Adjusting Entries

Measuring Business Income

Accounting

period assumption Cash accounting versus accrual accounting Matching principle Materiality concept

Adjusting Entries
Journal

entries that update the general ledger accounts to state revenues, expenses, assets, and liabilities more accurately Involve
One balance sheet account One income statement account Never cash

Adjusting Process
Identify

the accounts requiring adjustment Determine unadjusted balances Determine correct (adjusted) balances for each account Prepare adjusting entry to bring accounts in agreement with adjusted balances

Deferrals
A

cash payment or receipt occurred in current period Must defer a portion of expense or revenue until a future period

Deferrals
Two

situations

Pay a cost of benefit in advance and allocate cost as expenses to periods that receive benefit

Deferrals
Two

situations

Pay a cost of benefit in advance and allocate cost as expenses to periods that receive benefit Receive a cash revenue in advance and allocate amounts as revenues to periods in which revenues earned

Prepaid Insurance
Dec.

1, paid $600 for 12 month insurance premium recording as asset, Prepaid Insurance At Dec. 31
Prepaid Insurance balance $600 Insurance Expense balance $0

Prepaid Insurance
As

of Dec. 31, one months insurance has expired and become expense Correct Dec. 31 balance
Prepaid Insurance $550 Insurance Expense $50

Prepaid Insurance
Adjusting

entry

Debit Insurance Expense $50 Increases Insurance Expense to correct balance $50 Credit Prepaid Insurance $50 Decreases Prepaid Insurance to correct balance $550

Depreciation Expense
Similar

to prepaid insurance but for long-term asset Decrease in asset not recorded in asset account Recorded as increase in contra asset - Accumulated Depreciation

Depreciation Expense
Before Balance Sheet $26,000 Trucks 400 Accum Deprec
Income Statement Depreciation expense $0 $400

After
$26,000 800

Unearned Revenues
Dec.

1, received $600 for 6 month rent recording as liability, Unearned Rent At Dec. 31
Unearned Rent balance $600 Rent Revenue balance $0

Unearned Revenues
As

of Dec. 31, one months rent has been earned and become revenue Correct Dec. 31 balance
Unearned Revenue $500 Rent Revenue $100

Unearned Revenues
Adjusting

entry

Debit Unearned Rent $100 Decreases Unearned Rent to correct balance $500 Credit Rent Revenue $100 Increases Rent Revenue to correct balance $100

Accruals
Recognize

revenues and expenses that have accumulated (accrued) during the accounting period but have not been recorded

Accrued Revenues
Dec.11,

received 30-day, 15% note from customer. At Dec. 31

Interest Revenue balance $0 Interest Receivable balance $0

Accrued Revenues
As

of Dec. 31, 20 days interest has been earned and become revenue $1,200 x 0.15 x 20/360 = $10 Correct Dec. 31 balance
Interest Revenue $10 Interest Receivable $10

Accrued Revenues
Adjusting

entry

Debit Interest Receivable $10 Increases Interest Receivable to correct balance $10 Credit Interest Revenue $10 Increases Interest Revenue to correct balance $10

Accrued Expenses
Employees

paid Friday for 5-day work week at $1,000 per week At Dec. 31, a Tuesday
Wages Expense balance $50,000 represents past weeks wages Wages Payable balance $0

Accrued Expenses
As

of Dec. 31, 2 days wages have been incurred and become expense Correct Dec. 31 balance
Wages Expense $50,200 Wages Payable $200

Accrued Expenses
Adjusting

entry

Debit Wages Expense $200 Increases Wages Expense to correct balance $50,200 Credit Wages Payable $200 Increases Wages Payable to correct balance $200

Summarize Adjustments

Analyzing Information
Use

questions to compare companies

Income Statement
Which

company has the higher revenues? Which company has the higher percentage change in revenues? Which company has the lower percentage of expenses to revenues?

Balance Sheet
Which

company has the higher assets? What is the percentage change in assets for each company? Is the percent of total liabilities to total liabilities plus owners equity increasing or decreasing? Which company is more risky?

Integrative Analysis
Are

companies operating efficiently by using least amount of assets to generate a given level of revenues?
Calculate total asset turnover

Are

companies operating efficiently by using least amount of assets to generate a given net income?
Calculate return on assets