Lecture 4 & 5 Adjusting Entries

Cash Basis

Income is recorded when cash is received and expenses when cash is paid.

Accrual Basis

Income is recorded when earned and expenses when incurred.

Which Basis Is More Accurate

Accrual Basis.

Matching Concept

Income earned should be matched with expenses incurred to generate that income.

Revenue Recognition Principle

Revenue is recorded when earned, not when cash is received.

Adjusting Entries

Entries made at the end of the accounting period to update accounts.

Purpose of Adjusting Entries

To ensure income, expenses, assets and liabilities are correctly stated.

Accrued Income

Income earned but not yet received.

Accrued Income Example

Commission earned but not yet received.

Effect of Accrued Income

Increase Income and Increase Asset.

Accrued Expense

Expense incurred but not yet paid.

Accrued Expense Example

Salaries owing to employees.

Effect of Accrued Expense

Increase Expense and Increase Liability.

Prepaid Expense

Expense paid in advance before it is used.

Prepaid Expense Example

Insurance paid for future months.

Effect of Prepaid Expense

Decrease Expense and Increase Asset.

Unearned Revenue

Cash received before income is earned.

Unearned Revenue Example

Customer pays before service is provided.

Effect of Unearned Revenue

Decrease Revenue and Increase Liability.

Depreciation

Allocation of the cost of a non

Depreciation Is

A non

Purpose of Depreciation

To match asset cost with periods benefiting from its use.

Straight Line Depreciation Formula

(Cost

Accumulated Depreciation

Total depreciation charged since the asset was acquired.

Carrying Amount Formula

Cost

Bad Debt

Amount owed by a customer that is no longer collectible.

Bad Debt Effect

Increase Expense and Decrease Trade Receivables.

Allowance for Doubtful Debts

Estimate of receivables that may not be collected.

Purpose of Allowance for Doubtful Debts

To avoid overstating receivables.

Prudence Concept

Do not overstate assets or income.

Closing Inventory

Inventory remaining unsold at the end of the accounting period.

Closing Inventory Appears In

Income Statement and Statement of Financial Position.

Trial Balance

List of ledger balances at a particular date.

Purpose of Trial Balance

Check whether total debits equal total credits.

Unadjusted Trial Balance

Trial balance before adjustments.

Adjusted Trial Balance

Trial balance after adjustments.

Accounting Cycle

Process used to record, summarise and report business transactions.

First Step of Accounting Cycle

Identify transactions.

Second Step of Accounting Cycle

Record transactions.

Third Step of Accounting Cycle

Post to ledger accounts.

Fourth Step of Accounting Cycle

Prepare unadjusted trial balance.

Fifth Step of Accounting Cycle

Prepare adjusting entries.

Sixth Step of Accounting Cycle

Prepare adjusted trial balance.

Seventh Step of Accounting Cycle

Prepare financial statements.

Final Step of Accounting Cycle

Closing entries.

Why Are Adjustments Needed

To ensure income and expenses are recorded in the correct accounting period.

Income Earned But Not Yet Received

Accrued Income.

Expense Incurred But Not Yet Paid

Accrued Expense.

Cash Paid Before Expense Is Used

Prepaid Expense.

Cash Received Before Income Is Earned

Unearned Revenue.

Estimated Uncollectible Receivables

Allowance for Doubtful Debts.

Profit Formula

Income

Accrued Income Affects

Income Statement and Statement of Financial Position.

Accrued Expense Affects

Income Statement and Statement of Financial Position.

Prepaid Expense Affects

Income Statement and Statement of Financial Position.

Unearned Revenue Affects

Income Statement and Statement of Financial Position.

Depreciation Affects

Income Statement and Statement of Financial Position.