ADJUSTMENTS

Remember Financial statements should always be …

ACCURATE

TIMELY

UNDERSTANDABLE

To make Decisions

Reason for Adjustments

An example of the inefficiency of recording transactions: Each time a waiter used a napkin from the supplies closet, a

journal entry debiting Supplies Expense and crediting Supplies for $0.35 (estimated cost of napkin) should be recorded. However, it would be very costly and inefficient to try to keep up with each little transaction like this. So instead, we wait until the end of the accounting period and determine the total amount of supplies used. Then we make an adjusting entry to account for all the supplies used during the period.

Adjusting EntriesWhy adjust?

Can be inefficient and costly to account for certain types of transactions on a daily basis, so we prepare…

Adjusting Entries to bring certain account balances up to date at the end of the accounting period

How to Analyze an Adjusting Entry

When analyzing an adjusting entry, look for the item that has not been recorded but should have been. This information is often not explicit and must be inferred from the data given.For expenses, look for the amount usedFor revenue, look for the amount earned

Let’s think back to our restaurant example…(Supplies Adjustments)

•The beginning balance in the restaurants supplies account was $300. The restaurant purchased $500 worth of supplies during the January, an additional $200 in October. A year-end count of supplies revealed $400 worth of supplies was on hand at year-end. Account for the necessary adjustments.

Adjusting Supplies

RULE OF THUMB: Adjusting results in debiting (increase) an expense account and a credit(decrease) to an asset

DATE ACCOUNTPOS

TREF

DEBIT CREDIT

Dec 31 Supplies Expense 600 00

Supplies 600 00

Class Example - Supplies

•The Office Supplies on Hand account showed a balance of $3,500 at the beginning of 2010. Supplies costing $12,000 were purchased during 2010. Supplies of $2,200 were on hand at December 31, 2010. Prepare the adjustment.

The Adjustment

DATE ACCOUNTPOSTREF

DEBIT CREDIT

Dec 31 Supplies Expense 13,300 00

Supplies 13,300 00

RULE OF THUMB: Adjusting results in debiting (increase) an expense account and a credit(decrease) to an asset

Adjusting Prepaid Expenses

Prepaid expenses are future expenses that have been paid in advance

Adjusting Prepaid Expenses

You bought insurance on the restaurant building on August 1, 2013 for a 2 year insurance policy at a cost of $ 4800.

Analyzing the Entry

Each month, a portion of the prepaid insurance expires. At the end of the fiscal period, the Prepaid account must be updated for the insurance that has expired (been used)

Analyzing the Entry

What accounts are involved? When something is “used up” it indicates an expense account. In

this case, we need to debit an account called Insurance Expense for the expired insurance. Furthermore, the asset, Prepaid Insurance, has decreased so we will credit this asset.

The Adjustment

DATE ACCOUNTPOSTREF

DEBIT CREDIT

Dec 31 Insurance Expense 1000 00

Prepaid Insurance 1000 00

Class Example - Prepaid

•Now let’s assume that a business with a fiscal year-end of December 31 purchases a full prepaid 12-month property insurance policy for $36,000 on September 1, 2010. Prepare the adjusting entry on December 31, 2010

The Adjustment

DATE ACCOUNTPOSTREF

DEBIT CREDIT

Dec 31 Insurance Expense 12000 00

Prepaid Insurance 12000 00

RULE OF THUMB: Adjusting results in debiting (increase) an expense account and a credit(decrease) to an asset account

Adjusting Late-Arriving Purchase InvoicesThe journal entry to record is the same as it would be if the invoice arrived on time;

•however, the date must be recorded as if we received the invoice at the end of the year even though we received it in January

•Business may act as if the late-arriving invoice arrived just prior to the close of the period and record that invoice as if it had arrived on the final day of the previous period.

The Adjustment

DATE ACCOUNTPOSTREF

DEBIT CREDIT

Dec 31 Advertising Expense 400 00

Hydro Expense 200 00

Accounts Payable 600 00

RULE OF THUMB : Adjusting entry results in a decrease (a debit) to a liability

account and an increase (a credit) to an asset account.

Adjusting Unearned Revenue

•Receipt of cash recorded as a liability before the service is preformedRent, airline tickets, magazine subscriptionsAdjusting entry to record the revenue that has been earned and to show the liability that remains

Class Example - Adjusting Unearned Revenue

•You received $12,000 advance cash on November 1 for a painting job you are to complete over the next three months.

The Initial Entry

Initial EntryDATE ACCOUNT

POSTREF

DEBIT CREDIT

Nov 1 Cash 12000 00

Unearned Paint Revenue 12000 00

On November 1, Cash would be debited and a liability account called Unearned Paint Revenue would be credited. The liability account is credited because you owe the customer. You owe the customer painting services.

The AdjustmentDATE ACCOUNT

POSTREF

DEBIT CREDIT

Dec 31 Unearned Paint Revenue 8000 00

Paint Revenue 8000 00

RULE OF THUMB : Adjusting entry results in a decrease (a debit) to a liability

account and an increase (a credit) to a revenue account.

Each month as you perform catering services, you are earning a portion of the unearned revenue. At the end of the fiscal period, the Unearned Paint Revenue and Paint Revenue accounts must be updated for the revenue that has now been earned.

Remember

•Adjusting entries are non-cash transactions—the Cash account will never be used in an adjusting entry

•You are simply updating the accounts

•When analyzing an adjusting entry, look for the item that has not been recorded but should have been:• For expenses, look for the amount used• For revenue, look for the amount earned

•The rule of thumb*•*Always involves at least one income statement account and one balance sheet account

Practice

Page 276-277

• Exercise 1

• Exercise 2

• Exercise 6: a-d