial balance.

-Alternative adjusting entries do not apply to accrued revenues and accrued expenses
because no entries occur before companies make these types of adjusting entries.

Qualities of useful information:

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Enhancing qualities:

• Comparability → results when different companies use the same accounting

principles.
• Consistency (another type of comparability) → a company uses the same accounting
principles and methods from year to year.
• Verifiable → The information is verifiable if independent observers, using the same
methods, obtain similar results.
• Timely → must be available to decision-makers before it loses its capacity to
influence decisions.
• Understandability → if the information is presented in a clear and concise fashion, so
that reasonably informed users of that information can interpret it and comprehend
its meaning.

Assumptions in financial reporting:

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Principles in financial reporting:
Measurement principles:

• Historical cost principle: an accounting principle that states that companies should
record assets at their cost.
• Fair value principle: assets and liabilities should be reported at fair value (the price
received to sell an asset or settle a liability).

-Only in situations where assets are actively traded, such as investment securities, is the fair
value principle applied.

Full disclosure principle: accounting principle that dictates that companies disclose
circumstances and events that make a difference to financial statement users.

Cost constraint:

-Providing information is costly.

-Cost constraint: constraint of determining whether the cost that companies will incur to
provide the information will outweigh the benefit that financial statement users will gain
from having the information available.

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Notes from class:
-Maintenance should be covered for the whole year.
-Financial year (physical year) can be different from calendar year.

-Accrual basis system

-Cash basis system
-Prepaid expenses → assets
-Unearned revenue → liabilities
-Accrued revenue → assets

-Accrued expenses → liabilities

-Prepaid supplies (or supplies)→ assets
-Adjusting means what’s covered in the period of time.
-The accounts should be added in financial statements after the adjustments.
-Update the accounts then update the trial-balance.

-In balance sheet, we add what’s left from the amount. (example: prepaid insurance).
-In income statement, we add what we used from the amount. (example: insurance
expense).
-hints to adjustments: what’s left from the amount, trial-balance.

-Deferrals→ prepaid expenses, unearned revenue.

-Accrual→ accrual-revenue, accrual-expenses.

- Depreciation: we have to allocate the cost of a fixed asset every year.

- Depreciation expense → paid yearly.
-Accumulated depreciation → the amount should be put here. (the sum of all depreciation
over the year).
- depreciation expense → in income statement. (always increase and always debit).
- Accumulated depreciation → in balance sheet (should be minus)

-only with fixed assets. (all fixed assets except with land).
-accumulated depreciation is in balance sheet but opposite to debit (always in credit).
-Deduct any depreciation entries.

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-interest expense → expenses.
-interest payable → liability.

-Statement of financial position is the same as balance sheet.

-Salaries and wages expense → expenses (income statement).
-Salaries and wages payable → liability (balance sheet).
-The total expense in income statement is always between parenthesis.
-Debit and credit are not included or related to the financial statements.

-The sequence of FS:

1. Income statement.
2. Retained earnings.
3. Balance sheet.
In each FS add: the type of FS, the company’s name, the date.

-Current assets:

For example: cash, accounts receivable, prepaid insurance, prepaid supplies (supplies).

-Fixed assets:
For example: equipment, building.

-Book value: the amount of fixed assets minus accumulated depreciation + we have to
specify each account.

-Current liabilities:
For example: accounts payable, interest payable, salaries and wages payable, unearned
service revenue. (notes payable→ is mostly long-term liability but it depends on the time
period in the question, so it can be considered as current liability).
-long-term liabilities → more than one year.

-comparability: means that I can compare the FS with another company’s FS.

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