12-Jul-19 Chapter The Matching Concept and The Adjusting Process Time difference Remember “accounting period concept”? This is where all the problems in accounting start!!! Accountants must determine in which period to report the REVENUES and EXPENSES of the business So they use: Cash Basis OR Accrual Basis Objectives Cash Basis Explain how the matching concept relates to the accrual basis of accounting Explain why adjustments are necessary and list the characteristics of adjusting entries Journalise entries for accounts requiring adjustment Revenues and expenses are reported in the profit and loss statement in the period in which cash is received or paid Example: Your company purchased a machine in March on credit The indebted amount is paid in May Content Accrual Basis Time difference! Cash Basis and Accrual Basis Matching concept Adjusting process Revenues are reported in the profit and loss statement in the period in which they are earned Revenue is reported when services are provided to customers in March! (Cash may or may not be received) 12-Jul-19 Difference between Deferrals and Accruals Matching Concept Accounting concept that supports reporting revenues and related expenses in the same period is called the Matching Concept, or Matching Principle Deferrals ◦ Cash received or paid in the current period, but these items relates to future period Accruals ◦ Cash will not be received or paid until a future period, the revenue and expense relates to the current period Adjusting Process At the end of the month or year, some accounts require “updating” Ex: Supplies balance, Depreciation Account, etc Current Accounting Period Cash Received or Paid Deferrals Journal entries that update accounts are called Adjusting entries Revenue Earned or Expense Incurred Accruals Nature of Adjusting entries Affect at least one profit and loss account (revenue or expense) and one balance sheet account (asset or liability) Deferrals (expenses and revenues) Accruals (expenses and revenues) Future Accounting Period Revenue Earned or Expense Incurred Cash Received or Paid Deferred Expenses Initially recorded as assets but are expected to become expenses Supplies and Supplies Expense Prepaid Insurance and Insurance Expense 12-Jul-19 Supplies and Supplies Expense Supplies and Supplies Expense (Cont) Prepaid Insurance and Insurance Expense The company bought an 12-months insurance contract (@cost of $12,000) for their inventory on 1st of December How would they record this at the beginning and end of December? Let prepare your T-account for this transaction What is the effect of omitting adjusting entries? 1.1 Bought supplies with cost $1,000 Amount of supplies used during the month $350 The supplies account balance at the end of the month? Expenses Assets Owner’s Equity Prepaid Insurance and Insurance Expense Deferred Revenue Initial recorded as liabilities but are expected to become revenues Think of any example? Unearned Revenue and Revenue 12-Jul-19 Unearned Rent and Rent Revenue Let assume I have a house to rent out for students @ $100 per month What if you guys sign a 6-months rent contract with me at 1st December? (Paid in full) Accrued Expenses What if at the end of March Mr Vuong has paid you guys just mil? How to treat this unpaid salaries at the end of the month? Accrued Revenue These are expenses that have been incurred but have not been recorded in the accounts Are revenues that have been earned but have not been recorded in the accounts Accrued expenses are services that are paid for after the services has been performed Ex: Lawyer has provided services to a client but has not send an invoice still the end of the month Salaries owned to employees Account Receivable and Fees Earned Salaries Payable and Salaries Expense Salaries Payable and Salaries Expense You are hired as sale assistants in Mr Vuong’s food store on 1st March Salaries: mil per month How Mr Vuong record this at the beginning and the end of March? Salaries Payable and Salaries Expense Account Receivable and Fees Earned I signed an agreement with students on January 15th Binding by the agreement, I will help students to answer their accountingrelated-questions @ $10 per question Invoice will be sent to students on the 15th of each month Given that I had answered 20 questions at the end of January How I record this at the end of the month? 12-Jul-19 Fixed Assets and Depreciation Fixed Assets and Depreciation Fixed Assets: ◦ Permanent ◦ Duration Used to earn Revenue Depreciation: Fixed Assets and Depreciation Accumulated depreciation accounts are called Contra Accounts, or Contra Asset Accounts Fixed assets are presented on the BS at their Net Book Value (Cost of Fixed Assets – Accumulated Depreciation) Summary of Adjusting Process Deferred Expense Deferred Revenue Dr Accrued Expense Dr Accrued Revenue Dr Depreciation Dr ◦ Decrease in usefulness Recorded as expenses Dr Cr Cr Cr Cr Cr Fixed Assets and Depreciation Company bought a machine on 1/1/20X0 at cost of $10.000 At the year end, the estimated amount of depreciation for the year is assumed to be $1.000 How to record this at the year end?