Financial accounting

Financial Accounting: The Adjusting Process

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• published: 19 Jun 2013
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Introduction to Financial Accounting The Adjusting Process (Chapter 3) February 11th, 2013 by Professor Victoria Chiu The Professor begins by reviewing the topics discussed in the previous lecture, followed by giving a brief overview of the topics to be discussed in the current lecture. The first topic discussed in this lecture is accrual accounting, which involves recording the effect of each transaction as it occurs, regardless of when cash is received or paid. Revenues are recorded when earned and expenses are recorded when incurred. Most businesses uses the accrual basis and it is recommended by GAAP. Cash basis accounting, on the other hand, records only cash receipts and cash payments. It generally ignores receivables, payables, and depreciation. Some of these transactions are recorded in the wrong accounting period. Thus, revenues and expenses are not properly matched in the income statement. This method is only used by small businesses for the most part and is not recommended by GAAP. The SEC requires all publicly traded companies to follow GAAP for financial reporting, thus making the cash-basis accounting method a lot less popular and less widespread. For example, assume your business performed a service worth $100 on May 1, and only got paid the money on June 1. Under the accrual basis, we would debit accounts receivable (since we didn't get any cash yet) for 100 and service revenue for 100 on May 1. Then, on June 1 when we actually get paid, we would debit cash for 100 and credit accounts receivable for 100. Under the cash-basis, however, you record nothing on May 1 and only record the receipt of cash on June 1. Essentially, you go an entire month without recognizing that you had performed a service. Next, the Professor discusses the accounting period concept. Businesses prepare financial statements for specific periods to evaluate performance. The basic accounting period is one year. However, there are interim periods that are less than a year (monthly, quarterly, semi-annually). The revenue recognition principle is also discussed. It guides accountants, telling them when to record revenue and the amount of revenue to record. According to this principle, accountants should record revenue when it has been earned. Revenue has been earned when the service has been provided, when the product has been delivered to the customer, or when the company has completed the sale agreement (earnings process is complete). The amount of revenue that should be recorded is the value of the service (or product) transferred to the customer. The matching principle is discussed next. This principle presents guidelines for recording expenses. It involves the measurement of all expenses incurred during the period and matching the expenses against the revenues earned during the same period. The accountant must subtract the expenses incurred during one month from revenues earned during that same month (which can result in net income or a net loss). The time period concept is also covered. Since owners need periodic reports on their business, this concept requires that all businesses must report their accounting related information at regular intervals. Information must be reported at LEAST annually, although many companies report their financial information in smaller intervals too, such as semi-annually, quarterly, or even monthly. To measure their income accurately, companies must update their accounts at the end of each period (which is usually on a per-month basis). The Professor then moves on to discuss adjusting entries. This process begins with the creation of the trial balance (which is based on the general ledger / T-accounts). The amounts listed on the unadjusted trial balance are incomplete because they omit various revenue and expense transactions. The two primary categories of adjustments are prepaid and accruals. In a prepaid adjustment, the cash payment occurs before an expense is recorded. An accrual records an expense before the cash payment. Types of adjusting entries include prepaid expenses, depreciation, accrued expenses, accrued revenues, and unearned revenues. ------QUICK NAVIGATION------ Video begins with review of previous topics Overview of Learning Objectives: 2:52 Accrual vs. Cash-Basis Accounting: 5:45 --- Revenues: 12:11 --- Revenue Journal Entries: 13:57 --- Expenses: 15:31 --- Expenses Journal Entries: 15:51 --- Summary Chart Comparison: 18:09 Accounting Period Concept: 20:06 Revenue Recognition Principle: 23:03 Matching Principle: 26:01 Time-Period Concept: 31:22 --- Journal Entries: 32:50 Adjusting Entries: 37:14 Unadjusted Trial Balance (illustration): 42:54 Rules for Adjusting Entries: 43:26 Types of Adjusting Entries: 45:42 Prepaid Expenses: 47:55 --- Journal Entry: 50:07 Depreciation: 55:52 --- Accumulated Depreciation: 58:45 --- Journal Entry: 1:01:59 --- Posting (T-account): 1:07:56