Download Financial Accounting and Accounting Standards

Chapter 3
Adjusting the Accounts
Learning Objectives
After studying this chapter, you should be able to:
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1.
Explain the time period assumption.
2.
Explain the accrual basis of accounting.
3.
Explain the reasons for adjusting entries.
4.
Identify the major types of adjusting entries.
5.
Prepare adjusting entries for deferrals.
6.
Prepare adjusting entries for accruals.
7.
Describe the nature and purpose of an adjusted trial balance.
Preview of Chapter 3
Financial Accounting
IFRS Edition, 2e
Weygandt Kimmel Kieso
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Timing Issues
Accountants divide the economic life of a business into
artificial (人為的) time periods (Time Period Assumption
，會計期間假設).
.....
Jan.
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Feb.
Mar.
Apr.
Dec.

Generally a month (月), a quarter (季), or a year (年).

Also known as the “Periodicity Assumption”
LO 1 Explain the time period assumption.
Timing Issues
Fiscal and Calendar Years
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
Monthly and quarterly time periods are called interim
periods.

Most large companies must prepare both quarterly and
annual financial statements.

Fiscal Year (會計年度) = Accounting time period that is
one year in length.

Calendar Year (曆年制) = January 1 to December 31.
LO 1 Explain the time period assumption.
Timing Issues
Accrual-Basis (應計基礎) vs. Cash-Basis (現
金基礎) Accounting
Accrual-Basis Accounting (應計基礎)
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
Transactions recorded in the periods in which the
events occur.

Revenues are recognized when the services are
performed, rather than when cash is received.

Expenses are recognized when incurred, rather than
when paid.
LO 2 Explain the accrual basis of accounting.
Timing Issues
Accrual- vs. Cash-Basis Accounting
Cash-Basis Accounting (現金基礎)
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
Revenues recognized when cash is received.

Expenses recognized when cash is paid.

Cash-basis accounting is not in accordance with
International Financial Reporting Standards (IFRS).
LO 2 Explain the accrual basis of accounting.
Timing Issues
Recognizing Revenues and Expenses
Revenue Recognition Principle (收入認列原則)
Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.
In a service enterprise,
revenue is considered to be
earned at the time the service
is performed.
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LO 2 Explain the accrual basis of accounting.
Timing Issues
Recognizing Revenues and Expenses
Expense Recognition Principle
(Matching Principle，配合原則)
Match expenses with
revenues in the period when
the company makes efforts to
generate those revenues.
“Let the expenses follow
the revenues.”
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LO 2 Explain the accrual basis of accounting.
Timing Issues
Illustration 3-1
IFRS relationships in revenue
and expense recognition
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LO 2 Explain the accrual basis of accounting.
The Basics of Adjusting Entries (調整分錄)
Adjusting Entries
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
Ensure that the revenue recognition and expense
recognition principles are followed.

Necessary because the trial balance may not contain
up-to-date and complete data.

Required every time a company prepares financial
statements.

Will include one income statement account and one
statement of financial position account.
LO 3 Explain the reasons for adjusting entries.
The Basics of Adjusting Entries
Types of Adjusting Entries
Illustration 3-2
Categories of adjusting entries
Deferrals (遞延事項)
Accruals (應計事項)
1. Prepaid Expenses. (預付費
用) Expenses paid in cash
3. Accrued Revenues. (應收收
益) Revenues for services
before they are used or
consumed.
performed but not yet
received in cash or recorded.
2. Unearned Revenues. (預收
收入) Cash received before
services are performed.
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4. Accrued Expenses. (應付費
用) Expenses incurred but
not yet paid in cash or
recorded.
LO 4 Identify the major types of adjusting entries.
The Basics of Adjusting Entries
Types of Adjusting Entries
Trial Balance (試
算表) – Each
account is
analyzed to
determine whether
it is complete and
up-to-date.
Illustration 3-3
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LO 4 Identify the major types of adjusting entries.
The Basics of Adjusting Entries
Adjusting Entries for Deferrals (遞延事項)
Deferrals are either:

Prepaid expenses
OR

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Unearned revenues.
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Prepaid Expenses
Payment of cash, that is recorded as an asset because
service or benefit will be received in the future.
Cash Payment
BEFORE
Expense Recorded
Prepayments often occur in regard to:
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
insurance

rent

supplies

equipment

advertising

buildings
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
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
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LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration: Pioneer Advertising Agency
purchased supplies costing $2,500 on
October 5. Pioneer recorded the payment
by increasing (debiting) the asset
Supplies. This account shows a balance
of $2,500 in the October 31 trial balance.
An inventory count at the close of
business on October 31 reveals that
$1,000 of supplies are still on hand.
Oct. 31
Supplies expense
Supplies
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1,500
1,500
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration 3-5
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LO 5
The Basics of Adjusting Entries
Illustration: On October 4, Pioneer
Advertising paid $600 for a one-year fire
insurance policy. Coverage began on
October 1. Pioneer recorded the payment
by increasing (debiting) Prepaid
Insurance. This account shows a balance
of $600 in the October 31 trial balance.
Insurance of $50 ($600 ÷ 12) expires
each month.
Oct. 31
Insurance expense
50
Prepaid insurance
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50
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration 3-6
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LO 5
The Basics of Adjusting Entries
Depreciation
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
Buildings, equipment, and vehicles (assets with long
lives) are recorded as assets, rather than an expense,
in the year acquired.

Depreciation allocates a portion of the asset’s cost as
an expense during each period of the asset’s useful life.

Depreciation does not attempt to report the actual
change in the value of the asset.
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration: For Pioneer Advertising, assume
that depreciation on the equipment is $480 a
year, or $40 per month.
Oct. 31
Depreciation expense
Accumulated depreciation
40
40
Accumulated Depreciation is called a contra
asset account.
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LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration 3-7
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LO 5
The Basics of Adjusting Entries
Statement Presentation
3-23

Accumulated Depreciation (累計折舊) is a contra asset
account (資產抵銷科目) (credit).

Appears just after the account it offsets (Equipment) on
the statement of financial position.

Book value (帳面價值) is the difference between the
cost of any depreciable asset and its accumulated
depreciation.
Illustration 3-8
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration 3-9
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LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Unearned Revenues
Receipt of cash that is recorded as a liability because service
has not be performed.
Cash Receipt
BEFORE
Revenue Recorded
Unearned revenues often occur in regard to:
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
Rent

Magazine subscriptions

Airline tickets

Customer deposits
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Unearned Revenues

Adjusting entry is made to record the revenue for
services performed 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
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LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration: Pioneer Advertising received $1,200 on October 2
from R. Knox for advertising services expected to be completed by
December 31. Unearned Service Revenue shows a balance of
$1,200 in the October 31 trial balance. Analysis reveals that the
company earned $400 of those fees in October.
Oct. 31
Unearned service revenue
Service revenue
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400
400
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration 3-11
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LO 5
The Basics of Adjusting Entries
Illustration 3-12
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LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Adjusting Entries for Accruals
Accruals are made to record

Revenues for services performed
OR

Expenses incurred
in the current accounting period that have not been
recognized through daily entries.
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LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Accrued Revenues
Revenues for services performed but not yet received in cash
or recorded.
Revenue Recorded
BEFORE
Cash Receipt
Accrued revenues often occur in regard to:
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
Interest

Services performed

Rent
LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Accrued Revenues

Adjusting entry shows the receivable that exists and
records the revenues for services performed.

Adjusting entry:
►
Increases (debits) an asset account and
►
Increases (credits) a revenue account.
Illustration 3-13
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LO 6
The Basics of Adjusting Entries
Illustration: In October Pioneer Advertising
Agency recognized $200 for advertising
services performed but not recorded.
Oct. 31
Accounts receivable
200
Service revenue
200
On November 10, Pioneer receives cash of
$200 for the services performed.
Nov. 10
Cash
200
Accounts receivable
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200
LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Illustration 3-14
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LO 6
The Basics of Adjusting Entries
Illustration 3-15
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LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Accrued Expenses
Expenses incurred but not yet paid in cash or recorded.
Expense Recorded
BEFORE
Cash Payment
Accrued expenses often occur in regard to:
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
Rent

Taxes

Interest

Salaries
LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
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
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LO 6
The Basics of Adjusting Entries
Illustration: Pioneer Advertising signed a three-month note
payable in the amount of $5,000 on October 1. The note requires
Pioneer to pay interest at an annual rate of 12%.
Illustration 3-17
Oct. 31
Interest expense
Interest payable
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50
50
LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Illustration 3-18
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LO 6
The Basics of Adjusting Entries
Illustration: Pioneer Advertising last paid salaries on October 26;
the next payment of salaries will not occur until November 9. The
employees receive total salaries of $2,000 for a five-day work
week, or $400 per day. Thus, accrued salaries at October 31 are
$1,200 ($ 400 x 3 days).
Illustration 3-19
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LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Illustration 3-20
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LO 6
The Basics of Adjusting Entries
Illustration 3-21
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LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Summary of Basic Relationships
Illustration 3-22
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LO 6 Prepare adjusting entries for accruals.
Steps in Preparing a Worksheet
Illustration 3-25
General journal
showing adjusting
entries
Adjusting
Journal
Entries
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LO 1 Prepare a worksheet.
The Adjusted Trial Balance
Adjusted Trial Balance (調整後試算表)
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
Prepared after all adjusting entries are journalized and
posted.

Purpose is to prove the equality of debit balances and
credit balances in the ledger.

Is the primary basis for the preparation of financial
statements.
LO 7 Describe the nature and purpose of an adjusted trial balance.
Illustration 3-25
3-46
Preparing Financial Statements
Financial Statements are prepared directly from the
Adjusted Trial Balance.
Income
Statement
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Retained
Earnings
Statement
Statement
of Financial
Position
LO 7 Describe the nature and purpose of an adjusted trial balance.
Illustration 3-26
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LO 7
Illustration 3-27
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LO 7
APPENDIX 3A
Alternative Treatment of Prepaid Expenses and
Unearned Revenues
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
When a company prepays an expense, it debits that
amount to an expense account.

When a company receives payment for future
services, it credits the amount to a revenue account.
LO 8 Prepare adjusting entries for the alternative treatment of deferrals.
APPENDIX 3A
Prepaid Expenses
Company may choose to debit (increase) an expense account
rather than an asset account. This alternative treatment is simply
more convenient.
Illustration 3A-2
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LO 8 Prepare adjusting entries for the alternative treatment of deferrals.
APPENDIX 3A
Unearned Revenues
Company may credit (increase) a revenue account when they
receive cash for future services.
Illustration 3A-5
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LO 8 Prepare adjusting entries for the alternative treatment of deferrals.
APPENDIX 3A
Summary of Additional Adjustment Relationships
Illustration 3A-7
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LO 8 Prepare adjusting entries for the alternative treatment of deferrals.
APPENDIX 3B
CONCEPTS IN ACTION
Qualities of Useful Information
Illustration 3B-1
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LO 9 Discuss financial reporting concepts.
APPENDIX 3B
CONCEPTS IN ACTION
Enhancing Qualities
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
Comparability

Consistency

Verifiability

Timeliness

Understandability
LO 9 Discuss financial reporting concepts.
APPENDIX 3B
CONCEPTS IN ACTION
Illustration 3B-2
Assumptions
in Financial
Reporting
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LO 9
APPENDIX 3B
CONCEPTS IN ACTION
Illustration 3B-2
Assumptions
in Financial
Reporting
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LO 9
APPENDIX 3B
CONCEPTS IN ACTION
Principles of Financial Reporting

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Measurement Principles
►
Historical Cost Principle
►
Fair Value Principle

Revenue Recognition Principle

Expense Recognition Principle

Full Disclosure Principle
LO 9 Discuss financial reporting concepts.
APPENDIX 3B
CONCEPTS IN ACTION
Principles of Financial Reporting

Constraints in Financial Reporting
Accounting standard-setters weigh the cost that companies
will incur to provide the information against the benefit that
financial statement users will gain from having the information
available.
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LO 9
Another Perspective
Key Points
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
Like IFRS, companies applying GAAP 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 IFRS, cash-basis accounting is not in accordance with GAAP.

GAAP 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.

GAAP has more than 100 rules dealing with revenue recognition. Many
of these rules are industry specific. Revenue recognition under IFRS is
determined primarily by a single standard, IAS 18. Despite this large
disparity in the detailed guidance devoted to revenue recognition, the
general revenue recognition principles required by IFRS that are used in
this textbook are similar to those under GAAP.
Another Perspective
Key Points
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
Internal controls are a system of checks and balances designed to
detect and prevent fraud and errors. The Sarbanes-Oxley Act requires
U.S. companies to enhance their systems of internal control. However,
many foreign companies do not have this requirement.

Under IFRS, revaluation to fair value of items such as land and buildings
is permitted. This is not permitted under GAAP.

The form and content of financial statements are very similar under
GAAP and IFRS. Any significant differences will be discussed in those
chapters that address specific financial statements.

Revenue recognition fraud is a major issue in U.S. financial reporting.
The same situation exists for most other countries as well.
Another Perspective
Key Points

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As indicated above, both the IASB and FASB are working together on a
common conceptual framework. Some of the major issues that are being
addressed are:
►
What are the qualitative characteristics that make accounting
information useful?
►
What is the primary objective of financial reporting?
►
What basis should be used to measure and report, that is, should a
historical cost or fair value approach be used?
►
What criteria should be used to determine when revenue should be
recognized and when expenses have been incurred?
►
What guidelines should be established for disclosing financial
information?
Another Perspective
Key Points

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Income includes both revenues, which arise during the normal course of
operating activities, and gains, which arise from activities outside of the
normal sales of goods and services. The term income is not used this
way under GAAP. Instead, under GAAP income refers to the net
difference between revenues and expenses. Expenses under IFRS
include both those costs incurred in the normal course of operations, as
well as losses that are not part of normal operations. This is in contrast
to GAAP, which defines each separately.
Another Perspective
Looking to the Future
As this textbook is being written, the IASB and FASB are close to completing
a joint project on revenue recognition. The purpose of this project is to
develop comprehensive guidance on when to recognize revenue. This
approach focuses on changes in assets and liabilities as the basis for
revenue recognition. It is hoped that this approach will lead to more
consistent accounting in this area. For more on this topic, see
www.fasb.org/project/revenue_recognition.shtml.
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