BUSS1030 Chapter Notes - Chapter 3: Deferred Income, Trial Balance, Matching Principle
28 May 2018
School
Department
Course
Professor
CHAPTER 3: THE ADJUSTING PROCESS
ACCRUAL VERSUS CASH-BASIS ACCOUNTING
• Accrual accounting: records the effect of each transaction as it occurs à wider criteria to determine if revenue is
realised or expenses incurred
o Uses receivables and payables (credit)
• Cash-basis accounting: recognises a transaction only if it involves an immediate inflow/outflow of cash
o Uses cash receipts (revenues) and payments (expenses)
WHY WE ADJUST THE ACCOUNTS
• (Unadjusted) trial balance: lists revenues and expenses of an entity BUT omit various transactions
o Accrual accounting requires adjusting entries at the end of the period
• Adjusting entries assign revenues to the period when they are earned, and expenses to the period when they are
incurred = matching principle
o Adjustments are needed to measure two things:
§ Profit/loss in the income statement
§ Assets and liabilities in the balance sheet
o Key facts:
§ Adjusting entries never involve the Cash Account
§ They either:
• Increase revenue earned
• Increase an expense
§ When info is provided about an adjustment to an account and worded as “accrued” or “prepaid,”
an amount, you journalise the stated amount to the stated account
CATEGORIES OF ADJUSTING ENTRIES
• Prepayments: cash payment occurs before expense is recorded OR cash receipt occurs before revenue is earned
o AKA deferrals à recognition of revenue or expense is deferred to date after cash is received/paid
• Accruals: records an expense before cash payment OR records revenue before cash is received
• Five Types of Adjusting Entries:
1. Prepaid expenses
2. Depreciation of non-current assets
3. Accrued expenses
4. Accrued revenues
5. Unearned revenues
PREPAID EXPENSES
• Prepayments: cash payment occurs before expense is recorded OR cash receipt occurs before revenue is earned
• Advance payments of expenses = assets
o When prepayment is used up, the used portion of asset becomes an expense via an adjusted journal entry
o E.g. prepaid rent, prepaid insurance, supplies
• E.g. Smart Touch prepays 3 months of rent of $3000 (3 months x $1000 per month on 1 June 2014)
June 1
Prepaid rent ($1000 x 3)
3000
Cash
3000
Paid rent in advance
o The adjusting entry is as follows:
June 30
Rent Expense ($3000 x 1/3)
1000
Prepaid rent
1000
To record rent expense
DEPRECIATION OF NON-CURRENT ASSETS
• Property, plant and equipment assets: long-lived, non-current, tangible assets used in the operation of a business
o E.g. land, buildings, equipment, furniture, vehicles etc.
o As a business uses non-current assets, their value and usefulness decline = expense
§ Accountants systematically spread cost over its useful life
o The allocation of a non-current asset’s value to expense = depreciation
§ NONE for land as typically doesn’t decline w/ use
Document Summary
Accrual versus cash-basis accounting: accrual accounting: records the effect of each transaction as it occurs wider criteria to determine if revenue is realised or expenses incurred, uses receivables and payables (credit) Cash-basis accounting: recognises a transaction only if it involves an immediate inflow/outflow of cash: uses cash receipts (revenues) and payments (expenses) Assets and liabilities in the balance sheet: key facts: Adjusting entries never involve the cash account. When info is provided about an adjustment to an account and worded as accrued or prepaid, an amount, you journalise the stated amount to the stated account. Five types of adjusting entries: prepaid expenses, depreciation of non-current assets, accrued expenses, accrued revenues, unearned revenues. Smart touch prepays 3 months of rent of (3 months x per month on 1 june 2014) 3000: the adjusting entry is as follows: Accountants systematically spread cost over its useful life: the allocation of a non-current asset"s value to expense = depreciation.
