Chapter 4: Adjusting the Accounts

Explain accrual accounting and state how it

improves financial statements.
 i.e., A client paid Sea Wind Resort P7,
Accrual basis 000 on 8 Apr for accommodation on
May 13, 2022.
 Financial statements are prepared
o Under accrual, it will only be
o Except cash flow statement
recognized as revenues when
o Inform users of:
services have been rendered
 past transactions
o Under cash basis, it will be
 obligations in the future
considered as revenue of 8 Apr
 cash to be received
itself.
 Effects of transactions are recognized
o Observe that accrual basis
when they occur
provide better measure of the
o Not as cash is received or paid
results of transactions
 Records revenue as they are earned
 Records expenses as they are incurred Periodicity Concept

 Generally accepted accounting Liquidation: how to objectively determine the

principles require that a business use success of a business
an accrual basis.
 Close its doors
 Sell all its assets

Cash-basis  Pay the liabilities

 Return any excess cash
 Doesn’t record until cash is received or
paid But, it’s not a practical way of measuring
 Cash are treated as revenues performance

 Cash basis income

It’s valued when it’s relayed early enough
o The difference between
To do this, we have artificial time periods to
operating cash receipts and
provide timely information
disbursements
 Exclude: Investment by and distribution Thus, the “Periodicity concept”
to the owner in the income
Accounting periods are generally a month, a
quarter, or a year.
The most basic accounting period, a year.
1. Fiscal year: any 12 consecutive months
2. Natural: Ends at their lowest level of
the annual cycle “seasonal”
3. Calendar: annual period ending on Dec
31.
4. Interim: less than a year
“Some even do 52 weeks”
Use of periodic reports
1. To know financial condition and
performance
2. Ensure report at regular intervals
3. Recognition & derecognition principles
(use of accruals)
To measure profit income and expense are
updated before the end of the period
4.3 Recognition and Derecognition
Recognition: “inclusion” in the statement of
financial position or the statement of financial
performance
“Carrying amount” the amount to which an
asset, liability or equity in the financial position.
Statement of Financial Position and the
Statement of Financial Performance
 Structured summaries
 Designed to make financial information
comparable;
 and understandable
Recognition links the statement of financial
position and the statements of financial
performance
The recognition of one item requires the
recognition or derecognition of or more items
a. Recognition of Income
1. Recognition of asset; increase in
carrying amount of asset
2. Derecognition of liability; decrease
in carrying amount of liability.
b. Recognition of Expenses
1. Recognition of liability; increase in
carrying amount of liability
2. Derecognition of an asset; decrease
in carrying amount of asset.
Matching of costs with income: the
simultaneous recognition of income and related
expense
Recognition is appropriate when:
1. It results in relevant information
2. Faithful representation
Derecognition: “removal” of all or a part initially
recognized from an entity’s statement of
financial position
Occurs when: Entity no longer meets definition
For asset, loss of control of all or a part of
recognized asset
For liability, entity has no obligation for all or a
part of recognized liability
4.4 Revenue from contracts with customers
(PFRS 15)
“Asset-liability approach” as a basis for
revenue recognition
Dependent on changes in assets and liabilities
Entities analyze contracts because:
1. To be informed of the terms of
transactions
2. Know measurement of consideration
3. Specify promises agreed upon
Note: “A contract is an agreement between
two or more parties that creates enforceable
rights and obligations.”
PFRS 15 defines performance obligation as a
promise in a contract to provide a product or
service to a customer
Transaction price: “amount of consideration”
To which an entity expects to be entitled in
exchange for promised goods or services
*Does not include third-party collections
If more than one performance obligation or
contracts are listed, allocate the transaction
price based on relative fair values.
Fair value: what the good or service could be
sold on a stand-alone basis or selling price.
When does an entity satisfy its performance
obligation “contract”?
When the customer obtains control of good or
service
 Can be satisfied over time or a point in
time
THE NEED FOR ADJUSTMENTS
 To reflect in the accounts information
on economic activities that have not yet
occurred but have not yet been
recorded
 Assign revenues to the period where
they are earned
 Assign expenses to the period where
they are incurred
 These entries allow proper measuring
of profit for the period
 To bring asset and liability to correct
balances for the financial statements
 Adjusting is done to apply recognition
and derecognition principle thus
reporting the effects of transactions at
the end of the period
 Changing accounts from the current
balance to the correct balance for
proper financial reporting
 Without financial entries, financial
statements may not fairly show the
 solvency of the entity in the balance o Already recorded in a balance
sheet and the profitability in the sheet account
income statement. o Decrease: balance sheet;
increase: income statement
1. End of the period – adjusting entries o Allocating assets to expense to
are recorded in the General Journal reflect expenses incurred
2. Posting to the ledger  Prepaid insurance
3. Adjusted trial balance  Supplies
 Depreciation
DEFERRALS AND ACCRUALS
o Allocating revenues received in
 Adjusting entries are used to apply the
advance to reflect revenues
accrual accounting that cover more
earned
than one accounting period – thus, the
 subscriptions
deferrals and accruals.
 Adjusting entry affect a balance sheet
Accrual:
account (asset or liability) and an
income statement account (income or
expense)

Deferral: the postponement of the

recognition of

o To be earned; to be incurred

Expense already paid; not incurred

Revenue already collected; not

earned