Seoul National University Business School

Spring 2025

Chapter 3
Adjusting the Accounts

1
Chapter Outline
LEARNING OBJECTIVES
LO 1 Explain the accrual basis of accounting and the
reasons for adjusting entries.
LO 2 Prepare adjusting entries for deferrals.
LO 3 Prepare adjusting entries for accruals.
LO 4 Describe the nature and purpose of an adjusted
trial balance.

2
Learning Objective 1
Explain the accrual basis of accounting
and the reasons for adjusting entries.

3
LO 1
Time Period (Periodicity) Assumption
• Business life is continuous.
• But accounting divides it into months, quarters, or years.
• Like a calendar, it helps track and report performance
clearly.

WHEN to recognize revenues

and expenses is an important
issue!!!

4
LO 1
Fiscal and Calendar Years
• Accounting time periods are generally a month, a quarter,
or a year.
• Monthly and quarterly time periods are called interim
periods.
• Most large companies must prepare both quarterly and
annual financial statements.
• Fiscal Year is an accounting time period that is one year in
length.
• Calendar Year is from January 1 to December 31.
• Sometimes a company’s year-end will vary from year to year
, resulting in accounting periods of either 52 or 53 weeks.
5
LO 1
Accrual-Basis Accounting
• Transactions are recorded in the periods in which
the events occur.
• Companies recognize revenues when they perform services
(rather than when they receive cash).
• Expenses are recognized when incurred (rather than when
paid).
• Accrual-basis accounting is in accordance with IFRS.

Comparison: Cash vs. Accrual Accounting

Basis When Revenue is Recorded When Expense is Recorded

Cash When cash is received When cash is paid

Accrual When service is performed When expense is incurred

6
LO 1
 Cash-Basis Accounting
• Revenues are recorded when cash is received.
• Expenses are recorded when cash is paid.
• Cash-basis accounting is NOT in accordance with IFRS.
• So if you provide a service today, but you get paid next month, you
don’t record anything until the money arrives.

Comparison: Cash vs. Accrual Accounting

Accrual Basis Cash Basis

Revenue When service is performed When cash is received

Expense When expense is incurred When cash is paid

Allowed by IFRS ✅ Yes ❌ No

7
LO 1
Revenue Recognition Principle
• Companies recognize revenue in the accounting period in which
the performance obligation is satisfied.

• Company satisfies its performance obligation by performing a

service or providing a good to a customer.

For example:
• A customer orders a haircut.
• You perform the haircut.
• Even if the customer pays next week, the revenue
is recorded today, because you’ve completed your
obligation.

Revenue recognition is about what you’ve

done, not when you’re paid. 8
LO 1
Expense Recognition Principle

Even if you pay the bill later, you record the

expense when the benefit happens — when it
helps generate revenue.

For example:
You sell a product in March, but paid for advertising
in February.
You recognize the ad expense in March, when it
helped generate the sale.

9
LO 1
 Expense Recognition Principle
Revenue vs. Expense
Concept When to Record Key Focus

Revenue Recognition When performance is done Performance obligation fulfilled

Expense Recognition When revenue is earned Matched with related revenue

Revenue Recognition Principle Expense Recognition Principle (Matching

• Revenue is recorded when the company Principle)
satisfies the performance obligation • Expenses are recorded in the period
• Not based on when cash is received they help generate revenue
• Focus: Did we complete the service or • Not based on when cash is paid
deliver the product? • Focus: Did the cost help us earn revenue
in this period?

10
LO 1
Five-Step Revenue Recognition
Process – Sierra Travels Example
• Revenue recognition results from a five-step process. This process can best
be illustrated with an example. Assume that Sierra Travels signs a contract
with the Lewis family to provide guide services for a one-week backpacking
trip for €1,500.

• No performance, no revenue.
• You must do the work before
you get the revenue.

11
LO 1
Revenue and Expense Recognition

12
LO 1
Adjusting Entries
• Why do we make adjusting entries?
 Because they help us follow the two most important principles
we just learned:
• The Revenue Recognition Principle
• The Expense Recognition (Matching) Principle
• We make these adjustments every time we prepare financial
statements.
• Every adjusting entry will include one income statement
account and one statement of financial position account.

Adjusting entries bring the books up to date before financial

statements are prepared.
13
LO 1
The Need for Adjusting Entries
Why are adjusting entries required?
• Some events are not recorded daily because it’s not practical
or efficient.
(e.g., depreciation, supplies usage)
• Some costs expire with the passage of time, not through daily
transactions.
(e.g., insurance, rent, prepaid expenses)
• Some items may be unrecorded at the end of the period.
(e.g., salaries earned but not yet paid)

14
LO 1
Types of Adjusting Entries
Deferrals:
1. Prepaid expenses: Expenses paid in cash before they are
used or consumed.
2. Unearned revenues: Cash received before services are
performed.
Accruals:
1. Accrued revenues: Revenues for services performed but
not yet received in cash or recorded.
2. Accrued expenses: Expenses incurred but not yet paid in
cash or recorded.
• Did the cash come first? → It’s a deferral.
• Did the action happen first? → That’s an accrual.
15
LO 1
Trial Balance – Yazici Advertising

So even though our Trial Balance is in balance…

we have to ask: Is it telling the full story?
No — not yet.
That’s why we go back and look at these accounts — because they might need adjustment.
16
LO 1
 DO IT! 1: Timing Concepts
Below is a list of concepts in the left column, with a description of the concept in the right
column. There are more descriptions provided than concepts. Match the description to the
concept.

1. ___Accrual-basis accounting. a) Monthly and quarterly time periods.

2. ___Calendar year. b) Efforts (expenses) should be recognized in the
3. ___Time period assumption. period in which a company uses assets or incurs
liabilities to generate results (revenues).
4. ___Expense recognition
principle. c) Accountants divide the economic life of a business
into artificial time periods.
d) Companies record revenues when they receive cash
and record expenses when they pay out cash.
e) An accounting time period that starts on January 1
and ends on December 31.
f) Companies record transactions in the period in
which the events occur.

17
LO 1
 DO IT! 1: Timing Concepts
Below is a list of concepts in the left column, with a description of the concept in the right
column. There are more descriptions provided than concepts. Match the description to the
concept.

1. ___Accrual-basis accounting. a) Monthly and quarterly time periods.

2. ___Calendar year. b) Efforts (expenses) should be recognized in the
3. ___Time period assumption. period in which a company uses assets or incurs
liabilities to generate results (revenues).
4. ___Expense recognition
principle. c) Accountants divide the economic life of a business
into artificial time periods.
d) Companies record revenues when they receive cash
1. f and record expenses when they pay out cash.
e) An accounting time period that starts on January 1
2. e and ends on December 31.
3. c f) Companies record transactions in the period in
which the events occur.
4. b 18
LO 1
Learning Objective 2
Prepare adjusting entries for deferrals.

19
LO 2
 Adjusting Entries for Deferrals

Deferrals are expenses or revenues that are recognized at a date

later than the point when cash was originally exchanged.
There are two types:
• Prepaid expenses
• Unearned revenues
Adjusting Entry Example: Adjusting Entry Example:
Prepaid Insurance Unearned Revenue
Original: $600 in Prepaid Insurance Received $1,200 in advance $400 of
After 1 month: $200 has expired services completed
Dr. Insurance Expense $200 Dr. Unearned Service Revenue $400
Cr. Prepaid Insurance $200 Cr. Service Revenue $400
If a company does not make an adjustment for these deferrals, asset and liability are over
stated, and the related expense and revenue are understated. LO 2
20
 Prepaid Expenses
• Prepaid expenses are costs that expire either with the passage
of time (e.g., rent and insurance) or through use (e.g., supplies).
• Prior to adjustment, assets are overstated and expenses are
understated.

Prepaid expenses move from asset to expense as

they’re used LO 2
21
Supplies
Companies recognize supplies expense at the end of the accounting
period – not as the supplies are used.

Supplies are recorded as assets first, and

become expenses later — when we know
how much was used.

22
LO 2
Supplies Adjustment Example
Assume: Yazici Advertising purchased supplies costing
₺2,500 on October 5. Yazici recorded the purchase by
increasing (debiting) the asset Supplies. This account
shows a balance of ₺2,500 in the October 31 trial
balance. An inventory count at the close of business on
October 31 reveals that ₺1,000 of supplies are still on
hand.

Demonstrate: How do you record the adjustment for s

upplies?

23
LO 2
Assume: Yazici Advertising purchased supplies costing ₺2,500 on October 5.
Yazici recorded the purchase by
increasing (debiting) the asset Supplies. This account
shows a balance of ₺2,500 in the October 31 trial
balance. An inventory count at the close of business on October 31 reveals
that ₺1,000 of supplies are still on
hand.

24
LO 2
 Insurance
• The cost of insurance paid in advance is
recorded as an increase (debit) in the
asset account Prepaid Insurance.
• At the financial statement date, companies
increase (debit) Insurance Expense and
decrease (credit) Prepaid Insurance for the cost
of insurance that has expired during
the period.

Adjusting Entry on October 31:

Dr. Insurance Expense ₺50
Cr. Prepaid Insurance ₺50

25
LO 2
Insurance Adjustment Example
Assume: On October 4, Yazici Advertising paid ₺600 for a
one-year fire insurance policy. Coverage began on October 1.
Yazici recorded the payment by increasing (debiting) Prepaid
Insurance.
Demonstrate: How do you record the adjustment for insurance?

26
LO 2
Assume: On October 4, Yazici Advertising paid ₺600 for a
one-year fire insurance policy. Coverage began on October 1.
Yazici recorded the payment by increasing (debiting) Prepaid
Insurance.

27
LO 2
 Depreciation
• Depreciation is an allocation concept,
not a valuation concept.
• Depreciation allocates an asset’s cost to
the periods in which it is used.
• Depreciation does not attempt to report
the actual change in the value of the
asset.
Depreciation spreads the cost of an asset
over its useful life — it’s not about market
value changes.

28
LO 2
Depreciation Example
Assume: For Yazici Advertising, depreciation on equipment is
₺480 a year, or ₺40 per month.
Demonstrate: How do you record the adjustment for
depreciation?

Basic concept of DEPRECIATION

Asset → (when used/expired) →Expense

Reduce the asset & record the expense (depreciation expense)

over the useful life of the asset

29
LO 2
Assume: For Yazici Advertising, depreciation on equipment
is ₺480 a year, or ₺40 per month.

30
LO 2
Statement Presentation
• Use of a contra account to disclose both the cost of the
equipment and total cost expensed to date.
• Book value or carrying value: Difference between the cost of
any depreciable asset and its related accumulated
depreciation.

Equipment ₺5,000
Less: Accumulated depreciation―equipment 40
₺4,960

“Accumulated depreciation” is a contra-asset account, which

reduces the balance of the account to which it is related.

31
LO 2
Statement Presentation
• Accumulated depreciation is the sum of all depreciation
expense that has been recorded to date.

• Depreciation expense -> Income statement (expense)

• Accumulated Depreciation -> Statement of financial

position (contra asset account)

32
LO 2
Prepaid Expenses Summary
Accounting for Prepaid Expenses
Reason for Adjust Accounts Before Adjusting En
Examples
ment Adjustment try
Insurance, supplie Prepaid expenses ori Assets overstated. Dr. Expenses
s, advertising, rent ginally recorded in a Expenses understa Cr. Assets
, depreciation sset accounts have b ted. or Contra
een used. Assets

33
LO 2
 Unearned Revenues
• When companies receive cash before
services are performed, they record a
liability by increasing (crediting) a
liability account called unearned
revenues.
• Prior to adjustment, liabilities are
overstated and revenues are
understated.

34
LO 2
Unearned Revenues Illustrated

Adjusting Entry (Partial Revenue Earned):

Dr. Unearned Revenue ₺600
Cr. Service Revenue ₺600

35
LO 2
Unearned Revenue Example
Assume: Yazici Advertising received ₺1,200 on October 2 from
R. Knox for advertising services expected to be completed by
December 31. Yazici credited the payment to Unearned Service
Revenue. This liability account shows a balance of ₺1,200 in the
October 31 trial balance.
Demonstrate: How do you record the adjustment for
advertising revenue?

36
LO 2
Assume: Yazici Advertising received ₺1,200 on October 2 from R.
Knox for advertising services expected to be completed by
December 31. Yazici credited the payment to Unearned Service
Revenue. This liability account shows a balance of ₺1,200 in the
October 31 trial balance.

37
LO 2
Accounting for Unearned Revenues

Accounting for Unearned Revenues

Reason for Adjustm Accounts Before A Adjusting Ent
Examples
ent djustment ry
Rent, magazine su Unearned revenues r Liabilities overstate Dr. Liabilities
bscriptions, custo ecorded in liability a d. Revenues underst Cr. Revenues
mer deposits for fu ccounts are now reco ated.
ture service gnized as revenue for
services performed.

38
LO 2
Prepaid Expenses Review Question
Adjustments for prepaid expenses:
a. decrease assets and increase revenues.
b. decrease expenses and increase assets.
c. decrease assets and increase expenses.
d. decrease revenues and increase assets.

39
LO 2
Prepaid Expenses – Solution
Adjustments for prepaid expenses:
a. decrease assets and increase revenues.
b. decrease expenses and increase assets.
c. decrease assets and increase expenses. (Correct)
d. decrease revenues and increase assets.

40
LO 2
DO IT! 2: Adjusting Entries for
Deferrals
The ledger of Hammond Deliveries, on March 31, 2025, includes these selected
accounts before adjusting entries are prepared:

An analysis of the account shows the following:

1. Insurance expires at the rate of €100 per month.
2. Supplies on hand total €800.
3. The equipment depreciates €200 a month.
4. During March, services were performed for €4,000 of the unearned service revenue
.
Prepare the adjusting entries for the month of March.
41
LO 2
1. Insurance expires at the rate of €100 per month.
2. Supplies on hand total €800.
3. The equipment depreciates €200 a month.
4. During March, services were performed for €4,000 of the unearned service revenue.

42
LO 2
Learning Objective 3
Prepare adjusting entries for accruals.

43
LO 3
 Adjusting Entries for Accruals

Accruals are revenues and expenses that are recognized before the
actual cash transaction occurs.
Accruals are made to record the following:
• Revenues for services performed but not yet recorded at the
statement date – accrued revenues
or
• Expenses incurred but not yet paid or recorded at the statement date
– accrued expenses

Accruals happen when the work is done or cost

is incurred, but the cash has not moved yet.
44
LO 3
 Accrued Revenues
• Prior to adjustment, both assets and
revenues are understated.
• An adjusting entry for accrued revenues results in
 an increase (a debit) to an asset account, and
 an increase (a credit) to a revenue account.
• Accrued revenue happens when we’ve done
the work, but haven’t received payment yet.

Dr. Accounts Receivable ₺200

Cr. Service Revenue ₺200
Dr. Cash ₺200
Cr. Accounts Receivable ₺200

45
LO 3
Accrued Revenue Adjusting Entry

Remember, accrued revenue means we’ve earned money

— but we haven’t gotten it yet.
That’s why we increase receivables and increase revenue.

46
LO 3
Accrued Revenue Example
Assume: In October, Yazici Advertising performed
services worth ₺200 that were not billed to clients on or
before October 31. Because these services were not
billed, they were not recorded.

Demonstrate: How do you adjust for accrued revenue?

47
LO 3
Assume: In October, Yazici Advertising performed
services worth ₺200 that were not billed to clients on or before
October 31. Because these services were not
billed, they were not recorded.

48
LO 3
Accrued Revenue Collection Example
Assume: On November 10, Yazici receives cash of ₺200
for the services performed in October.
Demonstrate: How do you record the collection of the
receivables?

49
LO 3
 Accrued Revenue Collection – Soluti
on
Assume: On November 10, Yazici receives cash of ₺200
for the services performed in October.

Nov. 10 Cash 200

Accounts Receivable 200
(To record cash collected on account)

50
LO 3
Accrued Revenue Summary

Accounting for Accrued Revenues

Reason for Adjustm Accounts Before Adjusting Entr
Examples
ent Adjustment y
Interest, rent, servic Services performed b Assets understated. Dr. Assets
es ut not yet received in Revenues understa Cr. Revenues
cash or recorded. ted.

51
LO 3
Accrued Expenses
• Prior to adjustment, both liabilities and expenses are understated.
• An adjusting entry for accrued expenses results in
 an increase (a debit) to an expense account, and
 an increase (a credit) to a liability account.

Accrued expenses happen when we’ve used the service, but

haven’t paid yet.
→ That’s why we increase expenses and increase liabilities. LO 3 52
Accrued Expenses
Accruals Summary Table

Type Adjusting Entry Statement Impact

Accrued Revenue Dr. Receivable / Cr. Revenue Assets ↑ / Revenues ↑
Accrued Expense Dr. Expense / Cr. Payable Expenses ↑ / Liabilities ↑

Example: Accrued Salaries (Oct. 31)

• Dr. Salaries Expense $1,200
• Cr. Salaries Payable $1,200
Unpaid salaries at month-end must be recorded as an expense and a liability.

53
LO 3
Accrued Interest Example
Assume: Yazici Advertising signed a three-month note
payable in the amount of ₺5,000 on October 1. The note
requires Yazici to pay interest at an annual rate of 12%.
Demonstrate:
1) How do you determine the interest to be recorded?
2) How do you create the adjustment for accrued
interest for the month of October?

54
LO 3
Assume: Yazici Advertising signed a three-month note
payable in the amount of ₺5,000 on October 1. The note
requires Yazici to pay interest at an annual rate of 12%.

Demonstrate:
1) How do you determine the interest to be recorded?
2) How do you create the adjustment for accrued
interest for the month of October?

Time in
Face Value o Annual Int
× × Terms of = Interest
f Note erest Rate
One Year

1
₺5,000 × 12% × = ₺50
12

55
LO 3
Accrued Interest – Solution Part 2

56
LO 3
Accrued Salaries and Wages
• Companies pay for some types of expenses, such as employee
salaries and wages, after the services have been performed.

57
LO 3
Salaries and Wages Example
Assume: At October 31, the salaries and wages for these three
days represent an accrued expense and a related liability to
Yazici. The employees receive total salaries and wages of ₺2,000
for a five-day work week, or ₺400 per day. They have been paid
on October 26. Thus, accrued salaries and wages at October 31
are ₺1,200 (₺400 × 3).
Demonstrate: How do you create the adjustment for accrued
salaries and wages?

58
LO 3
Assume: At October 31, the salaries and wages for these three
days represent an accrued expense and a related liability to
Yazici. The employees receive total salaries and wages of ₺2,000 for a five-
day work week, or ₺400 per day. They have been paid on October 26. Thus, a
ccrued salaries and wages at October 31
are ₺1,200 (₺400 × 3).

59
LO 3
Salary Payment Example
Assume: Yazici pays salaries and wages every two week
s. Consequently, the next payday is November 9, when
the company will again pay total salaries and wages of
₺4,000. The payment consists of ₺1,200 of salaries and
wages payable at October 31 plus ₺2,800 of salaries and
wages expense for November (7 working days, as shown
in the November calendar × ₺400).
Demonstrate: What entry does Yazici make on
November 9?

60
LO 3
Assume: Yazici pays salaries and wages every two weeks.
Consequently, the next payday is November 9, when
the company will again pay total salaries and wages of
₺4,000. The payment consists of ₺1,200 of salaries and
wages payable at October 31 plus ₺2,800 of salaries and wages
expense for November (7 working days, as shown in the
November calendar × ₺400).

Nov. 9 Salaries and Wages Payable 1,200

Salaries and Wages Expense 2,800
Cash 4,000
(To record November 9 payroll)

61
LO 3
Accrued Expenses Summary

Accounting for Accrued Expenses

Reason for Adjus Accounts Before Adjus Adjusting Ent
Examples tment tment ry
Interest, rent, salarie Expenses have be Expenses understated. Dr. Expenses
s en incurred but no Liabilities understated. Cr. Liabilitie
t yet paid in cash o s
r recorded.

62
LO 3
Adjusting Entries Reminders
1) Adjusting entries should not involve debits or credits to Cash.
2) Evaluate whether the adjustment makes sense. For example,
an adjustment to recognize supplies used should increase
Supplies Expense.
3) Double-check all computations.
4) Each adjusting entry affects one statement of financial
position account and one income statement account.

Purpose of Adjusting Entries:

• To follow the Revenue Recognition and Expense Recognition
(Matching) principles.
• To make sure financial statements reflect the correct period.

63
LO 3
Summary of Basic Relationships

Type of Adjustment Accounts Before Adjustm Adjusting Entry

ent
Prepaid Expenses Assets overstated. Dr. Expenses
Expenses understated. Cr. Assets or
Contra Assets
Unearned revenues Liabilities overstated. Dr. Liabilities
Revenues understated. Cr. Revenues
Accrued revenues Assets understated. Dr. Assets
Revenues understated. Cr. Revenues
Accrued expenses Expenses understated. Dr. Expenses
Liabilities understated. Cr. Liabilities

64
LO 3
General Journal Example

65
LO 3
General Ledger Example

66
LO 3
DO IT! 3: Adjusting Entries for Accruals

Mahindra Computer Services began operations on August 1, 2025. At the end of

August 2025, management prepares monthly financial statements. The following
information relates to August (amounts in thousands).
1. At August 31, the company owed its employees ₹800 in salaries and wages
that will be paid on September 1.
2. On August 1, the company borrowed ₹30,000 from a local bank on a 15-year
mortgage. The annual interest rate is 10%.
3. Revenue for services performed but unrecorded for August totaled ₹1,100.
Prepare the adjusting entries needed at August 31, 2025.

67
LO 3
1. At August 31, the company owed its employees ₹800 in salaries and wages
that will be paid on September 1.
2. On August 1, the company borrowed ₹30,000 from a local bank on a 15-year
mortgage. The annual interest rate is 10%.
3. Revenue for services performed but unrecorded for August totaled ₹1,100.
Prepare the adjusting entries needed at August 31, 2025.

68
LO 3
Learning Objective 4
Describe the nature and purpose of an
adjusted trial balance.

69
LO 4
Adjusted Trial Balance and
Financial Statements

Adjusted trial balance:

• Shows the balance of all accounts, including those adjusted.
• Proves the equality of the total debit balances and the total
credit balances in the ledger after all adjustments.
• Primary basis for the preparation of financial statements.

70
LO 4
Preparing the Adjusted Trial Balance

71
LO 4
Preparing Financial Statements (1/2)

72
LO 4
Preparing Financial Statements (2/2)

73
LO 4
 DO IT! 4: Trial Balance
Kang Company was organized on April 1, 2025. The company prepares quarterly
financial statements. The adjusted trial balance amounts at June 30 are shown
below (amounts in millions).

a. Determine the net income for the quarter April 1 to June 30.
b. Determine the total assets and total liabilities at June 30, 2025, for Kang
Company.
c. Determine the amount of retained earnings at June 30, 2025.
74
LO 4
a. The net income
is determined
by adding reven
ues and subtract
ing expenses.
The net income
is computed as
follows (in milli
ons).

75
LO 4
b. Total assets and
liabilities are
computed as follo
ws (in millions).

76
LO 4
Learning Objective 5
Prepare adjusting entries for the
alternative treatment of deferrals.

77
LO 5
Alternative Treatment of Deferrals
Alternative treatment:
1) When a company prepays an expense, it debits that amount
to an expense account.
2) When it receives payment for future services, it credits the
amount to a revenue account.

Prepaid Expenses:
➤ Debit Expense account when payment is made.
→ Later, adjust if not fully used.

Unearned Revenues:
➤ Credit Revenue account when cash is received.
→ Later, adjust if not yet earned.
78
LO 5
Supplies Example
Assume: Yazici Advertising purchased supplies costing ₺2,500
on October 5. Yazici recorded the purchase by increasing
(debiting) Supplies Expense (rather than the asset account
Supplies). An inventory count at the close of business on
October 31 reveals that ₺1,000 of supplies are still on hand.
Demonstrate: How do you record the adjustment for supplies?

79
LO 5
 Assume: Yazici Advertising purchased supplies costing ₺2,500
on October 5. Yazici recorded the purchase by increasing
(debiting) Supplies Expense (rather than the asset account
Supplies). An inventory count at the close of business on
October 31 reveals that ₺1,000 of supplies are still on hand.

Oct. 31 Supplies 1,000

Supplies Expense 1,000
(To record supplies inventory)

80
LO 5
Prepaid Expense Comparison

81
LO 5
Service Revenue – Example
Assume: Yazici Advertising received ₺1,200 on October 2 from
R. Knox for advertising services expected to be completed by
October 31. However, Yazici has not performed ₺800 of the
services by October 31.

Demonstrate: How do you record the adjustment for advertising

services?

82
LO 5
 Assume: Yazici Advertising received ₺1,200 on October 2 from
R. Knox for advertising services expected to be completed by
October 31. However, Yazici has not performed ₺800 of the
services by October 31.

Oct. 31 Service Revenue 800

Unearned Service Revenue 800
(To record unearned service
revenue)

83
LO 5
Unearned Revenues Comparison

84
LO 5
Summary of Additional Adjustment
Relationships
Type of Adjustment Reason for Adjustment Accounts Balances befo Adjusting Entry
re Adjustment
1. Prepaid expenses (a) Prepaid expenses initially record Assets overstated. Dr. Expenses
ed in asset accounts have been us Expenses understand. Cr. Assets
ed. Assets understated. Dr. Assets
(b) Prepaid expenses initially recor Expenses overstated. Cr. Expenses
ded in expense accounts have n
ot been used.
2. Unearned revenues (a) Unearned revenues initially Liabilities overstated. Dr. Liabilities
recorded in liability accounts are Revenues understated. Cr. Revenues
now recognized as revenue. Liabilities understated. Dr. Revenues
(b) Unearned revenues initially Revenues overstated. Cr. Liabilities
recorded in revenue accounts
are still unearned.

85
LO 5
Learning Objective 6
Financial reporting concepts.

86
LO 6
Qualities of Useful Information
Fundamental Qualities

87
LO 6
Enhancing Qualities
Quality: It means:
Comparability (1) Different companies use the same accounting
principles, and
(2) A company uses the same accounting principles
and methods from year to year (consistency).
Verifiability Independent observers, using the same methods,
obtain similar results.
Timeliness It is necessary for accounting information to be
relevant.
Understandability Information is presented in a clear and concise
fashion, so that reasonably informed users of that
information can interpret it and comprehend its
meaning.

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LO 6
Assumptions in Financial Reporting (1/2)
1. Monetary Unit Assumption
• Only transactions that can be measured in money are recorded.
• Non-quantifiable factors (like employee satisfaction) are excluded.
• Assumes the value of money stays relatively stable over time.
• Example: A company reports salaries paid, not employee happiness.

2. Economic Entity Assumption

• Business transactions must be kept separate from personal or other company
activities.
• Each economic entity is accounted for individually.
• Example: Toyota’s financials must not include the CEO’s personal expenses.

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LO 6
Assumptions in Financial Reporting (2/2)
1. Time Period Assumption
• Business activities can be divided into specific time periods (e.g., months,
quarters, years).
• Allows for the preparation of timely financial reports.
• Example: Companies prepare annual or quarterly financial statements.

2. Going Concern Assumption

• Assumes that the business will continue operating for the foreseeable future.
• Financial statements are prepared with the expectation of continuity, unless
evidence suggests otherwise.
• Example: Assets are not reported at liquidation value because the business is
expected to operate normally.

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LO 6
Principles in Financial Reporting
Measurement Bases
Historical Cost Basis
• Dictates that companies record assets at their cost.
• This is true not only at the time the asset is purchased, but also
over the time the asset is held.
Current Value Basis
• Assets and liabilities should be reported at current value (the
price received to sell an asset or settle a liability), value in use
(the present value of the future cash flows associated with the
item), or current cost (the current replacement cost of the item).

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LO 6
Further Principles in Financial
Reporting
Revenue Recognition Principle
• Requires that companies recognize revenue in the accounting period
in which the performance obligation is satisfied.
Expense Recognition Principle
• Dictates that companies recognize expense in the period in which they
make efforts to generate revenue. Thus, expenses follow revenues.
Full Disclosure Principle
• Requires that companies disclose all circumstances and events that
would make a difference to financial statement users.
• If an important item cannot reasonably be reported directly in one of
the four types of financial statements, it should be discussed in the
notes.

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LO 6
Cost Constraint
The cost constraint means that the cost of providing financial
information must not exceed the benefits gained from its use.
• Cost: Time, resources, complexity
• Benefit: Better decisions for investors, creditors, etc.
A small company may not disclose detailed segment reports if
the cost outweighs the benefit to users.

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LO 6
Learning Objective 7
Compare the procedures for adjusting
entries under IFRS and U.S. GAAP.

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LO 7
Key Points
Both GAAP and IFRS address the following:
• What is the primary objective of financial reporting?
• What are the qualitative characteristics that make accounting
information useful?
• What are the elements that make up the financial statements?
• What basis should be used to measure and report, that is,
should a historical cost or current value approach be used?
• What recognition criteria should be applied for revenue and
expenses?
• What guidelines should be established for disclosing financial
information?

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LO 7
Similarities
• Like IFRS, companies applying GAAP use accrual-basis accounting
to ensure that they record transactions that change a company’s
financial statements in the period in which events occur.
• Similar to IFRS, cash-basis accounting is not in accordance with
GAAP.
• Under both GAAP and IFRS, the time period assumption applies.
GAAP requires that companies present a complete set of financial
statements, including comparative information annually.
• The form and content of financial statements are very similar under
GAAP and IFRS.
• Revenue recognition fraud is a major issue in U.S. financial
reporting. The same situation exists for most other countries as well.

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LO 7
Similarities
Key Similarities:
• Accrual Basis Accounting:
Both use accrual accounting, not cash-basis.
• Time Period Assumption:
Both require reports to cover defined time periods, typically one year.
• Complete Financial Statements:
Both frameworks require a full set of financial statements, including
comparative data.
• Form and Content:
Financial statement structure is very similar in both systems.
• Revenue Recognition Issues:
Fraud in revenue recognition is a global issue, not just in the U.S.

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LO 7
Differences
• Prior to the issuance of a new joint revenue recognition standard by
the IASB and the FASB, GAAP had more than 100 rules dealing
with revenue recognition. Revenue recognition under IFRS was
determined primarily by a single standard, IAS 18.
• The Sarbanes-Oxley Act requires U.S. companies to enhance their
systems of internal control. However, many foreign companies do
not have this requirement.
• Under IFRS, revaluation to current value of items such as land and
buildings is permitted. This is not permitted under GAAP.
• Under IFRS, the term “income” includes both revenues and gains.
Under GAAP income refers to the net difference between revenues
and expenses. Expenses under IFRS include both those costs
incurred in the normal course of operations, as well as losses that
are not part of normal operations. This is in contrast to GAAP,
which defines each separately.
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LO 7
Differences
1. Revenue Recognition
• GAAP had over 100 detailed rules.
• IFRS used a single principle-based standard (IAS 18, now IFRS 15).
2. Internal Control Requirements
• GAAP (U.S.): The Sarbanes-Oxley Act mandates internal controls.
• IFRS: No such universal requirement exists.
3. Revaluation of Assets
• IFRS allows revaluation of assets (like land/buildings) to fair value.
• GAAP does not allow revaluation of most assets.
4. Definition of Income and Expenses
• IFRS: “Income” includes revenues + gains, and “expenses” include
losses too.
• GAAP: Defines revenues, gains, expenses, and losses separately.

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LO 7
Thank You for Your Attention

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