CHAPTER 8

(Adjusting Entries)

Adjusting Entries
--entries made prior to the preparation of FS to update certain accounts so that they reflect correct
balances as of the designated time.

PURPOSE OF ADJUSTING ENTRIES

1. Take up unrecorded income and expense of the period.
2. Split mixed accounts into their real and nominal elements.

ADJUSTING ENTRIES
1. Accrual of income and expenses
2. Recognition of depre. exp. and bad debts expense
3. Deferrals of income and expenses (splitting mixed acc
ACCRUALS OF INCOME AND EXPENSES
1. Income already earned but NOT yet collected
2. Expense already incurred but NOT yet paid

*All adjusting entries involve at least one balance sheet account and one income statement account
*All adjusting entries affect the profit or loss for the period

I= Prt

Depreciation
--allocation of the cost of a depreciable asset over the periods the asset is used.

EXPENSE RECOGNITION PRINCIPLES

1. Matching (Cost of Goods Sold)
2. Systematic & Rational Allocation (Depreciation)
3. Immediate Recognition (Bad Debts Expense)

ACCOUNTS
1. Real Accounts (Permanent Accounts)
--not closed at the end of accounting period
--Balance Sheet Accounts except “Owners Drawings”
2. Nominal Accounts (Temporary Accounts)
--closed at the end of the accounting period
--Income Statement Accounts, Drawings, Clearing, Suspense Accounts
3. Mixed Accounts
--both real and nominal account
--subject to adjustment
--include unadjusted prepayments (prepaid assets) and deferrals (unearned income) that have both expired
and unexpired portions

*Expired Portion- nominal account component

*Unexpired Portion- real account component

Clearing Account (Income Summary)

--temporarily to store amounts that will eventually be transferred to another account
Suspense Account (Cash Shortage or Overage)
--temporarily to store discrepancies in the accounts pending their analysis and permanent classification.

METHODS OF INITIAL RECORDING OF INCOME AND EXPENSES

INCOME
1. Liability Method (earned portion)

Cash 120,000
Unearned Rent 120,000
#
Unearned Rent 90,000
Rent Income 90,000

2. Income Method (unearned portion)

Cash 120,000
Rent Income 120,000
#
Rent Income 30,000
Unearned Rent 30,000

EXPENSES
1. Asset Method (used portion)

Prepaid Insurance 120,000

Cash 120,000
#
Insurance Expense 30,000
Prepaid Insurance 30,000

2. Expense Method (unused portion)

Insurance Expense 120,000

Cash 120,000
#
Prepaid Insurance 90,000
Insurance Expense 90,000