FINANCIAL ACCOUNTING AND REPORTING
CHAPTER 4: ADJUSTING THE ACCOUNTS
Accrual Basis
The Financial Statements, except for cash flow
statement, are prepared on the accrual basis of
accounting in order to meet their objectives
The effects of transactions and other events are
recognized when they occur and not as cash is
received or paid.
Records revenues as they are earned and
expenses as they are incurred.
Cash Basis
The accountant does not record a transaction
until cash is received or paid.
Periodicity Concept
Accountants divide economic life of a business
into artificial time periods to provide timely
information.
oAccounting period are generally month,
quarter, or year.
oFiscal Year – period of any 12
consecutive months.
oCalendar Year – annual period ending
Dec. 31.
oNatural Business Year – 12 months
period that ends when business
activities are at lowest of annual cycle.
oInterim Period – period less than a year.
Deferral
Expense already paid but not yet incurred.
Revenue already collected but not yet earned.
Decreases the balance sheet account.
Increases income statement.
Deals with amount already recorded.
Prepaid Expenses
oPaid but not yet incurred
oExpenses that you paid to your vendors
in cash and are recorded as
assetsbeforethey are used/consumed.
Initial Entry
Asset: (dr) Prepaid Expense (cr) Cash
Expense: (dr) Expense (cr) Cash
Adjusting Entry
Asset: (dr) Expense (cr) Prepaid Exp
Expense: (dr) Prepaid Exp (cr) Exp
Deferred Revenue
oCollected but not yet paid.
oRevenues that your clients prepaid you
first; you received the cash but you have
not yet performed the work to merit the
cash received.
Initial Entry
Liability: (dr) Cash (cr) Unearned Rev
Income: (dr) Cash (cr) Rev
Adjusting Entry
Liability: (dr) Unearned Rev (cr) Rev
Income: (dr) Rev (cr) Unearned Rev
Accrual
Expense incurred but not yet paid.
Revenue earned but uncollected.
Expenses or revenues where the services are
used or provided or products have been
consumed but no cash has been received nor
that the events recorded in the books of the
business
Amounts unrecorded.
Increases both BS and IS.
Accrued Expense
oIncurred but not yet paid
oExpenses you have used or incurred but
you have not yet paid in cash
o(dr) Expense (cr) Payable
Accrued Revenue
oEarned but not yet collected.
oRevenues you have earned but not yet
received in cash.
o(dr) Receivable (cr) Revenue
Asset Method (used portion)
Initial Entry: (dr) Prepaid Expense, (cr) Cash
Adjusting Entry: (dr) Expense, (cr) Cash
Expense Method (unused)
Initial Entry: (dr) Expense, (cr) Cash
Adjusting Entry: (dr) Revenue, (cr) Unearned Rev
Liability Method (used)
Initial Entry: (dr) Cash, (cr) Unearned Revenue
Adjusting Entry: (dr) Unearned Rev, (cr) Revenue
Income Method (unused)
Initial Entry: (dr) Cash, (cr) Revenue
Adjusting Entry: (dr) Income, (cr) Unearned Revenue
Nominal/Temporary: Income statement accounts/
statement of profit and loss accounts.
Real/Permanent: ALE/ Balance sheet account/
statement of financial position accounts
Depreciation – Estimated amount allocated to
any one accounting period.
oCost – the amount an entity paid to
acquire depreciable asset.
Depreciation Expense = (cost-salvage value)/estimated
useful life.
Interest = Principal x Interest Rate x Length of Time
