BUS 211 – Chapter 3 – continued..

Accrual Accounting and

the Adjustment Process..
( continued..)
BUS 211 – Chapter 3-- Accrual Accounting and the adjustment process

Why do we need to adjust the accounts ?

We have to prepare the financial statements at end of period,
o The accounting period ends on a particular day, however..
o Some transactions span this cutoff point and affect more than
one accounting period; and therefore..
o In order to capture the Revenue and Expense effects of those
transactions in the current period, accrual accounting requires the
use of :
adjusting entries
BUS 211 – Accrual Accounting and the adjustement process

There are four types of such transactions which require adjustments

at the end of an accounting period :

1 2 3 4
Deferred Deferred Accrued Accrued
Expenses Revenues Expenses Revenues
Expense has been Revenue has been
Cash is paid Cash is received
incurred earned

? ? ? ?
however not recorded However not recorded
however expense however revenue because cash hasn’t been
because cash hasn’t
is not incurred is not earned been paid received
BUS 211 – Accrual Accounting and the adjustement process

• We will now look at Miller Design Studio’s trial balance. Some of the
accounts do not show their correct balances and must be adjusted.
Miller Design Studio
Unadjusted Trial Balance
July 31, 2011 Dr Cr
BUS 211 – Accrual Accounting and the adjustement process- Type 1
• Type 1 adjustment – Deferred Expenses
When companies make expenditures that benefit
more than one accounting period.
o These costs are initially debited to an asset
account.
o The asset represents the deferral of the
expense
o At the end of the accounting period, the
amount of the asset that has been
«used» is transferred from the asset
account to an expense account.
• Prepaid expenses are costs that companies
pay in advance, such as prepaid rent,
supplies, and prepaid insurance
BUS 211 – Accrual Accounting and the adjustement process- Type 1
Transaction – Prepaid Rent
• Miller Design Studio paid two months' rent in advance ( $ 3,200 )
at the beginning of July. The advance payment resulted in an asset
—the right to occupy the office for two months. As each day in
the month passed, part of the asset's cost expired and became an
expense. By July 31, one-half of the asset's cost ($1,600) had
expired.
Analysis:
Journal entry to record the expiration of prepaid rent :
• decreases the asset account Prepaid Rent with a credit
• increases the expense account Rent Expense with a debit

Miller
Miller Design
Design Studio
Unadjusted Trial Balance
July 31, 2011

Comment The Prepaid Rent account now has a balance of

$1,600, which represents one month's rent that will be
expensed during August.
BUS 211 – Accrual Accounting and the adjustement process- Type 1
Transaction - Supplies
Miller Design Studio purchased $5,200 of office supplies in
early July. At the end of July, an inven­tory shows that office
supplies costing $3,660 are still on hand. This means that of
the $5,200 of supplies originally purchased, $1,540 worth were
used (became an expense) by July 31.
Analysis :
The journal entry to record the consumption of office supplies
• decreases the asset account Office Supplies with a credit
• increases the expense account Office Supplies Expense
with a debit
Miller Design Studio
Unadjusted Trial Balance
July 31, 2011

Comment :
The asset account Office Supplies now reflects the
correct balance of $3,660 of supplies yet to be
consumed.
BUS 211 – Accrual Accounting and the adjustement process- Type 1

Transaction – Long lived assets-

Depreciation

• When a company buys a long-term asset—

such as a building, truck, computer, or
machinery—it is, in effect, paying for the
usefulness of that asset for as long as it
benefits the company.
• We must allocate the cost of the asset over
its (estimated useful) life.
o The amount of cost allocated to any one
accounting period is called depreciation.
o There are a number of methods for
estimating depreciation.
BUS 211 – Accrual Accounting and the adjustement process- Type 1
In July, Miller Design Studio purchased an Office Equipment
for $ 16,320.
To calculate depreciation expense : On July 31, Miller Design Studio will
first we determine an estimated useful life ! record $300 of depreciation expense
of office equipment.
Calculation of Depreciation Expense:
Cost $ 16,320
Estimated Useful Life 54 months
Depreciation exp. per month = $ 300

Miller Design Studio

Unadjusted Trial Balance

Adjusting Entry ?
July 31, 2011
 BUS 211 – Accrual Accounting and the adjustement process- Type 1
To maintain historical costs, Accumulated Depreciation
accounts are used to accumulate the depreciation on each
long-term asset.

These accounts are called contra accounts. A contra

account is paired with a related account (for example, an
asset account).

The journal entry to record depreciation :

• increases the contra account Accumulated
Depreciation—Office Equipment with a credit
• increases the expense account Depreciation
Expense—Office Equipment with a debit
 BUS 211 – Accrual Accounting and the adjustement process- Type 1

The balance of a contra account is shown on the Balance

Sheet as a deduction from its related account.
The net amount is called the carrying value (or book value)
of the asset.

The carrying value of the Office Equipment as of July 31, is:

$16,020 ($16,320 — $300) and is presented on the balance
sheet as follows :
BUS 211 – Accrual Accounting and the adjustement process

Let’s continue with type 2, 3 and 4

adjusting entries..
BUS 211 – Accrual Accounting and the adjustement process

There are four types of such transactions which require adjustments

at the end of an accounting period :

1 2 3 4
Deferred Accrued Deferred Accrued
Expenses Expenses Revenues Revenues
Expense has been Cash is received Revenue has been
Cash is paid incurred earned

? ? ? ?
however not recorded However not recorded
however expense because cash hasn’t
however revenue because cash hasn’t been
is not incurred been paid is not earned received
BUS 211 – Accrual Accounting and the adjustement process- Type 2
Type 2 adjustment – Accrued Expenses
• Some expenses are incurred during the
current period but have not been recorded
because cash will be paid in a future
accounting period. These expenses require
adjusting entries at the end of the period, to
record the expense which has been
incured but not recorded !
• Examples include:
o Interest on borrowed money
o Wages (salaries)
o Utilities, etc..
• These expenses are called accrued
expenses because, as the expense and the
corresponding liability accumulate, they are
said to have accrued.
BUS 211 – Accrual Accounting and the adjustement process- Type 2

End of period 1

Period 1 Period 2

incur expense pay cash

Adjusting entry at period end

when cash is paid entry will be:

…Expense (E+) xx Accounts Payable(L-) xx

Accounts Payable(L+) xx Cash (A-) xx

Expense is recognized before cash is paid, when incured ! (when the service has been used / consumed)
BUS 211 – Accrual Accounting and the adjustement process- Type 2
Transaction : Suppose Miller has two pay periods a month. In July its pay periods end on the 12th and the 26th,
as indicated in the calendar below. Miller Design Studio

July Unadjusted Trial Balance

July 31, 2011

By the end of business on July 31, Miller’s employees will have worked three days (Mon­day, Tuesday, and
Wednesday) after the last pay period. The employee has earned the wages for those days but will not be paid until
the first payday in August. The wages for these three days are an expense for July, and the liabilities should
reflect that the company owes the assistant for those days.
Suppose the assistant's wage rate is $240 per day, the expense is $720 ($240 × 3 days). On July 31, Miller
would record the $720 accrual of unrecorded wages
BUS 211 – Accrual Accounting and the adjustement process- Type 2
This adjusting entry to record the accrual of .

wages
• increases the owner’s equity account
Wages Expense with a debit
• increases the liability account Wages
Payable with a credit

• Note that the increase in Wages Expense

will decrease owner's equity and that total
wages for the month are $5,520, of which
$720 will be paid next month.
BUS 211 – Accrual Accounting and the adjustement process- Type 2

• Other examples for «accrued expenses» are :

-- Interest expense on borrowed money

-- Commissions expense
-- Tax expense
-- Utilities expense
-- etc..
BUS 211 – Accrual Accounting and the adjustement process

There are four types of such transactions which require adjustments

at the end of an accounting period :

1 2 3 4
Deferred Accrued Deferred Accrued
Expenses Expenses Revenues Revenues
Expense has been Revenue has been
Cash is paid Cash is received
incurred earned

? ? ? ?
however not recorded However not recorded
however expense because cash hasn’t
however revenue because cash hasn’t been
is not incurred been paid is not earned received
BUS 211 – Accrual Accounting and the adjustement process- Type 3
Type 3 adjustment- Deferred Revenues
• When a company receives cash for revenues
in advance, it has an obligation to deliver
goods or perform services. These unearned
revenues are shown in a liability account.
This liability represents the deferral of the
revenue
o As a company delivers part of the goods or
performs part of the services, it earns a
part of the advance receipts.
o At period end, the earned portion must
be transferred from the liability account to a
revenue account.
BUS 211 – Accrual Accounting and the adjustement process- Type 3

End of period 1
Period 1 Period 2

Receive cash Service performed during period

Entry for cash receipt:

Cash(A+) xx
Unearned Revenue(L+) xx

Adjusting entry at period end

Unearned Revenue (L-) xx

Service Revenue(A-) xx
Revenue is recognized after the service has been performed, when earned
BUS 211 – Accrual Accounting and the adjustement process- Type 3
Transaction—
During July, Miller Design Studio received $1,400 from a client
as advance payment for a series of design work. By the end of
the month, it had completed $800 of the work. On July 31,
Miller would record the performance of services for which $800
cash was received in advance.
Analysis The journal entry to record performing services for
which cash was received in advance
• increases the owner's equity account Design Revenue with
a credit
• decreases the liability account Unearned Design Revenue
with a debit
Miller Design Studio
Unadjusted Trial Balance
July 31, 2011

Unearned Design Revenue now reflects the amount of work

still to be per­formed, $600.
BUS 211 – Accrual Accounting and the adjustement process

There are four types of such transactions which require adjustments

at the end of an accounting period :

1 3 2 4
Deferred Deferred Accrued Accrued
Expenses Revenues Expenses Revenues
Expense has been Revenue has been
Cash is paid Cash is received
incurred earned

? ? ? ?
however not recorded However not recorded
however expense however revenue because cash hasn’t been
because cash hasn’t
is not incurred is not earned been paid received
BUS 211 – Accrual Accounting and the adjustement process- Type 4
Type 4 adjustement – Accrued Revenues

• Accrued revenues are revenues that a

company has earned by performing a service
or delivering goods but for which no entry has
been made in the accounting records, since
cash will be received in a future period.
o Any revenues earned but not recorded
during an accounting period require an
adjusting entry that debits an asset account
and credits a revenue account.
o Examples: Service Revenue
Interest Revenue
BUS 211 – Accrual Accounting and the adjustement process- Type 4

End of period 1

Period 1 Period 2

revenue is earned cash is received

Adjusting entry at period end

when cash is received entry will be:

Accounts Receivable (A+) xx Cash(A+) xx

Service Revenue(R+) xx Accounts Receivable (A-) xx

Revenue is recognized before cash is received, when EARNED !

BUS 211 – Accrual Accounting and the adjustement process- Type 4
Transaction- During July, Miller Design Studio agrees to
create two advertisements for Joe's Pizza Co. for a total of
$800, and to finish the first advertisement by July 31.
By the end of July, Miller has earned $400 for completing the
first advertisement, but it will not bill and collect cash from
Joe's until the entire project has been completed. On July 31,
Miller records the accrual of $400 of unrecorded revenue.
The journal entry to record the accrual of unrecorded revenue
• increases the owner's equity account Design Revenue with
a credit
• increases the asset account Accounts Receivable with a
debit
Miller Design Studio
Unadjusted Trial Balance
July 31, 2011
BUS 211 – Accrual Accounting and the adjustement process

Purpose of adjusting entries :

• Measure income
• Update balance sheet

Each adjusting entry affects :

• One income statement account (Revenue or Expense)
• One balance sheet account (Asset or liability)
BUS 211 – Accrual Accounting and the adjustement process

Preparing the Adjusted Trial Balance

After adjusting entries have been recorded and

posted, an adjusted trial balance is prepared by
listing all accounts and their balances.
BUS 211 – Accrual Accounting and the Adjustment Process

The Accounting Cycle:

1) Record journal entries
2) Post journal entries to the General Ledger ( T-acct)
3) Prepare the ( unadjusted ) Trial Balance
4) Prepare period end adusting entries (adjust the accounts)
5) Post the adjusting entries to the General Ledger
Chapter 3
6) Prepare the ADJUSTED TRIAL BALANCE
7) Prepare the Financial Statements
8) Close the accounts
9) Prepare the Post-Closing Trial Balance
ADJUSTED ACCOUNT balances of Miller Design Studio

Cash Accounts Receivable Office Supplies Prepaid Rent

22,480 4,600 5,200 1,540 3,200 1,600
400
5,000 3,660 1,600

Equipment Accumulated Depreciation Accounts Payable Unearned Design Revenue

16,320 300 6,280 800 1,400

600

Wage Payable Capital Withdrawal Design REVENUE

720 40,000 2,800 12,400
800
400
13,600

Wage Expense Utility Expense Rent Expense Supplies Expense

4,800 680 1,600 1,540
720
5,520

Depreciation Expense
300
Preparing the ADJUSTED TRIAL BALANCE
Miller Design Studio Cash Accounts Receivable Office Supplies Prepaid Rent
ADJUSTED Trial Balance 22,480 4,600 5,200 1,540 3,200 1,600
400
July 31, 2011
5,000 3,660 1,600

Unearned
Equipment Accumulated Depreciation Accounts Payable Design Revenue
16,320 300 6,280 800 1,400

600

Wage Payable Capital Withdrawal Design REVENUE

720 40,000 2,800 12,400
800
400
13,600

Wage Expense Utility Expense Rent Expense Supplies Expense

4,800 680 1,600 1,540
720
5,520

Depreciation Expense
300
BUS 211 – Accrual Accounting and the adjustement process

PREPARING THE ADJUSTED TRIAL BALANCE

Miller Design Studio
Miller Design Studio Unadjusted Trial
ADJUSTED Trial Balance Balance
July 31, 2011 July 31, 2011
BUS 211 – Accrual Accounting and the adjustement process
Preparing the Financial Statements using the
Adjusted Trial Balance

• INCOME STATEMENT
• STATEMENT OF OWNER’S EQUITY
• BALANCE SHEET
BUS 211 – Accrual Accounting and the adjustement process
Preparing the Financial Statements using the
Adjusted Trial Balance

• The revenue and expense accounts are used to prepare the income
statement; the asset and liability accounts are used to prepare the
balance sheet.
• Net income from the income statement is combined with the Withdrawals
account on the statement of owner’s equity to give the net change in the
Capital account.
• The balance of the Capital account is used in preparing the balance sheet.
BUS 211 – Accrual Accounting and the adjustement process
Preparing the Financial Statements using the Adjusted Trial Balance
Miller Design Studio Miller Design
ADJUSTED Trial Balance
July 31, 2011 1

Miller Design

1
1
BUS 211 – Accrual Accounting and the adjustement process
Preparing the Financial Statements using the Adjusted Trial Balance

Miller Design
Miller Design
1