Adjusting the

Accounts
Financial Accounting – Kieso,Kimmel
Learning Objectives

1. Explain the accrual basis of accounting and

the reasons for adjusting entries.
2. Prepare adjusting entries for deferrals.
3. Prepare adjusting entries for accruals.
4. Describe the nature and purpose of an
adjusted trial balance.
Adjusting the Accounts

Timing Issues The Basics The

of Adjusted
Adjusting Trial
Entries Balance
 Time Issues
Accountants divide the economic life of a business into some
artificial time periods.(Time Period Assumption)

• Generally a month or a quarter or a year

• Fiscal Year vs. Calendar Year
 Time Issues

Accrual vs. Cash-Basis Accounting

Accrual Basis Accounting
 Transactions recorded in the periods in which the
events occur
 Revenues are recognized when earned, rather than
when cash is received
 Expenses are recognized when incurred, rather than
paid
 Time Issues

Cash Basis Accounting

 Revenues are recognized when cash is
received
 Expense are recognized when cash is paid
 Cash-basis accounting is not in accordance
with GAAP
RECOGNIZING REVENUES
AND EXPENSES
Revenue recognition principle

The revenue recognition principle states that revenue

should be recognized in the accounting period in which
it is earned.
In a service enterprise, revenue
is earned when service is done
Matching Principle
The expense recognition (or
matching) principle aims to
record expenses in the same
accounting period as the
revenues that are recognized
as a result of those
expenses.
GAAP relationship between Revenue
and Expenses
 The Need for Adjusting
Entries

In order for revenues to be recorded in the period

in which services are performed and for expenses
to be recognized in the period in which they are
incurred, companies make adjusting entries.
Adjusting entries ensure that the revenue
recognition and expense recognition principles are
followed.

Adjusting entries are required every time a

company prepares financial statements.
Types of Adjusting
Entries

Adjusting Entries

Deferrals Accruals

Prepaid Unearned Accrued Accrued

Expenses revenues revenues Expenses
DEFERRALS & ACCRUALS

DEFERRALS:
1.Prepaid expenses: Expenses paid in cash before they
are used or consumed.
2. Unearned revenues: Cash received before services are
performed.
Accruals:
1. Accrued revenues: Revenues for services performed
but not yet received in cash or
recorded.
2. Accrued expenses: Expenses incurred but not yet paid
in cash or recorded.
DEFERRALS & ACCRUALS
 Adjusting Entries For
Deferrals
PREPAID EXPENSES:
Prepaid expenses are costs that expire either with
the passage of time(e.g., rent and insurance) or
through use (e.g., supplies).

An adjusting entry for prepaid expenses results in

an increase (a debit) to an expense account and a
decrease (a credit) to an asset account.
PREPAID EXPENSES

Prepaid Expenses

Supplies Insurance Rent Advertising

PREPAID EXPENSES
 Adjusting Entries For
Deferrals
Supplies:

The purchase of supplies, such as paper and

envelopes, results in an increase (a debit) to an asset
account. During the accounting period, the company
uses supplies. Rather than record supplies expense as
the supplies are used, companies recognize supplies
expense at the end of the accounting period.
SUPPLIES
Adjusting entries
 Adjusting Entries For
Deferrals

INSURANCE:

Companies purchase insurance to protect themselves from

losses due to fire, theft and unforeseen events. Insurance
must be paid in advance, often for more than one year. The
cost of insurance (premiums) paid in advance is recorded as
an increase (debit) in the asset account Prepaid Insurance.
At the financial statement date, companies increase (debit)
Insurance Expense and decrease (credit)Prepaid Insurance
for the cost of insurance that has expired during the period.
INSURANCE
Adjusting entries
 Describe the nature and
purpose of an adjusted trial
balance.
The Nature of
Adjusted Trial
Balance.
General Journal

General ledger

Trail Balance
SLIDE TITLE
The purpose of an adjusted
trial balance.