Financial Accounting

IFRS 4th Edition

Weygandt ● Kimmel ● Kieso

Chapter 3

Adjusting the Accounts

Chapter Preview
In Chapter 1, you learned a neat little formula:
Net income = Revenues – Expenses.
In Chapter 2, you learned some rules for recording revenue and
expense transactions.
Guess what?
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 some revenues and expenses. In other words, in
measuring net income, timing is everything.

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Chapter Outline

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

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

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 Accrual-Basis Accounting and Adjusting
Entries
Time period (or periodicity) assumption:
Accountants divide the economic life of a business into artificial
time periods.

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 Fiscal and Calendar Years
• Accounting time periods are generally a month, a quarter, or a
year.
• 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.
• 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-Basis Accounting
• Transactions are recorded in the periods in 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).
• Accrual-basis accounting is in accordance with IFRS.

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 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 IFRS.

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 Accrual- versus Cash-Basis Accounting
Example: Followings are transactions occurred in August 20X8:
1. Sent out an invoice for $5,000 for a web design project
completed this month
2. Received a bill for $1,000 in developer fees for work done this
month
3. Paid $75 in fees for a bill you received last month
4. Received $1,000 from a client for a project that was invoiced last
month
Calculating the company’s profit or loss in August 20X8 based on:
- Accruals basis
- Cash basis

LO 2
 Recognizing Revenues and Expenses

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 Recognizing Revenues and Expenses

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 Recognizing Revenues and Expenses

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 Ethics Insight Krispy Kreme

Cooking the Books?

What motivates sales executives and finance and accounting
executives to participate in activities that result in inaccurate
reporting of revenues?

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

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 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
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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 Types of Adjusting Entries

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 Learning Objective 2
Prepare adjusting entries for deferrals.

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Adjusting Entries for Deferrals

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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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.

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 Supplies

Rather than record supplies expense as the supplies are used,

companies recognize supplies expense at the end of the
accounting period.
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 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?

Continues on next slide

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 Supplies

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 Insurance

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 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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 Insurance

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 Depreciation
Depreciation is the process of allocating the
cost of an asset to expense over its useful
life.

Depreciation is an allocation concept, not a

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.

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 Depreciation
Assume: For Yazici Advertising, depreciation on the equipment is
480 a year, or 40 per month.

Demonstrate: How do you record the adjustment for

depreciation?

Continues on next slide

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 Depreciation

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

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Prepaid Expenses
Statement Presentation.

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

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 Unearned Revenues

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Unearned Revenues
When companies receive cash before services are performed, they record a
liability by increasing (crediting) a liability account called unearned revenues.

Prior to adjustment, liabilities are overstated and revenues are understated.

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 Service Revenue
Assume: Yazici Advertising received 1,200 on October 2 from R.
Knox for advertising services expected to be completed by
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

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 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
should recognize revenue and why?

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

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 Learning Objective 3
Prepare adjusting entries for accruals.

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Adjusting Entries for Accruals

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

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Accrued Revenues

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.

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 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?

Continues on next slide

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 Accrued Revenues

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 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

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 Accrued Revenues - Summary

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Accrued Expenses

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.

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 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?

Continues on next slide

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 Accrued Interest

Continues on next slide

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 Accrued Interest

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Accrued Salaries and Wages

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 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

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 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

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 Accrued Expenses - Summary

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 People, Planet, and Profit
Insight
Got Junk?
What accounting issue might this cause for companies?

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

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 Adjusting Entries
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

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 Summary of Basic Relationships

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 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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 DO IT! Adjusting Entries for Accruals
Solution

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 Learning Objective 4
Describe the nature and purpose of an
adjusted trial balance.

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Adjusted Trial Balance and
Financial Statements

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

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 Preparing Financial Statements (1/2)

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 Preparing Financial Statements (2/2)

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 Preparing Financial Statements (2/2)

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 DO IT! Trial Balance

Continues on next slide

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 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.

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 DO IT! Adjusting Entries for Accruals
Solution (1/2)

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 DO IT! Adjusting Entries for Accruals
Solution (2/2)

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Chapter Appendix Outline

Appendix 3A

Appendix 3B

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 Learning Objective 5*
Prepare adjusting entries for the
alternative treatment of deferrals.

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 Alternative Treatment of Deferrals

Alternative treatment:
(1) When a company prepays an expense, it debits that amount to
an expense account.
(2) When it receives payment for future services, it credits the
amount to a revenue account.

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 Prepaid Expenses
Supplies
Assume: Yazici Advertising purchased supplies costing 2,500 on
October 5. Yazici recorded the purchase by increasing (debiting)
Supplies Expense (rather than to the asset account Supplies).
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?

Continues on next slide

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 Supplies

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 Prepaid Expenses
Adjustment Approaches - Comparison

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 Unearned Revenues
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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 Service Revenue

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 Unearned Revenues
Adjustment Approaches - Comparison

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 Summary of
Additional Adjustment Relationships

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 Learning Objective 6*
Discuss financial reporting concepts.

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 Qualities of Useful Information
Fundamental Qualities

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 Qualities of Useful Information
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 (1/2)

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 Assumptions in Financial Reporting (2/2)

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 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)
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
difference to financial statement users.
If an important item cannot reasonably be reported directly in one of the four types of
financial statements, then it should be discussed in notes that accompany the
statements.

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 Cost Constraint

It weighs the cost that companies will incur to provide the

information against the benefit that financial statement users
will gain from having the information available.

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Copyright
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