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 Assignment)One)
What)you)did)really)Well
• Professional+format
• Electronic+file+(+one+student+submitted+picture)

Areas)for)Improvements
Academical+integrity:+
• Identical+papers
• Identical+mistakes

2
 Lyryx
Resources:
Read+txt+book,+have+interactive+exercise

Assignments+on+Lyryx:++(+3<6)
Starting+from+Assignment+Three

Exams+on+Moodle:++
no+Changes.++

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Introduction*to*Financial*Accounting

Chapter(3
Adjusting(Accounts(for(
Financial(Statements

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 Chapter 3)Learning)Objectives
LO1)– Explain)how)the)timeliness,)matching,)and)recognition)GAAP)
require)the)recording)of)adjusting)entries

LO2)– Explain)the)use)of)and)prepare)the)adjusting)entries)required)
for)prepaid)expenses,)depreciation,)unearned)revenues,)accrued)
revenues,)and)accrued)expenses)

LO3)– Prepare)an)adjusted)trial)balance)and)explain)its)use

LO4)– Use)an)adjusted)trial)balance)to)prepare)financial)statements

LO5)– Identify)and)explain)the)steps)in)the)accounting)cycle

LO)6)– Explain)the)use)of)and)prepare)closing)entries)and)a)postB
closing)trial)balance

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 3.2$Adjusting$Entries

LO2$– Explain#the#use#of#and#prepare#the#adjusting#entries#required#
for#prepaid#expenses,#depreciation,#unearned#revenues,#accrued#
revenues,#and#accrued#expenses#

At#the#end#of#an#accounting#period,#before#financial#
statements#can#be#prepared,#the#accounts#must#be#
reviewed#for#potential#adjustments#
! this#review#is#done#by#using#the#unadjusted)trial)balance
! the#unadjusted$trial$balance$is#a#trial#balance#where#the#
accounts#have#not#yet#been#adjusted

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 3.2$Adjusting$Entries
Big$Dog$Carworks Corp.
The$trial$balance$of Unadjusted$Trial$Balance
At$January$31,$2015
Big$Dog$Carworks Acct. Account Debit Credit

Corp.$(from$Chapter 101 Cash $3,700

110 Accounts$receivable 2,000
2)$is$shown$here):
161 Prepaid insurance 2,400
! It$is$an$unadjusted) 183 Equipment 3,000
trial)balance)because$ 184 Truck 8,000
the$accounts$have$not$ 201 Bank$loan $6,000
yet$been$updated$for$ 210 Accounts$payable 700
adjustments 247 Unearned revenue 400
! We$will$use$this$trial$ 320 Share$capital 10,000
balance$to$illustrate$ 330$ Dividends 200
how$adjustments$are$ 450 Repair$revenue 10,000
identified$and$ 654 Rent$expense 1,600
recorded 656 Salaries$expense 3,500
668 Supplies$expense 2,000
670 Truck$operation expense 700
$27,100 $27,100

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2.5$The$Accounting$Cycle

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 3.2$Adjusting$Entries
Adjusting*entries:
! record&adjustments
! ensure&both&the&balance&sheet&and&the&income&statement&faithfully&
represent&the&account&balances&for&the&accounting&period
! help&satisfy&the&matching&principle
There&are&five$types$of&adjusting&entries&as&shown&below:&
❶ ❷ ❸ ❹ ❺

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 ❶ Adjusting+Prepaid+Asset+Accounts

An#asset#or#liability#account#requiring#adjustment#at#
the#end#of#an#accounting#period#is#referred#to#as#a#
mixed#account#because#it#includes#both#a#balance#
sheet#portion#and#an#income#statement#portion

! The#income#statement#portion#must#be#removed#from#the#
account#by#an#adjusting#entry

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 Adjusting*Prepaid*Asset*Accounts
The$unadjusted$trial$balance$presented$earlier$shows$an$
unadjusted$balance$in$prepaid$insurance$of$$2,400
! Recall$from$Chapter 2$that$Big$Dog$paid$for$a$12Amonth$
insurance$policy$that$went$into$effect$on$January$1$
(transaction$5)

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 Adjusting*Prepaid*Asset*Accounts
At#January#31,#one#month#or#$200#of#the#policy#has#
expired#(been#used#up)#calculated#as#$2,400/12#months#=#
$200
The$adjusting$entry$on$January$31$to$transfer$$200$out$of$
prepaid$insurance$and$into$insurance$expense$is:
General Journal

Date Account/Explanation Debit Credit

Jan.#31 Insurance 200
Prepaid#Insurance 200
To#adjust#for#the#use#of#one#month#of#Prepaid#
Insurance

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 Adjusting*Prepaid*Asset*Accounts
As#shown#below,#the#balance#remaining#in#the#Prepaid#
Insurance#account#is#$2,200#after#the#adjusting#entry#is#posted
! the#$2,200#balance#represents#the#unexpired#asset#that#will#benefit#
future#periods,#namely,#the#11#months#from#February#to#December,#
2015
! the#$200#transferred#out#of#prepaid#insurance#is#posted#as#a#debit#to#
the#Insurance#Expense#account#to#show#how#much#insurance#has#been#
used#during#January

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 Adjusting*Prepaid*Asset*Accounts

If#the#adjustment#was#not#recorded,#assets#on#the#
balance#sheet#would#be#overstated#by#$200#and#
expenses#would#be#understated#by#the#same#amount#
on#the#income#statement.

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 3.2$Adjusting$Entries
Adjusting*entries:
! record&adjustments
! ensure&both&the&balance&sheet&and&the&income&statement&faithfully&
represent&the&account&balances&for&the&accounting&period
! help&satisfy&the&matching&principle
There&are&five$types$of&adjusting&entries&as&shown&below:&
❶ ❷ ❸ ❹ ❺

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❷ Adjusting+Unearned+Liability+Accounts
On#January#15,#Big#Dog#received#a#$400#cash#payment#in#
advance#of#services#being#performed:#$300#for#January#
and#$100#for#February

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 Adjusting*Unearned*Liability*Accounts
! This%advance%payment%was%originally%recorded%as%unearned,%
since%the%cash%was%received%before repair%services%were%
performed
! At%January%31,%$300%of%the%$400%unearned%amount%has%been%
earned
! $300%must%be%transferred%from%unearned%repair%revenue%into%repair
revenue
The$adjusting$entry$at$January$31$is:
General Journal
Date Account/Explanation Debit Credit
Jan.%31 Unearned%Repair Revenue 300
Repair Revenue 300
To%adjust%for%repair%revenue%earned.

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 Adjusting*Unearned*Liability*Accounts
After&posting&the&adjustment,&the&$100&remaining&
balance&in&unearned&repair&revenue&($400&– $300)&
represents&the&amount&at&the&end&of&January&that&will&be&
earned&in&February

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 Adjusting*Unearned*Liability*Accounts

! If#the#adjustment#was#not#recorded,#unearned#repair#
revenue#would#be#overstated#(too#high)#by#$300#
causing#liabilities#on#the#balance#sheet#to#be#
overstated.#
! Additionally,#revenue#would#be#understated#(too#low)#
by#$300#on#the#income#statement#if#the#adjustment#
was#not#recorded.

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 3.2$Adjusting$Entries
Adjusting*entries:
! record&adjustments
! ensure&both&the&balance&sheet&and&the&income&statement&faithfully&
represent&the&account&balances&for&the&accounting&period
! help&satisfy&the&matching&principle
There&are&five$types$of&adjusting&entries&as&shown&below:&
❶ ❷ ❸ ❹ ❺

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 ❸ Adjusting+Plant+and+Equipment+Accounts
! Plant&and&equipment&assets,&also&known&as&long4lived&
assets,&are&expected&to&help&generate&revenues&over&the&
current&and&future&accounting&periods&because&they&are&
used&to&produce&goods,&supply&services,&or&used&for&
administrative&purposes
! the&truck&and&equipment&purchased&by&Big&Dog&Carworks
Corp.&in&January&are&examples&of&plant&and&equipment&
assets&that&provide&economic&benefits&for&more&than&one&
accounting&period
! Because&plant&and&equipment&assets&are&useful&for&more&
than&one&accounting&period,&their&cost&must&be&spread&
over&the&time&they&are&used&to&satisfy&the&matching+
principle

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 Adjusting*Plant*and*Equipment*Accounts

Example: The$$100,000$cost$of$a$machine$expected$to$be$
used$over$five$years$is$not$expensed$entirely$in$the$year$
of$purchase$because$this$would$cause$expenses$to$be$
overstated$in$Year$1$and$understated$in$Years$2,$3,$4,$and$
5
! the$$100,000$cost$must$be$spread$over$the$asset's$
fiveByear$life

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 Depreciation
! the$process$of$allocating$the$cost$of$a$plant$and$
equipment$asset$over$the$period$of$time$it$is$expected$to$
be$used
! calculated$using$the$actual$cost$and$an$estimate$of$the$
asset's$useful&life and$residual&value
! useful/life/
! an$estimate$of$how$long$it$will$actually$be$used$by$the$
business$regardless$of$how$long$the$asset$is$expected$to$last
! residual/value
! an$estimate$of$what$the$plant$and$equipment$asset$will$be$
sold$for$when$it$is$no$longer$used$by$a$business

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 Depreciation

! there%are%different%formulas%for%calculating%
depreciation
! we%will%use%the%straight.line0method0of%depreciation,%
calculated%as%follows:

Cost%– Estimated Residual%Value

Estimated%Useful%Life

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 Depreciation

! Depreciable-cost-of#an#asset#
! cost#less#estimated#residual#value

! Straight2line-method-
! allocates#the#depreciable#cost#equally#over#the#asset's#
estimated#useful#life

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 Depreciation
! To#record#depreciation,#depreciation#expense#is#debited#
and#a#contra'account called#accumulated'depreciation is#
credited
! contra+account
! an#account#that#is#related#to#another#account
! typically#has#an#opposite#normal#balance#that#is#subtracted#
from#the#balance#of#its#related#account#on#the#financial#
statements
! accumulated+depreciation+
! records#the#amount#of#the#asset's#cost#that#has#been#
expensed#since#it#was#put#into#use
! has#a#normal#credit#balance
! is#subtracted#from#a#Plant#and#Equipment#asset#account#on#
the#balance#sheet

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 Depreciation

The$goal$in$recording$depreciation$is$to$match-the$
cost$of$the$asset$to$the$revenues$it$helped$generate

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 Depreciation
The$adjusting$journal$entry$to$record$depreciation$is:
General Journal

Date Account/Explanation Debit Credit

Depreciation6Expense xx
Accumulated Depreciation xx
To6adjust6for6depreciation.

Subtracting6the6accumulated6depreciation6account6balance6
from6the6Plant6and6Equipment6asset6account6balance6equals6
the6carrying1amount1or6net1book1value1of6the6plant6and6
equipment6asset6that6is6reported6on6the6balance6sheet.

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 Depreciation
Examples:**
Big$Dog$Carworks Corp.'s$January$31,$2015$unadjusted$trial$
balance$showed$the$following$two$plant$and$equipment$
assets:

Big-Dog-Carworks Corp.
Unadjusted-Trial-Balance
At-January-31,-2015
Acct. Account Debit Credit
183 Equipment 3,000
184 Truck 8,000

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 Depreciation

Example(#1:
The$equipment$was$purchased$for$$3,000

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 Depreciation
! The$equipment$was$recorded$as$a$plant$and$equipment$asset$
because$it$has$an$estimated$useful$life$greater$than$1$year
! Assume$its$actual$useful$life$is$10$years$(120$months)$and$the$
equipment$is$estimated$to$be$worth$$0$at$the$end$of$its$useful$
life$(residual$value$of$$0)

Cost%– Estimated%Residual%Value $3,000%−%$0

= =%$25%/%month
Estimated%Useful%Life 120%Months

Note%that%depreciation%is%always%rounded%to%the%nearest%whole%
dollar
! depreciation$is$not$exact,$but$based$on$estimates$
! estimated$residual$value$and$estimated$useful$life

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 Depreciation

The$following$adjusting$journal$entry$is$made$on$
January$31:

General Journal
Date Account/Explanation Debit Credit
Jan.$31 Depreciation$Expense,$Equipment 25
Accumulated Depreciation,$Equipment 25
To$adjust$for$one$month$of$depreciation$on$the$
equipment.

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 Depreciation
When%the%adjusting%entry%is%posted,%the%accounts%appear%
as%follows:

For%financial%statement%reporting,%the%asset%and%contra%asset%
accounts%are%combined
! net%book%value%of%the%equipment%on%the%balance%sheet
is%shown%as%$2,975%($3,000%– $25)

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 Depreciation

! If#depreciation#adjustments#are#not#recorded
! assets#on#the#balance#sheet#would#be#overstated
! expenses#would#be#understated#on#the#income#
statement#causing#net#income#to#be#overstated
! retained#earnings#on#the#balance#sheet#would#then#also#
be#overstated
! Note#that#land#is#a#long:lived#asset#but#it#is#not$
depreciated because#it#does#not#get#used#up#over#
time
! land#is#often#referred#to#as#a#non:depreciable#asset

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 Depreciation
Example(#2:
BDCC$also$shows$a$truck$for$$8,000$on$the$January$31,$
2015$unadjusted$trial$balance

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 Depreciation

! Assume&the&truck&has&an&estimated&useful&life&of&80&
months&and&a&zero&estimated&residual&value&
! At&January&31,&one&month&of&the&truck&cost&has&
expired&since&it&was&put&into&operation&in&January
! Using&the&straightAline&method,&depreciation&is&calculated&
as:

Cost%– Estimated%Residual%Value $8,000%−%$0

= =%$100%/%month
Estimated%Useful%Life 80%Months

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 Depreciation

The$adjusting$entry$recorded$on$January$31$is:

General Journal

Date Account/Explanation Debit Credit

Jan.31 Depreciation9Expense,9Truck 100

Accumulated Depreciation,9Truck 100
To9adjust9for9one9month9of9depreciation9on9the9
truck.

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 Depreciation
When%the%adjusting%entry%is%posted,%the%accounts%
appear%as%follows:

! For%financial%statement%reporting,%the%asset%and%contra%asset
accounts%are%combined
! The%net%book%value%of%the%truck%on%the%balance%sheet%is%shown
as%$7,900%($8,000%– $100)

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 ❹ Adjusting+for+Accrued+Revenues
Accrued+revenues
! revenues'that'have'been'earned'but'not'yet'
collected'or'recorded
Example:)))
A'bank'has'numerous'notes'receivable
! Interest'is'earned'on'the'notes'receivable'as'time'passes
! At'the'end'of'an'accounting'period,'there'would'be'notes'
receivable'where'the'interest'has'been'earned'but'not'
collected'or'recorded

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 Adjusting*for*Accrued*Revenues

The$adjusting$entry$for$accrued$revenues$is:

General Journal

Date Account/Explanation Debit Credit

Receivable xxx
Revenue xxx
To9adjust9for9accrued9revenue.

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 Adjusting*for*Accrued*Revenues
For$Big$Dog$Carworks Corp.,$assume$that$on$January$
31,$$400$of$repair$work$was$completed$for$a$client$
but$it$had$not$yet$been$collected$or$recorded.$
BDCC$must$record$the$following$adjusting$entry:
General Journal

Date Account/Explanation Debit Credit

Jan 31 Accounts$Receivable 400

Repair$Revenue 400
To$adjust$for$accrued$revenue.

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 Adjusting*for*Accrued*Revenues

If#the#adjustment#was#not#recorded,#assets#on#the#balance#
sheet#would#be#understated#by#$400#and#revenues#would#be#
understated#by#the#same#amount#on#the#income#statement.

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 ❺ Adjusting+for+Accrued+Expenses

Accrued+expenses
! expenses&that&have&been&incurred&but&not&yet&paid&or&
recorded
Example:
A&utility&bill&received&at&the&end&of&the&accounting&period&is&
likely&not&payable&for&2–3&weeks
! utilities&for&the&period&have&been&used&but&have&not&yet&
been&paid&or&recorded

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 Adjusting*for*Accrued*Expenses

The$adjusting$entry$for$accrued$expenses$is:

General Journal

Date Account/Explanation Debit Credit

Expense xxx
Payable xxx
To9adjust9for9accrued9expense.

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 Accruing(Interest(Expense

For$Big$Dog$Carworks Corp.,$the$January$31,$2015$
unadjusted$trial$balance$shows$a$$6,000$bank$loan$
balance.$$Assume$it$is$a$4%,$60Hday$bank$loan$dated$
January$3$
! this$means$that$on$January$31,$28$days$of$interest$
have$accrued$(January$31$less$January$3$=$28$days)$
as$shown$in$the$figure$on$the$next$slide
! the$maturity$date$is$March$4,$2015$calculated$as:$
January$31$less$January$3$=$28$days$+$28$days$in$
February$=$56$days$+$4$days$=$March$4

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 Accruing(Interest(Expense

Interest(Incurred(During(an(Accounting(Period

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 Accruing(Interest(Expense

! The$formula$for$calculating$interest$when$the$term$is
expressed$in$days:
Interest(=(Principal(X(Interest(rate(X Elapsed(time(in(days
365

! The$interest$expense$accrued$at$January$31$is$calculated$
as:
Interest(=($6000(X(.04(X _28_ =($18
365

(calculations+rounded+to+the+nearest+whole+dollar+for+simplicity+of+demonstrations)

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 Accruing(Interest(Expense
BDCC's adjusting.entry.on.January.31.is:
General Journal

Date Account/Explanation Debit Credit

Jan.831 Interest8Expense 18
Interest8Payable 18
To8adjust8for8accrued8interest;8$6,0008X84%8X8
28/3658=8$18.418(rounded8to8$188for8
illustrative8purposes).

This8adjusting8entry8enables8BDCC8to8include8the8interest8expense8on8
the8January8income8statement8even8though8the8payment8has8not8yet8
been8made
! the8entry8creates8a8payable8that8will8be8reported8as8a8liability8on8the
balance8sheet8at8January831

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 Accruing(Interest(Expense

When%the%adjusting%entry%is%posted,%the%accounts
appear%as:

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 Accruing(Interest(Expense
On#February#28,#interest#will#again#be#accrued#and
recorded#as:
General Journal

Date Account/Explanation Debit Credit

Feb#28 Interest#Expense 18
Interest#Payable 18
To#adjust#for#accrued#interest;#$6,000#X#4%#X#
28/365#=#$18.41#(rounded#to#$18#for#
illustrative#purposes).

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 Accruing(Interest(Expense
On#March#4#when#the#bank#loan#matures,#Big#Dog#will#pay#the#
interest#and#principal#and#record#the#following#entry:
General Journal

Date Account/Explanation Debit Credit

Mar#4 Interest#Expense 3
Interest#Payable 36
Bank#Loan 6,000
Cash 6,039
To#record#payment#of#the#bank#loan#and#
interest;#interest#expense#for#March#is#$6,000#X#
4%#X#4/365#=#$2.63#(rounded#to#$3)

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 Accruing(Interest(Expense
! The$$36$debit$to$interest$payable$will$cause$the$
Interest$Payable$account$to$go$to$zero$since$the$
liability$no$longer$exists$once$the$cash$is$paid
! Total$interest$expense$recorded$on$the$bank$loan$was$
$39
– $18 expensed$in$January,$
– $18$expensed$in$February,$and$
– $3$expensed$in$March
! The$interest$expense$was$matched$to$the$life$of$the$
bank$loan.

52
 Accruing(Income(Tax(Expense

! Another(adjustment(that(is(required(for(Big(Dog(
Carworks Corp.(involves(the(recording(of(corporate(
income(taxes
! In(most(jurisdictions,(a(corporation(is(taxed(as(an(
entity(separate(from(its(shareholders
! For(simplicity,(assume(BDCC's income(tax(due(for(
January(2015(is($500(

53
 Accruing(Income(Tax(Expense

The$adjusting$entry$at$January$31$is:

General Journal

Date Account/Explanation Debit Credit

Jan731 Income7Tax7Expense 500

Income7Tax7Payable 500
To7adjust7for7January7accrued7income7tax.

54
 Accruing(Income(Tax(Expense
When%the%adjusting%entry%is%posted,%the%accounts
appear%as%follows:

The%above%adjusting%entry%enables%the%company%to%match%the%
income%tax%expense%accrued%in%January%to%the%income%earned%
during%the%same%month.

55
Summary'of'the'Five'Types'of'Adjusting'Entries

❶ ❷

❸ ❹

56
 3.3#The#Adjusted#Trial#Balance
Big#Dog#Carworks Corp.
Adjusted#Trial#Balance
At#January#31,#2015
Account Debit Credit
Cash $ 3,700
Accounts6receivable 2,400
Prepaid insurance 2,200
Equipment 3,000
Accumulated6depreciation6@ equipment $66666625
Truck 8,000
Accumulated6depreciation – truck 100
Bank6loan 6,000
Accounts6payable 700
Interest6payable 18
Unearned6repair6revenue 100
Income6tax6payable 500

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3.3#The#Adjusted#Trial#Balance#(cont’d)
Account Debit Credit
Share&capital 10,000
Dividends 200
Repair&revenue 10,700
Depreciation&expense – equipment 25
Depreciation&expense&– truck 100
Rent expense 1,600
Insurance expense 200
Interest&expense 18
Salaries&expense 3,500
Supplies&expense 2,000
Truck&operation&expense 700
Income&tax&expense 500
Total&debits&and&credits $28,143 $28,143

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