STUDY OBJECTIVES
After studying this chapter, you should understand:
Time period assumption Adjusting entries for prepayments
Accrual basis of accounting Adjusting entries for accruals
Why adjusting entries are necessary
Purpose of an adjusted
trial balance
Major types of adjusting entries
ADJUSTING THE ACCOUNTSADJUSTING THE ACCOUNTS
• The time period assumption assumes that the economic life of a business can be divided into artificial time periods.
• Accounting time periods are generally a month, a quarter, or a year (fiscal year)
STUDY OBJECTIVE 1
TIME PERIOD ASSUMPTION
STUDY OBJECTIVE 1
TIME PERIOD ASSUMPTION
STUDY OBJECTIVE 2
ACCRUAL vs. CASH-BASIS ACCOUNTING
STUDY OBJECTIVE 2
ACCRUAL vs. CASH-BASIS ACCOUNTING
Accrual BasisRevenue recognized when earned
Expenses are matched against revenuesRequired by GAAP
Accrual BasisRevenue recognized when earned
Expenses are matched against revenuesRequired by GAAP
Cash-Basis Revenues and expenses
recorded when cash is paid or received Not GAAP
Cash-Basis Revenues and expenses
recorded when cash is paid or received Not GAAP
• The revenue recognition principle dictates that revenue be recognized in the accounting period in which it is earned.
• In a service business, revenue is considered to be earned when the service is performed.
REVENUE RECOGNITION PRINCIPLEREVENUE RECOGNITION PRINCIPLE
• The practice of expense recognition is referred to as the matching principle.
• The matching principle dictates that efforts (expenses) be matched with accomplishments (revenues).
Revenues earned
this monthare offset against....
expensesincurred inearning the
revenue
MATCHING PRINCIPLEMATCHING PRINCIPLE
Time-Period Assumption
Economic life of businesscan be divided into
artificial time periods
Revenue-Recognition Principle
Revenue recognized in the accounting period in
which it is earned
Matching Principle
Expenses matched with revenuesin the same period when efforts
are expended to generate revenues
GAAP RELATIONSHIPS IN
REVENUE & EXPENSE RECOGNITION
GAAP RELATIONSHIPS IN
REVENUE & EXPENSE RECOGNITION
Adjusting entries are needed to ensure that revenue recognition and matching principles are followed
1 Revenues are recorded in the period earned, and...... 2 Expenses are recognized in the period incurred.
STUDY OBJECTIVE 3
WHY ADJUSTING ENTRIES ARE NECESSARY
STUDY OBJECTIVE 3
WHY ADJUSTING ENTRIES ARE NECESSARY
STUDY OBJECTIVE 4
TYPES OF ADJUSTING ENTRIES
STUDY OBJECTIVE 4
TYPES OF ADJUSTING ENTRIES
Adjusting entries are required each time financial statements are prepared.
Two main categories of adjustments are: Adjusting entries are required each time financial statements are prepared.
Two main categories of adjustments are:
PREPAYMENTS ACCRUALS
ADJUSTING ENTRIES:
PREPAYMENTS
ADJUSTING ENTRIES:
PREPAYMENTS
Prepaid Expenses Expenses are paid
and recorded as assets
before they are
used or consumed
Example: Prepaid Insurance
Prepaid Expenses Expenses are paid
and recorded as assets
before they are
used or consumed
Example: Prepaid Insurance
Unearned Revenues Cash received and
recorded as liabilities
before revenue is earned
Example: Cash received for
services provided in future
Unearned Revenues Cash received and
recorded as liabilities
before revenue is earned
Example: Cash received for
services provided in future
ADJUSTING ENTRIES:
ACCRUALS
ADJUSTING ENTRIES:
ACCRUALS
Accrued RevenuesRevenues earned but
Not yet received
In cash or recorded
Example: Sales of merchandise
On account
Accrued RevenuesRevenues earned but
Not yet received
In cash or recorded
Example: Sales of merchandise
On account
Accrued Expenses Expenses incurred
but not yet paid
in cash or recorded
Example: Utilities used but not yet paid for
Accrued Expenses Expenses incurred
but not yet paid
in cash or recorded
Example: Utilities used but not yet paid for
PIONEER ADVERTISING AGENCY Trial Balance October 31, 2006 Debit Credit Cash $ 15,200 Advertising Supplies 2,500 Prepaid Insurance 600 Office Equipment 5,000 Notes Payable $ 5,000 Accounts Payable 2,500 Unearned Revenue 1,200 Common Stock
Retained Earnings 10,000
0 Dividends 500 Service Revenue 10,000 Salaries Expense 4,000 Rent Expense 900 $ 28,700 $ 28,700
The Trial Balance is the starting place
for adjusting entries.
The Trial Balance is the starting place
for adjusting entries.
TRIAL BALANCETRIAL BALANCE
Adjusting entries for prepayments are required to
record the portion of the prepayment representing:
1 the expense incurred, or
2 the revenue earned in the current period.
STUDY OBJECTIVE 5
ADJUSTING ENTRIES FOR PREPAYMENTS
STUDY OBJECTIVE 5
ADJUSTING ENTRIES FOR PREPAYMENTS
Adjusting Entries
Asset
Unadjusted Balance
Credit Adjusting Entry (-)
Expense
Debit Adjusting Entry (+)
Prepaid Expenses
Liability
Unadjusted Balance
Debit Adjusting Entry (-)
Revenue
Credit Adjusting Entry (+)
Unearned Revenues
ADJUSTING ENTRIES
FOR PREPAYMENTS
ADJUSTING ENTRIES
FOR PREPAYMENTS
Advertising Supplies ExpenseOct. 31 1,500
Advertising Supplies Oct. 5 2,500 Oct. 31 1,500 31 1,000
Date Account Titles and Explanation Debit Credit Oct. 31 Advertising Supplies Expense 1,500 Advertising Supplies 1,500 (To record supplies used)
JOURNAL ENTRYJOURNAL ENTRY
POSTINGPOSTING
ADJUSTMENTADJUSTMENT October 31, an inventory count reveals that $1,000 of $2,500 of supplies are still on hand.
ADJUSTING ENTRIES FOR PREPAYMENTS
SUPPLIES
ADJUSTING ENTRIES FOR PREPAYMENTS
SUPPLIES
Insurance Expense 63Oct. 31 50
Prepaid Insurance 10 Oct. 4 600 Oct. 31 50 31 550
Date Account Titles and Explanation Debit Credit Oct. 31 Insurance Expense 50
Prepaid Insurance 50 (To record insurance expired)
JOURNAL ENTRYJOURNAL ENTRY
POSTINGPOSTING
ADJUSTMENTADJUSTMENT October 31, an analysis of the policy reveals that $50 of insurance expires each month.
ADJUSTING ENTRIES FOR PREPAYMENTS
INSURANCE
ADJUSTING ENTRIES FOR PREPAYMENTS
INSURANCE
REVIEW QUESTION
ADJUSTING ENTRY-SUPPLIES
REVIEW QUESTION
ADJUSTING ENTRY-SUPPLIES
The trial balance shows supplies of $1,350 and supplies expense of $0. If $750 of supplies are on hand at
the end of the period, what is the adjusting entry?
$600 Supplies
$600Supplies Expense
CreditDebit Account
The balance in supplies after adjustment is $750, the amount remaining unused.
The amount used is transferred to expense.
• Depreciation is the allocation of the cost of an asset to expense over its useful life.
• Depreciation is an estimate of expired cost.• Depreciation Expense is debited and a contra-asset account, Accumulated
Depreciation, is credited • Cost – accumulated depreciation = Book value
Depreciation ExpenseXXX
Accumulated DepreciationXXX
ADJUSTING ENTRIES FOR PREPAYMENTS
DEPRECIATION
ADJUSTING ENTRIES FOR PREPAYMENTS
DEPRECIATION
Accumulated Depreciation -Office Equipment
Oct. 31 40
Date Account Titles and Explanation Debit Credit Oct. 31 Depreciation Expense 40
Accumulated Depreciation - Office Equipment 40 (To record monthly depreciation)
JOURNAL ENTRYJOURNAL ENTRY
POSTINGPOSTING
ADJUSTMENTADJUSTMENT October 31, depreciation on the office equipment is estimated to be $480 a year, or $40 per month.
Depreciation ExpenseOct. 31 40
ADJUSTING ENTRIES FOR PREPAYMENTS
DEPRECIATION
ADJUSTING ENTRIES FOR PREPAYMENTS
DEPRECIATION
Service RevenueOct. 31 10,000 31 400
Unearned RevenueOct. 31 400 Oct. 2 1,200
31 800
JOURNAL ENTRYJOURNAL ENTRY
POSTINGPOSTING
ADJUSTMENTADJUSTMENTOctober 31, analysis reveals that, of $1,200 in fees received in advance of performance, $400 has been earned in October.
Date Account Titles and Explanation Debit Credit Oct. 31 Unearned Revenue 400
Service Revenue 400 (To record revenue for services provided)
ADJUSTING ENTRIES FOR PREPAYMENTS
UNEARNED REVENUES
ADJUSTING ENTRIES FOR PREPAYMENTS
UNEARNED REVENUES
• Adjusting entries for accruals are required to record revenues earned and expenses incurred in the current period.
• The adjusting entry for accruals will increase both a balance sheet and an income statement account.
STUDY OBJECTIVE 6
ADJUSTING ENTRIES FOR ACCRUALS
STUDY OBJECTIVE 6
ADJUSTING ENTRIES FOR ACCRUALS
Adjusting Entries
Asset
Debit Adjusting Entry (+)
Accrued Revenues
Revenue
Credit Adjusting Entry (+)
Accrued Expenses
Expense
Debit Adjusting Entry (+)
Liability
Credit Adjusting Entry (+)
ADJUSTING ENTRIES
FOR ACCRUALS
ADJUSTING ENTRIES
FOR ACCRUALS
Service RevenueOct. 31 10,000 31 400 31 200 31 10,600
Accounts ReceivableOct. 31 200
Date Account Titles and Explanation Debit Credit Oct. 31 Accounts Receivable 200
Service Revenue 200 (To accrue revenue for services provided)
October 31, the agency earned $200 for advertising services that were not billed to clients before October 31.
JOURNAL ENTRYJOURNAL ENTRY
POSTINGPOSTING
ADJUSTMENTADJUSTMENT
ADJUSTING ENTRIES FOR ACCRUALS
ACCRUED REVENUE
ADJUSTING ENTRIES FOR ACCRUALS
ACCRUED REVENUE
Interest PayableOct. 31 50
Interest ExpenseOct. 31 50
Date Account Titles and Explanation Debit Credit Oct. 31 Interest Expense 50
Interest Payable 50 (To accrue interest on notes payable)
JOURNAL ENTRYJOURNAL ENTRY
POSTINGPOSTING
ADJUSTMENTADJUSTMENT October 31, the portion of the interest to be accrued on a 3-month note payable is calculated to be $50.
ADJUSTING ENTRIES FOR ACCRUALS
ACCRUED INTEREST
ADJUSTING ENTRIES FOR ACCRUALS
ACCRUED INTEREST
Salaries PayableOct. 31 1,200
Date Account Titles and Explanation Debit Credit Oct. 31 Salaries Expense 1,200
Salaries Payable 1,200 (To record accrued salaries)
JOURNAL ENTRYJOURNAL ENTRY
POSTINGPOSTING
ADJUSTMENTADJUSTMENT October 31, accrued salaries are calculated to be $1,200.
Salaries ExpenseOct. 26 4,000 31 1,200 31 5,200
ADJUSTING ENTRIES FOR ACCRUALS
ACCRUED SALARIES
ADJUSTING ENTRIES FOR ACCRUALS
ACCRUED SALARIES
REVIEW QUESTION
ADJUSTING ENTRY-SALARIES
REVIEW QUESTION
ADJUSTING ENTRY-SALARIES
$400 Salaries Payable
$400Salaries Expense
CreditDebit Account
This entry recognizes an expense for the salaryearned by Kathy in the last week of September, and a
liability for the amount due to Kathy at September 30th.
Kathy Siska earned a salary of $400 for the last week of September. She will be paid on October 1.
What is the required adjusting entry?
• An Adjusted Trial Balance is prepared after all adjusting entries have been journalized and posted.
• Its purpose is to prove the equality of the total debit and credit balances in the ledger after all adjustments have been made.
• Financial statements can be prepared directly from the adjusted trial balance.
STUDY OBJECTIVE 7
ADJUSTED TRIAL BALANCE
STUDY OBJECTIVE 7
ADJUSTED TRIAL BALANCE
PIONEER ADVERTISING AGENCY Adjusted Trial Balance October 31, 2006
Debit Credit Cash $ 15,200 Accounts Receivable 200 Advertising Supplies 1,000 Prepaid Insurance 550 Office Equipment 5,000 Accumulated Depreciation - Office Equpment $ 40 Notes Payable 5,000 Accounts Payable 2,500 Interest Payable 50 Unearned Revenue 800 Salaries Payable 1,200 Common Stock
Retained Earnings 10,000
0 Dividends 500 Service Revenue 10,600 Salaries Expense 5,200 Advertising Supplies Expense 1,500 Rent Expense 900 Insurance Expense 50 Interest Expense 50 Depreciation Expense 40 $ 30,190 $ 30,190
PREPARING THE INCOME STATEMENT FROM
THE ADJUSTED TRIAL BALANCE
PREPARING THE INCOME STATEMENT FROM
THE ADJUSTED TRIAL BALANCE
INCOMESTATEMENTACCOUNTS
INCOMESTATEMENTACCOUNTS
PIONEER ADVERTISING AGENCY Income Statement For the Month Ended October 31, 200 6 Revenues Fees earned $ 10,600 Expenses Salaries expense $ 5,200 Advertising supplies expense 1,500 Rent expense 900 Insurance expense 50 Interest expense 50 Depreciation expense 40 Total expenses 7,740 Net income $ 2,860
The income statement is prepared from the revenue and expense accounts.The income statement is prepared from the revenue and expense accounts.
INCOME STATEMENTINCOME STATEMENT
PIONEER ADVERTISING AGENCY Adjusted Trial Balance October 31, 2006
Debit Credit Cash $ 15,200 Accounts Receivable 200 Advertising Supplies 1,000 Prepaid Insurance 550 Office Equipment 5,000 Accumulated Depreciation - Office Equpt. $ 40 Notes Payable 5,000 Accounts Payable 2,500 Interest Payable 50 Unearned Revenue 800 Salaries Payable 1,200 C.ommon Stock
Retained Earnings 10,000
0 Dividends 500 Service Revenue 10,600 Salaries Expense 5,200 Advertising Supplies Expense 1,500 Rent Expense 900 Insurance Expense 50 Interest Expense 50 Depreciation Expense 40 $ 30,190 $ 30,190
PREPARING THE RETAINED EARNINGS STATEMENT
FROM THE ADJUSTED TRIAL BALANCE
PREPARING THE RETAINED EARNINGS STATEMENT
FROM THE ADJUSTED TRIAL BALANCE
RETAINEDEARNINGS
STATEMENTACCOUNTS
BALANCESHEET
ACCOUNTS
PIONEER ADVERTISING AGENCY Retained Earnings Statement For the Month Ended October 31, 2006 Retained earnings, October 1 $ -0- Add: Net income 2,860 2,860 2,860 Less: Dividends 500 Retained earnings, October 31 $ 2,360
The retained earnings statement is prepared from the revenue, expense, dividends, and retained earnings accounts.
The retained earnings statement is prepared from the revenue, expense, dividends, and retained earnings accounts.
RETAINED EARNINGS STATEMENTRETAINED EARNINGS STATEMENT
PIONEER ADVERTISING AGENCY Balance Sheet October 31, 2006 Assets Liabilities and Stockholders’ Equity Cash $ 15,200 Liabilities Accounts receivable 200 Notes payable $ 5,000 Advertising supplies 1,000 Accounts payable 2,500 Prepaid insurance 550 Interest payable 50 Office equipment $ 5,000 Unearned fees 800 Less: Accumulated Salaries payable 1,200 depreciation 40 4,960 Total liabilities 9,550 Stockholders’ Equity
Common Stock
10,000 Retained Earnings 2,360 Total liabilities and owner’s Total assets $ 21,910 equity $ 21,910
The balance sheet is prepared from asset and liability and stockholders equity accounts. The balance sheet is prepared from asset and liability and stockholders equity accounts.
BALANCE SHEETBALANCE SHEET