CSEC POA SEC. 6-Accounting Adjustments

Principles
of Accounts
Accounting Concepts
and Adjustments
Learning Outcomes:
In this lesson, you will learn about:
● The accounting concepts that underpins the need for

adjustments.
● Why adjustments are made to financial statements
● Preparing journal entries and ledger accounts to reflect
adjustments
● The treatment of adjustments in the statement of financial
position (balance sheet).
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Accounting Concepts, Income and Expense Adjustments
Accounting Concepts and
Adjustments
 A number of adjustments have to be made to
financial statements to enhance the quality of
the information they contain and make it more
useful.
 These adjustments are made to satisfy a
number of key accounting concepts,
four of which are explained here.
Accounting Concepts and Adjustments:
Accruals (Matching) Concept
 The accruals concept (sometimes referred to as
the matching concept) establishes that, when
calculating profits and losses for a certain period
(normally a year), only the revenue and other
income for that period should be included and it
should be 'matched' to the expenses for the same
period, whether or not all the amounts concerned
have actually been received/paid.
 Revenue, income and expenses relating to good
and services supplied or received during other
financial periods should not be included.
Accruals (Matching) Concept
 Therefore, when preparing an income statement,
adjustments have to be made for expenses and
income for the period that are not yet paid
(expense accruals/income due) and expenses
and income relating to the next period that have
been paid in advance (expense prepayments/
income received in advanced).
 In addition, provisions for doubtful debts must be
taken into account, and, when calculating profit,
the wear and tear on current assets
(depreciation) must be considered.
The Prudence Concept
 It is important that users of accounting information are
not misled into thinking a business is performing better
than is really the case.
 The prudence concept requires asset values and
profits, where there is doubt, to be understated rather
than overstated, that expenses and liabilities are
recognized as soon as possible where there is
uncertainty, while revenues and assets are only
recognized when they are assured of being received.
 For example, bad debts are written off promptly and
accounts receivable are adjusted to make a provision
for doubtful debts.
The Consistency Concept
 The owners of businesses have choices to make
when preparing financial statements.
 Having chosen particular policies, it is important that
they are implemented in the same way each year.
 This Is an application of the consistency concept.
 As a result the users of financial statements can make
valid comparisons of performance.
The Consistency Concept
 For example, a business should apply the same
depreciation method each year and maintain the same
percentage provision for doubtful debts each year,
unless there are overwhelming reasons for making a
change in these policies.
 Where a policy is changed this must be clearly
indicated in the notes to the financial statements.
The True and Fair Principle
 The true and fair principle reflects the idea that it is not
acceptable to manipulate figures in the financial
statements in order to present the finances of the
business in a false light to gain some kind of
advantage.
 Rather, the records must be accurate or at least
present a reasonable estimate of the position.
 For example, if it is expected that some accounts
receivable will not be paid, provision should be
made for this to reduce the income recorded.
Benefits of Accounting Concepts:
 Accounting concepts are important because:

 They help decide the right course of action to take
when an accounting situation is not clear cut.
 They help reassure the users of accounting
information that the statements would have been
prepared in the same way regardless of who had
been responsible for preparing them.
 Users can be confident that the financial
statements are reliable.
Expense and Income Adjustments:
Adjustments to Expenses
 Expense Accruals: This is the term used when an
expense is not fully paid at the end of the year, leaving
an amount that is due but unpaid.
 At the year end the amount of an expense accrual
is added to find the correct amount to be charged
to the income statement for that expense.
 An accrual is recorded as a credit balance (when
brought down) in an expense account as it is a
current liability.
 Expense prepayments: When a payment for an
expense covers more than the year under review, i.e.
part of the payment made for an expense covers the
business at the beginning of the next financial year, it
is called a prepayment.
 The amount of any prepayment must be deducted
to find the correct value of the expense to be
charged to the income statement.
 A prepayment is recorded as a debit balance on an
expense account as it represents a current asset.
 Adjustments to Income: Sometimes businesses
receive income not just from sales (revenue) but also
from some activities, such as rent received when a
business lets out part of its premises to a tenant, and
interest received on investments and savings.
 Other income items are added to gross profit in the
second part of the income statement.
 Income due: This is the income that has yet to be
received at the year end.
 The amount of any income due at the year end is
added to find the correct amount of income to be
shown in an income statement.
 Income due is recorded as a debit balance (when
brought down) in an income account as it is a
current asset.
 Advanced Income: This is the amount of any income
received that covers more than the year under review,
i.e. part of the amount received covers the beginning
of the next financial year.
 It is necessary to deduct the amount of any income
received in advance at the year end to find the
correct value of income to be shown in an income
statement.
 Advanced income is recorded as a credit balance
on an income account as it represents a current
liability.
 Please Note: All transfers to the income

statement from expense accounts and
income accounts will first be recorded in
the general journal.
Key Terms
 Accruals concept: in order to calculate profit, income

fora financial period is matched exactly with the
expenses that relate to that period, whether paid or
not. The concept is Sometimes called the 'matching
concept.’
 Prudence concept: the principle that requires that,
where there is doubt, asset and profit values are
understated rather than overstated and liabilities and
losses are overstated rather than understated).
Key Terms
 Consistency concept: the rule that

accounting policies should be carried out in the
same way year after year.
 True and Fair Concept: the principle that
accounting records should be factually
accurate wherever possible, or otherwise
present a reasonable estimate of, or
judgement about, the financial position.
Recording Expense and Income Adjustments
EXPENSES
 During the year ended 31 December 2018 a business has paid wages of $27 300.
At 31 December 2018, $400 remains due for wages for the last part of the year.
 The business has also paid insurance of $9 500. However, this includes $1 500
that is insurance for January 2019.
 Journal entries to record transfers to the income statement:
Journal Page 3
Date Dr Cr
2018 Details $ $
Dec 31 Income statement 27 700

Wages 27 700
Transfer of wages for the year to the income statement
Income statement 8 000
31 Insurance 8 000
Transfer of insurance for the year to the income statement
NOTE: This is how the expense accounts will appear in the general
ledger:
Dr Wages Cr
Date Details Folio $ Date Details Folio $
2018 2018
Dec 31 Cash Dec 31 Bank 27 700
(total payments for the year) 27
300
31 Balance c/d 400
27 700 27 700
2019
Jan 1 Balance b/d 400
NOTE: This is how the expense accounts will appear in the general
ledger:
Dr Insurance Cr
2018 2018
Dec 31 Cash Dec 31 Bank 8 000
(total payments for the year) 9 500
Dec 31 Balance c/d 1 500
9 500 9 500
2019
Jan 1 Balance b/d 1 500
INCOME:
 A business has received interest of $1 450 on an
investment during the year ended 31 December 2018.
 At 31 December interest of $350 is due but not yet
received.
 The business has also received rent from a tenant of $3
900.
 However, this includes rent of $300 for the month of
January 2019.
EXPENSES
 Journal entries to record transfers to the income statement:
Journal Page 4
Date Dr Cr
2018 Details $ $
Dec 31 Interest received 1 800

Transfer of interest received for the year to the income
statement
31 Rent received 3 600
Transfer of rent received for the year to the income
statement
NOTE: In this case, the ledger accounts will appear as follows:
Dr Interest Received Cr
2018 2018
Dec 31 Income statement 1 800 Dec 31 Bank 1 450
31 Balance c/d 350
1 800 1 800
2019
NOTE: In this case, the ledger accounts will appear as follows:
Dr Rent Received Cr
2018 2018
Dec 31 Income statement 3 600 Dec 31 Bank 3 900
31 Balance c/d 300
3 900 3 900
2019
INCOME and EXPENSES

 Expenses and income adjustments are designed to
implement the accruals concepts when preparing financial
statements.
 The following is a summary of how they are treated in the
statement of financial position (balance sheet) of a
business
INCOME and EXPENSES
Adjustments Shown under…

Expense accrual Current labilities
Prepaid expense Current assets*
Income due Current assets*
Income receive in advance Current liabilities
*Placed immediately after accounts receivable when

assets are recorded in the order of permanence
INCOME STATEMENT and BALANCE SHEET

Income statement (extracted) for the year ended 31
December 2018
$ $
Gross profit xxx
Add: interest received 1 800
rent received 3 600
5 400
Less: insurance 8 000
wages 27 700
other expenses xxx
xxx
xxx
Statement of financial position (balance sheet) (extracted) at 31
December 2018
CURRENT ASSETS $ $ $
Inventory xxx
Accounts receivable xxx
Income dues (interest) 350
Prepayments (rent) 1 500
Cash at bank xxx
xxx
CURRENT LIABILITIES
Accounts payable xxx
Income received in advance (rent) 300
Accruals (wages) 400
(xxx)
Working Capital/Net Current Assets xxx
Summary Questions
By now you should be able to answer the
following:
 What are the differences between an expense
accrual and an expense prepayment?
 Explain why:
a) an expense accrual is a current liability
b) an advanced income is a current liability
Summary Questions
By now you should be able to answer the
following:
 Explain why:
a) an expense prepayment is a current asset
b) an income due is a current asset

CSEC POA SEC. 6-Accounting Adjustments

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Principles

In this lesson, you will learn about:

● The accounting concepts that underpins the need for

 Accounting concepts are important because:

 Please Note: All transfers to the income

 Accruals concept: in order to calculate profit, income

 Consistency concept: the rule that

Dec 31 Income statement 27 700

Dec 31 Interest received 1 800

NOTE: In this case, the ledger accounts will appear as follows:

NOTE: In this case, the ledger accounts will appear as follows:

INCOME and EXPENSES

INCOME and EXPENSES

Adjustments Shown under…

*Placed immediately after accounts receivable when

INCOME STATEMENT and BALANCE SHEET

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