HI5001 Lecture 4 Version 3

HI5001 Accounting for Business Decisions
Lecture 4
Adjusting Entries & Preparing Financial Statements
Click to edit Master title style
Overview
Lecture Lecture Topic Readings/Preparation
1 Role of Accounting for Decision Making Textbook Chapter: 1
2 Financial Statements & Decision Making Textbook Chapter: 2
3 Recording Business Transactions Textbook Chapter: 3
4 Adjusting Entries & Preparing Financial Statements Textbook Chapter: 4
5 The Accounting Cycle Textbook Chapters: 5
6 Accounting Systems Textbook Chapter: 7
7 Cash Management & Control Textbook Chapter: 11
8 Receivables Textbook Chapter: 12
9 Inventories Textbook Chapter: 6 & 13
10 Non-current Assets Textbook Chapter: 14 & 15
11 Liabilities Textbook Chapter: 16
12 Analysis & Interpretation of Financial Reports Textbook Chapter: 19
Applied Business Statistics for Managers Holmes Institute

Click to edit Master title style
Overview
Lecture 3 Lecture 4
Recording Transactions Adjusting Entries &

Preparing Financial
Statements

Topics
Click toCovered In This
edit Master titleLecture
style
Here’s what you will learn from this lecture:
1 Cash basis and accrual basis of measuring profit
2 Process involved with the preparation of financial statements
3 Different types of adjusting entries
4 Prepare an adjusted trial balance and financial statements

Topics
Click toCovered In This
edit Master titleLecture
style
Here’s what you will learn from this lecture:
5 Use a worksheet to prepare the financial statements
6 Financial statements and decision making

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Measurement of Profit
title style
Cash or
Accrual
accounting
? B
B
b
Ordinary
Illegal

title style
Profit Income Expenses
Measurement Recognition
Cash Accrual
basis basis

title style
Profit measurement
Cash Accrual
basis basis
Cash basis accounting

• Income recorded when received
• Expenses recorded when paid
• This method more applicable to small cash-only businesses

title style
Profit measurement
Cash Accrual
basis basis
Accrual basis accounting

• Income recognised when the anticipated inflow of economic
benefit can be reliably measured
• Expenses when the consumption of benefits can be reliably
measured
• This method used by the corporate sector
Measurement title style
of Profit
An example:
You own a small consulting service business. You provided

consulting service to a client for two hours during the month
of June and invoiced the client for $1000. The client paid you
in July.
Should you recognize the service revenue in June or July?

Measurement title style
of Profit
Accrual basis:
Temporary (nominal) accounts
• Income statement accounts
✓ Income
✓ Expenses
Permanent (real) accounts
• Balance sheet accounts
✓ Assets
✓ Liabilities
✓ Equity

Click to edit&Master
Temporary title style
Permanent Accounts
Temporary
accounts
Income
statement
accounts
Temporary (nominal) accounts

• These are accounts are those that apply for one accounting period only and are
closed off.
• These are the revenue/income and expense accounts which are closed off to
P/L
Click to edit&Master
Temporary title style
Permanent Accounts
Temporary Permanent
accounts accounts
Ordinary
Income
Balance sheet
statement
accounts
accounts
Permanent (real) accounts
• These are accounts that remain open from one accounting period to the next
such as asset accounts, liability accounts and equity accounts.
• They relate to the Balance Sheet and include negative-asset accounts such as
Accumulated Depreciation.
Pause Point 1title style
Pause the video here and ensure you understand the following:
• Search on the advantages and disadvantages of cash and accrual

system of accounting.
• Understand what are temporary accounts and permanent accounts

and what are the accounting treatment to them at the end of the
accounting period.

ClickAccounting
The to edit Master title– style
Cycle Further Expansion
1. Recognise and record Source documents
transactions
2. Journalise transactions General journal
3. Post to ledger accounts General ledger
4. Prepare unadjusted trial Trial balance

balance of GL (unadjusted)
Continued next slide

ClickAccounting
The to edit Master title– style
Cycle Further Expansion
5. Determine adjusting entries General

and/or journalise journal
6. Post adjusting entries to General ledger

general ledger
(accounts adjusted)
7. Prepare adjusted trial balance Trial balance

of GL (adjusted)
(adjusted)
8. Prepare financial statements worksheet Financial statements

ClickNeed
The to edit
forMaster
Adjusting
titleEntries
style
➢ In some cases the period in which cash is paid or received

does not coincide with period in which expense and income
are recognised
➢ Therefore, some accounts must be adjusted on the last day
of the accounting period to correct recognition of income and
expenses not reflected in cash receipts or payments.

Classification of Adjusting
title style
Entries
Deferrals Accruals
•Prepaid expenses • Accrued expenses

•Unearned revenues • Accrued revenues

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Deferrals - Prepaid
MasterExpenses
title style
➢ Amounts paid before the benefit is consumed
➢ Initially recorded as assets and charged to expenses in subsequent
periods as consumed
ASSET ACCOUNT
Prepaid Expenses Expense Account
Initial cost Adjusting entry Adjusting entry
Debit Credit Debit
Cost used up,

incurred or expired

Click to edit
Prepaid Expenses:
Master Prepaid
title style
Insurance
Prepaid insurance
On 1 June a 24 month insurance policy was purchased for $1,920. Initially
recorded as:
June 1 Prepaid Insurance 1,920

Cash at Bank 1920
Purchase of a 24 month fire and business liability insurance policy (Without GST)
June 1 Prepaid Insurance 1,920

GST Outlays 192
Cash at Bank 2,112
Purchase of a 24 month fire and business liability insurance policy (With GST)

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Prepaid Expenses:
Master Prepaid
title style
Insurance
Prepaid insurance (cont.)
By 30 June, the period end, we need to adjust prepaid insurance account to
reflect the consumption
June 30 Insurance expense 80

Prepaid insurance 80
Adjusting entry to record expiration of 1 month’s insurance
Prepaid insurance Insurance expense

1,920 80 80
Cost used up,
incurred or expired
Click to edit
Prepaid Expenses:
Master Office
title style
Supplies
Office supplies
On 5 June, an entry was made to record a tax invoice covering purchase of
office supplies worth $1,240.
June 5 Office Supplies 1,240

Accounts Payable 1,240
Office supplies purchased on credit (Without GST)
June 5 Office Supplies 1,240

GST Outlays 124
Accounts Payable 1,364
Office supplies purchased on credit (With GST)
Click to edit
Prepaid Expenses:
Master Office
title style
Supplies
Office supplies (Cont.)

By 30 June, the period end, we need to adjust office supplies account to reflect
the remaining supplies of $1,080.
Jun 30 Office Supplies Expense 160

Office Supplies 160
Adjusting entry to record supplies consumed in June
Office supplies Office supplies expense

1,240 160 160
Cost used up,
incurred or expired
Click to edit
Prepaid Expenses:
Master Depreciation
title style
Depreciation of Equipment & Buildings
• The portion of the asset’s cost assigned to expense is called depreciation

• Depreciation is reported as an expense in the income statement
• The balance in the Accumulated Depreciation account reflects the
portion of the cost that has been assigned to expense and accumulated
since the item was purchased

Click to edit
Prepaid Expenses:
Master Depreciation
title style
ASSET ACCOUNT
Initial cost
Debit
Adjusting
entries for CONTRA- ASSET ACCOUNT
depreciation for Accumulated Depreciation EXPENSE ACCOUNT
non-current Adjusting entry Adjusting entry
assets:
Credit Debit
Cost used up &

allocated to current
period

Click to edit
Prepaid Expenses:
Master Depreciation
title style
To illustrate:
Assume an equipment of $19 200 was purchased at 1 July 2018. It has an 8-year
useful life and a zero residual value.
The adjusting entry to record the depreciation at the end of the financial year 30
June 2019:
30 June Depreciation Expense - Equipment 2400

Accumulated Depreciation - Equipment 2400
(Adjusting entry to record depreciation of equipment for the year
ending 30 June 2019. $19200/ 8 years = $2400)

Pause the video here and take a few moments to do further study and
online research.
Provide examples of other types of prepaid expenses.
What would be the impact to the profit or loss of the entity if the adjusting
entries are not made for prepaid expenses?

Click to edit
Deferrals - Pre-collected
Master title style
or Unearned Revenue
Pre-collected or Unearned Revenue:
• Revenues received before they are earned
• Adjusting entries for pre-collected or unearned revenues:
LIABILITY ACCOUNT INCOME ACCOUNT

Unearned revenue Revenue
Adjusting entry Cash receipt Adjusting entry

Debit Credit
Revenue earned during the current

period

Pre-collected or Unearned
title style
Revenue
To illustrate:
Assume a $560 advance payment was received on 2 June for a valuation
appraisal service to be completed on 30 June.
2 June Cash at Bank 560 Liability
Unearned Appraisal Fees 560
(Cash received for appraisals to be performed on 30 June)
The Adjusting entry at 30 June is: Liability
30 June Unearned Appraisal Fees 560

Appraisal Fees Revenue 560
(Appraisal fees earned on 30 June)

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Accruals - Accrued
Master or
title
Unrecorded
style Expenses
Examples of
accrued
expenses
Accrued
Accrued
electricity
salaries
expense
Accrued
interest
expense

Click to edit
Accrued or Unrecorded
Master title Expenses
style
Accrued or Unrecorded Expenses:
• Expenses incurred but not yet paid
• Adjusting entry for Accrued or Unrecorded Expenses:
LIABILITY ACCOUNT
Expense Payable EXPENSE ACCOUNT
Adjusting entry Adjusting entry
Credit Debit
expenses incurred

Click to edit
style (cont.)
Accrued salaries (liability)

Click to edit
style (cont.)
Accrued salaries (Cont.)
On 22 June salaries were paid for the period of 8 June to 22 June:
June 22 Salary expense 3,800

Cash at bank 3,800
Salaries paid to employees

Click to edit
style (cont.)
By 30 June, the period end, we need to adjust records to recognise liability
since last pay day
June 30 Salaries expense 1,990
Salaries payable 1,990
Adjusting entry to record salaries payable from 23 to 30 June
Salaries payable Salary expense

Initial salaries
1,990 1,990
Earned, but not

yet paid
Click to edit
style (cont.)
The liability is eliminated on 6 July when the next payment is
made to employees
July 6 Salaries payable 1,990

Salary expense 1,710
Cash at Bank 3,700
Salaries paid to employees

Click to edit
style (cont.)
Accrued interest (liability)
• On 2 June, company took on a 20 year $240,000, 8% mortgage requiring
an annual payment of $12,000 plus accrued interest
• On 30 June, adjusting entry is made to record interest expense incurred in
June:
June 30 Interest expense 1,600

Interest payable 1,600
Adjusting entry to record interest payable on mortgage for June

Click to edit
style (cont.)
Accrued electricity (liability)
• The electricity provider invoices customers after the service has been
provided
• Assume a business makes an estimate of $420 for electricity used in June
• On 30 June, adjusting entry is made to record the estimated electricity used in
June:
June 30 Electricity expense 420

Electricity account payable 420
Adjusting entry to record electricity consumed in June

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Accruals - Unrecorded
Master titleor
style
Accrued Revenue
Unrecorded or Accrued Revenue:
• Revenue earned but not yet received
• The adjusting entry for unrecorded or accrued revenue is:
ASSET ACCOUNT INCOME ACCOUNT

Accounts receivable Revenue
Debit Credit
Revenue earned but not yet

received

Click to edit or
Unrecorded Master
Accrued
title Revenue
style
To illustrate:
Assume ABC Service signed an agreement on 1 June to provide marketing

service for a monthly fee of $800. The agreement provides for fee to be received
on the 5th day of the following month.
The adjusting entry at 30 June is:
30 June Accounts Receivable 800

Marketing Service Revenue 800
(Adjusting entry to record marketing services fee receivable for
June)

– Deferrals
Click to edit
Summary Master title
& Accruals
style
Prepaid Expense
Amount paid - Services
not consumed
Deferrals B
B
b
Applied Business Statistics for Managers Ordinary Holmes Institute

– Deferrals
Click to edit
& Accruals
style
Prepaid Expense Unearned Revenue
Amount paid - Services Amount received - Services
not consumed not performed
Deferrals

– Deferrals
Click to edit
& Accruals
style
Deferrals
Accrued Expense
Amount not paid -
Expense incurred
Accruals

– Deferrals
Click to edit
& Accruals
style
Deferrals B
B
b
Ordinary
Accrued Expense Accrued Revenue
Amount not paid - Amount not received -
Expense incurred Services performed
Accruals

Pause the video here and take a few moments to do further

study and research.
Provide other examples to each type of adjustments.

Click to edit
Adjusted Trial
Master
Balance
title style
• Same accounting process applied.
• Unadjusted trial balance used as starting point.
• Adjusting entries are posted to the general ledger.
• An adjusted trial balance can then be prepared.
• Reflects balances in ledger accounts after end-of-period
adjusting entries
• Debits must still equal credits.
• Adjusting entries always affect an income statement and a
balance sheet account.

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Adjusted Trial
Master
Balance
title style

Click to edit
Adjusted Trial
Master
Balance
title style
Preparation of Financial Statements
• Income statement
✓Prepared first to determine profit or loss
✓Reflects entity’s performance
• Statement of changes in equity
✓Profit (loss) must be added to (subtracted from) equity
✓Shows details of movements in equity
✓Equity balance is reported in balance sheet

Click to edit
Adjusted Trial
Master
Balance
title style
Preparation of Financial Statements
• Balance sheet:
✓ Reflects entity’s financial position as at the end of the
period.
✓ Three major categories of accounts:
o Assets
o Liabilities
o Equity
✓ Statement users find it useful if assets and liabilities are
further classified.

Click to edit
Adjusted Trial
Master
Balance
title style
Subcategories for Assets and Liabilities
ASSETS LIABILITIES
• Current assets • Current liabilities
✓ Cash at bank ✓ Account payables
✓ Account receivables ✓ Unearned revenues
✓ Inventory ✓ Short terms loans
✓ Supplies • Non-current liabilities
✓ Prepaid Expenses ✓ Long term loans
✓ Other short term assets ✓ Mortgages payable
• Non-current assets ✓ Other long terms debts
✓ Investments
✓ PPE
✓ Intangible assets
✓ Other assets

Distinguishing
current
titleand
style
non-current Assets
& Liabilities
The Operating Cycle

Pause the video here and take a few moments to do some online
research.
Download the financial statements of a company and familiarize yourself

with the types of accounts included in the financial statements.

Preparing Financial
Click to edit title style from a worksheet
MasterStatements
• Assembles all information needed to adjust the accounts and

prepare financial statements
• Aids in the preparation of interim financial statements when

adjusting and closing entries are not required
• Contains information needed to close off profit and loss

accounts for the period

Preparing Financial
MasterStatements
10 Columns Worksheet
Trial Balance Adjustments Adjusted Trial Balance Financial Performance Financial Position
Account Names
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
Cash
Accounts Receivable
Prepaid insurance
Roofing Supplies
Equipment
Accumulated Dep. -
Equipment
Accounts Payable
Unearned Service
Revenue
Capital
Drawings
Service Revenue
Salaries Expense
Miscellaneous Expense
Insurance expense
Supplies expense
Depreciation expense
Accrued salaries
Total

Preparing Financial
MasterStatements
Preparation of the worksheet:

1. Enter ledger account titles and balances in the account title
and unadjusted trial balance columns
2. Enter the adjustments in the adjustment column
3. Prepare an adjusted trial balance
4. Extend adjusted balances to the financial statements’
columns
5. Next slide

Preparing Financial
MasterStatements
Worksheet
Preparation of the worksheet (Cont.)
5. Total the two income statement columns and the two balance
sheet columns.
Calculate the difference between the totals of the two income
statement columns and enter this as a balancing amount in
both the income statement and balance sheet columns.
Calculate the four column totals again with the balancing
amount included.

Preparing
Click to edit Financial title style from a worksheet
MasterStatements
Worksheet
An Example: The trial balance of Stein Roofing at 30 June 2009 is as follows:
STEIN ROOFING
Trial Balance
As at 30 June 2009
Account Debit ($) Credit ($)
Cash 2300
Accounts Receivable 2600
Prepaid insurance 2000
Roofing Supplies 1100
Equipment 6000
Accumulated Depreciation - Equipment 1200
Accounts Payable 1100
Unearned Service Revenue 300
Stein Roofing, Capital 7400
Drawings 1000
Service Revenue 5600
Salaries Expense 500
Miscellaneous Expense 100
Total $ 15600 $ 15600
Preparing Financial
MasterStatements
An Example (Cont.)
Additional information for the period:

a. Insurance expired during the year $1000
b. A physical count reveals only $520 of roofing supplies on hand
c. Equipment is depreciated of $1200
d. Unearned service revenue amounted to $100 on 30 June ($200
unearned service revenue was earned)
e. Accrued salaries are $850
f. Accrued service revenue, $ 800
Required:
1) Enter the trial balance on a worksheet and complete the worksheet.
2) Prepare the adjusting journal entries.

Preparing Financial
MasterStatements
Trial Balance Adjustments Adjusted Trial Balance Financial Performance Financial Position
Account Names
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
Cash 2300 2300 2300
Accounts Receivable 2600 800 (f) 3400 3400
Prepaid insurance 2000 1000 (a) 1000 1000
Roofing Supplies 1100 580 (b) 520 520
Equipment 6000 6000 6000
Acc. Dep. - Equipment 1200 1200 (c) 2400 2400
Accounts Payable 1100 1100 1100
Unearned Revenue 300 200 (d) 100 100
Capital 7400 7400 7400
Drawings 1000 1000 1000
5600 200 (d) 6600 6600
Service Revenue 800 (f)
Salaries Expense 500 850 (e) 1350 1350
Miscellaneous Expense 100 100 100
Insurance expense 1000 (a) 1000 1000
Supplies expense 580 (b) 580 580
Depreciation expense 1200 (c) 1200 1200
Accrued salaries 850 (e) 850 850
Total 18450 18450 4230 6600 14220 11850
2370 2370
6600 6600 14220 14220

Click toofedit
Re-cap the Master title style
Accounting Cycle
1 Recognize & record transactions
2 Journalize transaction
3 Post to ledger accounts
4 Prepare unadjusted trial balance

Click toofedit
Accounting Cycle
3 Post to ledger accounts
4 Prepare unadjusted trial balance 5 Determine adjusting entries

Click toofedit
Accounting Cycle
3 Post to ledger accounts 6 Post adjusting entries to ledger

Click toofedit
Accounting Cycle
2 Journalize transaction 7 Prepare adjusted trial balance

Click toofedit
Accounting Cycle
1 Recognize & record transactions 8 Prepare financial statements
2 Journalize transaction 7 Prepare adjusted trial balance

Pause the video here and take a few moments to do further practice.
Understand how to complete the adjustments in a worksheet.
Understand why a worksheet is used.
Understand how a worksheet will help in the preparation of financial

statements.

Critical
Clickareas addressed
to edit by Financial
Master title style Statement Analysis
Analysis
Use of financial
Is statements
business
profitable?
ABC Corp

Critical
Analysis
Use of financial
statements
Is business
profitable?
ABC Corp
Is profit
satisfactory
?

Critical
Analysis
Use of financial
Is statements
business
profitable?
ABC Corp
Is profit
satisfactory
?
Is
business
solvent?

Critical
Analysis
Use of financial
Is
statements
business
profitable?
ABC Corp
Is profit
satisfactory
?
Is
business
solvent?
Availability
of cash?

Critical
Analysis
Use of financial
Is statements
business
profitable?
ABC Corp
Is profit
satisfactory
?
Is Requirement
business of bank
solvent? overdraft?
Availability
of cash?

Critical
Analysis
Use of financial
Is
statements
business
profitable?
ABC Corp
Additional
Is profit
Capital
satisfactory
requirement
?
?
Is Requirement
business of bank
solvent? overdraft?
Availability
of cash?

Critical
Analysis
Use of financial
statements Long term
Is business
debt
profitable?
finance?
ABC Corp
Is profit Additional
satisfactory Capital
requirement
?
?
Ordinary
Requirement
Is business
of bank
solvent?
overdraft?
Availability
of cash?

Click to edit
Financial Statements
Master title
& style
Decision Making
A case study for Financial Statements & Decision Making:

ABC Learning
https://www.youtube.com/watch?v=YYF6JW9vJKo&list=PL12C0ADD577F
6B741
David Koch presents the ABC of a Corporate Collapse for CPA

Australia, a step-by-step guide through the financial and
business decisions that lead to the spectacular collapse of ABC
Learning.

Key Take
Click Aways
to edit Master title style
Summary of Lecture 4
• Cash basis and accrual basis of measuring profit

• Process involved with the preparation of financial statements
• Different types of adjusting entries
• Prepare an adjusted trial balance and financial statements
• Use a worksheet to prepare the financial statements
• Financial statements and decision making

End ofto
Click Lecture 4
edit Master title style
• Recommended Readings:
Hoggett & Edwards - Chapter 4
• Tutorial Questions
Hoggett & Edwards - Chapter End Questions
• Discussion Board & Drop-in Session

Post your questions in the discussion board
• Next Lecture
Lecture 5 – Complete the Accounting Cycle

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HI5001 Accounting for Business Decisions

Applied Business Statistics for Managers Holmes Institute

Recording Transactions Adjusting Entries &

Applied Business Statistics for Managers Holmes Institute

1 Cash basis and accrual basis of measuring profit

2 Process involved with the preparation of financial statements

3 Different types of adjusting entries

4 Prepare an adjusted trial balance and financial statements

Applied Business Statistics for Managers Holmes Institute

5 Use a worksheet to prepare the financial statements

6 Financial statements and decision making

Applied Business Statistics for Managers Holmes Institute

Applied Business Statistics for Managers Holmes Institute

Profit Income Expenses

Applied Business Statistics for Managers Holmes Institute

Cash basis accounting

Applied Business Statistics for Managers Holmes Institute

Accrual basis accounting

You own a small consulting service business. You provided

Should you recognize the service revenue in June or July?

Applied Business Statistics for Managers Holmes Institute

Applied Business Statistics for Managers Holmes Institute

Temporary (nominal) accounts

• Search on the advantages and disadvantages of cash and accrual

• Understand what are temporary accounts and permanent accounts

Applied Business Statistics for Managers Holmes Institute

2. Journalise transactions General journal

3. Post to ledger accounts General ledger

4. Prepare unadjusted trial Trial balance

Continued next slide

Applied Business Statistics for Managers Holmes Institute

5. Determine adjusting entries General

6. Post adjusting entries to General ledger

7. Prepare adjusted trial balance Trial balance

8. Prepare financial statements worksheet Financial statements

Applied Business Statistics for Managers Holmes Institute

➢ In some cases the period in which cash is paid or received

Applied Business Statistics for Managers Holmes Institute

•Prepaid expenses • Accrued expenses

Applied Business Statistics for Managers Holmes Institute

Cost used up,

Applied Business Statistics for Managers Holmes Institute

June 1 Prepaid Insurance 1,920

June 1 Prepaid Insurance 1,920

Applied Business Statistics for Managers Holmes Institute

June 30 Insurance expense 80

Prepaid insurance Insurance expense

Initial cost Adjusting entry Adjusting entry

June 5 Office Supplies 1,240

June 5 Office Supplies 1,240

Office supplies (Cont.)

Jun 30 Office Supplies Expense 160

Office supplies Office supplies expense

• The portion of the asset’s cost assigned to expense is called depreciation

Applied Business Statistics for Managers Holmes Institute

Cost used up &

Applied Business Statistics for Managers Holmes Institute

30 June Depreciation Expense - Equipment 2400

Applied Business Statistics for Managers Holmes Institute

Provide examples of other types of prepaid expenses.

Applied Business Statistics for Managers Holmes Institute

LIABILITY ACCOUNT INCOME ACCOUNT

Adjusting entry Cash receipt Adjusting entry

Revenue earned during the current