Completing the
Accounting Cycle
The Adjustment Process

At the end of a fiscal period, we have to make sure that all our financial
statements are 100% accurate.

We need to finalize our accounts.

When accountants prepare the financial statements, they have to make
sure that:
-Accounts are brought up to date,
-Late transactions are taken into account,
-Calculations have been made correctly, and
-Accounting principles and standards have been followed.
Accounting Principles and Standards

Our financial statements need to be correct in both MATH and??

The theory.

IFRS and ASPE requires that our financial statements be relevant, reliable,
and comparable.

Relevant: We need a good “picture” of the business’ important features.

Reliable: These need to be based on good evidence.

Comparable: We need to be able to look at old information and
compare. With other companies too.
Accrual Accounting

Accrue means to add over time.

Both revenues and expenses accrue over time.

We do not wait until cash is received to record revenue; we do not wait
until cheques are written before recording expenses. They write them in
the accounts as they happen.

This is called accrual accounting.

Time is important. We cannot wait for all cash before entering
transactions, we cannot always record revenues and expenses as they
happen.
Financial Statement Comparability

We need to have standard fiscal periods so we can compare information.

This is a problem sometimes though. Some expenses/revenues do not
occur right in line with our periods.

At the end of a period, an accountant must step in and deal with the
revenues and expenses that have been accruing but haven’t been
recorded yet.
LETS LOOK AT THAT.
ADJUSTING THE ACCOUNTS

This is what accountants do at the end of a fiscal period.

We want to make sure that the accounts actually have what they should.

We use adjusting entries to do this.

We need to be concerned about both the income statement and the
balance sheet when we do this.
Adjusting Entries for Supplies

Lets look at the Supplies account for Markell Company.

What do these numbers mean?
Adjusting Entries for Supplies

So…balance sheet problems? Is $15,000 accurate?

What about Income Statement problems?
-What would be wrong about the income
statement?
-What would this do to the business?
Adjusting Entries for Supplies

There is a very easy solution.

We would know right away that there is a
mistake with the Supplies account. SO…we
“take inventory.”

So we have to adjust the new account by
creating a credit. What is it for this example?

What is the debit that goes along with this
credit?
Adjusting Entries for Supplies
Adjusting Entries for Prepaid Expenses

Sometimes businesses buy things in advance. There is
no problem if the item falls entirely in a fiscal period.

Some things are in more than one period.

Prepaid expenses are things paid for in advance, but
the benefits extend into the future.

Insurance is the most common of these.

So let’s pretend that Markell Company purchased a
one year policy for $1800.

We would credit bank and debit the insurance
expense.
Adjusting Entries for Prepaid Expenses

To adjust this kind of account, it is similar to the
supplies account.

Need to figure out value, and make credits and
debits.

We cannot do an “inventory” like we did with
supplies. We need to do math.

The policy was for 12 months. By Dec. 31, 4 months
have expired, 8 months are still prepaid. What is the
true value then?
Adjusting Entries for Prepaid Expenses
Adjusting Entry for Late-Arriving
Purchase Invoices

Often, businesses will buy goods or services near the end of a period.
Sometimes, these things do not arrive until the next period.

Now, Revenue Recognition Principles say that we have to put expenses
and revenue together in the same period.

Accountants need to make sure that the books ACCURATELY show these
revenues and expenses.

Financial Statements are usually prepared after the period ends, so there
is time to correct these mmistakes.
Adjusting Entry for Late-Arriving
Purchase Invoices

For Markell Company, let us assume that the Senior Accountant waited
until January 15 2014 for late-arriving invoices.

Let’s pretend that two show up. A phone bill $212, and utilities bill for $315.

These two invoices show costs that the business had in 2013.
Adjusting Entry for Unearned Revenue

We have only looked at expenses so far. Sometimes though, we have to
adjust revenue.

Let’s pretend Markell Company deposited a cheque for $5000 on
December 23, 2013.

The cheque was to pay for services that will be done in January and
February 2014. The clerk debited bank $5000 and credited fees earned.

The Accountant saw this, realized a mistake was made and had to fix it.
Review of Adjusting Entries

We looked at adjusting entries for supplies, prepaid expenses, late-arriving
invoices, and unearned revenue.

No matter how complicated the adjustment is, use COMMON SENSE.

Now…we adjust everything using T-Accounts. We now need to do journal
entries. Let’s have a look at the entries we’ve seen so far.
Work:

Exercises #1, 3, 4, 5