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3 Adjusting The Accounts

Learning Objectives
Explain the accrual basis of accounting and the
1 reasons for adjusting entries.

2 Prepare adjusting entries for deferrals.

3 Prepare adjusting entries for accruals.

Describe the nature and purpose of an adjusted

4 trial balance.
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  Status: Student
 Status: Employee
 Status: Employer

 1st oct loan, 1st july loan pay back, 31st dec
 A/R

3-3
LEARNING Explain the accrual basis of accounting
1
OBJECTIVE and the reasons for adjusting entries.

Accountants divide the economic life of a business into

artificial time periods (Time Period Assumption).

.....
Jan. Feb. Mar. Apr. Dec.

Generally a
Alternative Terminology
 month, The time period assumption
is also called the
 quarter, or periodicity assumption.
 year.

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 Fiscal and Calendar Years

 Monthly and quarterly time periods are called interim

periods.
 Most large companies must prepare both quarterly and
annual financial statements.
 Fiscal Year = Accounting time period that is one year
in length.
 For example, a company might operate on a fiscal
year that begins on Nov. 1 and ends on Oct. 31.
 Calendar Year = January 1 to December 31.

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 Fiscal and Calendar Years

Question
The time period assumption states that:
a. revenue should be recognized in the accounting
period in which it is earned.

b. expenses should be matched with revenues.

c. the economic life of a business can be divided into
artificial time periods.
d. the fiscal year should correspond with the calendar
year.

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 Accrual- versus Cash-Basis Accounting

Accrual-Basis Accounting
 Transactions recorded in the periods in which the
events occur.
 Companies recognize revenues when they perform
services (rather than when they receive cash).
 Expenses are recognized when incurred (rather than
when paid).
 In accordance with generally accepted accounting
principles (GAAP).

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 Accrual- versus Cash-Basis Accounting

Cash-Basis Accounting
 Revenues recognized when cash is received.
 Expenses recognized when cash is paid.
 Cash-basis accounting is not in accordance with
generally accepted accounting principles (GAAP).

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  Accrual – Cash is not involved, Only
Accounts (payable/receivable) are used
 Salaries and wages expense (after paying it)
 Sal and wages payable (before paying it)

 Cash basis accounting

 We record transactions only when CASH is

involved (pay/receive)

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 Recognizing Revenues and Expenses

REVENUE RECOGNITION PRINCIPLE

Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.

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 Recognizing Revenues and Expenses

EXPENSE RECOGNITION PRINCIPLE

Match expenses with revenues
in the period when the company
makes efforts that generate those
revenues.

“Let the expenses

follow the revenues.”

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 Illustration 3-1
GAAP relationships in
revenue and expense
recognition

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 Recognizing Revenues and Expenses

Question
One of the following statements about the accrual basis of
accounting is false? That statement is:
a. Events that change a company’s financial statements are
recorded in the periods in which the events occur.
b. Revenue is recognized in the period in which the performance
obligation is satisfied.
c. The accrual basis of accounting is in accord with generally
accepted accounting principles.
d. Revenue is recorded only when cash is received, and
expenses are recorded only when cash is paid.

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 ADJUSTING ENTRIES

 Adjusting entries are required each time

financial statements are prepared.

 Adjusting entries can be classified as

1. prepayments (prepaid expenses or
unearned revenues),
2. accruals (accrued revenues or
accrued expenses), or

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 PREPAID EXPENSES

 Prepaid expenses are expenses paid

in cash and recorded as assets before
they are used or consumed.
 Prepaid expenses expire with the
passage of time or through use and
consumption.
 An asset-expense account
relationship exists with prepaid
expenses.
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 PREPAID EXPENSES

 The adjusting entry results in a debit to an expense

account and a credit to an asset account.
 https://www.youtube.com/watch?v=J8GYkIepumU
 Examples of prepaid expenses include supplies, rent,
insurance, and property tax.

 Prepaid Insurance amount Rs 100,000 is expired after

one year.
 Insurance expense 100,000
 Prepaid Insurance 100,000

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 UNEARNED REVENUES

 Unearned revenues are revenues

received and recorded as liabilities
before they are earned.
 Unearned revenues are subsequently
earned by performing a service or
providing a good to a customer.
 A liability-revenue account
relationship exists with unearned
revenues.
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 UNEARNED REVENUES

 The adjusting entry results in a debit

to a liability account and a credit to a
revenue account.
 Examples of unearned revenues
include rent, magazine subscriptions,
airplane tickets, and tuition.

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 ACCRUALS
ACCRUALS

 A different type of adjusting entry is

accruals.
 Adjusting entries for accruals are
required to record revenues earned
and expenses incurred in the current
period.(BUT CASH IS NOT INVOLVED)
 The adjusting entry for accruals will
increase both a balance sheet and an
income statement account.
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 ACCRUED REVENUES

 An asset-revenue account relationship

exists with accrued revenues.
 Prior to adjustment, assets and revenues
are understated.
 The adjusting entry requires a debit to an
asset account and a credit to a revenue
account.
 Examples of accrued revenues include
accounts receivable, rent receivable, and
interest receivable.

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  Unearned revenue
 Advance payment, service is not performed
yet

 Accrued Revenue

Service is performed, cash is not received yet.

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 ACCRUED EXPENSES
EXPENSES
 Accrued expenses are expenses incurred
but not yet paid.
 A liability-expense account relationship
exists.
 Prior to adjustment, liabilities and
expenses are understated.
 The adjusting entry results in a debit to an
expense account and a credit to a liability
account.
 Examples of accrued expenses include
accounts payable, rent payable, salaries
payable, and interest payable.
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 The Need for Adjusting Entries

Adjusting Entries
 Ensure that the revenue recognition and expense
recognition principles are followed.
 Necessary because the trial balance may not contain
up-to-date and complete data.
 Required every time a company prepares financial
statements.
 Will include one income statement account and one
balance sheet account.

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 The Need for Adjusting Entries

Question
Adjusting entries are made to ensure that:
a. expenses are recognized in the period in which
they are incurred.
b. revenues are recorded in the period in which
services are performed.
c. balance sheet and income statement accounts
have correct balances at the end of an accounting
period.
d. all of the above.

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 Types of Adjusting Entries
Illustration 3-2
Categories of adjusting entries

Deferrals Accruals

1. Prepaid Expenses. 1. Accrued Revenues.

Expenses paid in cash before Revenues for services
they are used or consumed. performed but not yet received
in cash or recorded.

2. Unearned Revenues. 2. Accrued Expenses.

Cash received before services Expenses incurred but not yet
are performed. paid in cash or recorded.
The service to be
performed is treated as a
liability

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 Types of Adjusting Entries

Trial Balance – Each account is analyzed to determine

whether it is complete and up-to-date.
Illustration 3-3

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 DO IT! 1 Timing Concepts

A list of concepts is provided in the left column below, with a description of the
concept in the right column below. There are more descriptions provided than
concepts. Match the description of the concept to the concept.

f Accrual-basis accounting.
1. ___ (a) Monthly and quarterly time periods.
e Calendar year. (b) Efforts (expenses) should be matched
2. ___
with results (revenues).
c Time period assumption.
3. ___ (c) Accountants divide the economic life of
4. ___
b Expense recognition a business into artificial time periods.
principle. (d) Companies record revenues when they
receive cash and record expenses
when they pay out cash.
(e) An accounting time period that starts on
January 1 and ends on December 31.
(f) Companies record transactions in the
period in which the events occur.
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 Prepaid Expenses

 Expire either with the passage of time or through use.

 Adjusting entry:
► Increase (debit) to an expense account and
► Decrease (credit) to an asset account.

Illustration 3-4

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  Prepaid Rent----20,000
 Cash----------20,000

 Adjusting entry

 Rent Expense------20,000 (expense has been incurred)

 Prepaid rent (asset) --------20,000 (one month has
passed)

 Prepaid insurance ------50

 Cash----------------------------50

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  Prepaid insurance ------50
 Cash----------------------------50

 Adjusting entry

 Insurance expense (advance payment expire)-------50

 used Prepaid insurance---------50

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 Supplies

Illustration: Pioneer Advertising

purchased supplies (assets) costing
$2,500 on October 5. Pioneer recorded
the payment by increasing (debiting) the
asset Supplies. This account shows a
balance of $2,500 in the October 31 trial
balance. An inventory count at the close
of business on October 31 reveals that
$1,000 of supplies are still on hand.

Oct. 31 Supplies Expense 1,500

Supplies (used) 1,500

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  Supplies purchased $2500 total
 Supplies used $1000

 Adjusting entry – For recording actual

expense

 2500 – 1000 = 1500 – Actual Expense

 Supplies Expense ---1500
 Supplies----------------------------------1500

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 Insurance

Illustration: On October 4, Pioneer

Advertising paid $600 for a one-year fire
insurance policy. Coverage began on October
1. Pioneer recorded the payment by
increasing (debiting) Prepaid Insurance. This
account shows a balance of $600 in the
October 31 trial balance. Insurance of $50
($600 ÷ 12) expires each month.

Oct. 31 Insurance Expense 50

Prepaid Insurance 50

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 Depreciation

 Buildings, equipment, and motor vehicles

(assets that provide service for many years) are
recorded as assets, rather than an expense, on
the date acquired.

 Depreciation is the process of allocating the cost

of an asset to expense over its useful life.

 Depreciation does not attempt to report the actual

change in the value of the asset.

► Allocation concept, not a valuation concept.

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  Contra asset accounts allow users to see how much of
an asset was written off, its remaining useful life, and the
value of the asset.

 Accumulated depreciation is a contra asset account

used to record the amount of depreciation to date on a
fixed asset. Examples of fixed assets include buildings,
machinery, office equipment, furniture, vehicles, etc.
 https://corporatefinanceinstitute.com/resources/kno
wledge/accounting/contra-asset-account/

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 Depreciation
 The basic journal entry for depreciation is to debit the
Depreciation Expense account (which appears in the
income statement) and credit the Accumulated Depreciation
account (which appears in the balance sheet as a
contra account that reduces the amount of fixed assets).
 Over time, the accumulated depreciation balance will
continue to increase as more depreciation is added to it, until
such time as it equals the original cost of the asset. At that
time, stop recording any depreciation expense, since the cost
of the asset has now been reduced to zero.

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 Depreciation

Illustration: For Pioneer Advertising, assume

that depreciation on the equipment is $480 a
year, or $40 per month.

Oct. 31
Depreciation expense 40
Accumulated depreciation 40

Accumulated Depreciation is called

a contra asset account.

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 General Entry For Recording Revenue

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 General Entry for Unearned Revenue
 ABC International hires Western Plowing to plow its parking
lot, and pays $10,000 in advance, so that Western will give
the company first plowing priority throughout the winter
months.
 At the time of payment, Western has not yet earned the
revenue, so it records all $10,000 in an unearned revenue
account, using this unearned revenue journal entry.

 Cash (advance payment received)---------10,000

 Unearned revenue (liability increases) -------------10,000

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 General Entry for Unearned Revenue
 Western expects to be plowing for ABC for a period of
five months, so it chooses to recognize $2,000 of the
unearned revenue per month in each of the five months.
In the first of the five months, Western records the
following unearned revenue journal entry:

Unearned revenue------2000 (liability reduces)
 Plowing revenue-------2000 (revenue earned)

3-40
 Unearned Revenues

Illustration: Pioneer Advertising received

$1,200 on October 2 from R. Knox for
advertising services expected to be
completed by December 31. Unearned
Service Revenue shows a balance of $1,200
in the October 31 trial balance. Analysis
reveals that the company performed $400 of
services in October.

Oct. 31 Unearned Service Revenue 400

Service Revenue 400

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 DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond Company, on March 31, 2017, includes these

selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
An analysis of the accounts shows the following.
1. Insurance expires at the rate of $100 per month.
2. Supplies on hand total $800.
3. The equipment depreciates $200 a month.
4. During March, services were performed for one-half of the unearned
service revenue.
Prepare the adjusting entries for the month of March.

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 DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond Company, on March 31, 2017, includes these

selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.

1. Insurance expires at the rate of $100 per month.

Insurance Expense 100

Prepaid Insurance 100

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 DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond Company, on March 31, 2017, includes these

selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.

2. Supplies on hand total $800.

Supplies Expense 2,000

Supplies 2,000

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 DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond Company, on March 31, 2017, includes these

selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.

3. The equipment depreciates $200 a month.

Depreciation Expense 200

Accumulated Depreciation—Equipment 200

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 DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond Company, on March 31, 2017, includes these

selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.

4. During March, services were performed for one-half of the unearned

service revenue.

Unearned Service Revenue 4,600

Service Revenue 4,600

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 LEARNING
OBJECTIVE
3 Prepare adjusting entries for accruals.

Accruals are made to record

 Revenues for services performed but not yet
recorded at the statement date.
 Expenses incurred but not yet paid or recorded at
the statement date.

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3-48
3-49
 Accrued Revenues

Illustration: In October Pioneer Advertising

performed services worth $200 that were not
billed to clients on or before October 31.

Oct. 31

Accounts Receivable 200

Service Revenue 200

On November 10, Pioneer receives cash of $200 for the services

performed.

Nov. 10 Cash 200

Accounts Receivable 200
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 Accrued Expenses (Not Paid Yet)

ACCRUED INTEREST
Illustration: Pioneer Advertising signed a three-month note
payable in the amount of $5,000 on October 1. The note requires
Pioneer to pay interest at an annual rate of 12%.
Illustration 3-17

Oct. 31 Interest expense 50

Interest payable 50

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 Accrued Expenses

Summary of the accounting for accrued expenses.

Illustration 3-21

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 DO IT! 3 Adjusting Entries for Accruals

Micro Computer Services began operations on August 1, 2017. At the

end of August 2017, management prepares monthly financial
statements. The following information relates to August.
1. At August 31, the company owed its employees $800 in
salaries and wages that will be paid on September 1.
2. On August 1, the company borrowed $30,000 from a local
bank on a 15-year mortgage. The annual interest rate is 10%.
3. Revenue for services performed but unrecorded for August
totaled $1,100.
Prepare the adjusting entries needed at August 31, 2017.

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 DO IT! 3 Adjusting Entries for Accruals

Prepare the adjusting entries needed at August 31, 2017.

1. At August 31, the company owed its employees $800 in
salaries and wages that will be paid on September 1.
Salaries and Wages Expense 800
Salaries and Wages Payable 800

2. On August 1, the company borrowed $30,000 from a local

bank on a 15-year mortgage. The annual interest rate is 10%.
Interest Expense 250
Interest Payable 250

3. Revenue for services performed but unrecorded for August

totaled $1,100.
Accounts Receivable 1,100
Service Revenue 1,100
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  30,000 x 10% x 1/12 = 250 interest per month

3-55
 Class Practice Question

3-56
 Solution

3-57
 LEARNING Describe the nature and purpose of an
4
OBJECTIVE adjusted trial balance.

Adjusted Trial Balance

 Prepared after all adjusting entries are journalized and
posted.

 Purpose is to prove the equality of debit balances and

credit balances in the ledger.

 Is the primary basis for the preparation of financial

statements.

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 Illustration 3-25

3-59 LO 4
 Adjusted Trial Balance

Question
Which of the following statements is incorrect concerning the adjusted
trial balance?
a. An adjusted trial balance proves the equality of the total debit
balances and the total credit balances in the ledger after all
adjustments are made.
b. The adjusted trial balance provides the primary basis for the
preparation of financial statements.
c. The adjusted trial balance lists the account balances segregated
by assets and liabilities.
d. The adjusted trial balance is prepared after the adjusting entries
have been journalized and posted.

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 Preparing Financial Statements

Financial
FinancialStatements
Statementsare
areprepared
prepareddirectly
directlyfrom
fromthe
the
Adjusted
AdjustedTrial
TrialBalance.
Balance.

Owner’s
Income Balance
Equity
Statement Sheet
Statement

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 Illustration 3-26
Preparation of the income statement and owner’s
equity statement from the adjusted trial balance
3-62
 Illustration 3-27
Preparation of the balance sheet from
the adjusted trial balance

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 DO IT! 4 Trial Balance

(a) Determine the net income for the quarter April 1 to June 30.
(b) Determine the total assets and total liabilities at June 30, 2017, for Skolnick Co.
3-64 (c) Determine the amount of owner’s capital at June 30, 2017. LO 4
 DO IT! 4 Trial Balance

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 DO IT! 4 Trial Balance

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 DO IT! 4 Trial Balance

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  During the first month of operation, W Company had the following
transactions;
 a) Issued capital stock for $16,000.(Cash 16000
 Capital 16000)
 b) Paid rent on office building for the month, $3,000.
 c) Purchased supplies on account, $1,200.
 d) Paid creditor on account, $800.
 e) Earned sales commissions and sent invoices to customers,
$22,500.
 f) Paid automobile expenses for month, $2,900, and miscellaneous
 expenses, $1,450.
 g) Paid office salaries, $4,200.
 h) Determined the cost of supplies used was $960.
 Supplies expense 960
 Supplies 960
 i) Paid cash dividends, $1,400.

 POST JOURNAL ENTRIES FOR ALL ABOVE TRANSACTIONS

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  a) Journalize the transactions
 b) Prepare T-accounts and post the entries to
the appropriate accounts. Determine balances
after all entries are posted.

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 solution

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