1 1. describe the nature of the adjusting process. 2. journalize entries for accounts requiring...
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1. Describe the nature of the adjusting process.
2. Journalize entries for accounts requiring adjustment.
3. Summarize the adjustment process.4. Prepare an adjusted trial balance.
After studying this chapter, you should be able to:
3 - The Adjusting 3 - The Adjusting ProcessProcess
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Under the cash basis of accounting, revenues and expenses are reported in the income statement in the period in which cash is received or paid. E.g. Some
Government Accounting
Under the accrual basis of accounting, revenues are reported in the income statement in the period in
which they are earned.
Objective 1 - Describe the nature of the adjusting process.
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The accounting concept that supports this approach to reporting of revenues is called the revenue recognition
concept.
Expenses are reported in the same period as the revenue to which they relate.
The accounting concept that supports reporting revenues and related expenses in the same period is called the
matching concept, or matching principle.
Our focus in the course will be on the accrual basis of accounting i..e. revenues are reported in the income statement in the period in which they are earned.
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The analysis and updating of accounts at the end of the period before the financial
statements are prepared is called the adjusting process.
3-1Some accounts may need to updated at the end of an accounting period e.g. Supplies vs
Supplies Expense
The journal entries that bring the accounts up to date at the end of the accounting period are called adjusting entries.
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Prepaid expenses, sometimes referred to as deferred expenses, are items that have been initially recorded as assets but are expected to become expenses
over time or through the normal operations of the business.
3-1Items That Need Adjusting - 1
“Cash is paid for the service/expense before the service/expense is used”
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Unearned revenues, sometimes referred to as deferred revenues, are
items that have been initially recorded as liabilities but are expected to become
revenues over time or through the normal operations of the business.
3-1Items That Need Adjusting - 2
“Cash is collected before service is rendered”
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Accrued revenues, sometimes referred to as accrued assets (accrued means unpaid), are
revenues that have been earned but have not been recorded in
the accounts.
3-1Items That Need Adjusting - 3
“Services rendered for which cash has not yet been collected”
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Accrued expenses, sometimes referred to as accrued
liabilities, are expenses that have been incurred but have
not been recorded in the accounts.
3-1Items That Need Adjusting - 4
“The service has been used or the expense incurred, but the cash has not been paid”
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Example Exercise 3-2
Classify the following items as (1) prepaid expense, (2) unearned revenue, (3) accrued expense, or (4) accrued revenue.a. Wages owed but not c. Fees received but not
yet yet paid. earned.b. Supplies on hand. d. Fees earned but not yet
received.
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Journalize entries for accounts requiring
adjustment.
Objective 2Objective 2Objective 2Objective 2
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NetSolutions’ Supplies account has a balance of $2,000 in the
unadjusted trial balance. Some of these supplies have been used.
On December 31, a count reveals that $760 of supplies are on hand.
3-2Adjusting Process for Prepaid Expenses (1)
Supplies (balance on trial balance) $2,000Supplies on hand, December 31 – 760Supplies used $1,240
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Supplies 1 240 00
Supplies used ($2,000 –
$760)
Dec. 31 1,240Dec. 31 1,240
SuppliesBal. 2,000
Supplies ExpenseBal. 800
14 55
2,040760
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Dec. 31 Supplies Expense 1 240 002007
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The debit balance of $2,400 in NetSolutions’ Prepaid
Insurance account represents the December 1 prepayment of
insurance for 12 months.
3-2Adjusting Process for Prepaid Expenses (2)
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Dec. 31 200 Dec. 31 200Prepaid InsuranceBal.
2,400
Insurance Expense15 56
2,200
31 Insurance Expense 200 00
Prepaid Insurance 200 00
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15Insurance expired
($2,400/12).
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On December 1, the tenant prepaid three months’ rent
for use of an office building owned by NetSolutions. As of December 31, only $120
has been earned.
3-2Adjusting Process for Unearned Revenue
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Dec. 31
120
Dec. 31
120
Unearned RentBal. 360
Rent Revenue23 42
31 Unearned Rent 120 00
Rent Revenue 120 00
Rent earned ($360/3
months)
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240Bal.
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NetSolutions provided $500 in services during December for which the customer has not
been billed.
3-2Adjusting Process for Accrued Revenues
31 Accounts Receivable 500 00
Fees Earned 500 00
Accrued fees
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Assuming that wages were last paid on Friday, December 27th, and at the end of December,
outstanding/accrued wages amounted to $250. (e.g. This is for Monday & Tuesday, Dec 30th &
31st.) Without this adjusting entry, Wages Expense is understated.
3-2Adjusting Process for Accrued Expenses
31 Wages Expense 250 00
Wages Payable 250 00
Accrued wages.
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Dec. 31 250Dec. 31 250
Wages Payable Bal.
4,275
Wages Expense22 51
Bal. 4,525
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Physical resources that are owned and used by a business and are permanent or have a long life are
called fixed assets, or plant assets.
3-2Adjusting Process for Depreciation Expenses
As time passes, a fixed asset loses its ability to provide useful services (by being used in the business i.e. an expenses) This decrease (or
expense) in usefulness is called depreciation.
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Normal titles for fixed asset accounts and their related contra asset accounts are as follows:
Fixed Asset Contra Asset
Land None—Land is not depreciatedBuildings Accumulated Depreciation—
BuildingsStore Equipment Accumulate Depreciation—Store
EquipmentOffice Equipment Accumulated Depreciation—Office
Equipment
3-2Instead of the assets account being credited, a contra
account is established that normally carries a credit balance and appears as a deduction on the balance sheet
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Dec. 31 50Depreciation Expense
Dec. 31 50Accum. Depr.—Office Equip. 1953
31 Depreciation Expense 50 00
Accum. Depreciation—
Office Equipment 50 00
Depreciation of
office equipment.
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NetSolutions estimates the depreciation on its office equipment to be $50 for the
month of December.
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NetSolutions’ balance sheet would show the office
equipment at cost, less the accumulated depreciation.
Office equipment $1,800 Less accumulated depreciation 50 $1,750
Book Value or Net Book Value or Net Book ValueBook Value
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Summarize the adjustment process
Objective 3Objective 3Objective 3Objective 3
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See pages 116 – 120 and exhibit 8 for Ledger with adjusting entries
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Prepare an adjusted trial balance.
Objective 4Objective 4Objective 4Objective 4
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The purpose of the adjusted trial balance is to verify the
equality of the total debit balances and total credit
balances before the financial statements are prepared.
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