Abstract To evaluate the effects of vasodilator therapy on mortality among patients with chronic congestive heart failure, we randomly assigned 642 men with impaired. Incorrectly Classified Data. One of the most common accounting errors that affects a balance sheet is the incorrect classification of assets and liabilities. This article uses a small business scenario to suggest ways to help you successfully extend a Trial Balance ETB. Months before first adjustment This is the number of months that the interest rate is fixed. After this period, the interest rate will be subject to rate adjustments. The Adjusting Process And Related Entries. In the previous chapter, tentative financial statements were prepared directly from a trial balance. However, a caution was issued about adjustments that may be needed to prepare a truly correct and up to date set of financial statements. This occurs because of multi period items revenue and expense items that relate to more than one accounting period and accrued items revenue and expense items that have been earned or incurred in a given period, but not yet entered into the accounting records. In other words, the ongoing business activity brings about changes in account balances that have not been captured by a journal entry. Time brings about change, and an adjusting process is needed to cause the accounts to appropriately reflect those changes. These adjustments typically occur at the end of each accounting period, and are akin to temporarily cutting off the flow through the business pipeline to take a measurement of what is in the pipeline. This is consistent with the revenue and expense recognition rules. There is simply no way to catalog every potential adjustment that a business may need to make. What is required is a firm understanding of a particular businesss operations, along with a good handle on accounting measurement principles. The following discussion describes typical adjustments. Strive to develop a conceptual understanding of these examples. Critical thinking skills will then allow extension of these basic principles to most any situation. The specific examples relate to Prepaid Expenses. It is common to pay for goods and services in advance. Insurance is typically purchased by prepaying for an annual or semi annual policy. Or, rent on a building may be paid ahead of its intended use e. Another example of prepaid expense relates to supplies that are purchased and stored in advance of actually needing them. At the time of purchase, such prepaid amounts represent future economic benefits that are acquired in exchange for cash payments. As such, the initial expenditure gives rise to an asset. As time passes, the asset is diminished. This means that adjustments are needed to reduce the asset account and transfer the consumption of the assets cost to an appropriate expense account. As a general representation of this process, assume that one prepays 3. June 1 to receive three months of lawn mowing service. As shown in the following illustration, this transaction initially gives rise to a 3. June 1 balance sheet. As each month passes, 1. June 1 for three months of lawn mowing service. Examine the journal entries for this illustration, and take note of the impact on the balance sheet account for Prepaid Mowing as shown by the T accounts below Illustration of Prepaid Insurance. Insurance policies are usually purchased in advance. Cash is paid up front to cover a future period of protection. Assume a three year insurance policy was purchased on January 1, 2. X1, for 9,0. 00. By December 3. 1, 2. X1, 3,0. 00 of insurance coverage would have expired one of three years, or 13 of 9,0. The following entries would be needed to record the transaction on January 1 and the adjustment on December 3. As a result of the above entry and adjusting entry, the income statement for 2. X1 would report insurance expense of 3,0. X1 would report prepaid insurance of 6,0. The remaining 6,0. X2 and 2. 0X3. Illustration of Prepaid Rent. Assume a two month lease is entered and rent paid in advance on March 1, 2. X1, for 3,0. 00. By March 3. 1, 2. X1, half of the rental period has lapsed, and financial statements are to be prepared. The following entries would be needed to record the transaction on March 1, and adjust rent expense and prepaid rent on March 3. How Often are Adjustments NeededIn the illustration for insurance, the adjustment was applied at the end of December, but the rent adjustment occurred at the end of March. Whats the difference What was not stated in the first illustration was an assumption that financial statements were only being prepared at the end of the year, in which case the adjustments were only needed at that time. In the second illustration, it was explicitly stated that financial statements were to be prepared at the end of March, and that necessitated an end of March adjustment. There is a moral to this adjustments should be made every time financial statements are prepared, and the goal of the adjustments is to correctly assign the appropriate amount of expense to the time period in question leaving the remainder in a balance sheet account to carry over to the next time periods. Every situation will be somewhat unique, and careful analysis and thoughtful consideration must be used to determine the correct amount of adjustment. Illustration of Supplies. The initial purchase of supplies is recorded by debiting Supplies and crediting Cash. Supplies Expense should subsequently be debited and Supplies credited for the amount used. This results in expense on the income statement being equal to the amount of supplies used, while the remaining balance of supplies on hand is reported as an asset. The following illustrates the purchase of 9. Subsequently, 7. Supplies account One might find it necessary to back in to the calculation of supplies used. Assume 2. 00 of supplies in a storage room are physically counted at the end of the period. Since the account has a 9. December 8 entry, one backs in to the 7. December 3. 1. In other words, since 9. The following year is slightly more challenging. If an additional 1,0. X2, and the ending balance at December 3. X2, is 3. 00, then these entries would be needed The 1,0. One must take into account that 2. X2 started with a 2. Thus, 9. 00 was used up during the period Depreciation. Long lived assets like buildings and equipment will provide productive benefits to a number of periods. Thus, a portion of their cost is allocated to each period. This process is called depreciation. A subsequent chapter will cover depreciation in great detail. However, one simple approach is called the straight line method, where an equal amount of asset cost is assigned to each year of service life. By way of example, if a 1. January 1 of Year 1, depreciation expense would be 5. This expense would be reported on each years income statement. The annual entry involves a debit to Depreciation Expense and a credit to Accumulated Depreciation rather than crediting the asset account directly Accumulated depreciation is a unique account. It is reported on the balance sheet as a contra asset. A contra account is an account that is subtracted from a related account. As a result, contra accounts have opposite debitcredit rules. In other words, accumulated depreciation is increased with a credit, because the associated asset normally has a debit balance. The following statements show how accumulated depreciation and depreciation expense would appear for each year As one can see on each years balance sheet, the asset continues to be reported at its 1. However, it is also reduced each year by the ever growing accumulated depreciation. The asset cost minus accumulated depreciation is known as the book value or net book value of the asset. For example, at December 3. X2, the net book value of the truck is 5. By the end of the assets life, its cost has been fully depreciated and its net book value has been reduced to zero. Customarily the asset could then be removed from the accounts, presuming it is then fully used up and retired. Unearned Revenues. Often, a business will collect monies in advance of providing goods or services. For example, a magazine publisher may sell a multi year subscription and collect the full payment at or near the beginning of the subscription period. Such payments received in advance are initially recorded as a debit to Cash and a credit to unearned Revenue. Unearned revenue is reported as a liability, reflecting the companys obligation to deliver product in the future. Remember, revenue cannot be recognized in the income statement until the earnings process is complete. As goods and services are delivered e. Revenue is reduced debited and Revenue is increased credited. The balance sheet at the end of an accounting period would include the remaining unearned revenue for those goods and services not yet delivered. This amount reflects the entitys obligation for future performance. Equally important, the reported revenue only reflects goods and services actually delivered.
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