CHAPTER 3

ADJUSTING THE
ACCOUNTS
 Chapter 3 Accrual Accounting
Learning Objectives
1. Explain accrual basis accounting, and
when to recognize revenues and
expenses.
2. Prepare adjusting entries for
prepayments.
3. Prepare adjusting entries for accruals.
4. Describe the nature and purpose of an
adjusted trial balance, and prepare one.

2
 Week 3 Assignment

 Problem 3 – 3A (page 3 – 41):

 Problem 3 – 5A (page 3 – 42):
Complete the assignment on Wiley Plus. It
will be due in one week.
 Accounting Cycle
1. Analyze
transactions

7. Prepare 2. Journalize the

financial transactions
statements
3. Post to ledger
accounts
6. Prepare
adjusted trial 4. Prepare a trial
balance balance
5. Journalize
and post
adjusting
entries
 Chapter 3 Accrual Accounting
Learning Objectives
1. Explain accrual basis accounting, and
when to recognize revenues and
expenses.
2. Prepare adjusting entries for
prepayments.
3. Prepare adjusting entries for accruals.
4. Describe the nature and purpose of an
adjusted trial balance and prepare one.

5
 TIME PERIOD

 The life of a business is divided into artificial

time periods for reporting purposes.
 Periods of less than one year are interim
periods.
 The period of one year is called the fiscal
year.
 Cash Basis Versus Accrual
Accounting
 Cash Basis
 Revenue is recorded when cash is received
 Expenses are recorded when paid
 Not allowed under generally accepted accounting
principles
 Accrual basis
 Events are recorded in the period when they occur
not when cash is paid or received
 Complies with generally accepted accounting
principles
 Adjusting Entries - Basics

• Required for the preparation of financial statements

– Needed to ensure that revenue is recorded when
services are performed, and expenses are recorded as
incurred
– Make it possible to accurately report assets, liabilities
and owner’s equity
• Part of the accounting cycle
• Every adjusting entry includes one income statement and
one balance sheet account
• Classified as prepayments or accruals
 Revenue Recognition Principle

• Revenue is recognized when there is an increase in assets or a

decrease in liabilities due to business activities with customers
• Revenue recognition principle provides guidance
• Two approaches to revenue recognition that determine when
and how much revenue is recognized:
1. contract-based approach: used by all companies that
follow IFRs
2. earnings approach: used by companies that follow ASPE
• Under both IFRS and ASPE, the revenue recognition principle
follows the accrual basis of accounting
 Contract Based Approach

• Companies that follow IFRS use a five-step contract-

based approach to revenue recognition
• Revenue is recognized when the performance obligation
is satisfied
o For a service entity, often when the service is provided
o For an entity that provides goods, often when goods are
transferred to the buyer
• The amount that is recognized as revenue reflects the
payment a business expects to receive in exchange for its
goods or services
 Earnings Approach

• For companies that follow ASPE

• Revenue is recognized when:
o The performance obligation is complete
o The goods have been delivered to the customer
o The amount that will be recognized is known;
that is there is no significant uncertainty about
the selling price of the goods
o The seller is confident that the amount due from
the purchaser will be received
 Expense Recognition

 Expenses are decreases in assets or increases in

liabilities from business activities.
 Expenses matched to revenues when a direct
relationship exists – matching concept
 For long-lived assets, expenses are recognized over
the asset’s life.
 Otherwise, expenses recognized in the period incurred.

Revenues expenses
earned are offset incurred in
this month against.... earning the
revenue
 Cash Versus Accrual Accounting
Example

 Contractor builds picnic tables for the

city, who pays its bills in 90 days.
 The $30,000 contract costs the
contractor, $10,000 in materials and
$10,000 in employee wages.
Prepare income statements for 3 months
using the cash and accrual basis of
accounting.
 Adjusting Entries Videos

Adjusting entries class (49 minutes, 160K

views)
 Chapter 3 Accrual Accounting
Learning Objectives

2. Prepare adjusting entries for

prepayments.

15
 Starting Point –
Unadjusted Trial Balance
Pioneer Advertising
Lynk Software Agency
Services
Trial Balance
Unadjusted Trial Balance
October 31,
October 31, 2024
2011
Debit Credit
Cash $ 14,250
Accounts Receivable 1,000
Advertising Supplies 2,500
Prepaid Insurance 600
Office Equipment 5,000
Notes Payable $ 5,000
Accounts Payable 1,750
Unearned Revenue 1,200
C.R. Byrd, Capital 10,000
C.R. Byrd, Drawings 500
Service Revenue 10,000
Salaries Expense 4,000
Rent Expense 900
$ 28,750 $ 27,950
 Adjusting Entries

 Adjusting entries are required before financial

statements are prepared. They are prepared by the
accountant.
 Adjusting entries are made, ledger accounts are
updated, and an adjusted trial balance is
prepared.
 Adjusting entries can be classified as
1. prepayments
2. accruals
 1. Prepayments

Prepayments are either prepaid expenses

or unearned revenues.
1.Prepaid Expenses — paid in cash and
recorded as assets before they are used.
2. Unearned Revenues — received in
cash and recorded as liabilities before they
are earned.
 1. Prepayments - Supplies

Prepaid expenses are expensed when used or through the

passage of time.
Examples: supplies, rent, insurance, property tax
a.Supplies – Lynk Software purchased $2,500 of office supplies
on October 4. A physical count reveals that only $1,000
remains on October 31. Prepare the monthly adjusting entry.
Oct. 31 Supplies expense 1,500
Supplies 1,500
$2,500 – 1,000
 Inventory Equation
Beginning + purchases = Ending + Supplies

Balance Balance Expense

Supplies – $1,000 of supplies on July 1, purchased $2,000 of
supplies during the month. A physical count reveals only $500
remaining on July 31. Prepare the month end adjusting entry.
Jul. 31 Supplies expense 2,500
Supplies 2,500
$1,000 + 2,000 – 500
 1. Prepayments - Insurance

b. Prepaid insurance – Lynk Software

bought a 1-year insurance policy on
October 3 for $600.
Prepare the month end adjusting entry.
Oct. 31 Insurance expense 50
Prepaid insurance 50
$600 / 12
 1. Prepayments - Depreciation

• Long – lived assets: land, buildings, vehicles,

equipment provide services for years.
• Expense each asset over its useful life, except
for land which has unlimited life.
• When an asset is purchased, its useful life is
estimated, and it is expensed based on that
estimate.
• Straight line method – divide original
purchase price by its useful life span.
 Deprecation Expense

 Depreciation — Attempts to allocate of the

cost of capital assets to expense for the
periods when it is used by the business.
 Expense = Cost / Estimated useful life
 Adjusting entry
Depreciation expense xxx
Accumulated depreciation xxx
 Contra Accounts
Accumulated depreciation is a contra account, an account with the
opposite balance (credit) compared to its related asset account.
A contra account is created for each asset category (e.g., buildings,
equipment) and is deducted for its related asset on the balance sheet.

Oct. Nov.
Equipment $5,000 $5,000
Less: Accumulated depreciation— 83 166
equipment
Carrying amount $4,917 $4,834
 Depreciation Example

c. Depreciation — Lynk Software purchased a

$5,000 in office equipment on October 2
with a five-year life span.
Prepare the adjusting entry for Oct. 31.
Oct. 31 Depreciation expense 83
Accumulated depreciation 83
$5,000/5years/12 months
 Balance Sheet Presentation

Balance Sheet Presentation

Equipment $5,000
Less: Accumulated Estimate
Depreciation 83
Net book value $4,917
 1. Prepayments – Unearned
Revenue
Unearned revenues – recognized as revenue when you do
the work. Air Canada – Advance ticket sales - $1.7 Billion
d. Unearned revenue: Lynk Software received a $1,200
cash advance from a customer on October 3rd. By
month’s end, it had done $400 work for the client. Prepare
the month end adjusting entry.
Oct. 31 Unearned revenue 400
Service revenue 400
 Practice: E3 – 5 (page 3-40)
E3.5 Action Quest Games adjusts its accounts annually. Assume that any
Prepare the year end adjusting entries:
prepaid expenses are initially recorded in asset accounts. Assume that any
revenue collected in advance is initially recorded as liabilities. The following
information is available for the year ended December 31, 2021:
1. A $4,020 one-year insurance policy was purchased on April 1, 2021.
Dec. 31 Insurance Expense............................ 3,015
2. Paid $6,500 on August 31, 2021, for five months' rent in advance.
Prepaid
3. On September 27, 2021, Insurance
received $3,600 .........................
cash from a corporation that3,015
sponsors games for($4,020
the most×improved
9/12 = $3,015)
students attending a nearby school.
The $3,600
Dec. 31 wasRent for 10Expense
games, worth $360 each, that are played
.................................... 5,200on the first
Friday of each month starting in October. (Use the Unearned Revenue
Prepaid Rent................................. 5,200
account.)
($6,500
4. Signed a contract for cleaning× 4/5 = $5,200)
services starting December 1, 2021, for $500
per month.
Dec. 31 PaidUnearned
for the firstRevenue
three months on November 30,
........................... 2021.
1,080
5. On December 15, 2021,
Feessold $935.................................
Earned of gift certificates to a local game club. 1,080On
December 31, 2021, determined that $545 of these gift certificates had not yet
($3,600 × 3/10 = $1,080)
been redeemed. (Use the account Unearned Revenue.)
Dec. 31
Instructions Office Expense .................................. 500
Prepaid Expenses.........................
a. For each transaction, prepare the journal entry to record the initial
500
transaction.
Dec. 31 Unearned Revenue ........................... 390
Admission
b. For each transaction, Revenue
prepare the ......................
adjusting journal entry required on390
December 31, 2021. Do both–entries
($935 $545 =for each transaction before doing the next
$390)
transaction.
 Practice: E3 – 5 Solution
a. Apr. 1 Prepaid Insurance ............................. 4,020
Prepare the year end adjusting 1
entries:
Cash .............................................
b. Dec. 31 Insurance Expense .......................... 3,015
4,020

Prepaid Insurance......................... 3,015

1
($4,020 × 9/12 = $3,015)
Dec. 31a. Insurance
Aug. 31
Expense............................ 3,015
Prepaid Rent ..................................... 6,500
Prepaid Insurance......................... 6,500
Cash ............................................. 3,015
b. Dec. 31 ($4,020 × 9/12
Rent Expense 2 = $3,015)
.................................. 5,200
Prepaid Rent ................................. 5,200
Dec. 31 Rent Expense
2 ....................................
($6,500 × 4/5 = $5,200) 5,200
a.
Prepaid Rent.................................
Sept. 27 Cash.................................................. 3,600
5,200
($6,500
Unearned × 4/5 = $5,200)
Revenue ....................... 3,600
Dec. 31b. Unearned
Dec. 31 UnearnedRevenue
3
...........................
Revenue ........................... 1,080 1,080
Service Revenue ......................... 1,080
Fees
3 Earned
($3,600 .................................
× 3/10 = $1,080) 1,080
a. Nov. 30
($3,600 × 3/10 = $1,080)
Prepaid Expenses ............................. 1,500
Dec. 31 OfficeCash .............................................
Expense .................................. 1,500
500
b. Dec. 31 Prepaid
Office Expense
Expenses.................................. 500
......................... 500
Prepaid Expenses......................... 500
Dec. 31a. Unearned
Dec. 15 Revenue ...........................
Cash.................................................. 935 390
Admission Revenue
Unearned Revenue ......................
....................... 935 390
b. Dec. 31 ($935 – $545
Unearned = ...........................
Revenue $390) 390
4
Admission Revenue ..................... 390
4
($935 – $545 = $390)
Prepaid Adjusting Entries Videos

Adjusting entries (12 minutes, 437K views)

Depreciation expense(10 minutes, 20K
views)
Prepaid expenses (12 minutes, 12K views)
Unearned revenue (6 minutes, 11K views)
 Chapter 3 Accrual Accounting
Learning Objectives

3. Prepare adjusting entries for accruals.

31
 2. Accruals

The second type of adjusting entry.

1. Accrued Revenues — Revenues earned but not
yet received in cash or recorded.
2. Accrued Expenses — Expenses incurred but not
yet paid in cash or recorded.
Adjusting entries for accruals are required to record
revenues earned and expenses incurred.
 2. Accruals – Adjusting Entries

 Accrued expenses are expenses incurred but not

yet paid.
 Examples: accounts payable, rent payable,
salaries payable, interest payable.
 2. Accruals – Interest Expense
e. On October 2, Lynk Software signed a three
month, $5,000, 6% note payable is due with
accrued interest on January 2, 2024.
• Prepare the journal entries until the note
matures.
• What if a customer signed a similar note owing
to Lynk that date?
 Formula to Calculate Interest

Face Time
Time
FaceValue
Value Annual
Annual
(in
(inTerms
Termsof
of
ofNote
Note Interest
Interest of Interest
Interest
x Rate
Rate
x One
OneYear)
Year) =

$5,000 x 6% x 1/12 = $25

 Accruals – Interest Expense

Notes payable Notes receivable

Oct. 2 Equipment 5,000 Oct. 2 Notes receivable 5,000
Notes payable 5,000 Equipment 5,000
Oct. 31 Interest expense 25 Oct. 31 Interest receivable 25
Interest payable 25 Interest revenue 25
Nov. 30 Interest expense 25 Nov. 30 Interest receivable 25
Interest payable 25 Interest revenue 25
Dec. 31 Interest expense 25 Dec. 31 Interest receivable 25
Interest payable 25 Interest revenue 25
Jan. 2 Interest Payable 75 Jan. 2 Cash 5,075
Notes payable 5,000 Notes receivable 5,000
Cash 5,075 Interest receivable 75
 2. Accruals – Wage Expense
F. Accrued expenses: The four employees were last paid on Friday,
October 25 for the period ending Oct. 25. Their next pay day is on
November 8. Each employee is paid $500 per five-day work week.
Prepare the adjusting entry for October 31 and payroll entry
for November 8.
Oct. 31 Salaries expense 1,600
Salaries payable 1,600
$500*4*2*4/10
Nov. 8 Salaries expense 2,400
Salaries payable 1,600
Cash 4,000
Accrual Adjusting Entries Videos

Accrued expenses (9 minutes, 23K views)

Notes payable (8 minutes, 29K views, same
calculations but we use months instead of
days)
Salaries expense (5 minutes, 26K views)
 Practice: E3 – 9 (page 3-41)
E3.9 Plex Paintball records adjusting entries on an annual basis. The company
has the following information available on accruals that must be recorded for
the year ended June 30, 2021.
1. Plex Paintball has a 4% note payable with its bank for $48,000. Interest is
payable monthly on the first of the month.
2. Plex Paintball is open seven days a week and employees are paid a total of
$3,500 every Monday for a seven-day (Monday–Sunday) workweek. June 30,
2021 is a Wednesday so employees will have worked three days (Monday–
Wednesday) before the year end that they have not been paid for as at June
30. Employees will be paid next on Monday, July 5, 2021.
3. Plex Paintball receives a commission from Pizza Shop next door for all pizzas
sold to customers using the Plex Paintball facility. The amount owing for June
is $520, which Pizza Shop will pay on July 7, 2021.
4. The June utility bill for $425 was unrecorded on June 30. Plex Paintball paid
the bill on July 9, 2021.
5. Plex Paintball sold some equipment on June 1, 2021, in exchange for a $6,000,
6% note receivable. The principal and interest are due on September 1, 2021.
Instructions
a. For each of the above items, prepare the year end adjusting entry.
 Practice: E3 – 9 (page 3-41)

Prepare the year end adjusting entries:

a. June 30 Interest Expense1 .............................. 160
Interest Payable............................ 160
1
($48,000 × 4% × 1/12 = $160)
To accrue interest expense.
30 Salaries Expense2 ............................. 1,500
Salaries Payable........................... 1,500
2
($3,500 × 3/7 = $1,500)
To record accrued salaries.
30 Accounts Receivable......................... 520
Commission Revenue .................. 520
To accrue revenue for commissions earned.
30 Utilities Expense................................ 425
Accounts Payable ......................... 425
To accrue utilities expense.
30 Interest Receivable ........................... 30
Interest Revenue3 ......................... 30
3
($6,000 × 6% × 1/12 = $30)
To accrue interest revenue.
 Chapter 3 Accrual Accounting
Learning Objectives

4. Describe the nature and purpose of an

adjusted trial balance and prepare one.

41
 Adjusted Trial Balance
 Adjusted Trial Balance is prepared after all
adjusting entries have been journalized and posted.
 It shows the balances of all accounts at the end of
the accounting period and the effects of all financial
events that have occurred.
Adjusted Trial Balance
Review of Preparing Financial Statements
(YouTube Videos)

Preparing financial statements (9 minutes,

84K views)
Preparing financial statements (9 minutes,
7K views)
 Preparing the Income Statement

Lynk
LynkSoftware
SoftwareServices
Services
Income Statement
Income Statement
Month
MonthEnded
EndedOctober
October31,
31,2024
2024
Revenues
Revenues
Service
Servicerevenue
revenue $$ 11,400
11,400
The income
Expenses
Expenses statement is
Supplies
Suppliesexpense $$ 1,500
Depreciation
expense
Depreciationexpense
expense
1,500
83
83
prepared from the
Insurance expense
Insurance expense 50
50 revenue and expense
Salaries
Salariesexpense 5,600
Rent
expense
Rentexpense
expense
5,600
900
900
accounts
Interest
Interestexpense
expense 25
25
Total
Totalexpenses
expenses 8,158
8,158
Profit
Profit $$ 3,242
3,242
Preparing the Statement of Owner’s Equity

Lynk
LynkSoftware
SoftwareServices
Services
Statement
StatementofofOwner's
Owner'sEquity
Equity
Month
MonthEnded
EndedOctober
October31,
31,2024
2024
T.
T.Jacobs,
Jacobs,capital,
capital,October
October11 $$ --
Add:
Add:Investments
Investments 10,000
10,000
Profit
Profit 3,242
3,242
13,242
13,242
Less: Drawings
Less: Drawings 500
500
T. Jacobs, capital, October 31
T. Jacobs, capital, October 31 $ 12,742
$ 12,742

The statement of owner’s equity is

derived from the owner’s capital
and drawing accounts and Profit
from the Income statement
 Preparing the Balance Sheet
Lynk Software Services
Lynk Software Services
Balance Sheet
Balance Sheet
October 31, 2024
October 31, 2024
Assets
Assets
Cash $ 14,250
Cash $ 14,250
Accounts receivable 1,200
Accounts receivable 1,200
Advertising supplies 1,000
Advertising supplies 1,000
Prepaid insurance 550
Prepaid insurance
Office equipment
Office equipment
$
$
5,000
5,000
550
The balance sheet is
Less: Accumulated depreciation
Less: Accumulated depreciation
Total assets
83
83
4,917
4,917
$ 21,917
prepared from the asset
Total assets
Liabilities and Owner's Equity
$ 21,917
and liability accounts and
Liabilities
Liabilities
Liabilities and Owner's Equity
the Statement of owner’s
Notes payable
Notes payable
Accounts payable
$ 5,000
$ 5,000
1,750
equity
Accounts payable 1,750
Unearned revenue 800
Unearned revenue 800
Salaries payable 1,600
Salaries payable 1,600
Interest payable 25
Interest payable 25
Total liabilities $ 9,175
Total liabilities $ 9,175
Owner's equity
Owner's equity
T. Jacobs, capital 12,742
T. Jacobs, capital 12,742
Total liabilities and owner's equity $ 21,917
Total liabilities and owner's equity $ 21,917
Demo Problem, page 3-29