THE ADJUSTING

PROCESS

Dr. Kamilah Ahmad

Faculty of Technology Management & Business
Learning Outcomes

On the completion of the chapter, you should be able to:

• Make adjustments for accruals, depreciations and
prepayments.
• Prepare a set of financial reports incorporating such
adjustments.
Introduction

A number of end-of-year adjustments would normally be

made before the financial accounts are finalized.
The adjustments are due to some outstanding matters at
the end of the financial year which has to be included in
the accounts.
The chapter explains examples of adjustments which
commonly happen during in a last-minute adjustment.
Adjusting process

Adjustment helps measure the period’s income and bring

the related asset and liability accounts to correct balance.

Adjustment is made due to several factors such as accrual

basis, periodic concept and revenue and matching
principles.
Accrual basis vs. Cash basis

a. Accrual-basis:
• Accrual basis means the transactions are
recorded/recognized when the revenues are
earned or expenses are incurred.

b. Cash-basis:
• While the cash basis, the transactions are
recorded when cash is paid or cash is received. It
ignores receivables, payables, and depreciation.

• Example: refer to note

The time period concept

• This concept requires that accounting information should

be reported at regular intervals. This concept interacts
with the revenue principle and the matching principle
which requires income should be measured accurately for
each accounting period.
Main types of adjustments
Prepaid
The cash transaction occurs before an expense or revenue is
recorded. Examples: prepaid expense, unearned revenue and
depreciation.

Accruals
Records all expenses & revenues that have occurred, even no
cash transactions involved. Examples: revenue earned but
cash received later (accrued revenue) and expenses incurred
but payment is made later (accrued expenses).
 Prepaid expense

Depreciation expenses

Subcategories of
adjustments Unearned revenue

Accrued revenue

Accrued expenses
Prepaid expense
• Prepaid expense is advance payment of expenses.
Examples are prepaid rental, prepaid insurance,
and supplies.
Example: Bell Designer prepays two months’ rent on Jan 1,
2023, RM1,000. This payment creates an asset for Bell Designer.

Jan 1 Prepaid Rent 1,000

Cash 1,000
(Paid rent in advance)

At Jan 31, prepaid rent should be decreased for the amount of

the asset that has been used up.
Jan 31 Rent expense (1,000x1/2) 500
Prepaid rent 500
(To record rent expense)
Depreciation

The allocation of the cost of a long-term asset as an expense

over the asset's useful life (the anticipated number of
productive years the asset will benefit the business).

Among the most common methods:

a. Straight-line method
b. A declining balance
c. Sum of the year’s digits method.
d. Units of production
Straight line method

• Straight line method: is the simplest and most commonly

used method. The value of depreciation expense under the
straight-line depreciation method is similar every year
during the useful life of the asset.

(Purchase price of asset - approximate salvage value) ÷

Estimated useful life of asset
Supposed that on Jan 5, Zara purchased furniture on account
for RM 6000. Zara believed the furniture will remain useful
for 8 years with salvage value RM1,000.
Example: Depreciation

Jan 1 Furniture 6,000

Accounts Payable 6,000
(Purchase furniture on account)

Jan 31 Depreciation expense-Furniture 100

Accumulated depreciation-Furniture 100
(Monthly depreciation expense-furniture)
Unearned revenues
A liability created when a business collects cash from customers
in advance of doing work. This is also called deferred revenue.
Accrued revenues and Accrued expenses

Accruals refer to the two types of transactions.

• Accrued revenue
The revenue is earned but payment has not yet received. Also called
unrealized revenue or accrued assets.

• Accrued expenses
Accrued expenses are expenses (wages, salaries, rents, utility
charges) which are incurred but not yet paid for, during a given
accounting period. They are liabilities and also known as accrued
liabilities. Example, January salaries expense will be paid on February
and the record will be dr. Salaries expense, cr. Salaries payable.
The adjusted trial balances.

The adjusted trial balance is a listing of all account balances

after adjustments.
• Here are the steps used to prepare an adjusted trial balance:
1.Run an unadjusted trial balance. This provides an initial summary of your general
ledger accounts prior to entering any adjusting entries.
2.Make any adjusting entries that are needed. Adjusting entries can include adjustments
for prepayments, interest and depreciation expense, and payroll accruals.
3.Run the adjusted trial balance. You can ensure that the entries have posted correctly
by comparing the initial trial balance totals with the adjusted trial balance totals.
Closing the accounts

Account closing is the end-of-period process that prepares

the accounts for the next period. It involves both revenue and
expenditure accounts.

A closing entry is a journal entry made at the end of the

accounting period. It involves shifting data from temporary
accounts on the income statement to permanent accounts on
the balance sheet. All income statement balances are
eventually transferred to retained earnings.
Closing the account procedure
• The basic sequence of closing entries is as follows:
1.Debit all revenue accounts and credit the income summary account,
thereby clearing out the balances in the revenue accounts.
2.Credit all expense accounts and debit the income summary account,
thereby clearing out the balances in all expense accounts.
3.Close the income summary account to the retained earnings
account.
• If there was a profit in the period, then this entry is a debit to
the income summary account and a credit to the retained
earnings account.
• If there was a loss in the period, then this entry is a credit to the
income summary account and a debit to the retained earnings
account.
POST CLOSING TRIAL BALANCE