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    Topic 4 - Adjusting Accounts and Preparing Financial Statements

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    This document discusses key accounting concepts related to adjusting accounts and preparing financial statements, including: 1) The difference between the accrual and cash basis of accounting and how revenues and expenses are recognized under each. 2) How adjustments are needed to ensure expenses are properly matched to revenue, including prepaid expenses, accrued expenses, and depreciation. 3) Prepaid expenses occur when expenses have been paid but not yet used, so the amount must be deducted from expenses. Accrued expenses occur when expenses have been incurred but not yet paid, so the amount must be added to expenses. 4) Depreciation allocates the cost of a fixed asset over its useful life through systematic

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    Topic 4 - Adjusting Accounts and Preparing Financial Statements

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    This document discusses key accounting concepts related to adjusting accounts and preparing financial statements, including: 1) The difference between the accrual and cash basis of accounting and how revenues and expenses are recognized under each. 2) How adjustments are needed to ensure expenses are properly matched to revenue, including prepaid expenses, accrued expenses, and depreciation. 3) Prepaid expenses occur when expenses have been paid but not yet used, so the amount must be deducted from expenses. Accrued expenses occur when expenses have been incurred but not yet paid, so the amount must be added to expenses. 4) Depreciation allocates the cost of a fixed asset over its useful life through systematic

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    This document discusses key accounting concepts related to adjusting accounts and preparing financial statements, including: 1) The difference between the accrual and cash basis of accounting and how revenues and expenses are recognized under each. 2) How adjustments are needed to ensure expenses are properly matched to revenue, including prepaid expenses, accrued expenses, and depreciation. 3) Prepaid expenses occur when expenses have been paid but not yet used, so the amount must be deducted from expenses. Accrued expenses occur when expenses have been incurred but not yet paid, so the amount must be added to expenses. 4) Depreciation allocates the cost of a fixed asset over its useful life through systematic

    Copyright:

    © All Rights Reserved
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    Download as ppt, pdf, or txt
    72 views18 pages

    Topic 4 - Adjusting Accounts and Preparing Financial Statements

    Uploaded by

    api-388504348
    This document discusses key accounting concepts related to adjusting accounts and preparing financial statements, including: 1) The difference between the accrual and cash basis of accounting and how revenues and expenses are recognized under each. 2) How adjustments are needed to ensure expenses are properly matched to revenue, including prepaid expenses, accrued expenses, and depreciation. 3) Prepaid expenses occur when expenses have been paid but not yet used, so the amount must be deducted from expenses. Accrued expenses occur when expenses have been incurred but not yet paid, so the amount must be added to expenses. 4) Depreciation allocates the cost of a fixed asset over its useful life through systematic

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    TOPIC 4

    Adjusting Accounts and Preparing


    Financial Statements
    Accrual Basis versus Cash
    Basis

    Accrual Basis Cash Basis


    Revenues are Revenues are
    recognized when recognized when cash
    earned and expenses is received and
    are recognized when expenses are recorded
    incurred. when cash is paid.
    Accrual Basis versus Cash
    Basis

    Accrual Basis Cash Basis


    Revenues are Revenues are
    recognized when recognized when cash
    earned and expenses is received and
    are recognized when expenses are recorded
    incurred. when cash is paid.
    Non-GAAP
    Accrual Basis versus Cash
    Basis
    Illustration:
    In 20X1,
    2 Dec: student enquiry
    5 Dec: student signed up
    20 Dec: Class started
    5 Jan 20X2: Paid school fees
    When should revenue be recognised?
    Recognizing Revenues &
    Expenses
    Revenue Recognition Principle
    We have delivered the
    product to our customer,
    so I think we should record
    the revenue earned.
    Recognizing Revenues &
    Expenses
    Matching Principle
    Now that we have
    Summary recognized the revenue,
    of Expenses let’s see what expenses
    Rent $1,000 we incurred to
    Gasoline 500
    Advertising 2,000
    generate that revenue.
    Salaries 3,000
    Utilities 450
    and . . . . ....
    Adjustments
    An adjustment is needed to ensure that expenses are
    properly matched to revenue.
    Framework for Adjustments
    Adjustments

    Paid cash before expense


    Paid cash after expense
    recognized
    recognized
    - Known as prepaid expense
    - Known as accrued expense
    - (including depreciation)
    Prepaid expense
    Prepaid expenses are expenses that have been paid
    but NOT yet used.

    Since they have not been used up yet, this amount


    must be deducted from the expense for the year.
    Prepaid expense
    Example:
    For the year, a total of $50,000 was paid for rental expense.
    However, as at 31 December 20X1, $2,000 was for rental in Jan
    20X2 (prepaid).

    Question:
    How much was the rental expense for the year, 20X1?
    Prepaid expense
    Solution:
    Total rental expense (portion used up) was
    50,000 - 2,000 = $48,000 (statement of comprehensive
    income).

    The $2,000 that was prepaid becomes an asset (statement of


    financial position)
    Depreciation
    Depreciation is the process of allocating the cost of a fixed
    asset over its useful life in a systematic and rational manner.

    Straight-Line Asset Cost - Residual Value


    Depreciation =
    Expense Useful Life
    Depreciation

    On December 1, 2011, Fast-forward purchased equipment for $26,000 cash. The


    equipment has an estimated useful life of four years (48 months) and Fast-
    forward expects to sell the equipment at the end of its life for $8,000 cash.
    (c) Let’s record depreciation expense for the month ended December 31, 2011.

    Dec. 2011 $26,000 - $8,000


    Depreciation = = $375 per month
    Expense 48 months
    Depreciation
    The depreciation expense of $375 will appear as an
    expense in the statement of comprehensive income.

    This $375 will be deducted from the cost of fixed


    asset in the statement of financial position.
    Depreciation
    FastForward
    Statement of financial position Equipment is
    At December 31, 2011 shown net of
    Fixed Assets accumulated
    $ depreciation.
    .
    Equipment $ 26,000
    Less: accumulated deprec. (375) 25,625
    .
    .
    Total Assets
    Accrued expense
    Accrued expenses are expenses that have been
    incurred but NOT paid yet.

    Since they have already been incurred, this amount


    must be added to the expense for the year.
    Accrued expense
    Example:
    Total salaries paid for the year, 20X1 was $80,000. However, as
    at 31 December 20X1, $5,000 salary was still owing to
    workers.

    Question:
    How much was the total salary for the year 20X1?
    Accrued expense
    Solution:
    Total salary for the year 20X1 was
    80,000 + 5,000 = $85,000 (statement of comprehensive
    income)

    The $5,000 that was still owing will appear as a current


    liability (statement of financial position)
    END OF CHAPTER 3

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