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Financial Accounting Chapter Preview

IFRS 4th Edition
In Chapter 1, you learned a neat little formula:
Weygandt ● Kimmel ● Kieso Net income = Revenues – Expenses.
In Chapter 2, you learned some rules for recording revenue and
expense transactions.
Guess what?
Chapter 3 Things are not really that nice and neat. In fact, it is often difficult
for companies to determine in what time period they should report
Adjusting the Accounts some revenues and expenses. In other words, in measuring net
income, timing is everything.

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Chapter Outline

Learning Objective 1
Explain the accrual basis of accounting
and the reasons for adjusting entries.

The learning objectives for Appendix A and B follow below the chapter slides.

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Accrual-Basis Accounting and Fiscal and Calendar Years

Adjusting Entries • Accounting time periods are generally a month, a quarter, or a
year.
Time period (or periodicity) assumption: • Monthly and quarterly time periods are called interim periods.
Accountants divide the economic life of a business into artificial
time 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.
• Sometimes a company’s year-end will vary from year to year,
resulting in accounting periods of either 52 or 53 weeks.

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Accrual- versus Cash-Basis Accounting Accrual- versus Cash-Basis Accounting

Accrual-Basis Accounting Cash-Basis Accounting
• Transactions are recorded in the periods in which the events • Revenues are recorded when cash is received.
occur. • Expenses are recorded when cash is paid.
• Companies recognize revenues when they perform services
• Cash-basis accounting is not in accordance with IFRS.
(rather than when they receive cash).
• Expenses are recognized when incurred (rather than when paid).
• Accrual-basis accounting is in accordance with IFRS.

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Recognizing Revenues and Expenses Recognizing Revenues and Expenses

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Recognizing Revenues and Expenses The Need for Adjusting Entries

• Adjusting entries ensure that the revenue
recognition and expense recognition principles are
followed.
• Required every time a company prepares financial
statements.
• Will include one income statement account and one
statement of financial position account.

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The Need for Adjusting Entries Types of Adjusting Entries

Reasons:
1. Some events are not recorded daily because it is not
efficient to do so.
2. Some costs are not recorded during the accounting
period because these costs expire with the passage
of time rather than as a result of recurring daily
transactions.
3. Some items may be unrecorded.

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Analyze each account to determine whether it is complete and up-

to-date for financial statement purposes.
DO IT! Timing Concepts

Continues on next slide

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DO IT! Timing Concepts

ACTION PLAN
Learning Objective 2
• Review the definitions of the timing concepts in the
Glossary Review section. Prepare adjusting entries for deferrals.
• Study carefully the revenue recognition principle, the
expense recognition principle, and the time period
assumption.

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Adjusting Entries for Deferrals Prepaid Expenses

Prepaid expenses are costs that expire either with the passage of
time (e.g., rent and insurance) or through use (e.g., supplies).

Prior to adjustment, assets are overstated and expenses are

understated.
Deferrals are expenses or revenues that are recognized at a date
later than the point when cash was originally exchanged.

There are two types:

• Prepaid expenses, and
• Unearned revenues.

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Supplies Supplies
Assume: Yazici Advertising 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.

Demonstrate: How do you record the adjustment for supplies?

Rather than record supplies expense as the supplies are used,

companies recognize supplies expense at the end of the
accounting period.
Continues on next slide

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Supplies Insurance

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Insurance Insurance
Assume: On October 4, Yazici Advertising paid 600 for a one-
year fire insurance policy. Coverage began on October 1.
Yazici recorded the payment by increasing (debiting) Prepaid
Insurance.

Demonstrate: How do you record the adjustment for

insurance?

Continues on next slide

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Depreciation Depreciation
Assume: For Yazici Advertising, depreciation on the equipment is
Depreciation is the process of allocating the 480 a year, or 40 per month.
cost of an asset to expense over its useful
life.
Demonstrate: How do you record the adjustment for
Depreciation is an allocation concept, not a depreciation?
valuation concept.

That is, 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.

Continues on next slide

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Depreciation Prepaid Expenses

Statement Presentation.
HELPFUL HINT
All contra accounts
have increases,
decreases, and
normal balances 1
opposite to the
account to which
they relate.

1 Book value or carrying value: Difference between the cost of any

depreciable asset and its related accumulated depreciation

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Prepaid Expenses Summary Unearned Revenues

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Unearned Revenues Service Revenue

When companies receive cash before services are performed, they record a Assume: Yazici Advertising received 1,200 on October 2 from R.
liability by increasing (crediting) a liability account called unearned revenues.
Knox for advertising services expected to be completed by
Prior to adjustment, liabilities are overstated and revenues are understated. December 31. Yazici credited the payment to Unearned Service
Revenue. This liability account shows a balance of 1,200 in the
October 31 trial balance.

Demonstrate: How do you record the adjustment for advertising

revenue?

Continues on next slide

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Service Revenue Unearned Revenues

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Accounting Across the Organization Marks & Spencer plc

Turning Gift Cards into Revenue

Suppose that Robert Jones purchases a €100 gift card on
December 24, 2019, and gives it to his wife, Mary Jones, on
December 25, 2019. On January 3, 2020, Mary uses the card to
purchase €100 worth of CDs. When do you think the company Learning Objective 3
should recognize revenue and why?
Prepare adjusting entries for accruals.

Answer and additional questions: See the book’s companion website.

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Adjusting Entries for Accruals Accrued Revenues

Accruals are made to record the following:

• 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

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Accrued Revenues Accrued Revenues

Assume: In October, Yazici Advertising performed
services worth 200 that were not billed to clients on or
before October 31. Because these services were not
billed, they were not recorded.

Demonstrate: How do you adjust for accrued revenue?

Prior to adjustment, both assets and revenues are understated.

An adjusting entry for accrued revenues results in an increase (a debit) to an asset

account and an increase (a credit) to a revenue account.
Continues on next slide

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Accrued Revenues Accrued Revenues

Assume: On November 10, Yazici receives cash of 200
for the services performed in October and makes the
following entry.

Demonstrate: How do you record the collection of the

receivables?

Continues on next slide

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Accrued Revenues Accrued Revenues - Summary

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Accrued Expenses Accrued Interest

Assume: Yazici Advertising 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%.

Demonstrate:
(1) How do you determine the interest to be recorded?
(2) How do you create the adjustment for accrued
interest?
Prior to adjustment, both liabilities and expenses are understated.

An adjusting entry for accrued expenses results in an increase (a debit) to an expense

account and an increase (a credit) to a liability account.
Continues on next slide

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Accrued Interest Accrued Interest

Continues on next slide

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Accrued Salaries and Wages Accrued Salaries and Wages

Assume: At October 31, the salaries and wages for these
three days represent an accrued expense and a related
liability to Yazici. The employees receive total salaries
and wages of 2,000 for a five-day work week, or 400 per
day. Thus, accrued salaries and wages at October 31 are
1,200 ( 400 × 3).

Demonstrate: How do you create the adjustment for

accrued salaries and wages?

Continues on next slide

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Accrued Salaries and Wages Accrued Salaries and Wages

Assume: Yazici pays salaries and wages every two weeks.
Consequently, the next payday is November 9, when the company
will again pay total salaries and wages of 4,000. The payment
consists of 1,200 of salaries and wages payable at October 31 plus
2,800 of salaries and wages expense for November (7 working
days, as shown in the November calendar × 400).

Demonstrate: Which entry does Yazici make on November 9?

Continues on next slide

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Accrued Salaries and Wages Accrued Expenses - Summary

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Adjusting Entries Summary of Basic Relationships

1) Adjusting entries should not involve debits or credits to
Cash.
2) Evaluate whether the adjustment makes sense. For example,
an adjustment to recognize supplies used should increase
Supplies Expense.
3) Double-check all computations.
4) Each adjusting entry affects one statement of financial
position account and one income statement account.

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Summary of Basic Relationships DO IT! Adjusting Entries for Accruals

ACTION PLAN
• Make adjusting entries at the end of the period to recognize revenues for services
performed and for expenses incurred.
• Don’t forget to make adjusting entries for accruals. Adjusting entries for accruals will
increase both a statement of financial position account and an income statement
account.

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Adjusted Trial Balance and

Financial Statements
Learning Objective 4
Describe the nature and purpose of an
adjusted trial balance. Adjusted trial balance:

• Proves the equality of the total debit balances and the total
credit balances in the ledger after all adjustments.
• Primary basis for the preparation of financial statements.

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Preparing the Adjusted Trial Balance Preparing Financial Statements (1/2)

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Preparing Financial Statements (2/2) Preparing Financial Statements (2/2)

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DO IT! Trial Balance DO IT! Trial Balance

ACTION PLAN
• In an adjusted trial balance, all asset, liability, revenue, and
expense accounts are properly stated.
• To determine the ending balance in Retained Earnings, add net
income and subtract dividends.

Continues on next slide

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Chapter Appendix Outline

Appendix 3A
Learning Objective 5*
Appendix 3B Prepare adjusting entries for the
alternative treatment of deferrals.

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Alternative Treatment of Deferrals Prepaid Expenses

Supplies
Alternative treatment:
Assume: Yazici Advertising purchased supplies costing 2,500 on
(1) When a company prepays an expense, it debits that amount to October 5. Yazici recorded the purchase by increasing (debiting)
an expense account. Supplies Expense (rather than to the asset account Supplies).
(2) When it receives payment for future services, it credits the An inventory count at the close of business on October 31 reveals
amount to a revenue account. that 1,000 of supplies are still on hand.

Demonstrate: How do you record the adjustment for supplies?

Continues on next slide

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Supplies Prepaid Expenses

Adjustment Approaches - Comparison

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Unearned Revenues Service Revenue

Service Revenue
Assume: Yazici Advertising received 1,200 on October 2
from R. Knox for advertising services expected to be
completed by October 31. However, Yazici has not
performed 800 of the services by October 31.

Demonstrate: How do you record the adjustment for

advertising?

Continues on next slide

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Unearned Revenues Summary of

Adjustment Approaches - Comparison Additional Adjustment Relationships

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Qualities of Useful Information

Fundamental Qualities
Learning Objective 6*
Discuss financial reporting concepts.

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Qualities of Useful Information Assumptions in Financial Reporting (1/2)

Enhancing Qualities
Quality: It means:
Comparability (1) Different companies use the same accounting
principles, and
(2) A company uses the same accounting principles and
methods from year to year.
Verifiability Independent observers, using the same methods, obtain
similar results
Timeliness It is necessary for accounting information to be relevant.
Understandability Information is presented in a clear and concise fashion,
so that reasonably informed users of that information
can interpret it and comprehend its meaning.

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Assumptions in Financial Reporting (2/2) Principles in Financial Reporting (1/2)

Measurement Principles
IFRS generally uses one of two measurement principles, the historical cost
principle or the fair value principle.

Historical cost principle (or cost principle): dictates that

companies record assets at their cost. This is true not only at the
time the asset is purchased, but also over the time the asset is
held.
Fair value principle: states that assets and liabilities should be
reported at fair value (the price received to sell an asset or settle
a liability).

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Principles in Financial Reporting (2/2) Cost Constraint

Revenue Recognition Principle
Requires that companies recognize revenue in the accounting period in which the
performance obligation is satisfied.

Expense Recognition Principle

Dictates that companies recognize expense in the period in which they make efforts to
generate revenue. Thus, expenses follow revenues.

Full Disclosure Principle

Requires that companies disclose all circumstances and events that would make a It weighs the cost that companies will incur to provide the
difference to financial statement users. information against the benefit that financial statement users
If an important item cannot reasonably be reported directly in one of the four types of will gain from having the information available.
financial statements, then it should be discussed in notes that accompany the
statements.

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Copyright
Copyright © 2019 John Wiley & Sons, Inc.
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or from the use of the information contained herein.

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