Accounting - Topics - Balance day adjustments - Illustration - the
Illustration - the accounting equation
Illustration of use
A difficult question to ask would be to describe the effect of failing to
make the reversing entry for Prepaid Rent Expense of $400.
This question can be approached as follows:
Step 1 Draw the see saw; that is A + E = R + L + P.
2 Use arrows pointing upward or downward under the item classification to show the effect of the original adjusting entry.
3 Reverse the arrows to show the effect of the reversing entry.
4 Change terminology to overstate (O/S) and understate (U/S).
5 For failure to act to decrease, O/S will occur, and to increase U/S takes place.
6 The student must then state the effect on both the Profit and Loss and balance sheet, including the dollar amount.
SOLUTION A + E = R + L + P
Expenses are understated, leading to profit being overstated by $400 in
the Profit and Loss statement. In the balance sheet assets are overstated
and owner's equity (proprietorship) is overstated (that is, profit
increases by $400).
Stock loss or gain, and the disposal of non-current assets with an
accompanying profit or loss, must also be accounted for in the relevant
journal, ledger, record and report. These items fall under the topic of
balance day adjustments.
Apart from the traditional adjustments students may well be examined on
the 'asset approach for recording transactions where payment precedes
benefit received'. When adopting this approach the payment is initially
recognised as an asset rather than as an expense. At the end of each period
part of this asset is allocated as an expense and posted to the Profit and
Loss account. No reversing entries are required.
It should be noted that the treatment of the liability approach for
revenue is not required.
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