University of Economics and

Human Sciences in Warsaw

INTERNATIONAL
FINANCIAL ACCOUNTING
Lecture IV
RAFAŁ KUSY
Ph. D. 1
 Learning objectives
After studying this session you should be able to
• Understand the role of adjustments in accrual accounting.
• 2.Make adjustments for the expiration or consumption of
assets.
• 3.Make adjustments for the recognition of unearned revenues.
• 4.Make adjustments for accrual of unrecorded expenses.
• 5.Make adjustments for the accrual of unrecorded revenues.
• 6.Describe the sequence of the final steps in the recording
process and relate cash flows to adjusting entries.
• 7.Prepare a classified balance sheet and use it to assess short-
term liquidity.
• 8.Prepare single-and multiple-step income statements.
• 9.Use ratios to assess profitability.
 The Revenue Recognition Principle
• Requires that revenues be recorded in the time
period when the work is performed.
The earnings process is complete.
Governs the timing of revenues.
 The Matching Principle
Requires that expenses be recorded in the same
time period as the revenues that helped generate.
Governs the timing of expenses.
Examples:
–Recognition of the usage of office supply office
supplies expense.
–Recognition of the usage of noncurrent assets to
generate revenues
Depreciation expense
 Adjustments to the Accounts
Explicit transactions are
–observable events that trigger nearly all day-to-
day routine entries.
–supported by source documents.
–Examples: Cash receipts, making payments etc.
Implicit transactions
–do not generate source documents or any visible
evidence that the event actually occurred.
–usually occur due to artificial timing of reporting
periods.
–are recorded in end-of-period entries called
adjustments.
 Adjustments
Adjusting entries are at the core of accrual
accounting.
The basis of accrual accounting is that net
income represents the economic realities of the
entity’s performance for the reporting period.
Adjusting entries ensure that
–all assets and liabilities and
–the resulting revenues and expenses
are properly disclosed and valued in line with the
actual economic activities of the entity.
Adjusting Entries -Classification
•Expiration of Unexpired Costs.
•Earning of Revenues Received
in Advance.
•Accrual of Unrecorded
Expenses.
•Accrual of Unrecorded
Revenues.
 Adjusting Entries - Summary
Type of account Type of account
Adjusting entry debited credited

Prepaid expense;
Expiration of Unexpired
• accumulated
Costs. Expense depreciation

•Earning of Revenues Unearned

Received in Advance. revenue Revenue
•Accrual of Unrecorded

Expenses. Expense Payable

•Accrual of Unrecorded

Revenues. Receivable Revenue

Expiration of Unexpired Costs
An explicit transaction in the past
creates an asset, and subsequent
implicit transactions to serve to
adjust the value of the asset.
 Expiration of Unexpired Costs
Example:
Cash-Purchase of €10,000 of Office Supplies
Inventory on Oct. 1, 2007
–Journal entry for explicit transaction:

–The company uses €2,000 during Oct. 2007.

Required adjusting entry:
Earning of Revenues Received in
Advance
represents payments from
customers who pay in advance for
services that the company
promises to deliver in the future.
requires recording both the
receipt of cash and the liability
for future services
Earning of Revenues Received in
Advance
A company receives rent for 3 months in advance, €6,000.
The journal entries below represent
a)An explicit transaction that recognizes the receipt of an
unearned revenue.
b)A transaction showing the adjustment for one month’s
rent earned
Earning of Revenues Received in
Advance
The revenue is recognized (earned) only
when the owner makes the adjusting entry
in transaction (b).
The liability “Unearned Rent Revenue”
is decreased (debited), the Stockholders’
equity account Rent Revenues is increased
(credited).
Failure to record the adjusting entry
overstates liabilities and understates
revenues.
Exercise –Prepayment/Precollection
On December 1, 20X7, rent of €15,000
was paid (received) for one quarter in
advance. Prepare the journal entries on
–December 1, 20X7,
–December 31, 20X7,
–January 31, 20X8,
–February 28, 20X8.
a) for the tenant,
b) for the landlord.
Adjusting Entries -Classification
•Expiration of Unexpired Costs.
•Earning of Revenues Received
in Advance.
•Accrual of Unrecorded
Expenses.
•Accrual of Unrecorded
Revenues.
 Adjusting Entries - Summary
Type of account Type of account
Adjusting entry debited credited

Prepaid expense;
Expiration of Unexpired
• accumulated
Costs. Expense depreciation

•Earning of Revenues Unearned

Received in Advance. revenue Revenue
•Accrual of Unrecorded

Expenses. Expense Payable

•Accrual of Unrecorded

Revenues. Receivable Revenue

 Accrual of Unrecorded Expenses
Some liabilities (and expenses) grow moment to
moment as time goes by. Examples include:
–Wages
–Interest
Adjustments are made to bring each accrued
expense (and corresponding liability) account up
to date at the end of the accounting period before
preparation of the financial statements.
Adjustments are necessary to accurately match
the expense to the period.
Accounting for Accrual of Wages
Assume a company owes €30,000 for
employee services rendered during the last
3 days of the month October, but will not
pay the employees for theses services until
November 5.
The following transaction shows the
entry to accrue wages for October.

Failure to record the adjustment

understates both expenses and liabilities
Accrual of Unrecorded Revenues
is the mirrow immage of the
accrual of unrecorded expenses.
An adjustment is required to
recognize revenues earned but not
received in cash
Accounting for Accrual of Revenues
Assume a tax consultant renders €10,000
of services during October, but does not bill
for these services until December.
The following adjustment is made for
unrecorded revenues for the month of
October:
 Exercise –Unrecorded
Expense/Revenue
Company A takes out a 9 % p.a., 90 day, €10,000
loan with Company B on November 2, 20X7. The
principal (= amount of the loan) and interest will
be repaid on January 31, 20X8.
Prepare the journal entries on
–November 2, 20X7,
–December 31, 20X7,
–January 31, 20X8.

a) for company A,
b) for company B
The Adjusting Process in Perspective
Each adjusting entry affects at least
–One income statement account and
–One balance sheet account.
The Cash account is not adjusted.
The end-of-period adjustment
process is reserved for implicit
transactions, which anchor the
accrual basis of accounting.
The Adjusting Process in Perspective
Transformed
NoncashAssets by Expenses Expiration
Advance Cash create in the Balance in the
Payments for of
Sheet Income
Future Services
Statement
Unexpired
to be Received
Costs
Transformed
by
Advance Cash adjustments Revenues
create Liabilities in
Collections for into in the Earnings of
the Balance
Future Sheet Income Revenues
Services to be Statement
Rendered Received in
Advance
 University of Economics and
Human Sciences in Warsaw
INTERNATIONAL
FINANCIAL ACCOUNTING
Lecture II
RAFAŁ KUSY
Ph. D. 24