PRINCIPLE OF ACCOUNTING 2 nd Semester DBA Prepared

PRINCIPLE OF ACCOUNTING 2 nd Semester DBA Prepared By: Kamran (Lecturer) Specialization (Accounting) Kardan Institute of Higher Education

Accounting Period Assumption. . . Divides the economic life of a business into artificial time periods. WHY? To provide immediate feedback on how the business is doing. 2

Time Period (Periodicity) Concept Ø Periodicity: divides the life of a business into short, even time periods, usually one year Ø Short periods keeps reporting timely and information updated. Ø Periods of equal length are comparable Ø An accounting time period that starts on January 1 and ends December 31 is called a calendar year. Ø An accounting time period that is one year long is called fiscal year. ©Kimberly Lyons 3

REVENUE RECOGNITION PRINCIPLE AND MATCHING PRINCIPLE 4

Revenue Recognition Principle. . . Ø Dictates that revenue be recognized in the accounting period in which it is earned. Ø Revenue is considered earned when the service has been provided or when the goods are delivered. 5

Matching Principle. . . Expenses should be matched with the revenues they generate in any specific accounting period. 6

Accrual VS Cash Accounting 9/9/2021 7

Cash-Basis Accounting Ø Revenue and expenses are recognized only when cash is received or payments are made. Ø Mainly Ø Not used by small businesses. an accurate picture of true profitability.

Cash Basis in not GAAP P A GA 9

Accrual Basis Accounting Subject to the: Ø Revenue Recognition Principle Ø Matching Principle 10

Accrual Accounting Ø A system of accounting in which revenues and expenses are recorded as they are earned and incurred, not when cash is received or paid. Ø Provides a more accurate picture of a company’s profitability.

Cash-Basis Accounting VS Accrual basis Accounting Ø Example: Bo Jovian Co. purchases inventory in December of 2008 for $10, 000 and sells the inventory in January of 2009 for $13, 000. Bo Jovian has a December 31 st year-end. Ø Compare net income for Bo Jovian for the two years under both accrual and cash basis accounting 12

Cash versus Accrual-Basis Net Income Cash Basis: 2008 Revenues 0 $13, 000 - Expenses (10, 000) 0 = Net Income (loss) (10, 000) $13, 000 Accrual Basis: $ 2009 2008 Revenues $ - Expenses 0 = Net Income (loss) $ 2009 0 $13, 000 (10, 000) 0 $ 3, 000 13

Adjusting Entries Adjusting entries are required at the end of each accounting period for accrual-basis accounting, prior to preparing the financial statements. ØTo bring balance sheet accounts current. ØTo reflect proper amounts of revenues and expenses on the Income Statement.

Adjusting Entries Tips Each adjusting entry always involves at least One Income Statement Account Øand ØOne Balance Sheet Account. Adjusting entries never involve cash.

Common Adjusting Entries Prepaid Payments made in advance for items charged Expenses to expense, to show the partial using-up of an asset. Un-earned Amounts received before the actual earnings Revenues of revenues (the unearned revenues are liabilities). Unrecorded Revenues earned but not yet recorded by period’s end. Unrecorded Expenses incurred but not yet recorded by Expenses period’s end.

PREPAID EXPENSES Prepaid Expenses are characterized by a previous transaction which must be adjusted because it is now the end of the period (time period assumption). The transaction is not yet complete at the end of the period. e. g. Shop supplies, Depreciation, prepaid Rent, prepaid Advertisement, Insurance premium. Example: Prepaid expenses expense. Information: You are a tenant renting office space for $2, 000 per month. On Jan 1 st 2010, you prepay six months of rent or $12, 000 to your landlord. The original entry may have been: 1/1/2010 Prepaid Rent Cash 12, 000 14

Adjusting Entries (Prepayments) Suppose it is now Feb 28 th 2010, two months later. The previous entry must be adjusted. The adjusting entry would be: To adjust: 2/28/2010 Rent Expense 4, 000 Prepaid Rent 4, 000 Note: You had to refer back to the original entry to prepare the correct adjusting entry. 15

Shop Supplies (Prepayments) Suppose on Dec, 4 Shop supplies were purchased of amount $4000. These supplies are expected to last for three or four months so it will be treated as Asset and recorded as: To adjust: 12/4 Shop Supplies Cash 4, 000 19

Shop Supplies • Suppose during December amount $2000 supplies are consumed. The utilized shop supplies will be treated as expense and need adjustment. To adjust: 12/4 Supplies Expense Shop Supplies 2, 000 20

Depreciation The allocation of the cost of a fixed assets to expense in the periods in which services are received from the asset. Cost of fixed assets Balance Sheet Assets: Plant and equipment as the services are received

Depreciation Ø Book Value Ø Cost – Accumulated Depreciation Ø Accumulated Depreciation § The sum of depreciation over a number of years is called acc. depreciation. Ø Causes of Depreciation § Physical deterioration § Obsolescence

Depreciation Expense per Year = Cost - Residual Value Years of Useful Life

Depreciation On January 1, 2003, Bass Co. buys a new boat. Bass Co. pays $24, 000 for the boat. The boat has an estimated residual value of $3, 000 and an estimated useful life of 5 years. Compute depreciation for 2003 using the straightline method.

Depreciation Bass Co. will record $4, 200 depreciation each year for five years. Total depreciation over the estimated useful life of the boat is: Salvage Value

Adjusting Entries – “Unearned Revenues” Receipt of cash that is recorded as a liability because the revenue has not been earned. Cash Receipt BEFORE Revenue Earned Unearned revenues often occur in regard to: Rent Advertisement Airline tickets School tuition fee

Adjusting Entries – “Unearned Revenues” Example: On Nov. 1 st, Phoenix Corp. received $24, 000 from Arcadia High School for 3 months rent in advance. Show the journal entry to record the receipt on Nov. 1 st. Nov. 1 Cash 24, 000 Unearned rent revenue Cash Debit 24, 000 Credit 24, 000 Unearned Rent Revenue Debit Credit 24, 000

Adjusting Entries – “Unearned Revenues” Example: On Nov. 1 st, Phoenix Corp. received $24, 000 from Arcadia High School for 3 months rent in advance. Show the adjusting journal entry required on Nov. 30 th. Nov. 30 Unearned rent revenue 8, 000 Rent revenue Rent Revenue Debit Credit 8, 000 Unearned Rent Revenue Debit Credit 8, 000 24, 000 16, 000

Adjusting Entries – “Accrued Revenues” Revenues earned but not yet received in cash or recorded. Adjusting entry results in: Revenue Recorded BEFORE Cash Receipt Accrued revenues often occur in regard to: Rent Interest Services performed

Adjusting Entries – “Accrued Revenues” Example: On January 1 st, Phoenix Corp. deposited $100, 000 in a bank that return 12% interest per year. Show the journal entry to record the deposit on January 1 st. January 1 Investments 100, 000 Cash Investments Debit 100, 000 Credit Debit Credit 100, 000

Adjusting Entries – “Accrued Revenues” Example: On January 1 st, Phoenix Corp. deposited $100, 000 in a bank that return 12% interest per year. Show the adjusting journal entry required on January 31 st. January 31 Interest receivable 1, 000 Interest revenue Interest Receivable Debit 1, 000 Credit 1, 000 Interest Revenue Debit Credit 1, 000

Adjusting Entries – “Accrued Expenses” Expenses incurred but not yet paid in cash or recorded. Adjusting entry results in: Expense Recorded BEFORE Cash Payment Accrued expenses often occur in regard to: Rent Salaries Interest Taxes

Adjusting Entries – “Accrued Expenses” Example: On Feb. 2 nd, Phoenix Corp. borrowed $200, 000 at a rate of 9% per year. Interest is due on first of each month. Show the journal entry to record the borrowing on Feb. 2 nd. Feb. 2 Cash 200, 000 Notes payable Cash Debit 200, 000 Notes Payable Credit Debit Credit 200, 000

Adjusting Entries – “Accrued Expenses” Example: On Feb. 2 nd, Phoenix Corp. borrowed $200, 000 at a rate of 9% per year. Interest is due on first of each month. Show the adjusting journal entry required on Feb. 28 th. Feb. 28 Interest expense 1, 500 Interest payable Interest Expense Debit Credit 1, 500 Interest Payable Debit Credit 1, 500

1. Naqeeb paid rent $ 60, 000 for 6 months of a buliding on November 1, 2010. He is preparing financial statements on 31 st December, prepare adjusting entries. 2. Salman received 20, 000 on 31 st September 2006 in advance for 4 months as advertisemnent charges, he is maintaining his books of accounts on 31 st December. Record adjusting entries for salman. 3. Saleem purchased a building on $50, 000. its useful life is 12 years and residual value is $ 2000. Pass the original and adjusting entry at the end of 1 st year. 4. You have purchased shop supplies of $15000. At the end of period you have $6000 shop supplies, pass the necessary journal entries. 9/9/2021 35

Q s? 9/9/2021 36