TOPIC 4

Adjusting Accounts and Preparing

Financial Statements
 Accrual Basis versus Cash
Basis

Accrual Basis Cash Basis

Revenues are Revenues are
recognized when recognized when cash
earned and expenses is received and
are recognized when expenses are recorded
incurred. when cash is paid.
 Accrual Basis versus Cash
Basis

Accrual Basis Cash Basis

Revenues are Revenues are
recognized when recognized when cash
earned and expenses is received and
are recognized when expenses are recorded
incurred. when cash is paid.
Non-GAAP
Accrual Basis versus Cash
Basis
Illustration:
In 20X1,
2 Dec: student enquiry
5 Dec: student signed up
20 Dec: Class started
5 Jan 20X2: Paid school fees
When should revenue be recognised?
Recognizing Revenues &
Expenses
Revenue Recognition Principle
We have delivered the
product to our customer,
so I think we should record
the revenue earned.
 Recognizing Revenues &
Expenses
Matching Principle
Now that we have
Summary recognized the revenue,
of Expenses let’s see what expenses
Rent $1,000 we incurred to
Gasoline 500
Advertising 2,000
generate that revenue.
Salaries 3,000
Utilities 450
and . . . . ....
Adjustments
An adjustment is needed to ensure that expenses are
properly matched to revenue.
Framework for Adjustments
Adjustments

Paid cash before expense

Paid cash after expense
recognized
recognized
- Known as prepaid expense
- Known as accrued expense
- (including depreciation)
Prepaid expense
Prepaid expenses are expenses that have been paid
but NOT yet used.

Since they have not been used up yet, this amount

must be deducted from the expense for the year.
 Prepaid expense
Example:
For the year, a total of $50,000 was paid for rental expense.
However, as at 31 December 20X1, $2,000 was for rental in Jan
20X2 (prepaid).

Question:
How much was the rental expense for the year, 20X1?
 Prepaid expense
Solution:
Total rental expense (portion used up) was
50,000 - 2,000 = $48,000 (statement of comprehensive
income).

The $2,000 that was prepaid becomes an asset (statement of

financial position)
Depreciation
Depreciation is the process of allocating the cost of a fixed
asset over its useful life in a systematic and rational manner.

Straight-Line Asset Cost - Residual Value

Depreciation =
Expense Useful Life
 Depreciation

On December 1, 2011, Fast-forward purchased equipment for $26,000 cash. The

equipment has an estimated useful life of four years (48 months) and Fast-
forward expects to sell the equipment at the end of its life for $8,000 cash.
(c) Let’s record depreciation expense for the month ended December 31, 2011.

Dec. 2011 $26,000 - $8,000

Depreciation = = $375 per month
Expense 48 months
 Depreciation
The depreciation expense of $375 will appear as an
expense in the statement of comprehensive income.

This $375 will be deducted from the cost of fixed

asset in the statement of financial position.
 Depreciation
FastForward
Statement of financial position Equipment is
At December 31, 2011 shown net of
Fixed Assets accumulated
$ depreciation.
.
Equipment $ 26,000
Less: accumulated deprec. (375) 25,625
.
.
Total Assets
Accrued expense
Accrued expenses are expenses that have been
incurred but NOT paid yet.

Since they have already been incurred, this amount

must be added to the expense for the year.
Accrued expense
Example:
Total salaries paid for the year, 20X1 was $80,000. However, as
at 31 December 20X1, $5,000 salary was still owing to
workers.

Question:
How much was the total salary for the year 20X1?
Accrued expense
Solution:
Total salary for the year 20X1 was
80,000 + 5,000 = $85,000 (statement of comprehensive
income)

The $5,000 that was still owing will appear as a current

liability (statement of financial position)
END OF CHAPTER 3