Comm 201 Chapter 4 Seminotes

Chapter 4 – Adjustments in Accounting

Why Adjustments Are Needed

• Adjustments are necessary at the end of the period to:

  • Ensure assets and liabilities are accurately reported.

  • Record revenues and expenses in the correct period according to revenue recognition and expense recognition principles.

  • Address situations where cash is not received or paid in the same period as the related revenue or expenses.

• Key principles:

  • Revenues are recorded when earned.

  • Expenses are recorded when incurred to generate revenues.

  • Assets reflect economic benefits at the current period's end.

  • Liabilities reflect the amounts owed at the period's end requiring future resource sacrifices.

Financial Statements Preparation

1. Income Statement:

   • Formula: Revenues – Expenses = Net Income

2. Statement of Retained Earnings:

   • Formula: Beginning Retained Earnings + Net Income – Dividends Declared = Ending Retained Earnings

3. Balance Sheet:

   • Formula: Assets = Liabilities + Shareholders’ Equity

Adjustments Categories

1. Deferral Adjustments

• Definition: Postponing the recognition of expenses or income until a later period.

• Example: Prepaid expenses (e.g., paying rent in advance).

• Impacts:

  • Decreases balance sheet accounts.

  • Increases corresponding income statement accounts.

• Each deferral adjustment involves one asset and one expense account or one liability and one revenue account.

2. Accrual Adjustments

• Definition: Recognizing revenues or expenses that have occurred but have not yet been recorded because cash will be received or paid later.

• Used to:

  • Record revenue or expenses when they occur before cash transactions occur.

  • Adjust corresponding balance sheet accounts.

• Each accrual adjustment involves one asset and one revenue account or one liability and one expense account.

Adjustment Timing

• Adjustments are made at the end of each accounting period before preparing an adjusted trial balance and financial statements.

• Closure Process:

  • Permanent accounts (balance sheet) carry ending balances to the next year.

  • Temporary accounts (revenues, expenses, dividends) track current year results and are closed before the next year's records.

Example: Deferral Adjustment - Depreciation

• Deferral Adjustments involve recognizing expenses or incomes that have been deferred.

Learning Activities

Activity 4-1: Journal Entries for Deferral Transactions

• Example: Zip Car Corporation balance sheet and income statement preparations.

Activity 4-2: Adjusting Journal Entries

• Examples of adjustments for wages payable, supplies on hand, interest not yet recorded, and service revenue recognition.

Activity 4-3: Dividends Adjustments

• Journal entries for declaring dividends, impacting T-accounts for unadjusted balances, postings, and reporting adjusted accounts.

Activity 4-4: Financial Statements Preparation

• RunHeavy Corporation (RHC) events during January 2024 requiring classified balance sheet and income statement preparation. Examples of transactions included purchasing equipment and concert bookings.

Closing Process

• Close temporary accounts after year-end, resetting their balances.

• Permanent accounts retain their balances into the next year.

  1. Closing Entries:

     • Dr. Revenues, Cr. Expenses, Cr. Retained Earnings.

     • Dr. Retained Earnings, Cr. Dividends Declared.

Post-Closing Trial Balance

• Only permanent accounts will have balances; temporary accounts will not.

Adjustments and Financial Results

• Adjustments ensure financial statements accurately reflect the company’s profit-making status and economic resources owned/owed.

• Without these adjustments, financial results could be misleading.