Principles of Accounting - Essay Example

Principles of Accounting Principles of Accounting Generally the day to day business transactions are recorded in a book called journal in chronological order which is later posted to ledger accounts. Even though entries are made on the basis of best information accessible at the time, it needs to make some alterations in entries at the end of accounting period in order to reflect current varied circumstances. In the opinion of Albrecht, Stice, Stice & Swain (2008), adjusting entries are “entries required at the end of each accounting period to recognize, on an accrual basis, revenues and expenses for the period and to report proper amounts for asset, liability, and owners’ equity accounts” (Albrecht et al 2008, p.135). Similarly some events such as daily use of supplies are not entered up to date since it weakens the accuracy of financial statements. Likewise, some costs like rent & insurance related to plant equipments, are incurred with the passage of time rather than as a result of daily business operations. Hence it can be recorded with the help of adjusting entries only at the time of preparation of financial and income statements. Since items like utility bills will not be received by the company till the beginning of next accounting period, adjusting entries are the only tools to record these items. Adjusting entries take part in the preparation of financial statements with intent to scrutinize the accuracy of accounts that appear in the trial balance of the firm. Since recording of some items consumes much time, as mentioned in Weygandt (2009), firms generally enter theses items after the date of balance sheet by using adjusting entries but show the items recorded as on the date of balance sheet (p.101). Moreover, it is important to note that adjusting entries are made only after the thorough evaluation of earned revenues and incurred expenses at the end of the financial year. It is also helpful in preparing accurate asset valuation statements in the final accounts. Deferrals and Accruals Adjusting entries are classified under two heads such as deferrals and accruals. Deferrals are costs realized earlier for a future event, but not related with the current accounting year. On the other hand, accruals are costs incurred but not yet exchanged. Deferrals include prepaid expenses and unearned revenues whereas accrued revenues and accrued expenses constitute accruals (Kieso, Weygandt & Warfield 2010, p. 93). These terms are described below. Prepaid expenses: expenses paid in advance for the coming financial year and recorded in the books of current year. Unearned revenues: revenues received during the accounting period and recorded but they are not actually earned. Accrued revenues: revenues earned but not yet received or recorded. Accrued expenses: expenses incurred but not yet paid or recorded. The following illustrations will help to understand recording these adjusting entries in a manufacturing industry. Consider that ‘X’ industry is a manufacturing firm engages in the production of refrigerator. Assume that the following transactions have been taken place in the X Industry. 1-12-2010: The X industry paid an advance insurance premium of $500 5-12-2010: A rent worth $875 was received for company’s property; out of this, $375 was pertaining with the following year. 31-12-2010: Interest accrued worth $120, but not yet received 31-12-2010: Salary outstanding $950 The above given transactions can be journalized as follows. Date Account names & Explanation Debit Credit Dec.1,2010 Prepaid insurance Cash 500 500 Dec.5,2010 Cash Unearned rent 375 375 Dec.31,2010 Accrued interest Interest 120 120 Dec.31,2010 Salaries Outstanding salary 950 950 The emergence of computerized accounting software such as Peachtree and DacEasy brought revolutionary changes in the field of accounting system. Less time consumption, rare chance of clerical errors and reduced human efforts are the major benefits of computerized accounting system. The accounting software provide a large number of fixed ledger accounts with which we can record our transactions. In addition to this, we can create our own ledger accounts in order to record some special features which the computer will memorize later. “In a computerized accounting system, adjusting entries can be entered just like any other transactions” (Needles, Powers & Crosson, 2007, p.162). According to the Authors, if the adjusting entries are similar for all accounting period, the accounting system can be programmed to show them automatically whenever it is to be recalled. At the same time, accountants must give due care to check the arithmetical accuracy of entering amounts; otherwise the required output will not show a true and fair view of the state of affairs of the business. After the posting of adjusted entries, adjusted trial balance is obtained just with a mouse click (p.162). Similarly, there are some ethical concerns associated with the preparation of adjusting journal entries. Often business firms may misrepresent the depreciation of various fixed assets in order to inflate or deflate profit with the intention of falsify financial statements. Steps in the Accounting Cycle Wal-Mart Wal-Mart, one of the topmost retail companies in USA can be taken as an example. Based on their financial statements published on their website for the years 2005-2009, we can explicitly say that their growth rate is gradually declining. They could not uplift or even stabilize the ‘net sales increase’, especially for the last two years. It is happened because of the abnormal increase in the ‘operating, selling, general and administrative expenses’ (Walmart, n.d.). The expenses were only 50,178 million in 2005; whereas it reached at 76,651 in 2009. It shows an increase in expenses of 26,473 million within a short period of 4 years. At the same time, there is no proportional increase in ‘Net sales’ which can cover the expenses incurred by the company (Walmart). In order to explain the above mentioned facts, we can take some terms from the consolidated balance sheet of Wal-Mart and look how these items would be posted in the various books of the company. The balance sheet for the year 2010 shows Prepaid Expenses $3,063 million and Accrued Liabilities $18,112 million. These amounts are incurred for the whole year. The following illustration shows how these transactions are recorded on a journal. Date Accounts names & Explanations Debit Credit XX/XX/XX Expense Cash (Payment of expense including an advance ) XXX XXX The total paid amount of prepaid expense is recorded. Accrued liabilities are not recorded in the journal and it is considered only at the preparation of final accounts. Now at the end of the financial year, some adjusting entries must to be passed in order to determine the actual profit. These are described below; Date Accounts names & Explanations Debit Credit 31st Dec. 2010 Expense Prepaid Expense 3,063 3,063 31st Dec. 2010 Liability (Salary/Rent/interest etc.) Outstanding Liability 18,112 18,112 (source: www.walmartstores.com/) Then adjusted Trial Balance and subsequent financial statements are prepared using these adjusted entries. After that closing entries must be passed in order to prepare final Trial Balance (p.31). Reference Albrecht, W. S., Stice, J. D., Stice, E. K., Swain, M. R. (2008). Accounting: Concepts and applications. (Edn.10). US: Thomson Higher Education. Weygandt, J. J., Kimmel, P. D. & Kieso, D. E. (2009). Financial Accounting. (Edn 7). John Wiley and Sons. Kieso, D. E., Weygandt, J. J. & Warfield, T. D. (2010). Intermediate Accounting: IFRS. Volume 1, (Edn-11). John Wiley and Sons. Needles, B. E., Powers, M. & Crosson, S. V. (2007). Principles of Accounting. (Edn-10). USA: Cengage Learning. ‘Walmart 2009 Annual Report’. (n.d.). Walmart Official Website. Retrieved 20 Nov 2010 from http://walmartstores.com/ Read More