Lecture 6

Adjustments

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 Adjustments

Fiscal Period
Before illustrating the meaning of adjustments, we have to understand the meaning of fiscal
period.

Fiscal period or Accounting period is a Period of time that covering a complete accounting
cycle through the issuance of financial statements. It could be a week, month, quarter or full
year.

What is Adjustments?

Throughout an accounting period, an entity will continue to be engaged in a variety of

economic transactions. Some of those will affect the current period, while some of them will
affect future periods throughout the life of the entity. At the time that they occur, each of
these transactions, are supported by a source document. If they are applicable to the current
period, their flow through the accounting system is straight forward and without the need for
any special handling or considerations (Ordinary transactions). However, those transactions
which affect the present and future accounting periods will at some future date require
special considerations and handling. The special considerations are caused by absence of a
source document, which gives cause to their existence. Keep in minds that these transactions
either happened in a prior period or have not yet happened. The special handling is a
continuation of the special consideration, in a way to be dealt with a manner which adjusts
their effects in the current period by special journal entries. Consequently, their
consequences will be applied to the proper accounting period. Such transactions are related
mainly to the following types of expenses and revenues:

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 • Accruals

• Prepaid payments

• Deferred revenues

• Depreciation

Accruals

Businesses often incur expenses they have not yet been billed for, let alone paid.
Utility bills, for example, usually arrive after the business has consumed the electricity
or gas being billed. For some types of expenses, such as salaries or loan interest, no
bills will ever be received. At the end of each accounting period, businesses must
record adjusting entries called accruals to get these unbilled, unpaid expenses, which
we call accrued expenses, into the books. By recording these accruals, we ensure the
related expenses and liabilities are properly reflected in the financial statements for the
period.

Prepaid payments

A prepaid expense is an expense a company has paid for in advance of actually using
the benefit. Because it will provide a future economic benefit to the company, it is
recorded as an asset when the cash payment is made. Recording the initial transaction
this way results in the deferral of the expense to the future period in which the related
benefit is realized.

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Deferred (Un-earned) revenues

Businesses sometimes receive cash from customers before providing them with the
goods or services they have paid for. Because the goods or services have not been
delivered, the revenue recognition principle deems this to be unearned revenue. In fact,
the business now has an obligation to provide the goods or services at some future
date, which requires it to record a liability instead of revenue. Recording such
transactions in this way results in a deferral of revenue recognition until the liability
has been settled by providing the goods or services to the customer.

Depreciation

• Depreciation is the permanent and continuing decrease in the quality, quantity or value
of an asset.

• Depreciation is the measure of wearing out of a fixed asset. All fixed assets are
expected to be less efficient as time goes on and as they are continuously used in a
business, for example.
• Depreciation is calculated as the estimate of this measure of wear and is recorded in
the Profit & Loss report either on a monthly or an annual basis. The cost of the asset
less the total depreciation will give you the Net Book Value of the asset.

Why depreciation is used

• The idea of depreciation is to spread the cost of that capital asset over the period of its
"useful life to the entity" that currently owns it.
• If the full cost of the asset were to be borne in the year that it was purchased, then that
year's expenditure would be unfairly penalised whilst expenditure during the
remaining years, which were still receiving the benefit from the asset, would not be
affected.

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How do assets depreciate?

Assets depreciate for two main reasons which are:

• Wear and tear. For example, a car will decrease in value because of the mileage,
wear on tyres, and other factors related to the use of the vehicle.
• Obsolescence: Assets also decrease in value as they are replaced by newer models.
Last year's car model is less valuable because there is a newer model in the
marketplace.

Depreciation calculation (Straight-Line Method):

• Straight-line depreciation; meaning, the asset depreciates at the same rate over the
years.

• Depreciation is calculated as follows:

The original cost of the asset minus the salvage value (the "scrap" value) then divided
over the years of useful life of the asset.

Exercise:

Jill’s design company purchases a 3D printer for $1,240, which they estimate that they
will use for 3 years (the printer’s useful life). Under depreciation, the value of the
printer decreases each year, with an estimated residual value at the end of the three
years of $400. Calculate Depreciation Expense based on straight-line method.

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The trial balance

A trial balance summarizes the ledger by listing all accounts with their balances; assets first,
followed by liabilities, and then owner’s equity. Before computers, the trial balance provided
accuracy check by showing whether the total debits equalled the total credits. The trial
balance is still useful as a summary of all the accounts and their balances. A trial balance
may be created at any time the postings are up to date. The most common time is at the end
of the accounting period. The below trial balance is a sample of Hunter Environmental
Consulting at April 30, 2016, the end of the first month of operations before any adjustments
are made. Therefore, it is more accurately called the unadjusted trial balance at this stage.
The totals on this report came from the balances in general ledgers. Most trial balances
include the account numbers from the chart of accounts. Accounts with zero balances
typically are not listed on the trial balance.

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Adjusted trial balance:

After all Adjusting Entries and Reclassifying Entries have been journalized and posted, an
ADJUSTED TRIAL BALANCE is prepared from the ledger accounts. It shows the balance
of all accounts, including those that have been adjusted, at the end of the accounting period.
The purpose of an adjusted trial balance is to show the effects of all financial events that
have occurred during the accounting period. In addition, the financial statements are usually
prepared from the adjusted trial balance. Below is a sample of the Adjusted Trial Balance.

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Example:

 Moreau Ltd. prepays three months’ office rent ($3,000) on April 1.

 At the end of April, Moreau has only two months of future rental benefits
remaining (2/3 of $3000)

 On April 2, Moreau paid cash for $700 of office supplies

 Moreau’s count shows that $400 in supplies remain at April 30.

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  A customer engages Moreau Ltd. to provide consulting services over the next
year, agreeing to pay Moreau $450 per month for nine hours of services ($50/
hour), effective immediately.

 During the last 10 days of April, Moreau performed three hours of services for
the client, so by April 30, Moreau has settled one-third of the liability

 April 3, Moreau Ltd. purchased $16,500 of office furniture, including desks,

chairs, and storage cabinets, on account.

 Moreau Ltd.’s furniture is expected to remain useful for five years and then be
worthless.

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  Moreau Ltd. has one employee that receives a monthly salary of $1,900, which
is paid in equal $950 amounts on the 15th and last day of each month. The
following calendar illustrates Moreau’s pay days for April:

Complete the rest of transactions:

 Moreau Ltd. holds a loan receivable from a client. At the end of April, $125 of
interest revenue has been earned but not received. Prepare the adjusting entry at
April 30.

 Moreau Ltd. Received an amount of unearned service revenue of $150.

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Exercise – Adjustment

The trial balance of Goldsmith Inc. shown above pertains to December 31, 2014, which is the
end of its year-long accounting period. Data needed for the adjusting entries include the
following (all amounts in thousands):
a. Supplies on hand at year-end $2.
b. Depreciation on furniture and fixtures $20.
c. Depreciation on building $10.
d. Salary owed but not yet paid $5.
e. Accrued service revenue $12.
f. Of the $45 balance of unearned service revenue, $32 was earned during the year.
g. Accrued income tax expense, $35.

Prepare the adjusted trial balance besides to the ordinary financial statements

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 Assignment (4)

Adjustments
Assume that the Genove trucking company started business in June 1.2017 Assuming that
the books are closed on June 30.2017 the following trial balance was prepared
Genove trucking company
Trial balance
June 30, 2017
Acc. Account title Debit credit
101 Cash $ 5.250
111 A/R 550
112 N/R 1.440
131 Office supplies 230
141 Prepaid insurance 2.160
142 Prepaid rent 1.500
201 Office equipment 1.400
211 Trucks 26.000
301 A/P 200
302 N/P 8.000
321 Unearned rent 600
401 Lucy Genova capital 25.000
701 Lucy Genova withdrawing 500
501 Trucking revenue 7.465
601 Heat and light expense 40
602 Maintenance and repair expense 375
603 Telephone and telegraph expense 95
604 Gas and oil expense 525
605 Wages expense 1.200
$41.265 $41.265

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The following adjustments are to be recorded in order to prepare the balance sheet:

a. Rent in the amount of $1.500 was paid for three months on June1, 2017.

b. Insurance premium of $2.160 for comprehensive three –year insurance policy was paid on
June1, 2017.

c. In June30,2017 inventory of office supplies amounted to $60.

d. The Company rented out one of its trucks on a part –time basis and collected rent of $600
in Advance for six months starting June1.

e. The office equipment purchased on June1, 2017 has estimated life of 10 years and a Salvage
value of $200 at the end of this period: this is to be depreciated by using the straight line
method.

f. The trucks purchased on June1, 2017 has an estimated life of 10 years and a salvage Value of

$2000 at the end of this period: this is to be depreciated by using the straight line method.

g. The company lent $1.400 at 18% interest for 30 days note, issued on June20, 2017.

h. Wages of $1500 for June28, 29and30 have not been paid or recorded.

i. The company borrowed money from a bank on June10 and issued a40 days note at 18%

interest for $8.000.

Prepare the adjusted trial balance in addition to the ordinary financial statements

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