START HERE! Foundational Accounting Concepts

• Connection to Future Chapters: Understanding adjusting entries is fundamental for grasping more complex accounting topics. For instance, they serve as a stepping stone to understanding deferred taxes, pensions, and leases in later chapters.

• Impact on Financial Statements: A failure to make the right adjustments can distort financial statements. For example, your income could be either overstated or understated, affecting the quality of the financial information presented to shareholders.

• Supplies: Is the end-of-period balance accurate, or have some supplies been used?
• Prepaid Insurance: Has any coverage expired during the period that should be accounted for?
• Prepaid Rent: Is any part of our lease period lapsed that hasn't been accounted for?
• Unearned Revenue: Have we delivered all the goods and services that we received payment for in advance?
• Wages Expense: Have we accounted for any wages that are incurred but not yet paid?
• Bad Debts Expense (Found in Chapter 7!): Do we need to account for any receivables that are unlikely to be collected? This sets the stage for more advanced topics like allowance for doubtful accounts in Chapter 7.
• Depreciation Expense (Found in Chapter 8!): Have we accounted for the wear and tear on our long-term assets like machinery, buildings, vehicles, etc? Understanding this is essential for diving into Chapter 8, which deals extensively with depreciation methods.

• Matching Principle: This mandates that expenses must be matched with the revenues they help to generate.
• Revenue Recognition Principle: This establishes when revenue should be recognized in the financial statements.

• When you're at the end of an accounting period—often December 31st—an adjusting entry becomes your last opportunity to accurately record revenues and expenses for that year.
• If you miss this window, you can't just shift those numbers to the next year; that's against accounting rules and could misrepresent your financial position.
• So these aren't just principles; they are rules that govern the integrity of financial reporting. Failing to adhere to them not only misguides internal decision-making but can also lead to regulatory repercussions.

📌 A trial balance is straightforward to prepare. It involves listing all your accounts (Assets = Liabilities + Equity, Revenues, Expenses, Contra Accounts) alongside their current ending debit OR credit balance, which is derived from the posting process.

Please refer to the example below for clarity.

• Accounts Receivable is an asset account (+/-) that tracks the cash we anticipate receiving from customers in the future.
• In other words, “receivable” means we will receive cash later.
• We increase the Accounts Receivable account when we expect cash to be received in the future, such as when we offer services on credit and invoice the customer for future payment.
• We decrease the Accounts Receivable account when we receive the cash the customer originally owed us, indicating less cash is due. If a customer settles the full amount, the balance on Accounts Receivable returns to zero.
• See journal entry examples in sequential order below.
📝
Entry for when we provide services on credit. → Accounts Receivable 200,000 Fees Earned 200,000
📝
Entry for when we receive cash for those services provided on credit. Cash 200,000 → Accounts Receivable 200,000
💡
→ Notice that we first debit Accounts Receivable, an asset account (+/-), to indicate that expect to receive cash from a customer later. →Later, when we receive this amount, we credit Accounts Receivable, reducing its balance to reflect the decrease in our future cash receipts.
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See Also: Memorization Trick for Receivables
• To make Receivables easier to remember, consider visualizing these situations in reverse order.
• For instance, imagine you're receiving cash for services previously offered on a credit basis.
📝
Entry for when we receive cash for those services provided on credit. Cash 200,000 → Accounts Receivable 200,000
• From the Cash Cheat Code, would already know that receiving cash must mean we are debiting cash, so Accounts Receivable must be the credit!
• However, we can’t just credit Accounts Receivable out of thin air. It had to have originated from another transaction — such as providing services on credit!
📝
Entry for when we provide services on credit. → Accounts Receivable 200,000 Fees Earned 200,000
• To summarize:
• If we're aware that Accounts Receivable represents expected future cash receipts, then when the cash is received, we would debit the cash account and credit Accounts Receivable.
• This indicates that in the prior transaction, Accounts Receivable was debited!
• This type of “forward and backward” understanding really levels up your game to ensure you don’t fall for the tricks around Receivables in your exam.

• Accounts Payable is a liability account (-/+), representing the amount of cash we anticipate to pay to our suppliers or creditors (i.e. those we owe money to) in the future.
• In other words, “payable” means we will pay cash later.
• We increase the Accounts Payable account when we expect cash to flow out in the future, such as when we purchase supplies on credit and agree to pay the supplier at a later date.
• We decrease the Accounts Payable account when we pay off the cash that we originally owed to our suppliers, indicating less cash is due. If a supplier is paid the full amount, the balance on Accounts Payable returns to zero.

• See journal entry examples in sequential order below.
📝
Entry for when we purchase supplies on credit. Supplies 100,000 → Accounts Payable 100,000
📝
Entry for when we later pay cash for those same supplies purchased on credit. → Accounts Payable 100,000 Cash 100,000
💡
→ Notice that we first credit Accounts Payable, a liability account (-/+), to indicate that we owe an amount. →Later, when we pay this amount off, we debit Accounts Payable, reducing its balance to reflect the decrease in our outstanding liability.
‣
See Also: Memorization Trick for Payables
• To make Payables easier to remember, consider visualizing these situations in reverse order.
• For instance, imagine you're paying cash for supplies previously purchased on credit.
📝
Entry for when we later pay cash for those same supplies purchased on credit. → Accounts Payable 100,000 Cash 100,000
• From the Cash Cheat Code, would already know that paying cash must mean we are crediting cash, so Accounts payable must be the credit!
• However, we can’t just payable Accounts Payable out of thin air. It had to have originated from another transaction — such as purchasing supplies on credit!
📝
Entry for when we purchase supplies on credit. Supplies 100,000 → Accounts Payable 100,000
• To summarize:
• If we're aware that Accounts Payable represents expected future cash payments, then when the cash is paid, we would credit the cash account and debit Accounts Payable.
• This indicates that in the prior transaction, Accounts Payable was credited!
• This type of “forward and backward” understanding really levels up your game to ensure you don’t fall for the tricks around Payables in your exam.

• One common error is attempting to include both Accounts Receivable and Accounts Payable in the same journal entry. This isn't feasible because a single transaction cannot simultaneously increase the cash we expect to receive (Accounts Receivable) and the cash we owe to others (Accounts Payable). In other words, you can’t be on both sides of a transaction at the same time. Don’t twist your head up too much!
• Another common misunderstanding is that Accounts Receivable indicates money we owe others when, in fact, it represents money others owe us. The opposite is true for Accounts Payable - it doesn't signify money others owe us, but what we owe to others.