ACCT5001 2022 S2 - Module 3 - Lecture Slides Student

ACCT5001:
Foundation in Accounting
Module 3:
THE ADJUSTING PROCESS
Reading: Text
Ch. 3: 3.1- 3.6 (pp.105 – 139)
Slide 1
Copyright © 2016 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781486018000 Nobles/Horngren’s Accounting 8th edition
Module 2 recap:
Debits, credits and double-entry accounting
Assets = Liabilities + Owners’ Equity

Debits (LHS) = Credits (RHS)
Increases to assets are recorded on their natural (debit) side

Decreases are recorded on the opposite (credit) side
Increases to liabilities or equity are recorded on their natural (credit) side

Decreases are recorded on the opposite (debit) side
Slide 2
Module 2 recap:
Journal entries  Ledger accounts  Trial balance
Slide 3
Module 3: The Adjusting Process
Reading: Textbook Chapter 3
Textbook Learning objectives (see Textbook, Chp 3, p.105)

3.1 Differentiate between accrual and cash-basis accounting
3.2 Explain why adjusting entries are needed
3.3 Journalise and post adjusting entries
3.4 Explain the purpose of and prepare an adjusted trial balance
3.5 Prepare the financial statements from the adjusted trial balance
3.6 Describe the ethical challenges in accrual accounting
4
ACCT5001:
Module 3 - Part A
Cash v Accrual Accounting and the
need for end-of-period adjustments
Learning objectives 3.1 and 3.2
Slide 5
Cash v Accrual basis accounting
• Cash accounting records only cash receipts and cash payments. It

ignores receivables, payables and other items such as depreciation.
• Accrual accounting records the effect of each transaction as it occurs,
irrespective of whether cash has been received or paid.
– Revenues are recorded when earned, and
Expenses in the period they are incurred/used to earn revenue,
which is not necessarily in the same period as cash is received/paid.
• Most businesses use the accrual basis of accounting as it provides

a better measure of financial performance for the period and
a better measure of financial position at the end of the period.
• In ACCT5001 we focus on accrual accounting in modules 1-11,

and cash accounting and cash flow statements in module 12.
6
Cash-basis accounting vs. accrual-basis accounting
7
Activity
Accrual accounting
Slide 8
Accrual accounting activity
Slide 9
9 Copyright © 2016 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781486018000 Nobles/Horngren’s Accounting 8th edition
When and why we adjust the accounts
When?
• Accrual adjusting entries are made at end of the accounting period.
Why?
• To ensure all and only revenues earned and expenses incurred
during the accounting period are included in measuring periodic
profit/loss;
• To ensure the balance sheet includes all asset and liabilities,
and updates existing balances, as at the end of the accounting
period
Adjustments help to more fairly measure, and faithfully represent
(1) the financial performance during the period in the income statement,
and
(2) the financial position at the end of the period in the balance sheet
10
Two categories of adjusting entry
The two basic categories of adjusting entries are:
Prepayments (cash payment/receipt BEFORE revenue earned/expense incurred)
○ Prepaid expenses (prepayments) are initally recorded as an asset
○ Prepaid revenue (unearned revenue) is initially recorded as a
liability
they are adjusted at the end of the accounting period to recognise any revenue
earned or expenses incurred during that period.
• Accruals (cash payment/receipt AFTER revenue earned/expense incurred)

o Accrued expenses are initially recorded as an expense for the period,
and to show a liability at the end of the period
o Accrued revenue is initially recorded as revenue for the period, and to
show a receivable asset at the end of the period
when the cash is eventually paid or received, it is recorded to cash and the
receivable (asset) or payable (liability) is reduced to zero.
1
ACCT5001:
Module 3 – Part B
Types of Adjusting entries
Learning objective 3.3
Slide 12
Specific Types of Adjusting entries
Adjusting entries fall into five types:
a) Prepayment adjustments
i. prepaid expenses
ii. depreciation of non-current assets (a type of prepaid expense)
iii. unearned revenues (prepaid revenue)
b) Accruals adjustments
i. accrued expenses
ii. accrued revenues
13
a) i. Prepaid expenses (Prepayments)
• Prepayments are advanced payments of expenses. For example:
○ Insurance is often paid year in advance, but expires monthly
○ supplies are prepaid and become expenses when used
during the period
• Prepayments of expenses are initially recorded as assets, as they provide
future economic benefits
• When the prepayment is used up or expires, the used portion of the asset
becomes an expense and so must be adjusted
– E.g. On June 1 your firm prepaid three months of office rent, $3,000
Prepare the journal entry for 1 June and adjustment entry on 30 June
Jun 1 Dr Prepaid rent 3,000 Jun 30 Dr Rent exp 1,000

Cr Cash 3,000 Cr Prepaid rent 1,000
(Prepaid rent) (Adjustment - june rent exp)
the cash entry (in black) is recorded first, then an adjusting entry (in green) is
recorded later
14
a) ii. Depreciation
• Property, plant and equipment (PPE) assets are long-lived, non-current,

tangible assets with a limited useful life, used in the operation of a business
○ As a business uses these assets, their future economic benefits decline,
(or used up) and therefore become an expense (with the exception of Land)
○ Accountants systematically spread the asset’s cost over its useful life
as depreciation expense, by estimating the pattern of this decline.
• Depreciation expense is the allocation of a asset’s cost to an expense

o Thus, a part of the cost of a PPE asset (except Land) used during the
period is an expense that should be included in the measurement of
periodic profit
• Accumulated depreciation is an account that records the sum of the
depreciation, to be deducted from the asset, to recognise the part used up.
Its balance increases (accumulates) over time, and is a credit balance
o This is a contra asset account in that is deducted from the asset (at
cost) in the Balance Sheet to provide the net carrying amount
15
a) ii. Depreciation (continued)
E.g: Furniture was purchased on 1 June 2021 for $18,000, which is estimated to
have a useful life of 5 years and no residual value at end of that time
a) Provide the journal entry for depreciation for the month of June:
June 30 Dr Depreciation expense - Furniture 300
Cr Accumulated Depreciation - Furniture 300
(Depreciation expense for the month: 1/12 X $18,000/5yrs)
b) Show how the asset would appear in the Balance Sheet at 30 June 2021
How would it appear in the Balance Sheet
in the following year, 30 June 2022?
Furniture $18,000
Less, accumulated depreciation $ 3900
Carrying amount of furniture $14 100
Slide
16 16
a) iii. Prepaid revenue (Unearned revenue)
• Cash received from customers as a deposit or in advance of performing work,

creates a liability called unearned revenue (Revenue received in advance).
o The business owes a product/service to the customer, or their money back
o Only after completing the job will the business earn the revenue
• The Cash received is debited, and a liability ‘Unearned revenue’ is credited
o This ensures the revenue is not included in the measurement of profit for the
period, and temporarily records it on the Balance Sheet as a liability
• When the revenue is earned, we do an adjustment to recognise it as

revenue and decrease the liability, as now it has been earned.
• E.g. Received $600 on June 21 for services to be performed next month

June 21 Dr Cash 600 July 31 Dr unearned revenue 600
Cr Unearned revenue 600 Cr Service revenue 600
Slide 17
Copyright © 2016 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781486018000 Nobles/Horngren’s Accounting 8th edition 17
b) i. Accrued expenses
• Accrued expense refers to an expense that has been incurred during the
period but hasn’t been paid for yet (e.g. electricity expense)
o As the expense has been incurred and not recorded, it needs to be
recognised so that it is included in the measurement of profit for the period
o Also, as it has not been paid at the end of the period, the liability for the
amount owed needs to be recognised in the Balance Sheet
 When the liability is paid, the liability is decreased and cash is decreased
• Let’s have a look at an example!
Slide 18
Example: A business pays an employee a salary of $1000
every two weeks (for 10 days of work). Pay day is always on
Friday. The end of the accounting period is 30 June. Let’s
have a look at the journal entries for June and July and the
required adjusting entry on 30 June.
13 June
27 June
30 June
11 July
Slide 19
1 Copyright © 2016 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781486018000 Nobles/Horngren’s Accounting 8th edition
Activity
Accrued expense
Slide 20
b) ii. Accrued revenues
• Accrued revenue is revenue earned before cash is received

(e.g. a company has performed a service but has not yet billed the client)
o As the revenue has been earned, it must be recognised and included in
the measurement of profit for the period in the income statement
o Also, as the revenue is receivable at the end of the period, an asset
(receivable) is also recognised and reported in the Balance Sheet
When the cash is received the asset cash is increased and the asset
accounts/other receivable is decreased
• E.g. Half of an agreed $800 a month’s of work is performed from June 16-30,
but the $800 won’t be paid until July 13. What is the adjustment at June 30?
June 30 Dr Accounts receivable 400
Cr Service revenue 400
July 13 Dr Cash 800
Cr Accounts receivable 400
Cr Service revenue 400
Slide 21
Summary – Timing of prepaid and accrual adjustments
22
ACCT5001:
Module 3 - Part C
Adjusted trial balance and
preparing financial statements
Learning objective 3.4 – 3.6
Slide 23
The adjusted trial balance
• This is prepared after adjusting entries are posted to the accounts.

It ensures that the ledger still balances (debit account balances = credit
balances) after the adjustments have been posted to it
• It is a useful step in that financial statements, as they can be prepared

from a list of adjusted accounts
• Often this can be prepared on a worksheet for convenience

– Columns 1 and 2 Trial balance (debit and credit)
– Columns 3 and 4 Adjustments (debit and credit)
– Columns 5 and 6 Adjusted Trial balance (debit and credit)
24
trial
balance
Adjusted
Income Statement of
changes in
Balance sheet
statement
equity
25
The Financial Statements
The income statement reports revenues and expenses to measure
financial performance of the entity in terms of operating net profit/loss
A statement of changes in equity shows why capital changed during the
period and the main sources such as increased from profit or investments
by the owner; or decreased from losses or owner’s drawings
The balance sheet measures the financial position by reporting all
assets, liabilities and equity as at the end of the accounting period
Relationship between the statements and their preparation order:
1. Income statement to determine profit or loss
2. Statement of changes in equity, which needs profit or loss from
the income statement to calculate ending capital
3. Balance sheet, which needs the amount of ending capital
(beginning capital +/- profit/loss – drawings) to achieve its
balancing feature
26
Income statement prepared from the adjusted trial balance
See Exhibit 3-7 (p.123)

The red line from the profit amount links to the related entry in the statement of
changes in equity (next slide)
27
Statement of changes in equity prepared from the
adjusted trial balance and the result of the income statement
See Exhibit 3.8 (p.123)
The red arrow to the profit amount links from the corresponding amount in the
income statement.
The red line from the closing capital amount (30 June 2021) links to the related
entry in the balance sheet (next slide).
28
Balance sheet prepared from the adjusted trial balance and the
result of the statement of changes in equity
See Exhibit 3-9 (p.123)

The red arrow to the amount for Sheena Bright, capital links from the related
entry in the statement of changes in equity
29
Ethical issues in accrual accounting
Accrual accounting provides opportunities for unethical behaviour
• - A dishonest person could fail to record depreciation which would disregard

mandated accounting principles, overstate profit and disclose a more favourable
picture of the business’s financial position than actually existed
• - A dishonest person could record unearned revenue as revenue to increase

profit for the accounting period (see the “focus on ethics” question at the end of
Chapter 3, page 153 of the textbook).
• - A dishonest person could not record prepaid insurance that has expired to
reduce expenses and increase profit for the accounting period (see the “focus on
ethics” question at the end of Chapter 3, page 153 of the textbook).
30
Summary: Chapter 3
• Accrual accounting records revenues when they are earned, and expenses
in the period they are incurred/used to help earn the revenue, irrespective of
when cash is received or paid.
• Cash-basis accounting records revenues and expenses when cash is
received or paid during the period, irrespective of what period the revenues
and expenses were earned or incurred.
• Accrual accounting requires adjusting entries at the end of the period in
order to ensure revenues and expenses are allocated to the correct period
they are earned and incurred.
• The two basic categories of adjusting entries are prepayments and accruals.
• An adjusted trial balance includes all the transactions recorded in accounts
during the period plus/minus adjusting entries made at the end of the period.
This is often done on a worksheet as well as the adjusting entries journalised
and posted to the ledger.
• The financial statements must be formatted correctly and prepared in order:
(income statement, then statement of changes in equity, then balance sheet).
31
Questions?
Slide 32
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ACCT5001:

Assets = Liabilities + Owners’ Equity

Increases to assets are recorded on their natural (debit) side

Increases to liabilities or equity are recorded on their natural (credit) side

Reading: Textbook Chapter 3

Textbook Learning objectives (see Textbook, Chp 3, p.105)

3.2 Explain why adjusting entries are needed

3.3 Journalise and post adjusting entries

3.4 Explain the purpose of and prepare an adjusted trial balance

3.6 Describe the ethical challenges in accrual accounting

Learning objectives 3.1 and 3.2

• Cash accounting records only cash receipts and cash payments. It

• Most businesses use the accrual basis of accounting as it provides

• In ACCT5001 we focus on accrual accounting in modules 1-11,

• Accruals (cash payment/receipt AFTER revenue earned/expense incurred)

Learning objective 3.3

Adjusting entries fall into five types:

Jun 1 Dr Prepaid rent 3,000 Jun 30 Dr Rent exp 1,000

• Property, plant and equipment (PPE) assets are long-lived, non-current,

• Depreciation expense is the allocation of a asset’s cost to an expense

Carrying amount of furniture $14 100

• Cash received from customers as a deposit or in advance of performing work,

• When the revenue is earned, we do an adjustment to recognise it as

• E.g. Received $600 on June 21 for services to be performed next month

• Let’s have a look at an example!

• Accrued revenue is revenue earned before cash is received

Learning objective 3.4 – 3.6

• This is prepared after adjusting entries are posted to the accounts.

• It is a useful step in that financial statements, as they can be prepared

• Often this can be prepared on a worksheet for convenience

See Exhibit 3-7 (p.123)

See Exhibit 3.8 (p.123)

See Exhibit 3-9 (p.123)

Accrual accounting provides opportunities for unethical behaviour

• - A dishonest person could fail to record depreciation which would disregard

• - A dishonest person could record unearned revenue as revenue to increase

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