FAR chapt. 7

Chapter 7 Completing the Accounting Cycle for a service provider. Time Period Assumption - An accountant is allowed to divide the life of the business into uniform periods of time so that regular financial statements can be prepared. Calendar - A twelve-month period ending on December 12 - If it starts on Janu vary 1 and ends on December 31 Fiscal - Twelve-month period that ends on any month other than December 31. - It may start on a month other than January 1 The accounting period "Note : We cannot proceed to prepare the worksheet for the adjustments if the accounting period is not yet done" Adjusting the Accounts Timing Issue - Time Period Assumption - The economic life of a business is divided into time periods (monthly, quarterly or yearly) - EG. - A one-year insurance paid in advance on March 1, 2020, should be expensed only for ten months in 2020 (March to December) and for two months in 2021 (January to February). - A consultancy firm received an advance fee of P30,000 good for three months starting December 1, 2020. Only one month revenue of P10,000 should be recognized in 2020 and the remaining P20,000 in 2021.

The basics of adjusting entries Adjusting entries are entries prepared at the end of the accounting period to update some accounts and ensure their accuracy before preparing the financial statements Types of adjusting entries - Accrued income - Income already earned but not yet collected - Accrued expense - Expense already expired but not yet paid - Unearned income - Advance collection recorded as a liability, portion of which has been already been earned. - A service that is not yet rendered. - Prepaid expense - Advance payment is recorded as an asset, portion of which has been used up - Bad Debts - Clients' accounts that may not be collected anymore or are doubtful of collection - Depreciation expense - Declining utility value of asset cost that should be expensed Adjusting entries for accruals Accrual Basis Accounting - Also otherwise known as the Revenue Recognition Principle and the Expense recognition principle - Transactions recorded in the period in which the events occur - Accrued Revenues - Revenues are recognized when earned, rather than when cash is received Increases (debits) an asset account Increases (credits) a revenue account - Accrued Expenses - Expenses are recognized when incurred, rather than when paid.

Increase (debits) an expense account Increase (credits) a liability account EG: Adjusting entries for Accrued Reveneu and Accrued Expense Cash Basis Accounting - Revenues are recognized when collected - Expenses are recognized when paid. Matching Principle - The expense representing the effort of the business should be matched against the income representing the accomplishment of the business during the period it was earned. Adjusting entries for deferrals Prepaid Expenses - Expenses are paid in cash and recorded as assets before they are used or consumed - A prepayment is the opposite of accrual and represents advance payment for service to be received. - A payment of cash, that is recorded as an asset because service or benefit will be received in the future - EG - Insurance, Lease, supplies, advertising - Expenses to be incurred in the future. Asset method - The advance payment is recorded as an asset. This represents a right to receive service for cash already paid. - If received or expired transfer this amount from the asset called prepaid expense account to the expense amount Expense method - An alternative method to record the advance payment is to immediately debit it to an expense account.