3 The Adjusting Process

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

Revenue Recognition Concept 1 Revenue Recognition Concept The accounting concept supporting the reporting of revenues when they are earned regardless of when cash is received is called the revenue recognition concept.

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

1 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.

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

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

Types of Accounts Requiring Adjustment 1 Types of Accounts Requiring Adjustment Prepaid expenses are the advance payment of future expenses and are recorded as assets when cash is paid.

Types of Accounts Requiring Adjustment 1 Types of Accounts Requiring Adjustment Unearned revenues are the advance receipt of future revenues and are recorded as liabilities when cash is received.

Types of Accounts Requiring Adjustment 1 Types of Accounts Requiring Adjustment Accrued revenues are unrecorded revenues that have been earned and for which cash has yet to be received.

Types of Accounts Requiring Adjustment 1 Types of Accounts Requiring Adjustment Accrued expenses are unrecorded expenses that have been incurred and for which cash has not been paid.

1 Example Exercise 3-2 Follow My Example 3-2 Follow My Example 6-1 Type of Adjustment Classify the following items as (1) prepaid expense, (2) unearned revenue, (3) accrued expense, or (4) accrued revenue. Wages owed but not c. Fees received but not yet paid. earned. Supplies on hand. d. Fees earned but not yet received. Follow My Example 3-2 Follow My Example 6-1 a. Accrued expense c. Unearned revenue b. Prepaid expense d. Accrued revenue For Practice: PE 3-2A, PE 3-2B 3-17

2 Exhibit 3 Unadjusted Trial Balance for NetSolutions

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

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

2 Example Exercise 3-3 Example Exercise 3-3 Follow My Example 3-3 Adjustment for Prepaid Expenses 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. Insurance Expense……………………… 6,750 Prepaid Insurance…………………… 6,750 Insurance expired ($6,400 + $3,600 – $3,250). Follow My Example 3-3 For Practice: PE 3-3A, PE 3-3B 3-26

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

2 Example Exercise 3-4 Follow My Example 3-4 Adjustment for Unearned Revenue 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. Follow My Example 3-4 Unearned Fees……………………………. 22,600 Fees Earned………………………….. 22,600 Fees earned ($44,900 – $22,300). For Practice: PE 3-4A, PE 3-4B 3-31

2 Accrued Revenues 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.

2 Example Exercise 3-5 Follow My Example 3-5 Adjustment for Accrued Revenues 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. Follow My Example 3-5 Accounts Receivable……………………. 13,680 Fees Earned………………………….. 13,680 Accrued fees. For Practice: PE 3-5A, PE 3-5B 3-36

2 Accrued Expenses 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.

2 Example Exercise 3-6 Follow My Example 3-6 Adjustment for Accrued Expenses 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. Salaries Expense……………………….. 10,000 Salaries Payable…………………….. 10,000 Accrued salaries [($12,500 ÷ 5 days) × 4 days]. Follow My Example 3-6 For Practice: PE 3-6A, PE 3-6B 3-43

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

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

2 Normal titles for fixed asset accounts and their related contra asset accounts are as follows: Fixed Asset Contra Asset Land None—Land is not depreciated Buildings Accumulated Depreciation— Buildings Store Equipment Accumulated Depreciation—Store Equipment Office Equipment Accumulated Depreciation—Office

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

2 Example Exercise 3-7 Follow My Example 3-7 Adjustment for Depreciation The estimated amount of depreciation on equipment for the current year is $4,250. Journalize the adjusting entry to record the depreciation. Depreciation Expense………...……….. 4,250 Accumulated Depreciation— Equipment………………………….. 4,250 Depreciation on equipment. Follow My Example 3-7 For Practice: PE 3-7A, PE 3-7B 3-52

4 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.