Accounting Principles

Twelfth Edition
Weygandt ● Kimmel ● Kieso

Lecture 3
Adjusting the Accounts
Chapter 3
Chapter Outline
Learning Objectives
LO 1 Explain the accrual basis of accounting and the reasons
for adjusting entries.
LO 2 Prepare adjusting entries for deferrals.
LO 3 Prepare adjusting entries for accruals.
LO 4 Describe the nature and purpose of an adjusted trial
balance.

2
Accrual-Basis and Adjusting Entries

LEARNING OBJECTIVE 1
Explain the accrual basis of accounting and the reasons for
adjusting entries.
Accountants divide the economic life of a business into
artificial time periods (Time Period Assumption).

Generally a
• month, Alternative terminology
The time period assumption is
• quarter, or
also called the periodicity
• year. assumption.
LO 1 3
Fiscal and Calendar Years (1 of 5)
• 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
• Calendar Year = January 1 to December 31

LO 1 4
Accrual- versus Cash-Basis Accounting (1
of 2)
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)

LO 1 5
Accrual- versus Cash-Basis Accounting (2
of 2)
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)

LO 1 6
Recognizing Revenues and Expenses (1 of 3)

Revenue Recognition Principle

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

LO 1 7
Recognizing Revenues and Expenses (2 of 3)

Expense Recognition Principle

Companies recognize expenses
in the period in which they
make efforts (consume assets
or incur liabilities) to generate
revenue.
“Let the expenses follow
the revenues.”

LO 1 8
Recognizing Revenues and Expenses (3 of 3)

LO 1 9
The Need for Adjusting Entries (1 of 3)
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.

LO 1 10
Types of Adjusting Entries
Deferrals
1. Prepaid Expenses. Expenses
paid in cash before they are
used or consumed.
2. Unearned Revenues. Cash
received before services are
performed.
LO 1
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.
11
Adjusting Entries for Deferrals

LEARNING OBJECTIVE 2
Prepare adjusting entries for deferrals.

Deferrals are expenses or revenues that are recognized

at a date later than the point when cash was originally
exchanged. There are two types:
• Prepaid expenses
• Unearned revenues

LO 2 12
Prepaid Expenses (1 of 5)
Payments of expenses that are recorded as an asset to show
the service or benefit the company will receive in the future.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

• insurance
• advertising
• rent

LO 2 13
Supplies (1 of 2)
Illustration: Pioneer Advertising purchased
supplies 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 1,500

LO 2 14
Supplies (2 of 2)

LO 2 15
Insurance (1 of 2)
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

LO 2 16
Insurance (2 of 2)

LO 2 17
Depreciation (1 of 4)
• 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.
o Allocation concept, not a valuation concept

LO 2 18
Depreciation (2 of 4)
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.

LO 2 19
Depreciation (3 of 4)

LO 2 20
Depreciation (4 of 4)
Statement Presentation
• Accumulated Depreciation is a contra asset account (credit)
• Offsets related asset account on the balance sheet
• Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation
Equipment $5,000
Less: Accumulated depreciation—equipment 40
$4,960

$4, 960

LO 2 21
Prepaid Expenses (4 of 5)
Accounting for Prepaid Expenses
Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Insurance, Prepaid expense Assets Dr. Expenses
supplies, originally overstated. Cr. Assets or
advertising, rent, recorded Expenses Contra Assets
Depreciation in asset accounts understated.
have been used.

LO 2 22
Unearned Revenues (1 of 6)
Receipt of cash that is recorded as a liability because the
service has not been performed.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

• Rent • Magazine subscriptions
• Airline tickets • Customer deposits

LO 2 23
Unearned Revenues (3 of 6)
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

LO 2 24
Unearned Revenues (4 of 6)

LO 2 25
Unearned Revenues (5 of 6)
Accounting for Unearned Revenue
Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Rent, magazine Unearned revenues Liabilities Dr. Liabilities
subscriptions, recorded in liability overstated. Cr. Revenues
customer deposits accounts are now Revenues
for future service recognized as understated.
revenue for services
performed.

LO 2 26
Do It! 1: Adjusting Entries for Deferrals (1 of 5)

The ledger of Hammond Company, on March 31, 2020, 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 $4,000 of the unearned service revenue reported.
Prepare the adjusting entries for the month of March.

LO 2 27
Do It! 1: Adjusting Entries for Deferrals (2 of 5)

The ledger of Hammond Company, on March 31, 2020, 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

LO 2 28
Do It! 1: Adjusting Entries for Deferrals (3 of 5)

The ledger of Hammond Company, on March 31, 2020, 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 ($2,800 - $800) 2,000

Supplies 2,000

LO 2 29
Do It! 1: Adjusting Entries for Deferrals (4 of 5)

The ledger of Hammond Company, on March 31, 2020, 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

LO 2 30
Do It! 1: Adjusting Entries for Deferrals (5 of 5)

The ledger of Hammond Company, on March 31, 2020, 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 $4,000 of the unearned service revenue reported.

Unearned Service Revenue 4,000

Service Revenue 4,000

LO 2 31
Adjusting Entries for Accruals

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

LO 3 32
Accrued Revenues (1 of 5)
Revenues for services performed but not yet received in cash
or recorded.

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

• Rent
• Interest
• Services

LO 3 33
Accrued Revenues (3 of 5)
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. The journal entry on the 10th is:
Cash 200
Accounts Receivable 200
LO 3 34
Accrued Revenues (4 of 5)

LO 3 35
Accrued Revenues (5 of 5)
Accounting for Accrued Revenues
Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Interest, Services performed Assets Dr. Assets
rent, services but not yet received understated. Cr. Revenues
in cash or recorded. Revenues
understated.

LO 3 36
Accrued Expenses (1 of 7)
Expenses incurred but not yet paid in cash or recorded.

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

• Rent • Taxes
• Interest • Salaries

LO 3 37
Accrued Expenses (3 of 7)
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%.

Face Value Annual Time in Terms

of Note × Interest Rate × of One Year = Interest
$5,000 × 12% × 1 over
1 12 = $50
12

Oct. 31 Interest Expense 50

Interest Payable 50

LO 3 38
Accrued Expenses (4 of 7)

LO 3 39
Accrued Expenses (5 of 7)
Accrued Salaries and Wages
Illustration: Pioneer Advertising paid salaries and wages 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.

LO 3 40
Accrued Expenses (6 of 7)

LO 3 41
Accrued Expenses (7 of 7)
Accounting for Accrued Revenues
Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Interest, Expenses have Expenses Dr. Expenses
rent, salaries been incurred but understated. Cr. Liabilities
not yet paid in Liabilities
cash or recorded. understated.

LO 3 42
Summary of Basic Relationships
Accounts Before
Type of Adjustment Adjustment Adjusting Entry
Prepaid expenses Assets overstated. Dr. Expense
Expenses understated. Cr. Assets or Contra
Assets
Unearned revenues Liabilities overstated. Dr. Liabilities
Revenues understated. Cr. Revenues
Accrued revenues Assets understated. Dr. Assets
Revenues understated. Cr. Revenues
Accrued expenses Expenses understated. Dr. Expenses
Liabilities understated. Cr. Liabilities

LO 3 43
Do It! 2: Adjusting Entries Accruals (1 of 3)

Micro Computer Services began operations on August 1, 2020. At

the end of August 2020, 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, 2020.

LO 3 44
Do It! 2: Adjusting Entries Accruals (2 of 3)

Prepare the adjusting entries needed at August 31, 2020.

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 ($30,000 .10 x 1/12) 250
Interest Payable 250

LO 3 45
Do It! 2: Adjusting Entries Accruals (3 of 3)
Prepare the adjusting entries needed at August 31, 2020.
3. Revenue for services performed but unrecorded for August
totaled $1,100.
Accounts Receivable 1,100
Service Revenue 1,100

LO 3 46
Adjusted Trial Balance

LEARNING OBJECTIVE 4
Describe the nature and purpose of an adjusted trial
balance.
• Prepared after adjusting entries are journalized and
posted
• Proves equality of debit and credit balances
• Basis for the preparation of financial statements

LO 4 47
Adjusted Trial Balance (1 of 3)

LO 4 48
Preparing Financial Statements (1 of 3)

LO 4 49
Preparing Financial Statements (2 of 3)

LO 4 50
Preparing Financial Statements (3 of 3)

LO 4 51
Practice Exercises

52
Solution

53
54
55
56
E 3-5 Continue….

57
E 3-5 Solution…..

1. Interest Expense 300

Interest Payable 300
(10,000X9%) X 4/12

2. Supplies Expense 1550

Supplies 1550
(2450 – 900)

3. Depreciation Expenses 1000

Accumulated Dep Expenses 1000

58
E 3-5 Solution…..
4. Insurance Expense 1225
Prepaid Insurance 1225
(2100X7/12)

5. Unearned Consulting Services 8000

Consulting Services 8000
(320000/4 = 8000)

6. Accounts Receivable 4200

Consulting services 4200

7. Salary Expense 5400

Salary Payable 5400
(9000 X 3/5 = 5400)

59
60
E 3-9 Solution…..

1. Advertising Supplies Expense 2000

Advertising supplies 2000
(2500 – 500)

2. Insurance Expense 120

Prepaid Insurance 120

3. Depreciation Expenses 50
Accumulated Depreciation 50

61
E 3-9 Solution…..

4. Unearned Service Revenue 600

Service Revenue 600
(1200 – 600)

5. Accounts Receivable 360

Service Revenue 360

6. Interest Expense 95
Interest payable 95

7. Salary Expense 1625

Salary Payable 1625

62
 Some Important concepts in
Accounting

LO 6 63
LO 6 64
Financial Reporting Concepts (1 of 2)

Qualities of Useful Information

Two fundamental qualities
1. Relevance
• Make a difference in a business decision
• Provides information that has predictive value and
confirmatory value
• Materiality is a company-specific aspect of relevance
o An item is material when its size makes it likely to influence
the decision of an investor or creditor

LO 6 65
Financial Reporting Concepts (2 of 2)

Two fundamental qualities

2. Faithful Representation
• Information accurately depicts what really happened.
• Information must be
o complete (nothing important has been omitted)
o neutral (is not biased toward one position or another)
o free from error.

LO 6 66
Qualities of Useful Information
Enhancing Qualities
Comparability Information is verifiable Information has
results when if independent the quality of
different companies observers, using the understandability
use the same same methods, obtain if it is presented in
accounting similar results. a clear and concise
principles. fashion.

Consistency means that a For accounting

company uses the same information to have
accounting principles and relevance, it must be
methods from year to timely.
year.
LO 6 67
Accounting Assumptions, Principles & Conventions

LO 6 68
Assumptions in Financial Reporting (1 of 3)

LO 6 69
Assumptions in Financial Reporting (2 of 3)

LO 6 70
Principles in Financial Reporting (3 of 3)
Measurement Principles
Historical Cost Fair Value
Or cost principle, Indicates that assets
dictates that and liabilities should
companies be reported at fair
record assets at value (the price
their cost. received to sell an
asset or settle a
liability).

LO 6 71
Principles of Financial Reporting
Revenue Expense Full
Recognition Recognition Disclosure
Principle Principle Principle
Requires that Dictates that efforts Requires that
companies (expenses) be companies
recognize revenue matched with results disclose all
in the accounting (revenues). Thus, circumstances and
period in which the expenses follow events that would
performance revenues. make a difference
obligation is to financial
satisfied. statement users.

LO 6 72