Adjusting Entries

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Del curso dictado por University of Pennsylvania

Financial Acumen for Non-Financial Managers

12 calificaciones

University of Pennsylvania

Financial Acumen for Non-Financial Managers

12 calificaciones

Curso 1 de 4 en SpecializationThe Business of Health Care

In this course, you’ll explore how financial statement data and non-financial metrics can be linked to financial performance. Professors Rick Lambert and Chris Ittner of the Wharton School have designed this course to help you gain a practical understanding of how data is used to assess what drives financial performance and forecast future financial scenarios. You’ll learn more about the frameworks of financial reporting, income statements, and cash reporting, and apply different approaches to analyzing financial performance using real-life examples to see the concepts in action. By the end of this course, you’ll have honed your skills in understanding how financial data and non-financial data interact to forecast events and be able to determine the best financial strategy for your organization.

De la lección

Module 1

This module was designed to give you a foundational overview of financial reporting and income statements. You’ll identify and analyze balance sheet equations and its key components such as assets, liabilities, and shareholders’ equity. Through examining a sample real-world financial statement, you’ll learn how to calculate income, revenue, and expenses transactions, and see how the income statement is linked to changes in the balance sheet. By the end of this module, you’ll have a better understanding of the key components in financial reporting and learn how to craft an accurate income statement for your organization.

Course Introduction8:48

An Overview of Accounting and the Financial Reporting Environment12:09

The Balance Sheet Equation6:49

Assets, Liabilities, Shareholders' Equity14:07

Case 1, Part 1 - Balance Sheet Transactions6:05

Application to Real-World Financial Statements: Large U.S.-Based Multinational Consumer Goods Company (Part 1)7:26

Income, Revenue, and Expenses7:36

Case 1, Part 2 - Revenue and Expense Transactions6:12

Adjusting Entries6:31

Case 1, Part 3 - Adjusting Entries8:52

Conoce a los instructores

Richard Lambert
Professor of Accounting
Accounting- Wharton School
Christopher D. Ittner
EY Professor of Accounting
Accounting

In this video, we're going to continue to talk about

the income statement but now we're going to focus on the role of adjusting entries.

Adjusting entries are important because there

are many events that occur during the period

that don't result in

a specific transaction and don't necessarily result in cash changing hands.

Nevertheless, because they're important events we have to record them.

Now, in principle, we could be recording these at any point during the period but

it's commonly waited until the very end of the period to record these.

Adjusting entries are tricky,

because they don't involve a specific transaction and there's no cash to point to.

These are the ones that require the most subjectivity and the most expertise.

So, in some sense they're the most manipulable.

In addition, because they're often done at the end of the period,

when you basically already have a pretty good idea for what your income needs to be,

adjusting entries are a tempting way to try to move income up a little bit if you need

it to be higher or move it down a little bit if incomes are plenty high already.

So, an example of an adjusting entry would be depreciation.

When we buy an asset,

we typically don't charge

the entire cost of property plant and equipment to the period in which we buy it,

if it's going to last for a long time.

So instead we're going to stretch the purchase cost out over the benefit period,

which we refer to as the assets useful life.

Depreciation is the term that we use to

describe that charging off of the original purchase price.

Now, you'll often hear the term depreciation used in other ways as well,

and that's not exactly the same way that we use it here.

So, you may have heard the expression "as soon as you buy a car,

the second it rolls off the lot,

it depreciates by one third".

That's basically saying that the resale value of the asset goes down by a third.

That's not exactly the same sense in which we use depreciation.

Instead depreciation here is usually

a more arbitrary and more even allocation of the purchase price over time.

We're not intending to resell it now,

so we're going to spread the cost out more evenly.

Straight-line depreciation is a common method of depreciation.

Straight-line depreciation takes the purchase price of

the asset and spreads it out evenly over the useful life.

It does recognize, however,

that even at the end of the useful life,

the asset might still have some value.

So, what it really does is it depreciates the difference between the value when you

buy it and the value that you expect it to have at the end of the useful life,

when you might sell it for example,

and divide that evenly over the useful life.

Note that to calculate depreciation,

you need an estimate of what the salvage value or residual value of the asset is,

as well as how long the asset is going to live.

Nobody knows those numbers for sure.

And so, you've got some wiggle room in deciding what they're going to

be that can make your depreciation expense either higher or lower,

and therefore move your income up or down.

The accounting convention for recording depreciation is

actually not to deduct that from the asset value directly.

We keep track of the assets original cost in a separate account,

and then we record the depreciation that we're accumulating in a separate account.

The net of those two is what we actually show on the balance sheet,

that's referred to as the net book value as opposed to the original cost,

which is the gross book value.

There is a lot of other kinds of adjusting entries that have to go on as well,

and together all of these provide more opportunities to move income up or down.

For example, when we make a credit sale,

we're not sure we're going to collect all that.

So we need to adjust the receivable and

our income down to reflect the fact that we might not collect at all.

How much we're going to collect?

Nobody knows for sure,

so it's an estimate that we can potentially manipulate upwards or downwards.

Similarly, returns.

Not everything we sell is going to stay with the customers,

some are going to get returned.

We need an allowance for that to adjust for the fact that some of those returns are going

to be high and our ultimate income is going to be lower than what we've recorded so far.

Income tax is another one.

If we've reported pre-tax income to shareholders,

we have to allocate some income tax expense to

that even if we don't actually owe the taxes yet.

So we need to estimate what the taxes are going to be.

Some assets we actually mark to market.

So, for those kinds of assets you have to decide what would

the asset be worth now at the end of the period even though I haven't sold it.

For many assets, there's not market prices you can readily look up,

and so there's a lot of subjectivity in deciding what the assets are worth, as well.

On the flip side, some assets go down in value.

Recognizing the downturn in asset value or

an impairment charge often is a very subjective thing, too.

Nevertheless, this has to be done to properly calculate income.

If you borrowed money or if somebody has borrowed money from you,

you also have to record interest income or interest expense as the case

may be even if the interest payments aren't actually due at this point in time.

So there's many economic events that occur over

the course of a period that need to be accounted for,

for which there is no specific transaction that

occurred and no cash that's changing hands this period.

This is the role of adjusting entries.

Again, because many of these are done at the end of

the period they're the most subjective and are the ones that you

need to watch out for the most in assessing whether or

not income really reflects the real performance of the company.

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