American International University – Bangladesh

BBA 1102
Principles of Accounting
Session 6
What we have discussed so far….

● Monetary unit and economic entity assumption

● Golden rule of accounting
● Double entry system
● Accounting equation
● Tabular analysis
● Journalizing the transactions
● Preparing ledger accounts
● Preparing trial balance
DISCUSSION TOPICS

Adjusting the accounts

▪ Identifying nature of accounts
▪ Understanding the meanings of different
account balances
▪ Adjusting entries
▪ Periodicity (Time period) assumption
▪ Matching/Expense recognition principle
▪ Revenue recognition principle
 Understanding Ledger Balances

Following is the trial balance of TeleTalk Company as on March 31, 2020. After Key Points
completing first quarter of operation the given balances are found from the company’s
ledger accounts. ▪ Trial balance shows balances coming
from the ledger accounts (which is
Nature Debit Credit prepared based on the journal entry/
A Cash $1,500 - original transaction)
A Accounts Receivable 15,500 -
A Office Supplies 7,700 - ▪ Trial balance are with balance of accounts
A Prepaid Insurance 5,000 -
at a point of time (not before or after)
A Building 20,000 - ▪ Balances of assets and liabilities (both
A Equipment 13,000 - relate with future) represent how much
A- Accumulated Depreciation – Equipment - $3,000 the organization hold at the date of trial
L 12% Mortgage Payable (25% due in next quarter) - 20,000 balance
L Accounts Payable - 5,500
I Service Revenue - 26,500 ▪ Balances of income and expenses (both
I Rental Income - 5,000 related with past) represents how much is
OE Capital - 30,200 the balance for the period
OE- Drawing 5,000 -
(month/quarter/year)
E Salary 15,000 -
E Repair Expense 7,500 - Unadjusted trial balance
Total $90,200 $90,200 fails to provide true and fair
picture of an organization
 Unadjusted Trial Balance

Following is the trial balance of TeleTalk Company as on March 31, 2020. After
completing first quarter of operation the given balances are found from the company’s Compute Profit for the period
ledger accounts.

Nature Debit Credit Total Income

A Cash $1,500 - Service Revenue $26,500
A Accounts Receivable 15,500 - Rental Income $ 5,000
A Office Supplies 7,700 - $31,500
A Prepaid Insurance 5,000 -
A Building 20,000 -
A Equipment 13,000 -
Total Expenses
A- Accumulated Depreciation – Equipment - $3,000 Salary $15,000
L 12% Mortgage Payable (25% due in next quarter) - 20,000 Repair expenses $ 7,500
L Accounts Payable - 5,500 $22,500
I Service Revenue - 26,500 Net profit $ 9,000
I Rental Income - 5,000
OE Capital - 30,200
OE- Drawing 5,000 -
E Salary 15,000 - Let’s evaluate few more
E Repair Expense 7,500 -
information to confirm
Total $90,200 $90,200
the net profit figure…….
 Adjusting the accounts

Following is the trial balance of TeleTalk Company as on March 31, 2020. After
completing first quarter of operation the given balances are found from the company’s Other data:
ledger accounts.

Nature Debit Credit

1. Stock verification reveals only
A Cash $1,500 - $3,000 of office supplies is on hand.
A Accounts Receivable 15,500 -
A Office Supplies 7,700 -
2. Amount of unexpired insurance at
A Prepaid Insurance 5,000 - the end of the quarter is $1,500.
A Building 20,000 -
3. Interest on Mortgage Payable has to
A Equipment 13,000 -
A- Accumulated Depreciation – Equipment - $3,000 be recognized @ 12% per year.
L 12% Mortgage Payable (25% due in next quarter) - 20,000
4. Service provided but unbilled
L Accounts Payable - 5,500
I Service Revenue - 26,500 $2,500.
I Rental Income - 5,000
5. Annual depreciation on equipment
OE Capital - 30,200
OE- Drawing 5,000 -
is $2,000.
E Salary 15,000 -
E Repair Expense 7,500 -
Total $90,200 $90,200
Let’s analyze them…….
 Adjusting Entries
Stock verification reveals only $3,000 of office supplies is on hand.
TeleTalk Company
Trial Balance
as on March 31, 2020 Analysis:
Debit Credit
Cash $1,500 - ▪ True balance of supplies is $3,000
Accounts Receivable 15,500 - ▪ Supplies Balance is overstated by $4,700
Office Supplies 7,700 -
Prepaid Insurance 5,000 - ▪ Some supplies have been consumed, thus should be treated as expense
Building 20,000 -
Equipment 13,000 - ▪ The problem was, when we purchased supplies we have recorded the
Acc. Dep - Equipment - $3,000 purchase figures but the subsequent consumption is not journalized
12% Mortgage Payable - 20,000 ▪ To bring out the correct balance of supplies (asset), we must reduce
Accounts Payable - 5,500
reported supplies account by $4,700 and should also recognize it as
Service Revenue - 26,500
expense
Rental Income - 5,000
Capital - 30,200
Drawing 5,000 - Journal Entry
Salary 15,000 -
Repair Expense 7,500 -
Total $90,200 $90,200 Supplies expense Dr. 4,700
Office supplies Cr. 4,700
 Effect of Adjusting Entries on the Ledger Accounts

TeleTalk Company Office Supplies Account

Trial Balance
as on March 31, 2020 Date Explanation Ref. Debit Credit Balance
Debit Credit Jan X XX - XX
Cash $1,500 - Feb Y XX - XX
Accounts Receivable 15,500 - Mar Z XX - 7,700
Office Supplies 7,700 - 31 - 4,700 3,000
Prepaid Insurance 5,000 -
Building 20,000 - Supplies Expense Account
Equipment 13,000 -
Acc. Dep - Equipment - $3,000 Date Explanation Ref. Debit Credit Balance
12% Mortgage Payable - 20,000 Mar 31 4,700 - 4,700
Accounts Payable - 5,500
Service Revenue - 26,500
Rental Income - 5,000 The original trial balance is incorrect
Capital - 30,200
Drawing 5,000 - Journal Entry
Salary 15,000 -
Repair Expense 7,500 -
Total $90,200 $90,200 Supplies expense Dr. 4,700
Office supplies Cr. 4,700
 Time Period or Periodicity Assumption

Life of the organization is divided into smaller parts to evaluate the performance.
Each part is known as the “Accounting Period”

T I M E L I N E
Jan 1 Feb 1 Mar 1 Apr 1 May 1 Jun 1 Jul 1 Aug 1 Sep 1 Oct 1 Nov 1 Dec 1 Jan 1 Feb 1
2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 2006 2006
Accounting
period
1 month

Accounting period 3 months (Quarter)

Accounting period 12 months (Year)

▪ How frequently you like to evaluate your business is your decision.

▪ Usually in practice, accounting period is of 1 year
▪ Adjustments are required at the end of each accounting period to
reflect the true picture (financial status) of the business
 Adjusting Entries
Amount of unexpired insurance at the end of the quarter is $1,500.
TeleTalk Company
Trial Balance
as on March 31, 2020 Analysis:
Debit Credit ▪ True balance of prepaid insurance is $1,500
Cash $1,500 -
Accounts Receivable 15,500 - ▪ Prepaid insurance is overstated by $3,500
Office Supplies 7,700 -
Prepaid Insurance 5,000 -
▪ Part of insurance has been expired, thus should be treated as expense
Building 20,000 - ▪ The problem was, when we paid for insurance, we have recorded the figure
Equipment 13,000 - as advance payment for certain period, but insurance expires with the
Acc. Dep - Equipment - $3,000 passes of time which was not journalized
12% Mortgage Payable - 20,000
Accounts Payable - 5,500 ▪ To bring out the correct balance of prepaid insurance (asset), we must
Service Revenue - 26,500 reduce reported prepaid insurance account by $3,500 and should also
Rental Income - 5,000 recognize it as expense
Capital - 30,200
Drawing 5,000 - Journal Entry
Salary 15,000 -
Repair Expense 7,500 -
Total $90,200 $90,200 Insurance expense Dr. 3,500
Prepaid insurance Cr. 3,500
 Adjusting Entries
Interest on Mortgage Payable has to be recognized @ 12% per year
TeleTalk Company
Trial Balance
Analysis:
as on March 31, 2020
Debit Credit ▪ You took a loan keeping something as mortgage (collateral)
Cash $1,500 -
Accounts Receivable 15,500 - ▪ You have utilized the fund and consumed benefit of the fund (known as
Office Supplies 7,700 - interest), thus should be treated as expense (understated).
Prepaid Insurance 5,000 -
▪ The interest is not yet paid as well, thus a liability (understated) should
Building 20,000 -
also be recognized
Equipment 13,000 -
Acc. Dep - Equipment - $3,000 ▪ The problem was, we do not journalize unless the transaction took place
12% Mortgage Payable - 20,000
Accounts Payable - 5,500 ▪ If this expense is not recognized, we are violating “MATCHING
Service Revenue - 26,500 PRINCILE” and the profit calculation will be incorrect. Similarly, we will
Rental Income - 5,000 report less liability than actual
Capital - 30,200
Drawing 5,000 - Journal Entry
Salary 15,000 -
Repair Expense 7,500 -
Total $90,200 $90,200 Interest expense Dr. 600
Interest payable Cr. 600
Pop-up Quiz
▪ 9 MCQ questions
▪ 10 minutes