Chapter 3 AKD

Slide
3-1
Chapter 3
Adjusting the
Accounts
Financial Accounting, IFRS Edition
Weygandt Kimmel Kieso
Slide
3-2
Study Objectives
1. Explain the time period assumption.
2. Explain the accrual basis of accounting.
3. Explain the reasons for adjusting entries.
4. Identify the major types of adjusting entries.
5. Prepare adjusting entries for deferrals.
6. Prepare adjusting entries for accruals.
7. Describe the nature and purpose of an adjusted trial

balance.
Slide
3-3
Adjusting the Accounts
The Adjusted Trial

The Basics of
Timing Issues Balance and
Adjusting Entries
Financial Statements
Fiscal and calendar Types of adjusting Preparing the

years entries adjusted trial balance
Accrual- vs. cash- Adjusting entries for Preparing financial
basis accounting deferrals statements
Recognizing Adjusting entries for
revenues and accruals
expenses Summary of
journalizing and
posting
Slide
3-4
Timing Issues
Accountants divide the economic life of a business into

artificial time periods (Time Period Assumption).
.....
Jan. Feb. Mar. Apr. Dec.
Generally a month, a quarter, or a year

Fiscal year vs. calendar year
Also known as the “Periodicity Assumption”
Slide
3-5 SO 1 Explain the time period assumption.
Timing Issues
Review
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.
Slide Solution on
3-6 notes page SO 1 Explain the time period assumption.
Timing 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

when paid.
Slide
3-7
SO 2 Explain the accrual basis of accounting.
Timing Issues
Accrual- vs. Cash-Basis Accounting

Cash-Basis Accounting
Revenues are recognized when cash is received.
Expenses are recognized when cash is paid.
Cash-basis accounting is not in accordance with

International Financial Reporting Standards (IFRS).
Slide
3-8 SO 2 Explain the accrual basis of accounting.
Timing Issues
Recognizing Revenues and Expenses

Revenue Recognition Principle
Companies recognize
revenue in the accounting
period in which it is earned.
In a service enterprise,
revenue is considered to be
earned at the time the service
is performed.
Slide
Timing Issues
Recognizing Revenues and Expenses

Expense Recognition Principle – (Matching Principle)
Match expenses with
revenues in the period when
the company makes efforts to
generate those revenues.
“Let the expenses follow

the revenues.”
Slide
Timing Issues
IFRS relationships in Illustration 3-1
revenue and expense

recognition
Slide
Answer on
Slide
notes page SO 2
3-12
Timing Issues
Match the description of the concept to the

concept.
g
f
c
b
Slide Solution on
3-13 notes page SO 2 Explain the accrual basis of accounting.
Timing Issues
Review
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 it is
earned.
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.
Slide Solution on
3-14 notes page SO 2 Explain the accrual basis of accounting.
The Basics of Adjusting Entries
Adjusting entries make it possible to report correct

amounts on the statement of financial position
and on the income statement.
A company must make adjusting entries every time

it prepares financial statements.
Slide
3-15 SO 3 Explain the reasons for adjusting entries.
Revenues - recorded in the period in which they are

earned.
earned
Expenses - recognized in the period in which they

are incurred.
incurred
Adjusting entries - needed to ensure that the

revenue recognition and expense recognition are
followed.
Slide
3-16 SO 3 Explain the reasons for adjusting entries.
Review
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
they are earned.
c. statement of financial position and income
statement accounts have correct balances at
the end of an accounting period.
d. all of the above.
Slide Solution on
3-17 notes page SO 3 Explain the reasons for adjusting entries.
Types of Adjusting Entries
Types of Adjusting Entries Illustration 3-2

Categories of adjusting entries
Deferrals Accruals
1. Prepaid Expenses. 3. Accrued Revenues.
Expenses paid in cash and Revenues earned but not yet
recorded as assets before received in cash or
they are used or consumed. recorded.
2. Unearned Revenues. 4. Accrued Expenses.

Revenues received in cash Expenses incurred but not
and recorded as liabilities yet paid in cash or recorded.
before they are earned.
Slide
3-18 SO 4 Identify the major types of adjusting entries.
Illustration 3-3
Trial Balance –
Illustrations are
based on the
October 31, trial
balance of
Pioneer
Advertising
Agency Inc.
Slide
3-19 SO 4 Identify the major types of adjusting entries.
Adjusting Entries for Deferrals

Deferrals are either:
Prepaid expenses
OR
Unearned revenues.
Slide
3-20 SO 5 Prepare adjusting entries for deferrals.
Adjusting Entries for “Prepaid Expenses”
Payment of cash that is recorded as an asset because

service or benefit will be received in the future.
Cash Payment BEFORE Expense Recorded
Prepayments often occur in regard to:

insurance rent
supplies maintenance on equipment
advertising fixed assets (depreciation)
Slide
Prepaid Expenses
Costs that expire either with the passage of time or
through use.
Adjusting entries (1) to record the expenses that apply

to the current accounting period, and (2) to show the
unexpired costs in the asset accounts.
Slide
Adjusting entries for prepaid expenses

Illustration 3-4
Increases (debits) an expense account and

Decreases (credits) an asset account.
Slide
Illustration: Pioneer Advertising Agency purchased advertising
supplies costing $2,500 on October 5. Pioneer recorded the
payment by increasing (debiting) the asset Advertising 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 Advertising supplies expense 1,500

Advertising supplies 1,500
Illustration 3-5
Slide
Illustration: On October 4, Pioneer Advertising Agency 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
Illustration 3-6
Slide
Depreciation
Buildings, equipment, and vehicles (long-lived assets)
are recorded as assets, rather than an expense, in the
year acquired.
Companies report a portion of the cost of a long-lived

asset as an expense (depreciation) during each period
of the asset’s useful life.
Slide
Illustration: Pioneer Advertising estimates depreciation on the
office equipment to be $480 a year, or $40 per month.
Oct. 31 Depreciation expense 40

Accumulated depreciation 40
Illustration 3-7
Slide
Depreciation (Statement Presentation)

Accumulated Depreciation is a contra asset account.
Appears just after the account it offsets (Equipment) on
the statement of financial position.
Illustration 3-8
Slide
Summary Illustration 3-9
Slide
Adjusting Entries for “Unearned Revenues”
Receipt of cash that is recorded as a liability because the

revenue has not been earned.
Cash Receipt BEFORE Revenue Recorded
Unearned revenues often occur in regard to:

rent magazine subscriptions
airline tickets customer deposits
school tuition
Slide
Unearned Revenues
Company makes an adjusting entry to record the revenue
that has been earned and to show the liability that remains.
The adjusting entry for unearned revenues results in a
 decrease (a debit) to a liability account and an
 increase (a credit) to a revenue account.
Slide
Adjusting entries for unearned revenues

Illustration 3-10
Decrease (a debit) to a liability account and

Increase (a credit) to a revenue account.
Slide
Illustration: Pioneer Advertising Agency 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 earned $400 of those fees in October.
Oct. 31 Unearned service revenue 400

Service revenue 400
Illustration 3-11
Slide
Summary
Illustration 3-12
Slide
Answer on
Slide
notes page SO 5
3-35
Adjusting Entries for Accruals

Made to record:
Revenues earned and
OR
Expenses incurred
in the current accounting period that have not been

recognized through daily entries.
Slide
3-36 SO 6 Prepare adjusting entries for accruals.
Adjusting Entries for “Accrued Revenues”
Revenues earned but not yet received in cash or

recorded.
Adjusting entry results in:
Revenue Recorded BEFORE Cash Receipt
Accrued revenues often occur in regard to:

rent
interest
services performed
Slide
Accrued Revenues
An adjusting entry serves two purposes:
(1) It shows the receivable that exists, and
(2) It records the revenues earned.
Slide
Adjusting entries for accrued revenues

Illustration 3-13
Increases (debits) an asset account and

Increases (credits) a revenue account.
Slide
Illustration: In October Pioneer Advertising Agency earned

$200 for advertising services that had not been recorded.
Oct. 31 Accounts Receivable 200

Service Revenue 200
Illustration 3-14
Slide
Summary
Illustration 3-15
Slide
Adjusting Entries for “Accrued Expenses”
Expenses incurred but not yet paid in cash or recorded.
Adjusting entry results in:
Expense Recorded BEFORE Cash Payment
Accrued expenses often occur in regard to:

rent taxes
interest salaries
Slide
Accrued Expenses
An adjusting entry serves two purposes:
(1) It records the obligations, and
(2) It recognizes the expenses.
Slide
Adjusting entries for accrued expenses

Illustration 3-16
Increases (debits) an expense account and

Increases (credits) a liability account.
Slide
Illustration: Pioneer Advertising Agency 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
Illustration 3-18
Slide
Illustration: Pioneer Advertising Agency last paid salaries on
October 26; the next payment of salaries will not occur until
November 9. The employees receive total salaries of $2,000 for a
five-day work week, or $400 per day. Thus, accrued salaries at
October 31 are $1,200 ($400 x 3 days).
Illustration 3-19
Slide
Illustration: Pioneer Advertising Agency last paid salaries on
October 26; the next payment of salaries will not occur until
November 9. The employees receive total salaries of $2,000 for a
five-day work week, or $400 per day. Thus, accrued salaries at
October 31 are $1,200 ($400 x 3 days).
Oct. 31 Salaries expense 1,200

Salaries payable 1,200
Illustration 3-20
Slide
Summary
Illustration 3-21
Slide
The Adjusted Trial Balance
After all adjusting entries are journalized and posted the

company prepares another trial balance from the ledger
accounts (Adjusted Trial Balance).
Its purpose is to prove the equality of debit balances and

credit balances in the ledger.
Slide
3-49 SO 7 Describe the nature and purpose of an adjusted trial balance.
Illustration 3-24
Adjusted trial balance
Slide
3-50 SO 7
Review 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.
Slide
Preparing Financial Statements
Financial Statements are prepared directly from the

Adjusted Trial Balance.
Statement Retained
Income
of Financial Earnings
Statement
Position Statement
Slide
Illustration 3-25
Preparation of
the income
statement and
retained earnings
statement from
the adjusted trial
balance
Slide
3-53 SO 7
Illustration 3-26
Slide
3-54 SO 7
Understanding U.S. GAAP
Key Differences Adjusting the Accounts

Like IFRS, companies applying GAAP use accrual-basis
accounting to ensure that they record transactions that change a
company’s financial statements in the period in which events
occur.
Similar to IFRS, cash-basis accounting is not in accordance with
GAAP.
GAAP also divides the economic life of companies into artificial
time periods. Under both GAAP and IFRS, this is referred to as the
time period assumption. GAAP requires that companies present a
complete set of financial statements, including comparative
information annually.
Slide
3-55

GAAP has more than 100 rules dealing with revenue recognition.
Many of these rules are industry-specific. Revenue recognition
under IFRS is determined primarily by a single standard, IAS 18.
Despite this large disparity in the detailed guidance devoted to
revenue recognition, the general revenue recognition principles
required by IFRS that are used in this textbook are similar to those
under GAAP.
GAAP uses concepts such as realized, realizable, and earned as a
basis for revenue recognition.
Slide
3-56

Internal controls are a system of checks and balances designed to
detect and prevent fraud and errors. The Sarbanes-Oxley Act
requires U.S. companies to enhance their systems of internal
control. However, many foreign companies do not have this
requirement.
Under IFRS, revaluation to fair value of items such as land and
buildings is permitted. This is not permitted under GAAP.
The form and content of financial statements are very similar under
GAAP and IFRS. Any significant differences will be discussed in
those chapters that address specific financial statements.
Slide
3-57
Looking to the Future Adjusting the Accounts

The IASB and FASB are now involved in a joint project on revenue
recognition. Presently, the Boards are considering an approach
that focuses on changes in assets and liabilities (rather than on
“when earned”) as the basis for revenue recognition. It is hoped
that this approach will lead to more consistent accounting in this
area. The IASB and the FASB also face a difficult task in attempting
to update, modify, and complete a converged conceptual
framework. For example, how do companies choose between
information that is highly relevant but difficult to verify versus
information that is less relevant but easy to verify? Should a single
measurement method, such as historical cost or fair value, be
used, or does it depend on whether it is an asset or liability that is
Slide
being measured?
3-58
Alternative Treatment of Prepaid Expenses
and Unearned Revenues
APPENDIX
Some companies use an alternative treatment for
prepaid expenses and unearned revenues.
When a company prepays an expense, it debits that

amount to an expense account.
When a company receives payment for future services,

it credits the amount to a revenue account.
Slide
3-59 SO 8 Prepare adjusting entries for the alternative treatment of deferrals.
Alternative Treatment for “Prepaid Expenses”
Illustration: Pioneer Advertising purchased supplies on

October 5 for $2,500 and debited Advertising
Supplies Expense for the full amount. What if an inventory
of $1,000 of advertising supplies remains on October 31?
Oct. 31 Advertising supplies 1,000

Advertising supplies expense 1,000
Illustration 3A-1
Slide
Alternative Treatment for “Prepaid Expenses”
Adjustment approaches—a comparison

Illustration 3A-2
Slide
Alternative Treatment for “Unearned Revenues”
Illustration: Assume that Pioneer Advertising received $1,200

for future services on October 2 and credited the entire amount
to Service Revenue. If at the statement date Pioneer has not
performed $800 of the services, it would make an adjusting
entry.
Oct. 31 Service revenue 800

Unearned service revenue 800
Illustration 3A-4
Slide
Alternative Treatment for “Unearned Revenues”
Adjustment approaches—a comparison

Illustration 3A-5
Slide
Summary of Additional Adjustment Relationships
Illustration 3A-7
Slide
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3-65

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Slide

1. Explain the time period assumption.

2. Explain the accrual basis of accounting.

3. Explain the reasons for adjusting entries.

4. Identify the major types of adjusting entries.

5. Prepare adjusting entries for deferrals.

6. Prepare adjusting entries for accruals.

7. Describe the nature and purpose of an adjusted trial

The Adjusted Trial

Fiscal and calendar Types of adjusting Preparing the

Accountants divide the economic life of a business into

Generally a month, a quarter, or a year

Accrual- vs. Cash-Basis Accounting

Revenues are recognized when earned, rather than

Expenses are recognized when incurred, rather than

Accrual- vs. Cash-Basis Accounting

Expenses are recognized when cash is paid.

Cash-basis accounting is not in accordance with

Recognizing Revenues and Expenses

Recognizing Revenues and Expenses

“Let the expenses follow

IFRS relationships in Illustration 3-1

revenue and expense

Match the description of the concept to the

Adjusting entries make it possible to report correct

A company must make adjusting entries every time

Revenues - recorded in the period in which they are

Expenses - recognized in the period in which they

Adjusting entries - needed to ensure that the

Types of Adjusting Entries Illustration 3-2

2. Unearned Revenues. 4. Accrued Expenses.

Adjusting Entries for Deferrals

Payment of cash that is recorded as an asset because

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

Adjusting entries (1) to record the expenses that apply

Adjusting entries for prepaid expenses

Increases (debits) an expense account and

Oct. 31 Advertising supplies expense 1,500

Companies report a portion of the cost of a long-lived

Oct. 31 Depreciation expense 40

Depreciation (Statement Presentation)

Summary Illustration 3-9

Receipt of cash that is recorded as a liability because the

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

The adjusting entry for unearned revenues results in a

 decrease (a debit) to a liability account and an

 increase (a credit) to a revenue account.

Adjusting entries for unearned revenues

Decrease (a debit) to a liability account and

Oct. 31 Unearned service revenue 400

Adjusting Entries for Accruals

Revenues earned and

in the current accounting period that have not been

Revenues earned but not yet received in cash or

Adjusting entry results in:

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

(1) It shows the receivable that exists, and

(2) It records the revenues earned.

Adjusting entries for accrued revenues

Increases (debits) an asset account and

Illustration: In October Pioneer Advertising Agency earned