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Financial Statement Analysis

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Financial Statement Analysis-FIN621
VU
Lesson-7
ACCOUNTING CYCLE/PROCESS
(Continued)
e) Making adjusting entries: These are the Entries required for those transactions which affect
revenues or expenses of more than one accounting period.
Immediate recording of every event in some cases is not practical e.g. raw material,
office supplies, depreciation. Journal entries of such expenses are recorded at the end of accounting
period and are called adjusting entries. Regular journal entries (chronological) are recorded in blue and
adjusting entries are recorded in red.
Adjusting Entry to record Expenses on Fixed Assets
The expenditure use to acquire Fixed Assets is spread over a number of Accounting periods.
The spreading of that expenditure over a number of Accounting periods is called Expense for
that period.
Adjusting entry is also required to record Prepaid Costs.
Expenses are the expired portion of Assets.
Office supplies and Raw material are treated at the end of Accounting period.
The balance of Office supplies & Raw materials is calculated as follows:
Opening balance
Add: Purchases
Less: Closing balance
Prepaid Costs are initially taken as Asset.
Pre paid costs, if consumed entirely during Accounting period are charged directly to expense
Types of Adjusting Entries
i)
Entries to distribute expenditure benefiting more than one accounting period
e.g.
fixed assets, pre-paid costs (if for more than one year). Pre-paid costs are initially taken
as Asset and corresponding portion for an accounting period is reduced there from. In
the case of office supplies, raw materials, the formula is: - opening balance + purchases-
closing balance. This would give the amount/extent of official supplies, raw materials
consumed during the accounting period. It must also be noted that pre paid costs, if
consumed entirely during accounting period, are charged directly to expense.
Fixed assets are those which are used for more than one Accounting period.
ii)
Entries to distribute un-earned revenue i.e. revenue collected in advance (deferred
revenue). It is first recorded as liability, and is gradually reduced in the subsequent
accounting period.
iii)
Entries to record accrued expenses e.g. unpaid salaries, interest payable, to be paid in
the subsequent accounting period.
iv)
Entries to record accrued revenues. These are first recorded as Assets i.e. Revenue
Receivable. For example if rendering of services/delivery of goods is spread over a
number of accounting periods, and billing is to be done at the completion of rendering
services or delivering goods, then corresponding adjusting entry for each accounting
period is made for Revenue Receivable, but not yet earned.
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Financial Statement Analysis-FIN621
VU
Khizr Property dealer
Trial Balance
For the month of July 2006
Particulars
Rs.
Rs.
Cash
22,500
Accounts Receivable
9,500
Land
130,000
Building
36,000
Office Equipment
5,400
Accounts Payable
23,400
Khizr, Capital (owner's equity)
180,000
Total
203,400
203,400
Adjusted entries are all related to accrual accounting, as would be seen from the very description of each
adjusting entry given above.
f) Preparing adjusted trial balance:
This is the sixth step in Accounting Cycle. In this, we take into account the adjusting entries made
earlier in step 5 (e).
Adjusting entries are journalized and posted, i.e. recorded in journal and posted in ledger.
Accumulated depreciation would double after second month, in the example of adjusted trial
balance given above. In the above example, estimated life of building is taken as 20 years and that
of office equipment as 10 years, which makes the monthly figure of the use of these assets as
Rs.150 and Rs.45 respectively. Other transactions during August 2006 changed balances of cash,
A/Cs Receivable, A/Cs payable. Reverting to the earlier reference about invisible expenses of
Rs.195, in the Income Statement, these were depreciation expenses of building amounting to Rs.150
and depreciation expenses of office equipment amounting to Rs.45.
The adjusting entries which are recorded in Journal at the end of Accounting period are adjusted in,
Adjusted Trial Balance.
Khizr Property Dealer
Adjusted Trial Balance
August 31,2006
Particulars
Dr.
Cr.
Cash.
16,105
Accounts Receivable.
18,504
Land.
130,000
Building.
36,000
Accumulated depreciation: building.
150
Office equipment.
5,400
Accumulated Dep: office equipment.
45
Accounts Payable.
23,814
Owner's equity.
180,000
Sales commission earned.
10,640
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Financial Statement Analysis-FIN621
VU
Advertising expenses.
645
Salaries expenses.
7,400
Telephone expenses.
400
Depreciation expenses: building.
150
Depreciation expenses: office equipment.
45
214,649
214,649
The above is adjusted trial balance as on August 31, 2006.
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