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

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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

56

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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