CH 03

Financial Accounting
IFRS 4th Edition

Weygandt ● Kimmel ● Kieso
Chapter 3
Adjusting the Accounts

Chapter Preview
In Chapter 1, you learned a neat little formula:
Net income = Revenues – Expenses.
In Chapter 2, you learned some rules for recording revenue and
expense transactions.
Guess what?
Things are not really that nice and neat. In fact, it is often difficult
for companies to determine in what time period they should report
some revenues and expenses. In other words, in measuring net
income, timing is everything.
Copyright ©2019 John Wiley & Son, Inc. 2

Chapter Outline
The learning objectives for Appendix A and B follow below the chapter slides.

Learning Objective 1
Explain the accrual basis of accounting
and the reasons for adjusting entries.
LO 1 Copyright ©2019 John Wiley & Sons, Inc. 4

Time period (or periodicity) assumption:
Accountants divide the economic life of a business
into artificial time periods.
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Fiscal and Calendar Years
• Accounting time periods are generally a month, a quarter, or a year.

• Monthly and quarterly time periods are called interim periods.
• Most large 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.
• Organizations use the same reporting periods from year to year, so
that their financial statements can be compared to the ones produced
for prior years.

Accrual- versus Cash-Basis Accounting
Accrual-Basis Accounting Nguyên tắc cơ sở dồn
tích
• Transactions are recorded in the periods in which the events
occur.
• Companies recognize revenues when they perform services
(rather than when they receive cash).
• Expenses are recognized when incurred (rather than when paid).
• Accrual-basis accounting is in accordance with IFRS.

Accrual- versus Cash-Basis Accounting
Cash-Basis Accounting Nguyên tắc cơ sở tiền mặt
• Revenues are recorded when cash is received.
• Expenses are recorded when cash is paid.
• Cash-basis accounting is not in accordance with IFRS.

Do it!
Followings are transactions occurred in the month of August 2021:
1. Sent out an invoice for $5,000 for services completed this month
2. Received a bill for $1,000 in advertising fees for work done this
month
3. Paid $75 in fees for an utility bill company received last month
4. Received $1,000 from a customer for a project that was invoiced
last month
Journalize the transaction and calculate net income/loss based on:
a. Accrual basis
b. Cash basis

Recognizing Revenues and Expenses
Example service revenue: Example sales revenue:
Ron’s repair service Ron’s retail store received
company follows the an order for selling
revenue recognition products for $900 on June
principle. Ron repaired a 26. Ron shipped the
car on July 31. The products to customer on
customer sent a cheque to June 29 with FOB
Ron on August 5. Ron destination. The customer
received the cheque in received the products on
the mail, brought it to the July 2. Ron got the cash on
bank and withdrew cash July 4. When should Ron
successfully on August 7. record that the sale
When should Ron record revenue was earned?
that the service revenue
was earned?

Expense recognition principle also

refers to “matching principle”
“Let the expenses follow the

revenues.”


DO IT! Timing Concepts
Continues on next slide

The Need for Adjusting Entries
• Adjusting entries ensure that the revenue
recognition and expense recognition principles are
followed.
• Required every time a company prepares financial
statements.
• Will include one income statement account and one
statement of financial position account.

The Need for Adjusting Entries
Reasons:
1. Some events are not recorded daily because it is not
efficient to do so.
2. Some costs are not recorded during the accounting
period because these costs expire with the passage
of time rather than as a result of recurring daily
transactions.
3. Some items may be unrecorded.

Types of Adjusting Entries

Analyze each account to determine whether it is complete and up-
to-date for financial statement purposes.

Prepare adjusting entries for deferrals.

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.

Prepaid Expenses
When companies record payments of expenses that will benefit more than one
accounting period, they record an asset called prepaid expenses or prepayments.
Prepaid expenses are costs that expire either with the passage of time (e.g., rent
and insurance) or through use (e.g., supplies).
Prior to adjustment, assets are overstated and expenses are understated.

Supplies
Rather than record supplies expense as the supplies are used,

companies recognize supplies expense at the end of the
accounting period.
Supplies
Assume: Yazici Advertising purchased supplies costing 2,500 on
October 5. Yazici recorded the purchase 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.
Demonstrate: How do you record the adjustment for supplies?

Supplies

Insurance

Insurance
Assume: On October 4, Yazici Advertising paid 600 for a one-
year fire insurance policy. Coverage began on October 1.
Yazici recorded the payment by increasing (debiting) Prepaid
Insurance.
Demonstrate: How do you record the adjustment for

insurance?

Insurance

Depreciation
Depreciation is the process of allocating the
cost of an asset to expense over its useful
life.
Depreciation is an allocation concept, not a

valuation concept.
That is, depreciation allocates an asset’s

cost to the periods in which it is used.
Depreciation does not attempt to report the

actual change in the value of the asset.

Depreciation
Assume: For Yazici Advertising, depreciation on the equipment is
480 a year, or 40 per month.

depreciation?

Depreciation
- Accumulated
depreciation is
contra assets
account.
- All contra
accounts have
increases,
decreases, and
normal balances
opposite to the
account to which
they relate.
- Accumulated
depreciation is
specified for the
assets its contra
for.

Prepaid Expenses
Statement Presentation.
1 Book value or carrying value: Difference between the cost of any

depreciable asset and its related accumulated depreciation

Prepaid Expenses Summary

Unearned Revenues

Unearned Revenues
When companies receive cash before services are performed, they record a
liability by increasing (crediting) a liability account called unearned revenues.
Prior to adjustment, liabilities are overstated and revenues are understated.

Service Revenue
Assume: Yazici Advertising received 1,200 on October 2 from R.
Knox for advertising services expected to be completed by
December 31. Yazici credited the payment to Unearned Service
Revenue. This liability account shows a balance of 1,200 in the
October 31 trial balance.
Demonstrate: How do you record the adjustment for advertising

revenue?

Service Revenue

Unearned Revenues

Prepare adjusting entries for accruals.
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Adjusting Entries for Accruals
Accruals are made to record the following:

• Revenues for services performed but not yet recorded at the
statement date – accrued revenues
or
• Expenses incurred but not yet paid or recorded at the
statement date – accrued expenses

Accrued Revenues

Accrued Revenues
Prior to adjustment, both assets and revenues are understated.
An adjusting entry for accrued revenues results in an increase (a debit) to an asset

account and an increase (a credit) to a revenue account.

Accrued Revenues
Assume: In October, Yazici Advertising performed
services worth 200 that were not billed to clients on or
before October 31. Because these services were not
billed, they were not recorded.
Demonstrate: How do you adjust for accrued revenue?

Accrued Revenues

Accrued Revenues
Assume: On November 10, Yazici receives cash of 200
for the services performed in October and makes the
following entry.
Demonstrate: How do you record the collection of the

receivables?

Accrued Revenues

Accrued Revenues - Summary

Accrued Expenses
Prior to adjustment, both liabilities and expenses are understated.
An adjusting entry for accrued expenses results in an increase (a debit) to an expense

account and an increase (a credit) to a liability account.

Accrued Interest
Assume: Yazici Advertising signed a three-month note
payable in the amount of 5,000 on October 1. The note
requires Yazici to pay interest at an annual rate of 12%.
Demonstrate:
(1) How do you determine the interest to be recorded?
(2) How do you create the adjustment for accrued
interest?

Accrued Interest

Accrued Interest

Accrued Salaries and Wages
Assume: On October 31, the salaries and wages for these three days represent
an accrued expense and a related liability to Yazici. The employees receive
total salaries and wages of 2,000 for a five-day work week, or 400 per day.
Thus, accrued salaries and wages on October 31 are 1,200 ( 400 × 3).
Demonstrate: How do you create the adjustment for accrued salaries and
wages on October 31?


Assume: Yazici pays salaries and wages every two weeks.
Consequently, the next payday is November 9.
Demonstrate: Which entry does Yazici make on November 9?

Accrued Expenses - Summary

Summary of Basic Relationships

Describe the nature and purpose of an
adjusted trial balance.

Adjusted Trial Balance and
Financial Statements
Adjusted trial balance:
• Proves the equality of the total debit balances and the total
credit balances in the ledger after all adjustments.
• Primary basis for the preparation of financial statements.
• Prepared after all adjusting entries are journalized and posted.

Preparing the Adjusted Trial Balance

Preparing Financial Statements (1/2)



DO IT! Trial Balance

Chapter Appendix Outline
Appendix 3A
Appendix 3B

Learning Objective 5*
Prepare adjusting entries for the
alternative treatment of deferrals.
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Alternative Treatment of Deferrals
Alternative treatment:
(1) When a company prepays an expense, it debits that amount to
an expense account.
(2) When it receives payment for future services, it credits the
amount to a revenue account.
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Prepaid Expenses
Supplies
Assume: Yazici Advertising purchased supplies costing 2,500 on
October 5. Yazici recorded the purchase by increasing (debiting)
Supplies Expense (rather than to the asset account Supplies).
An inventory count at the close of business on October 31 reveals
that 1,000 of supplies are still on hand.
Demonstrate: How do you record the adjustment for supplies?

Supplies

Prepaid Expenses
Adjustment Approaches - Comparison

Unearned Revenues
Service Revenue
Assume: Yazici Advertising received 1,200 on October 2
from R. Knox for advertising services expected to be
completed by October 31. However, Yazici has not
performed 800 of the services by October 31.

advertising?

Service Revenue

Unearned Revenues
Adjustment Approaches - Comparison

Summary of
Additional Adjustment Relationships

Learning Objective 6*
Discuss financial reporting concepts.
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Qualities of Useful Information
Fundamental Qualities

Qualities of Useful Information
Enhancing Qualities
Quality: It means:
Comparability (1) Different companies use the same accounting
principles, and
(2) A company uses the same accounting principles and
methods from year to year.
Verifiability Independent observers, using the same methods, obtain

similar results
Timeliness It is necessary for accounting information to be relevant.
Understandability Information is presented in a clear and concise fashion,
so that reasonably informed users of that information
can interpret it and comprehend its meaning.

Assumptions in Financial Reporting (1/2)

Assumptions in Financial Reporting (2/2)

Principles in Financial Reporting (1/2)
Measurement Principles
IFRS generally uses one of two measurement principles, the historical cost
principle or the fair value principle.
Historical cost principle (or cost principle): dictates that

companies record assets at their cost. This is true not only at the
time the asset is purchased, but also over the time the asset is
held.
Fair value principle: states that assets and liabilities should be
reported at fair value (the price received to sell an asset or settle
a liability).

Principles in Financial Reporting (2/2)
Revenue Recognition Principle
Requires that companies recognize revenue in the accounting period in which the
performance obligation is satisfied.
Expense Recognition Principle

Dictates that companies recognize expense in the period in which they make efforts to
generate revenue. Thus, expenses follow revenues.
Full Disclosure Principle

Requires that companies disclose all circumstances and events that would make a
difference to financial statement users.
If an important item cannot reasonably be reported directly in one of the four types of
financial statements, then it should be discussed in notes that accompany the
statements.

Cost Constraint
It weighs the cost that companies will incur to provide the

information against the benefit that financial statement users
will gain from having the information available.

Homework
P3.2
P3.3
P3.4
P3.6*

Copyright
Copyright © 2019 John Wiley & Sons, Inc.
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Financial Accounting

IFRS 4th Edition

Adjusting the Accounts

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• Accounting time periods are generally a month, a quarter, or a year.

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Expense recognition principle also

“Let the expenses follow the

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Continues on next slide

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Deferrals are expenses or revenues that are recognized at a date

There are two types:

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Prior to adjustment, assets are overstated and expenses are understated.

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Rather than record supplies expense as the supplies are used,

Demonstrate: How do you record the adjustment for supplies?

Continues on next slide

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Demonstrate: How do you record the adjustment for

Continues on next slide

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Depreciation is an allocation concept, not a

That is, depreciation allocates an asset’s

Depreciation does not attempt to report the

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Demonstrate: How do you record the adjustment for

Continues on next slide

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1 Book value or carrying value: Difference between the cost of any

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Prior to adjustment, liabilities are overstated and revenues are understated.

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Demonstrate: How do you record the adjustment for advertising

Continues on next slide

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