MBA SOP 2021 - Sessions 2 & 3

SOP emba 2021
Adjusting the
Accounts
3-1
The Accounting Cycle
Start Prepare
Reverse
post-closing
(optional)
Analyze trial balance
transactions
Close
Journalize
Prepare
Post statements
Prepare Prepare
unadjusted Adjust adjusted
trial balance trial balance
3-2
3-3
3-4
3-5
3-6
Timing Issues
Accountants divide the economic life of a business into

artificial time periods (Time Period Assumption).
Jan. Feb. Mar. Apr.

..... Dec.
Generally a
Alternative Terminology
 month, The time period assumption
is also called the
 quarter, or
periodicity assumption.
 year.
3-7
Timing Issues
Fiscal and Calendar Years

 Monthly and quarterly time periods are called interim
periods.
 Public companies must prepare both quarterly and annual
financial statements.
 Fiscal Year = Accounting time period that is one year in
length.
 Calendar Year = January 1 to December 31.
3-8
Timing Issues
Accrual- versus Cash-Basis Accounting

Accrual-Basis Accounting
 Transactions recorded in the periods in which the
events occur.
 Companies recognize revenues when they perform
services (rather than when cash is received).
 Expenses are recognized when incurred (rather than
when paid).
3-9
Timing Issues
Accrual- vs. Cash-Basis Accounting

Cash-Basis Accounting
 Revenues recognized when cash is received.
 Expenses recognized when cash is paid.
 Cash-basis accounting is not in accordance with
generally accepted accounting principles (GAAP).
3-10
Timing Issues
Recognizing Revenues and Expenses

REVENUE RECOGNITION PRINCIPLE
Recognize revenue in the

accounting period in which the
performance obligation is
satisfied.
3-11
Timing Issues
Recognizing Revenues and Expenses

EXPENSE RECOGNITION PRINCIPLE
Match expenses with
revenues in the period when
the expense makes its
contribution to revenue.
“Let the expenses follow
the revenues.”
3-12
Timing Issues
3-13
The Basics of Adjusting Entries
Adjusting Entries
 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
balance sheet account.
3-14
Types of Adjusting Entries
Deferrals Accruals
1. Prepaid Expenses. 1. Accrued Revenues.

Expenses paid in cash before Revenues for services
they are used or consumed. performed but not yet received
in cash or recorded.
2. Unearned Revenues. 2. Accrued Expenses.

Cash received before services Expenses incurred but not yet
are performed. paid in cash or recorded.
3-15
Types of Adjusting Entries

Trial Balance –
Each account is
analyzed to
determine whether
it is complete and
up-to-date.
3-16
Adjusting Entries for Deferrals

Deferrals are expenses or revenues that are
recognized at a date later than the point when cash
was originally exchanged. There are two types:
 Prepaid expenses and
 Unearned revenues.
3-17
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:

 insurance  rent
 supplies  equipment
 advertising  buildings
3-18
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.
3-19
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 1,500

Supplies 1,500
3-20
3-21
Illustration: On October 4, Pioneer Advertising Agency 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 50
3-22
3-23
Depreciation
 Buildings, equipment, and motor vehicles (assets that
provide service for many years) are recorded as assets,
rather than an expense, in the year acquired.
 Depreciation is the process of allocating the cost of

an asset to expense over its useful life.
 Depreciation does not attempt to report the actual

change in the value of the asset.
3-24
Illustration: For Pioneer Advertising, assume that depreciation

on the equipment is $480 a year, or $40 per month.
Oct. 31
Depreciation expense 40
Accumulated depreciation 40
Accumulated Depreciation is called

a contra asset account.
3-25
3-26
Statement Presentation
 Accumulated Depreciation is a contra asset account
(credit).
 Appears just after the account it offsets (Equipment) on
the balance sheet.
 Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.
3-27
3-28
UNEARNED REVENUES
Receipt of cash that is recorded as a liability because the
service has not been performed.
Cash Receipt BEFORE Revenue Recorded
Unearned revenues often occur in regard to:

 Rent  Magazine subscriptions
 Airline tickets  Customer deposits
3-29
UNEARNED REVENUES
 Adjusting entry is made to record the revenue for
services performed during the period and to show the
liability that remains at the end of the period.
 Results in a decrease (debit) to a liability account and
an increase (credit) to a revenue account.
3-30
Illustration: Pioneer Advertising Agency 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 performed $400 of services in October.
Oct. 31 Unearned service revenue 400

Service revenue 400
3-31
3-32
3-33
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.
3-34
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:

 Rent  Services performed
 Interest
3-35
ACCRUED REVENUES
 Adjusting entry shows the receivable that exists and records
the revenues for services performed.
► Increases (debits) an asset account and
► Increases (credits) a revenue account.
3-36
Illustration: In October Pioneer Advertising Agency earned $200

for advertising services that had not been 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 200
3-37
3-38 LO 5
3-39
ACCRUED EXPENSES
Expenses incurred but not yet paid in cash or recorded.
Expense Recorded BEFORE Cash Payment
Accrued expenses often occur in regard to:

 Rent  Taxes
 Interest  Salaries
3-40
ACCRUED EXPENSES
 Adjusting entry records the obligation and recognizes the
expense.
► Increase (debit) an expense account and
► Increase (credit) a liability account.
3-41
Illustration: Pioneer Advertising Agency 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%.
Oct. 31 Interest expense 50

Interest payable 50
3-42
3-43
Illustration: Pioneer Advertising Agency 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).
3-44
3-45
3-46
Summary of Basic Relationships
3-47
The Adjusted Trial Balance
Adjusted Trial Balance

 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.
3-48
3-49
The Financial Statements
Financial
FinancialStatements
Statementsare
areprepared
prepareddirectly
directlyfrom
fromthe
the
Adjusted
AdjustedTrial
TrialBalance.
Balance.
Owner’s
Income Balance
Equity
Statement Sheet
Statement
3-50
3-51
3-52
Concepts in Action
Qualities of Useful Information

ENHANCING QUALITIES
Comparability results Information is Information has the

when different verifiable if quality of
companies use the independent understandability
same accounting observers, using the if it is presented in a
principles. same methods, obtain clear and concise
similar results. fashion.
Consistency means that

a company uses the For accounting information to
same accounting have relevance, it must be timely.
principles and methods
from year to year.
3-53
Concepts in Action
Assumptions in Financial Reporting
Monetary Unit Economic Entity

Requires that only those things
States that every economic
that can be expressed in
entity can be separately
money are included in the
identified and accounted for.
accounting records.
3-54
Concepts in Action
Assumptions in Financial Reporting
Time Period Going Concern

States that the life of a The business will remain in
business can be divided into operation for the
artificial time periods. foreseeable future.
3-55
Concepts in Action
Principles in Financial Reporting

MEASUREMENT PRINCIPLES
HISTORICAL FAIR VALUE

COST Indicates that
Or cost principle, assets and
dictates that liabilities should be
companies record reported at fair
assets at their value (the price
cost. received to sell an
asset or settle
a liability).
3-56
Concepts in Action
Principles in Financial Reporting

REVENUE EXPENSE FULL
RECOGNITION RECOGNITION DISCLOSURE
PRINCIPLE PRINCIPLE PRINCIPLE
Requires that Dictates that Requires that
companies efforts (expenses) companies disclose
recognize revenue be matched with all circumstances
in the accounting results (revenues). and events that
period in which the Thus, expenses would make a
performance follow revenues. difference to
obligation is financial statement
satisfied. users.
3-57
Concepts in Action
Cost Constraint
Cost Constraint
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.
3-58
Double-Entry Accounting
Assets
Assets = Liabilities
Liabilities + Equity
Equity
ASSETS LIABILITIES EQUITIES
Debit Debit Debit

+
Credit - -
Credit + -
Credit +
3-59
Double-Entry Accounting
Equity
Common
Common _ _
Stock
Stock
Dividends
Dividends
+ Revenues
Revenues Expenses
Expenses
Stock Dividends Revenues Expenses
Debit Credit Debit Credit Debit Credit Debit

- + + - - + +
Credit -
3-60
Expanded Accounting Equation
Assets
Assets = Liabilities
Liabilities + Equity
Equity
Common
Common _ Dividends _
Stock
Stock
Dividends
+ Revenues
Revenues Expenses
Expenses
Retained Earnings
3-61
3-62
Closing the Books
At the end of the accounting period, the company

makes the accounts ready for the next period.
Illustration 4-5
3-63
Closing the Books
Preparing Closing Entries

Closing entries formally recognize, in the general ledger,
the transfer of
 net income (or net loss) and
 dividends
to retained earnings.
Closing entries are only made at the end of the annual

accounting period.
3-64
Closing the Books
Note:
Dividends are closed directly
to retained earnings and not
to Income Summary because
Retained earnings is a
dividends are not an permanent account; all
expense. other accounts are
temporary accounts.
3-65
Closing the Books
Closing
Entries
Illustrated
3-66
Closing the Books
Posting
Closing
Entries
3-67
Summary of the Accounting Cycle
1.
1. Analyze
Analyze business
business transactions
transactions
9.
9. Prepare
Prepare aa post-closing
post-closing 2.
2. Journalize
Journalize the
the
trial
trial balance
balance transactions
transactions
8.
8. Journalize
Journalize and
and post
post 3.
3. Post
Post to
to ledger
ledger accounts
accounts
closing
closing entries
entries
7.
7. Prepare
Prepare financial
financial 4.
4. Prepare
Prepare aa trial
trial balance
balance
statements
statements
6.
6. Prepare
Prepare an
an adjusted
adjusted trial
trial 5.
5. Journalize
Journalize and
and post
post
balance
balance adjusting
adjusting entries
entries
3-68
The Classified Statement of Financial Position
 Presents a snapshot at a point in time.

 To improve understanding, companies group similar
assets and similar liabilities together.
Standard Classifications Illustration 4-17
3-69
3-70
3-71
Intangible Assets
 Assets that do not have physical substance.
Illustration 4-19
3-72
Property, Plant, and Equipment

 Long useful lives.
 Currently used in operations.
 Depreciation - allocating the cost of assets to a

number of years.
 Accumulated depreciation - total amount of

depreciation expensed thus far in the asset’s life.
3-73
Property, Plant, and Equipment

Illustration 4-20
3-74
Long-Term Investments
 Investments in ordinary shares and bonds of other
companies.
 Investments in non-current assets such as land or
buildings that a company is not using in its operating
activities.
Illustration 4-21
3-75
Current Assets
 Assets that a company expects to convert to cash or
use up within one year or the operating cycle,
whichever is longer.
 Operating cycle is the average time it takes from the

purchase of inventory to the collection of cash from
customers.
3-76
Current Assets Illustration 4-22
Usually listed in the reverse order they expect to convert them into
cash.
3-77
Equity
 Proprietorship - one capital account.
 Partnership - capital account for each partner.
 Corporation – Share Capital and Retained Earnings.
Illustration 4-23
3-78
Non-Current Liabilities
 Obligations a company expects to pay after one year.
3-79
Current Liabilities
 Obligations company is to pay within the coming
year or its operating cycle, whichever is longer.
 Usually list notes payable first, followed by accounts

payable. Other items follow in order of magnitude.
 Liquidity - ability to pay obligations expected to be

due within the next year.
3-80
Current Liabilities
Illustration 4-25
3-81
3-82
3-83
3-84
3-85
3-86

MBA SOP 2021 - Sessions 2 & 3

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MBA SOP 2021 - Sessions 2 & 3

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SOP emba 2021

Accountants divide the economic life of a business into

Jan. Feb. Mar. Apr.

Fiscal and Calendar Years

Accrual- versus Cash-Basis Accounting

Accrual- vs. Cash-Basis Accounting

Recognizing Revenues and Expenses

Recognize revenue in the

Recognizing Revenues and Expenses

Types of Adjusting Entries

1. Prepaid Expenses. 1. Accrued Revenues.

2. Unearned Revenues. 2. Accrued Expenses.

Types of Adjusting Entries

Adjusting Entries for Deferrals

 Prepaid expenses and

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

Oct. 31 Supplies expense 1,500

Oct. 31 Insurance expense 50

 Depreciation is the process of allocating the cost of

 Depreciation does not attempt to report the actual

Illustration: For Pioneer Advertising, assume that depreciation

Accumulated Depreciation is called

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

Illustration: Pioneer Advertising Agency received $1,200 on

Oct. 31 Unearned service revenue 400

Adjusting Entries for Accruals

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

Illustration: In October Pioneer Advertising Agency earned $200

Accounts receivable 200

On November 10, Pioneer receives cash of

Nov. 10 Cash 200

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

Illustration: Pioneer Advertising Agency signed a three-month

Oct. 31 Interest expense 50

Illustration: Pioneer Advertising Agency last paid salaries on

Summary of Basic Relationships

Adjusted Trial Balance

 Purpose is to prove the equality of debit balances and

 Is the primary basis for the preparation of financial

Qualities of Useful Information

Comparability results Information is Information has the

Consistency means that

Assumptions in Financial Reporting

Monetary Unit Economic Entity

Assumptions in Financial Reporting

Time Period Going Concern

Principles in Financial Reporting

HISTORICAL FAIR VALUE

Principles in Financial Reporting

ASSETS LIABILITIES EQUITIES

Debit Debit Debit

Stock Dividends Revenues Expenses

Debit Credit Debit Credit Debit Credit Debit

At the end of the accounting period, the company

Preparing Closing Entries

Closing entries are only made at the end of the annual

 Presents a snapshot at a point in time.

Standard Classifications Illustration 4-17