Professional Documents
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CHAPTER3
Adjusting the
Accounts
3-2
3-3
Timing Issues
.....
Jan. Feb. Mar. Apr. Dec.
Review
The time period assumption states that:
a. revenue should be recognized in the accounting
period in which it is earned.
In a service enterprise,
revenue is considered to be
earned at the time the
service is performed.
Review
One of the following statements about the accrual basis of
accounting is false. That statement is:
a. Events that change a company’s financial statements
are recorded in the periods in which the events occur.
b. Revenue is recognized in the period in which it is
earned.
c. The accrual basis of accounting is in accord with
generally accepted accounting principles.
d. Revenue is recorded only when cash is received, and
expenses are recorded only when cash is paid.
Review
Adjusting entries are made to ensure that:
a. expenses are recognized in the period in which
they are incurred.
b. revenues are recorded in the period in which they
are earned.
c. balance sheet and income statement accounts
have correct balances at the end of an accounting
period.
d. all of the above.
Deferrals Accruals
1. Prepaid Expenses. 3. Accrued Revenues.
Expenses paid in cash and Revenues earned but not yet
recorded as assets before received in cash or
they are used or consumed. recorded.
Trial Balance –
Each account is
analyzed to
determine
whether it is
complete and up-
to-date.
Illustration 3-3
Prepaid expenses
OR
Unearned revenues.
Prepaid Expenses
Payment of cash, that is recorded as an asset because
service or benefit will be received in the future.
Prepaid Expenses
Expire either with the passage of time or through use.
Adjusting entry:
► Increase (debit) to an expense account and
► Decrease (credit) to an asset account.
Illustration 3-4
3-22 SO 5
The Basics of Adjusting Entries
3-24 SO 5
The Basics of Adjusting Entries
Depreciation
Oct. 31
Depreciation expense 40
Accumulated depreciation 40
3-27 SO 5
The Basics of Adjusting Entries
Statement Presentation
Illustration 3-9
Unearned Revenues
Receipt of cash that is recorded as a liability because the
revenue has not been earned.
Unearned Revenues
Adjusting entry is made to record the revenue that
has been earned and to show the liability that remains.
Results in a decrease (debit) to a liability account
and an increase (credit) to a revenue account.
Illustration 3-10
3-33 SO 5
The Basics of Adjusting Entries
Illustration 3-12
Revenues earned
OR
Expenses incurred
Accrued Revenues
Revenues earned but not yet received in cash or recorded.
Accrued Revenues
Adjusting entry shows the receivable that exists and
records the revenues earned.
Adjusting entry:
► Increases (debits) an asset account and
► Increases (credits) a revenue account.
Illustration 3-13
3-38 SO 6
The Basics of Adjusting Entries
Oct. 31
Accounts receivable 200
Service revenue 200
3-40 SO 6
The Basics of Adjusting Entries
Illustration 3-15
Accrued Expenses
Expenses incurred but not yet paid in cash or recorded.
Accrued Expenses
Adjusting entry records the obligation and recognizes
the expense.
Adjusting entry:
► Increase (debit) an expense account and
► Increase (credit) a liability account.
Illustration 3-16
3-43 SO 6
The Basics of Adjusting Entries
3-45 SO 6
3-46
The Basics of Adjusting Entries
3-48 SO 6
The Basics of Adjusting Entries
Illustration 3-21
3-51 SO 7 Describe the nature and purpose of the adjusted trial balance.
Illustration 3-25
3-52
The Adjusted Trial Balance
Review
Which of the following statements is incorrect concerning the
adjusted trial balance?
a. An adjusted trial balance proves the equality of the total
debit balances and the total credit balances in the ledger
after all adjustments are made.
b. The adjusted trial balance provides the primary basis for
the preparation of financial statements.
c. The adjusted trial balance lists the account balances
segregated by assets and liabilities.
d. The adjusted trial balance is prepared after the adjusting
entries have been journalized and posted.
3-53 SO 7 Describe the nature and purpose of the adjusted trial balance.
The Financial Statements
Financial
FinancialStatements
Statementsare
areprepared
prepareddirectly
directlyfrom
fromthe
the
Adjusted
AdjustedTrial
TrialBalance.
Balance.
Owner’s
Balance Income
Equity
Sheet Statement
Statement
3-54 SO 7 Describe the nature and purpose of the adjusted trial balance.
Illustration 3-26
3-55 SO 7
Illustration 3-27
3-56 SO 7
APPENDIX3A
Alternative Treatment of Prepaid Expenses
and Unearned Revenues
When a company prepays an expense, it debits that
amount to an expense account.
Key Points
Companies applying IFRS also use accrual-basis accounting to
ensure that they record transactions that change a company’s
financial statements in the period in which events occur.
Similar to GAAP, cash-basis accounting is not in accordance with
IFRS.
IFRS also divides the economic life of companies into artificial
time periods. Under both GAAP and IFRS, this is referred to as the
time period assumption.
IFRS requires that companies present a complete set of financial
statements, including comparative information annually.
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IFRS A Look at IFRS
Key Points
GAAP has more than 100 rules dealing with revenue recognition.
Many of these rules are industry specific. In contrast, revenue
recognition under IFRS is determined primarily by a single
standard. Despite this large disparity in the amount of detailed
guidance devoted to revenue recognition, the general revenue
recognition principles required by GAAP that are used in this
textbook are similar to those under IFRS.
As the Feature Story illustrates, revenue recognition fraud is a
major issue in U.S. financial reporting. The same situation occurs
in other countries, as evidenced by revenue recognition
breakdowns at Dutch software company Baan NV, Japanese
electronics giant NEC, and Dutch grocer AHold NV.
3-62
IFRS A Look at IFRS
Key Points
A specific standard exists for revenue recognition under IFRS (IAS
18). In general, the standard is based on the probability that the
economic benefits associated with the transaction will flow to the
company selling the goods, providing the service, or receiving
investment income. In addition, the revenues and costs must be
capable of being measured reliably. GAAP uses concepts such as
realized, realizable (that is, it is received, or expected to be
received), and earned as a basis for revenue recognition.
Under IFRS, revaluation of items such as land and buildings is
permitted. IFRS allows depreciation based on revaluation of
assets, which is not permitted under GAAP.
3-63
IFRS A Look at IFRS
Key Points
The terminology used for revenues and gains, and expenses and
losses, differs somewhat between IFRS and GAAP. For example,
income is defined as:
Increases in economic benefits during the accounting
period in the form of inflows or enhancements of assets or
decreases of liabilities that result in increases in equity, other
than those relating to contributions from shareholders.
Expenses are defined as:
Decreases in economic benefits during the accounting
period in the form of outflows or depletions of assets or
incurrences of liabilities that result in decreases in equity other
than those r elating to distributions to shareholders.
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IFRS A Look at IFRS
3-65
IFRS A Look at IFRS
GAAP:
a. provides very detailed, industry-specific guidance on
revenue recognition, compared to the general
guidance provided by IFRS.
b. provides only general guidance on revenue
recognition, compared to the detailed guidance
provided by IFRS.
c. allows revenue to be recognized when a customer
makes an order.
d. requires that revenue not be recognized until cash is
received.
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IFRS A Look at IFRS
3-67
IFRS A Look at IFRS
3-68
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