Unit Four Professor Jason Cade, MBA, CFE 1

Chapter 3 The Adjusting Process 2

Describe the nature of the adjusting process. Objective 1 3

Under the accrual basis of accounting, revenues are reported in the income statement in the period in which they are earned. 4

The accounting concept supporting the reporting of revenues when they are earned regardless of when cash is received is called the revenue recognition concept. Revenue Recognition Concept 5

The accounting concept supporting reporting revenues and related expenses in the same period is called the matching concept, or matching principle. Matching Principle 6

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. 7

The Adjusting Process Under the accrual basis, at the end of the accounting period some of the accounts need updating for the following reasons: 1.Some expenses are not recorded daily. 2.Some revenues and expenses are incurred as time passes rather than as separate transactions. 3.Some revenues and expenses may be unrecorded. 8

The analysis and updating of accounts at the end of the period before the financial statements are prepared is called the adjusting process. The Adjusting Process 9

Indicate with a Yes or No whether or not each of the following accounts normally requires an adjusting entry. a.Cashd.Office Equipment b.Prepaid Rente.Accounts Receivable c.Wages Expensef.Unearned Rent Example Exercise 3-1 Accounts Requiring Adjustment 10

a.Cashd.Office Equipment b.Prepaid Rente.Accounts Receivable c.Wages Expensef.Unearned Rent No Yes No Yes Example Exercise 3-1 (continued) 11

Prepaid expenses are the advance payment of future expenses and are recorded as assets when cash is paid. Types of Accounts Requiring Adjustment 12

Unearned revenues are the advance receipt of future revenues and are recorded as liabilities when cash is received. Types of Accounts Requiring Adjustment 13

Exhibit 1 Type of Adjustments: Prepaid Expenses and Unearned Revenues 14

Accrued revenues are unrecorded revenues that have been earned and for which cash has yet to be received. Types of Accounts Requiring Adjustment 15

Accrued expenses are unrecorded expenses that have been incurred and for which cash has not been paid. Types of Accounts Requiring Adjustment 16

Exhibit 2 Type of Adjustments: Accrued Revenues and Expenses 17

Type of Adjustment 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 notc.Fees received but not yet paid. earned. b.Supplies on hand.d.Fees earned but not yet received. a. Accrued expense b. Prepaid expense c. Unearned revenue d. Accrued revenue 18

Journalize entries for accounts requiring adjustment. Objective 2 19

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. Prepaid Expenses Supplies (balance on trial balance) $2,000 Supplies on hand, December 31 – 760 Supplies used $1,240 20

Dec. 311,240 Supplies Supplies Expense Bal ,

The debit balance of $2,400 in NetSolutions’ Prepaid Insurance account represents the December 1 prepayment of insurance for 12 months. Prepaid Expenses 22

Dec Prepaid Insurance Bal.2,400 Insurance Expense ,200 Dec

The prepaid insurance account had a beginning balance of $6,400 and was debited for $3,600 of premiums paid during the year. Journalize the adjusting entry required at the end of the year assuming the amount of unexpired insurance related to future periods is $3,250. Adjustment for Prepaid Expenses Example Exercise 3-3 Insurance Expense………………………6,750 Prepaid Insurance……………………6,750 Insurance expired ($6,400 + $3,600 – $3,250). 24

The December 31 unadjusted trial balance of NetSolutions indicates a balance in the unearned rent account of $360. Unearned Revenues 25

Dec Unearned Rent Bal.360 Rent Revenue

Rent Revenue 42 Dec Unearned Rent Bal Bal. Dec

Adjustment for Unearned Revenue Example Exercise 3-4 The balance in the unearned fees account, before adjustment at the end of the year, is $44,900. Journalize the adjusting entry required if the amount of unearned fees at the end of the year is $22,300. Unearned Fees…………………………….22,600 Fees Earned…………………………..22,600 Fees earned ($44,900 – $22,300). 28

NetSolutions signed an agreement with Danker Co. on December 15 to provide services at $20 per hour. As of December 31, NetSolutions had provided 25 hours of assistance. Accrued Revenues 29

Dec Accounts Receivable Bal.16,340 Fees Earned Bal.2,220 2,720 Bal. 30

Dec Accounts Receivable Bal.16,340 Fees Earned Bal.2,220 2,720 Bal. 16,840 Bal. 31

At the end of the current year, $13,680 of fees have been earned but have not been billed to clients. Journalize the adjusting entry to record the accrued fees. Example Exercise 3-5 Follow My Example 3-5 Accounts Receivable…………………….13,680 Fees Earned…………………………..13,680 Accrued fees. Adjustment for Accrued Fees 32

NetSolutions pays it employees biweekly. During December, NetSolutions paid wages of $950 on December 13 and $1,200 on December 27. As of December 31, NetSolutions owes $250 of wages to employees for Monday and Tuesday. Accrued Expenses 33

Dec Wages Payable Bal.4,275 Wages Expense Bal.4,525 34

Dec Wages Payable Bal.4,275 Wages Expense Bal.4,525 35

The journal entry for the payment of wages on January 10 is shown below. After posting 36

Sanregret Realty Co. pays weekly salaries of $12,500 on Friday for a five-day week ending on that day. Journalize the necessary adjusting entry at the end of the accounting period, assuming that the period ends on Thursday. Example Exercise 3-6 Adjustment for Accrued Expenses Salaries Expense………………………..10,000 Salaries Payable……………………..10,000 Accrued salaries [($12,500 ÷ 5 days) × 4 days]. 37

Fixed assets, or plant assets, are physical resources that are owned and used by a business and are permanent or have a long life. Fixed Assets 38

As time passes, a fixed asset loses its ability to provide useful services. This decrease in usefulness is called depreciation. Depreciation 39

Normal titles for fixed asset accounts and their related contra asset accounts are as follows: Fixed Asset Contra Asset LandNone—Land is not depreciated BuildingsAccumulated Depreciation— Buildings Store EquipmentAccumulated Depreciation—Store Equipment Office EquipmentAccumulated Depreciation—Office Equipment 40

NetSolutions estimates the depreciation on its office equipment to be $50 for the month of December. 41

Dec Depreciation ExpenseAccum. Depr.—Office Equip

Dec Depreciation Expense Dec Accum. Depr.—Office Equip

NetSolutions’ balance sheet would show office equipment at cost, less accumulated depreciation. Office equipment$1,800 Less accumulated depreciation 50$1,750 Book value 44

The estimated amount of depreciation on equipment for the current year is $4,250. Journalize the adjusting entry to record the depreciation. Adjustment for Depreciation Depreciation Expense………...………..4,250 Accumulated Depreciation— Equipment…………………………..4,250 Depreciation on equipment. Example Exercise

Summarize the adjustment process. Objective 3 46

Exhibit 7 Adjusting Entries—NetSolutions 47

. Exhibit 7Adjusting Entries—NetSolutions (continued) 48

Example Exercise 3-8 For the year ending December 31, 2010, Mann Medical Co. mistakenly omitted adjusting entries for (1) $8,600 of unearned revenue that was earned, (2) earned revenue of $12,500 that was not billed, and (3) accrued wages of $2,900. Indicate the combined effect of the errors on (a) revenues, (b) expenses, and (c) net income for Effect of Omitting Adjustments 49

Example Exercise 3-8 (continued) a.Revenues were understated by $21,100 ($8,600 + $12,500). c.Net income was understated by $18,200 ($8, ,500 – $2,900). b.Expenses were understated by $2,

Prepare an adjusted trial balance. Objective 4 51

The purpose of the adjusted trial balance is to verify the equality of the total debit and credit balances before the financial statements are prepared. 52

Exhibit 9Adjusted Trial Balance—NetSolutions 53

For each of the following errors, considered individually, indicate whether the error would cause the adjusted trial balance totals to be unequal. If the error would cause the adjusted trial balance totals to be unequal, indicate whether the debit or credit total is higher and by how much. a.The adjustment for accrued fees of $5,340 was journalized as a debit to Accounts Payable for $5,340 and a credit to Fees Earned of $5,340. Effect of Errors on Adjusted Trial Balance Example Exercise

b.The adjustment for depreciation of $3,260 was journalized as a debit to Depreciation Expense for $3,620 and a credit to Accumulated Depreciation for $3,260. Example Exercise 3-9 a.The totals are equal even though the debit should have been to Accounts Receivable instead of Accounts Payable. b.The totals are unequal. The debit total is higher by $360 ($3,620 – $3,260). 55

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