Completing the Accounting Cycle. The Adjustment Process At the end of a fiscal period, we have to make sure that all our financial statements are 100%

Completing the Accounting Cycle

The Adjustment Process

At the end of a fiscal period, we have to make sure that all our financial statements are 100% accurate.

We need to finalize our accounts.

When accountants prepare the financial statements, they have to make sure that:-Accounts are brought up to date,-Late transactions are taken into account,-Calculations have been made correctly, and-Accounting principles and standards have been followed.

Accounting Principles and Standards

Our financial statements need to be correct in both MATH and??

The theory.

IFRS and ASPE requires that our financial statements be relevant, reliable, and comparable.

Relevant: We need a good “picture” of the business’ important features.

Reliable: These need to be based on good evidence.

Comparable: We need to be able to look at old information and compare. With other companies too.

Accrual Accounting

Accrue means to add over time.

Both revenues and expenses accrue over time.

We do not wait until cash is received to record revenue; we do not wait until cheques are written before recording expenses. They write them in the accounts as they happen.

This is called accrual accounting.

Time is important. We cannot wait for all cash before entering transactions, we cannot always record revenues and expenses as they happen.

Financial Statement Comparability

We need to have standard fiscal periods so we can compare information.

This is a problem sometimes though. Some expenses/revenues do not occur right in line with our periods.

At the end of a period, an accountant must step in and deal with the revenues and expenses that have been accruing but haven’t been recorded yet.

LETS LOOK AT THAT.

ADJUSTING THE ACCOUNTS

This is what accountants do at the end of a fiscal period.

We want to make sure that the accounts actually have what they should.

We use adjusting entries to do this.

We need to be concerned about both the income statement and the balance sheet when we do this.

Adjusting Entries for Supplies

Lets look at the Supplies account for Markell Company.

What do these numbers mean?

Adjusting Entries for Supplies

So…balance sheet problems? Is $15,000 accurate?

What about Income Statement problems?-What would be wrong about the income statement?-What would this do to the business?

Adjusting Entries for Supplies

There is a very easy solution.

We would know right away that there is amistake with the Supplies account. SO…we“take inventory.”

So we have to adjust the new account by creating a credit. What is it for this example?

What is the debit that goes along with thiscredit?

Adjusting Entries for Supplies

Adjusting Entries for Prepaid Expenses

Sometimes businesses buy things in advance. There is no problem if the item falls entirely in a fiscal period.

Some things are in more than one period.

Prepaid expenses are things paid for in advance, but the benefits extend into the future.

Insurance is the most common of these.

So let’s pretend that Markell Company purchased a one year policy for $1800.

We would credit bank and debit the insurance expense.

Adjusting Entries for Prepaid Expenses

To adjust this kind of account, it is similar to the supplies account.

Need to figure out value, and make credits and debits.

We cannot do an “inventory” like we did with supplies. We need to do math.

The policy was for 12 months. By Dec. 31, 4 months have expired, 8 months are still prepaid. What is the true value then?

Adjusting Entries for Prepaid Expenses

Adjusting Entry for Late-Arriving Purchase Invoices

Often, businesses will buy goods or services near the end of a period. Sometimes, these things do not arrive until the next period.

Now, Revenue Recognition Principles say that we have to put expenses and revenue together in the same period.

Accountants need to make sure that the books ACCURATELY show these revenues and expenses.

Financial Statements are usually prepared after the period ends, so there is time to correct these mmistakes.

Adjusting Entry for Late-Arriving Purchase Invoices

For Markell Company, let us assume that the Senior Accountant waited until January 15 2014 for late-arriving invoices.

Let’s pretend that two show up. A phone bill $212, and utilities bill for $315.

These two invoices show costs that the business had in 2013.

Adjusting Entry for Unearned Revenue

We have only looked at expenses so far. Sometimes though, we have to adjust revenue.

Let’s pretend Markell Company deposited a cheque for $5000 on December 23, 2013.

The cheque was to pay for services that will be done in January and February 2014. The clerk debited bank $5000 and credited fees earned.

The Accountant saw this, realized a mistake was made and had to fix it.

Review of Adjusting Entries

We looked at adjusting entries for supplies, prepaid expenses, late-arriving invoices, and unearned revenue.

No matter how complicated the adjustment is, use COMMON SENSE.

Now…we adjust everything using T-Accounts. We now need to do journal entries. Let’s have a look at the entries we’ve seen so far.

Work:

Exercises #1, 3, 4, 5