Ch. 8 – Completing the Accounting Cycle

The Adjustment Process  IFRS should be followed, meeting the objectives of relevancy, reliability, and comparability  Accrual accounting – means attempting to record revenues and expenses when they happen, regardless of whether cash is received or paid  The chunks of time used for financial measurement are called fiscal periods  The time period concept ensures that the comparability objectives in accounting is met  The action that senior accountants take at the end of a fiscal period is called adjusting the accounts

 An adjusting entry is a journal entry that assigns an amount of revenue or expense to the appropriate accounting period; at the same time, it is an entry that brings a balance sheet account to its true value  Example:  We have a debit balance of $ for supplies  However, we have used supplies throughout the year  It is too time-consuming to make an expense entry, every time supplies are used  However, a “taking inventory” could be performed on a quarterly basis  Therefore, supplies would be credited each quarter to arrive at a final balance

 After posting, the balance sheet amount of Supplies will be true, and the actual cost of using supplies will be recorded on the income statement  Many times expense items are paid in advance  Items such as insurance may cover a length of time that applies to the current fiscal period and the following fiscal period  Here, there is a need for special accounting treatment at statement time  A prepaid expense is an item paid for in advance, but one where the benefits extend into the future  Prepaid expenses have value and belong in the asset category  The pattern for making the adjustment to Prepaid Insurance is the same as the one for Supplies: determine the true value of the balance sheet account, make a credit entry to adjust the Dec. 31 st balance down to its true value, and make a corresponding debit to an expense account

 For supplies we can do an inventory  For insurance, we must do a little math  If our policy is $1600 for one year, each quarter we use up $400 of the the policy (see page example)  Financial statements are not usually prepared until 2 to 3 weeks after the fiscal year-end  This should be sufficient time to receive purchase invoices that affect the fiscal period that just ended  You must include all costs that helped the business earn revenue during a fiscal year  If late-arriving invoices were not recorded, net income would be overstated because valid expenses were not deducted from revenue  Similarly, there may be times when you may want to adjust revenue (see page 274 – where a cheque has been deposited but no service has been provided to earn anything during the fiscal period)

Review of Section  You now know how to prepare adjusting entries for four common year-end situations: 1) supplies, 2) prepaid expenses such as insurance, 3) late-arriving invoices, and 4) unearned revenue  No matter how complex an adjustment appears, you will be able to do it correctly if you use common sense and follow the theory that you have learned so far  Examples of journal entries on page 275