The International University, VNU-HCM

School of Business

FINANCIAL ACCOUNTING
Sem 2 (2019-2020)
Lecturer: Mr. Vu Tuan Anh, CMA, MSA
Email: anhtv@hcmiu.edu.vn (preferred)
Tutor: TBA
 PREVIEW OF LECTURE 3

3-2
 LECTURE

3 Adjusting the Accounts

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Explain the time period assumption.

2. Explain the accrual basis of accounting.
3. Explain the reasons for adjusting entries.
4. Identify the major types of adjusting entries.
5. Prepare adjusting entries for deferrals.
6. Prepare adjusting entries for accruals.
7. Describe the nature and purpose of an adjusted trial balance.

3-3
 Timing Issues
Learning
Objective 1 Accountants divide the economic life of
Explain the time
period a business into artificial time periods
assumption.
(Time Period Assumption).

.....
Jan. Feb. Mar. Apr. Dec.

 Generally a month, a quarter, or a year.

 Also known as the “Periodicity Assumption”

3-4 LO 1
 Fiscal and Calendar Years

 Monthly and quarterly time periods are called interim

periods.

 Most large companies must prepare both quarterly and

annual financial statements.

 Fiscal Year = Accounting time period that is one year in

length.

 Calendar Year = January 1 to December 31.

3-5 LO 1
 Fiscal and Calendar Years

Question
The time period assumption states that:

a. companies must wait until the calendar year is

completed to prepare financial statements.

b. companies use the fiscal year to report financial

information.

c. the economic life of a business can be divided into

artificial time periods.

d. companies record information in the time period in

which the events occur.
3-6 LO 1
 Accrual- versus Cash-Basis Accounting
Learning
Accrual-Basis Accounting Objective 2
Explain the
accrual basis of
 Transactions recorded in the periods in accounting.
which the events occur.

 Companies recognize revenues when they perform

services (rather than when they receive cash).

 Expenses are recognized when incurred (rather than

when paid).

3-7 LO 2
 Accrual- versus Cash-Basis Accounting

Cash-Basis Accounting
 Revenues are recorded when cash is received.

 Expenses are recorded when cash is paid.

 Cash-basis accounting is not in accordance with

International Financial Reporting Standards (IFRS).

3-8 LO 2
 Accrual- versus Cash-Basis Accounting

Illustration: Concordia Industries collected $105,000 from customers

in 2014. Of the amount collected, $28,000 was from revenue accrued
from services performed in 2013. In addition, Concordia recognized
$44,000 of revenue in 2014, which will not be collected until 2015.
Concordia Industries also paid $72,000 for expenses in 2014.
Of the amount paid, $30,000 was for expenses incurred on account
in 2013. In addition, Concordia incurred $37,000 of expenses in
2014, which will not be paid until 2015.

Instructions
(a) Compute 2014 cash-basis net income.
(b) Compute 2014 accrual-basis net income.

3-9 LO 5
 Accrual- versus Cash-Basis Accounting

Solution:

3-10 LO 5
 Recognizing Revenues and Expenses

REVENUE RECOGNITION PRINCIPLE

Recognize revenue in the
accounting period in which
the performance obligation is
satisfied.

3-11 LO 2
 Recognizing Revenues and Expenses

EXPENSE RECOGNITION PRINCIPLE

Match expenses with
revenues in the period when
the company makes efforts
to generate those revenues.

“Let the expenses follow the

revenues.”

3-12 LO 2
 Illustration 3-1
IFRS relationships in
revenue and expense
recognition

3-13 LO 2
 Recognizing Revenues and Expenses

Question
The revenue recognition principle states that:

a. revenue should be recognized in the accounting period in

which a performance obligation is satisfied.

b. expenses should be matched with revenues.

c. the economic life of a business can be divided into artificial

time periods.

d. the fiscal year should correspond with the calendar year.

3-14 LO 2
 > DO IT!
A list of concepts is provided in the left column below, with a description of the
concept in the right column below. There are more descriptions provided than
concepts. Match the description of the concept to the concept.

1. ___ Accrual-basis accounting. (a) Monthly and quarterly time periods.

(b) Efforts (expenses) should be matched
2. ___ Calendar year.
E

with results (revenues).

3. ___ Time period assumption. (c) Accountants divide the economic life of
4. ___ Expense recognition a business into artificial time periods.
principle. (d) Companies record revenues when they
receive cash and record expenses
when they pay out cash.
(e) An accounting time period that starts on
January 1 and ends on December 31.
(f) Companies record transactions in the
period in which the events occur.
3-15 LO 2
 The Basics of Adjusting Entries
Learning
Adjusting Entries Objective 3
Explain the reasons
for adjusting
 Ensure that the revenue recognition and entries.
expense recognition principles are followed.

 Necessary because the trial balance may not contain

up-to-date and complete data.

 Required every time a company prepares financial

statements.

 Will include one income statement account and one

statement of financial position account.

3-16 LO 3
 Adjusting Entries

Question
Adjusting entries are made to ensure that:

a. expenses are recognized in the period in which they are

incurred.

b. revenues are recorded in the period in which services are

performed.

c. statement of financial position and income statement accounts

have correct balances at the end of an accounting period.

d. All the responses above are correct.

3-17 LO 3
 Types of Adjusting Entries Learning
Objective 4
Identify the major
types of adjusting
entries.
Deferrals Accruals

1. Prepaid Expenses. 1. Accrued Revenues.

Expenses paid in cash Revenues for services
before they are used or performed but not yet
consumed. received in cash or recorded.

2. Unearned Revenues. 2. Accrued Expenses.

Cash received before Expenses incurred but not
services are performed. yet paid in cash or recorded.

Illustration 3-2
Categories of adjusting entries

3-18 LO 4
 Illustration 3-3
Trial balance Each account is analyzed to determine whether it is
complete and up-to-date for financial statement purposes.
3-19 LO 4
 Adjusting Entries for Deferrals
Learning
Deferrals are expenses or revenues that are Objective 5
Prepare adjusting
recognized at a date later than the point when entries for deferrals.
cash was originally exchanged. There are
two types:
 Prepaid expenses and

 Unearned revenues.

3-20 LO 5
 PREPAID EXPENSES

Payments of expenses that will benefit more than one

accounting period.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

 insurance  rent
 supplies  buildings and equipment
 advertising

3-21 LO 5
 PREPAID EXPENSES

 Expire either with the passage of time or through use.

 Adjusting entry:
► Increase (debit) to an expense account and

► Decrease (credit) to an asset account.

Illustration 3-4
Adjusting entries for prepaid
expenses
3-22 LO 5
 PREPAID EXPENSES

Illustration: Yazici Advertising Inc. Inc.

purchased supplies costing ₺2,500 on
October 5. Yazici recorded the purchase
by increasing (debiting) the asset
Supplies. This account shows a balance
of ₺2,500 in the October 31 trial balance.
An inventory count at the close of
business on October 31 reveals that
₺1,000 of supplies are still on hand.

Oct. 31 Supplies Expense 1,500

Supplies 1,500

3-23 LO 5
Illustration 3-5
Adjustment for supplies

3-24 LO 5
 PREPAID EXPENSES

Illustration: On October 4, Yazici Advertising

Inc. paid ₺600 for a one-year fire insurance
policy. Coverage began on October 1. Yazici
recorded the payment by increasing (debiting)
Prepaid Insurance. This account shows a
balance of ₺600 in the October 31 trial
balance. Insurance of ₺50 (₺600 ÷ 12)
expires each month.

Oct. 31 Insurance Expense 50

Prepaid Insurance 50

3-25 LO 5
Illustration 3-6
Adjustment for insurance

3-26 LO 5
 PREPAID EXPENSES

DEPRECIATION
 Buildings, equipment, and motor vehicles (assets that
provide service for many years) are recorded as
assets, rather than an expense, on the date acquired.

 Depreciation is the process of allocating the cost of an

asset to expense over its useful life.

 Depreciation does not attempt to report the actual

change in the value of the asset.

3-27 LO 5
 PREPAID EXPENSES

Illustration: For Yazici Advertising, assume

that depreciation on the equipment is ₺480 a
year, or ₺40 per month.

Oct. 31

Depreciation Expense 40
Accumulated Depreciation 40

Accumulated Depreciation is called a

contra asset account.

• HELPFUL HINT
All contra accounts have increases,
decreases, and normal balances opposite to
the account to which they relate.
3-28 LO 5
 Illustration 3-7
3-29 Adjustment for depreciation LO 5
 PREPAID EXPENSES

Statement Presentation
 Accumulated Depreciation is a contra asset account
(credit).
 Appears just after the account it offsets (Equipment)
on the balance sheet.
 Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.

Illustration 3-8
3-30 Statement of financial position presentation of accumulated depreciation LO 5
 PREPAID EXPENSES

Illustration 3-9
Accounting for prepaid expenses

3-31 LO 5
 UNEARNED REVENUES

Receipt of cash that is recorded as a liability because the

service has not been performed.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

 Rent  Magazine subscriptions
 Airline tickets  Customer deposits

3-32 LO 5
 UNEARNED REVENUES

 Adjusting entry is made to record the revenue for services

performed during the period and to show the liability that
remains at the end of the accounting period.

 Results in a decrease (debit) to a liability account and an

increase (credit) to a revenue account.
Illustration 3-10
Adjusting entries
for unearned
revenues

3-33 LO 5
 UNEARNED REVENUES

Illustration: Yazici Advertising Inc. received ₺1,200 on October 2

from R. Knox for advertising services expected to be completed by
December 31. Unearned Service Revenue shows a balance of
₺1,200 in the October 31 trial balance. Analysis reveals that the
company performed ₺400 of services in October.

Oct. 31 Unearned Service Revenue 400

Service Revenue 400

3-34 LO 5
 Illustration 3-11
Service revenue accounts after adjustment

3-35 LO 5
 UNEARNED REVENUES

Illustration 3-12
Accounting for unearned revenues

3-36 LO 5
 > DO IT!
The ledger of Zhu Company on March 31, 2017, includes these selected
accounts before adjusting entries are prepared.
(amounts in thousands) Debit Credit
Prepaid Insurance ¥ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment ¥ 5,000
Unearned Service Revenue 9,200
An analysis of the accounts shows the following.
1. Insurance expires at the rate of ¥100 per month.
2. Supplies on hand total ¥800.
3. The equipment depreciates ¥200 a month.
4. One-half of the unearned service revenue was performed in March.
Prepare the adjusting entries for the month of March.

3-37 LO 5
 Adjusting Entries for Accruals
Learning
Accruals are made to record Objective 6
Prepare adjusting
entries for accruals.
 Revenues for services performed but not
yet recorded at the statement date
(accrued revenues).

OR

 Expenses incurred but not yet paid or recorded at the

statement date (accrued expenses).

3-38 LO 6
 ACCRUED REVENUES

Revenues for services performed but not yet received in cash

or recorded.

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

 Rent  Services performed
 Interest

3-39 LO 6
 ACCRUED REVENUES

 Adjusting entry records the receivable that exists and

records the revenues for services performed.

 Adjusting entry:
► Increases (debits) an asset account and
► Increases (credits) a revenue account.

Illustration 3-13
Adjusting entries
for accrued
revenues

3-40 LO 6
 ACCRUED REVENUES

Illustration: In October, Yazici Advertising Inc.

performed services worth ₺200 that were not
billed to clients in October.

Oct. 31

Accounts Receivable 200

Service Revenue 200

On November 10, Yazici receives cash of ₺200 for the services

performed.

Nov. 10 Cash 200

Accounts Receivable 200
3-41 LO 6
 Illustration 3-14
Adjustment for accrued revenue

3-42 LO 6
 ACCRUED REVENUES

Illustration 3-15
Accounting for accrued revenues

3-43 LO 6
 ACCRUED EXPENSES

Expenses incurred but not yet paid in cash or recorded.

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

 Interest
 Taxes
 Salaries

3-44 LO 6
 ACCRUED EXPENSES

 Adjusting entry records the obligation and recognizes the

expense.

 Adjusting entry:
► Increase (debit) an expense account and
► Increase (credit) a liability account.
Illustration 3-16
Adjusting entries
for accrued
expenses

3-45 LO 6
 ACCRUED INTEREST

Illustration: Yazici Advertising Inc. signed a three-month note

payable in the amount of ₺5,000 on October 1. The note requires
Yazici to pay interest at an annual rate of 12%. Illustration 3-17
Formula for
computing interest

Oct. 31 Interest Expense 50

Interest Payable 50

3-46 LO 6
 Illustration 3-18
Adjustment for accrued interest

3-47 LO 6
 ACCRUED SALARIES AND WAGES

Illustration: Yazici paid salaries and wages on October 26; the

next payment of salaries will not occur until November 9. The
employees receive total salaries of ₺2,000 for a five-day work
week, or ₺400 per day. Thus, accrued salaries at October 31 are
₺1,200 (₺400 x 3 days).
Illustration 3-19
Calendar showing
Yazici’s pay
periods

3-48 LO 6
 Illustration 3-20
Adjustment for accrued salaries and wages

3-49 LO 6
 ACCRUED EXPENSES

Illustration 3-21
Accounting for accrued expenses

3-50 LO 6
 > DO IT!

Micro Computer Services began operations on August 1, 2017. At

the end of August 2017, management prepares monthly financial
statements. The following information relates to August.
1. At August 31, the company owed its employees ¥8,000 in
salaries and wages that will be paid on September 1.
2. On August 1, the company borrowed ¥300,000 from a local
bank on a 15-year mortgage. The annual interest rate is
10%.
3. Revenue for services performed but unrecorded for August
totaled ¥11,000.
Prepare the adjusting entries needed at August 31, 2017.

3-51 LO 6
 Summary of Basic Relationships

Illustration 3-22
Summary of adjusting entries

3-52 LO 6
 The Adjusted Trial Balance and Financial
Statements
Learning
Preparing the Adjusted Trial Balance Objective 7
Describe the
nature and
 Prepared after all adjusting entries are purpose of an
adjusted trial
journalized and posted. balance.

 Purpose is to prove the equality of debit balances and

credit balances in the ledger.

 Is the primary basis for the preparation of financial

statements.

3-53 LO 7
 Illustration 3-25
3-54
Adjusted trial balance LO 7
 Preparing the Adjusted Trail Balance

Question
Which of the following statements is incorrect concerning the adjusted
trial balance?
a. (a) An adjusted trial balance proves the equality of the total debit
balances and the total credit balances in the ledger after all
adjustments are made.
b. The adjusted trial balance provides the primary basis for the
preparation of financial statements.
c. The adjusted trial balance lists the account balances segregated
by assets and liabilities.
d. The adjusted trial balance is prepared after the adjusting entries
have been journalized and posted.

3-55 LO 7
 Preparing Financial Statements

Financial Statements are prepared directly from the

Adjusted Trial Balance.

Retained Statement of
Income
Earnings Financial
Statement
Statement Position

3-56 LO 7
 Illustration 3-26
Preparation of the income statement and retained
earnings statement from the adjusted trial balance
3-57 LO 7
 Illustration 3-27
Preparation of the statement of financial
position from the adjusted trial balance
3-58 LO 7
 > DO IT!

3-59 LO 7
 > DO IT!
(a) Determine the net income for the quarter April 1 to June 30.

3-60 LO 7
 > DO IT!
(b) Determine the total assets and total liabilities at June 30, 2017,
for Skolnick Co.

3-61 LO 7
 > DO IT!
(c) Determine the amount that appears for retained earnings at June
30, 2017.

3-62 LO 7