ACCOUNTING CYCLE
At the
end of
STEP 4: PREPARATION OF A TRIAL BALANCE
the Aim: To provide a listing to verify the equality of debits and credits in
accountin
the ledger
g period
STEP 5: PREPARATION OF THE WORKSHEET INCLUDING
ADJUSTING ENTRIES
Aim: To aid in the preparation of financial statements
STEP 6: PREPARATION OF FINANCIAL STATEMENTS
Aim: To provide useful information to decision-makers
• Financial information must be timely and
accurate to be useful to decision makers
• Financial statements need to be prepared
at regular intervals. (period)
• Accounts need to be adjusted (updated) to
ensure all revenues, expenses, assets, and
liabilities are recorded.
ACCOUNTING PRINCIPLE
• TIMELINESS PRINCIPLE
• REVENUE RECOGNITION PRINCIPLE
• MATCHING PRINCIPLE
PERIODICTY CONCEPT
Accounting information is valued when it is
communicated early enough to be used for
economic decision-making. To provide timely
information, the economic life of a business is
divided into artificial time periods.
ACCOUNTING PERIODS
• Time periods covered by statements
• Reports covering a one-year period are known as
annual financial statements.
• Many organizations also prepare interim financial
reports covering one, three (quarterly), or six
(semi-annual) months of activity.
ACCOUNTING PERIODS
• Fiscal year is a period of any twelve consecutive
months.
• Calendar year is an annual period ending on
December 31.
* Interim period – period is less than a year
The periodicity concept ensures that accounting
information is reported at regular intervals. It
interacts with the recognition and derecognition
principles to underlie the use of accruals.
EXPENSE RECOGNITION
PRINCIPLES
MATCHING CONCEPT (Direct association of
costs and revenues)
- Costs that are directly related to the earning of
revenue are recognized as expenses in the same
period the related revenue is recognized.
Expenses are to be matched in the same
accounting period as the revenues they helped to
earn.
• Expenses are defined as expired costs/assets
because you already received the benefit (to
generate revenue)
EXPENSE RECOGNITION
PRINCIPLES
SYSTEMATIC AND RATIONAL ALLOCATION
- Costs that are not directly related to the earning
of revenue are initially recognized as assets and
recognized as expenses over the periods their
economic benefits are consumed, using some
method of allocation.
Recognized assets are subsequently recognized
as an expense. (Example: Depreciation,
Amortization, Prepayments.
REVENUE RECOGNITION
PRINCIPLE
• Revenue is recognized (reported) in the time
period when it is earned, regardless of when the
cash is received.
ACCRUAL BASIS
- The effects of transactions and other events are
recognized when they occur and not as cash is
received or paid.
• Revenues are recorded when earned
• Expenses are recorded when incurred
* Cash basis, does not record a transaction
until cash is received or paid.
ADJUSTING AMOUNTS
• Accounts are adjusted at the end of each
accounting period to bring an asset or
liability account to its proper amount.
• Adjusting entries also update the related
expense or revenue accounts.
DEFERRAL AND ACCRUAL
Deferral is the postponement of the
recognition of “an expense already paid but
not yet incurred,” or of “revenue already
collected but not yet earned”. This adjustment
deals with an amount already recorded in a
balance sheet account.
DEFERRAL
1. Allocating assets to expense to reflect
expenses incurred during the accounting
period (e.g. prepaid insurance, supplies and
depreciation)
2. Allocating revenues received in advance to
revenue to reflect revenues earned during
the accounting period (e.g. subscription)
DEFERRAL
1. Prepaid Expenses - expenses paid in
advance.
At the end of an accounting period, the
portion of the asset that has expired becomes
an expense.
DEFERRAL
Initial Entry
Prepaid Expenses xx
Cash xx
Adjusting Entry
Expense xx
Prepaid Expense xx
DEFERRAL
2. Unearned Revenues – receives cash for
services or goods even before service is
rendered or goods are delivered.
As products and services are provided, the
amount of unearned revenues become
earned revenues.
DEFERRAL
Initial Entry
Cash xx
Unearned Revenue xx
Adjusting Entry
Unearned Revenue xx
Revenue xx
DEFERRAL AND ACCRUAL
Accrual is the recognition of “an expense
already incurred but unpaid”, or “revenue
earned but uncollected.” This adjustment
deals with an amount unrecorded in any
account.
ACCRUALS
1. Accruing expenses to reflect expenses
incurred during the accounting period that
are unpaid and unrecorded.
2. Accruing revenues to reflect revenues
earned during the accounting period that
are uncollected and unrecorded.
ACCRUALS
1. Accrued Expenses – costs incurred in a
period that are both unpaid and
unrecorded.
Adjusting entries must be made to record the
expense for the period and the related liability
at the balance sheet date.
ACCRUALS
Initial Entry
When expenses were incurred, but not yet
paid
NONE
Adjusting Entry
Expense xx
Payable xx
ACCRUALS
1. Accrued Revenues – revenues earned in
a period that are both unrecorded and not
yet received in cash.
Adjusting entries must be made to record the
revenue for the period and the related asset
at the balance sheet date.
ACCRUALS
Initial Entry
When revenue were earned, but not yet paid
NONE
Adjusting Entry
Receivable xx
Revenue xx
ALTERNATIVE METHODS
PREPAID EXPENSES
Initial Entry
1. An asset
Prepaid Expense xx
Cash xx
2. An Expense
Expense xx
Cash xx
ALTERNATIVE METHODS
PREPAID EXPENSES
Adjusting Entry
1. An asset
Expense xx
Prepaid Expense xx
2. An Expense
Prepaid Expense xx
Expense xx
ALTERNATIVE METHODS
UNEARNED REVENUES
Initial Entry
1. A liability
Cash xx
Unearned Revenue xx
2. A revenue
Cash xx
Revenue xx
ALTERNATIVE METHODS
UNEARNED REVENUES
Adjusting Entry
1. An asset
Unearned Revenue xx
Revenue xx
2. An Expense
Revenue xx
Unearned Revenuexx
DEPRECIATION
Companies acquire assets, such as
equipment, buildings, vehicles, and patents,
to generate revenue. These assets are
expected to provide benefits for more than
one accounting period.
Depreciation is the process of allocating the
costs of assets over their expected useful
lives.
DEPRECIATION
Calculation (simple)
Straight-Line Depreciation Expense = (Cost
of Asset – Salvage Value)/ Estimated useful
life
DEPRECIATION
Adjusting Entry
Depreciation Expense xx
Accumulated Depreciation xx
Accumulated Depreciation is a contra asset
The normal balance for a contra asset is the
opposite of the related account
BAD DEBTS EXPENSE
Adjustments for bad debts are made at the
end of the accounting period by recording an
adjusting journal entry.
Adjustments use a contra asset account
called Allowance for doubtful account (related
account for doubtful accounts is accounts
receivable)
BAD DEBTS EXPENSE
Allowance Method – the matching principle
requires that bad debts expense be matched
and recorded in the same period as the sale
that generated the receivable.
BAD DEBTS EXPENSE
It satisfies the matching principle by recording
any estimated bad debt expense associated
with the current period's sales in the same
period the related revenue is earned.
BAD DEBTS EXPENSE
Bad Debts Expense xx
Allowance for Doubtful Accounts xx
An allowance account is used since we do
not know which customer accounts will be
uncollectible.
BAD DEBTS EXPENSE
Percentage of Accounts Receivable
AR x %uncollectable = ADA, end
Percentage of Sales
Sales x %uncollectable = BDE
Aging of Receivables
SUMMARY
Balance Sheet Account Income Statement Account
Prepaid Expenses:
Asset Method Asset overstate Expensesunderstated
Expense Method Asset u
dnderstated Expensesoverstate
d
Depreciation Assets overstate Expensesunderstated
d
Unearned Revenues
Liability method Liabilities overstate Income understated
Income method Liabilities d
understated Income overstate
d
Accrued Expenses Liabilities understated Expensesunderstated
Accrued Revenues Assets understated Income understated