Adjusting the Accounts Chapter 4 Adjusting the Accounts

Guidelines to Report Revenue and Expenses Time Period Assumption Economic life of business can 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 revenues in the period when efforts are expended to generate revenues

Depreciation Entry: PREPAYMENT ASSET EXPENSE Cost of Truck $15,000 2008 2009 2010 1/1/08 12/31/08 12/31/09 12/31/10 Entry: Truck 15,000 Cash 15,000 Depreciation Expense 5,000 ASSET Accumulated Depreciation 5,000 Depreciation Expense 5,000 EXPENSE Accumulated Depreciation 10,000 CONTRA ASSET Depreciation Expense 5,000 Statement Presentation: Balance Sheet Asset Truck $15,000 Contra Asset Less: Accum. Depr. 5,000 10,000 15,000 Book Value $10,000 $ 5,000 $ -0- Accumulated Depreciation 15,000

Depreciation Year Calculation Annual Depreciation Expense Truck – cost $10,000, useful life 5 years, and salvage value is 0. Calculate the Annual Depreciation Expense, Accumulated Depreciation and Book Value using the below table Year Calculation Annual Depreciation Expense Accumulated Depreciation Book Value 1 10,000-0/5 2,000 8,000 2 4,000 6,000 3 4 10.000-0/5 5 10,000

Prepayment Relationships PREPAYMENTS Benefits More Than One Accounting Period RECORD AS ASSET RECORD AS LIABILITY Prepaid Insurance 1,200 Cash (Acquired one year policy) Cash 6,000 Unearned Rent (Received one year’s rent) Initial Entry Insurance Expense 100 Prepaid Insurance (One month expired) Unearned Rent 500 Rent Revenue (One month earned) Adjusting Entry Benefits Consumed or Earned in Current Period

Prepayment Relationships (continued) Account Effects: Balance Sheet Prepaid Insurance Unearned Rent 1,200 100 500 6,000 Bal. 1,100 Bal. 5,500 Income Statement Insurance Expense Rent Revenue

Accrual Relationships ACCRUALS Expense or Revenue Not Yet Recorded RECORD EXPENSE RECORD REVENUE Salaries Expense 500 Salaries Payable (Accrued salary owed) Accounts Receivable 1,000 Service Revenue (Accrued revenue for services provided) Adjusting Entry Salaries Payable 500 Cash (Paid salaries) Cash 1,000 Accounts Receivable (Collected account receivable) Subsequent Entry

Examples of Adjusting Entries Instructions: For each entry indicate the name of the account debited and the account credited. Adjusting Entry Account Debited Account Credited 1. To record expired rent which had been prepaid 2. To record supplies used during the period 3. To record depreciation on furniture 4. To record unearned revenue that has been earned 5. To record salary owed but not paid 6. To record rent earned but not recorded.

Examples of Adjusting Entries (continued) Answer: Account Debited Credited 1. Rent Expense Prepaid Rent 2. Supplies Expense Supplies 3. Depreciation Expense Accumulated Depreciation 4. Unearned Revenue Revenue 5. Salary Expense Salary Payable 6. Rent Receivable Rent Revenue

Posting of Adjusting Entries The following unadjusted accounts and related balances are provided at September 30: Accounts Receivable………………………………. $ 2,400 Supplies…………………………………………….. 1,200 Salary Payable…………………………………….. -0- Unearned Revenue……………………………….. 500 Revenue…………………………………………….. 15,000 Salary Expense…………………………………….. 2,100 Depreciation Expense…………………………….. Accumulated Depreciation……………………….. 3,000 Instructions: Open T-accounts and post the adjusting entries indicated from the following data: Supplies on hand, $200. Revenue earned but not accrued, $900. Unearned revenue earned but not recorded, $400. Salary owed to employees, $700. Depreciation of $200 is recognized.

Accumulated Depreciation Supplies on hand, $200. Revenue earned but not accrued, $900. Unearned revenue earned but not recorded, $400. Salary owed to employees, $700. Depreciation of $200 is recognized. Accounts Receivable Supplies Salary Payable 2,400 1,000 (a) 1,000 -0- (b) 900 (d) 700 3,300 200 700 Unearned Revenue Supplies Expense Salary Expense (c) 400 500 2,100 (a) 1,000 (d) 700 100 2,800 Revenue Depreciation Expense Accumulated Depreciation 15,000 3,000 (b) 900 (e) 200 (e) 200 (c) 400 3,200 16,300

Posting of Adjusting Entries (continued) Accounts Receivable Supplies Salary Payable 2,400 1,000 (a) 1,000 -0- (b) 900 (d) 700 3,300 200 700 Unearned Revenue Supplies Expense Salary Expense (c) 400 500 2,100 (a) 1,000 (d) 700 100 2,800 Revenue Depreciation Expense Accumulated Depreciation 15,000 3,000 (b) 900 (e) 200 (e) 200 (c) 400 3,200 16,300

Types of Adjusting Entries Type of Adjustment Reason for Adjustment Account Balances Before Adjustment Adjusting Entry 1. Prepaid Expenses (a) Prepaid expenses originally recorded in asset accounts before have been used Assets Overstated Expenses Understated Dr. Expenses Cr. Assets 2. Unearned Revenues (b) Unearned revenues initially recorded in liability accounts before have been earned Liabilities Overstated Revenues Understated Dr. Liabilities Cr. Revenues 3. Accrued Revenues (c) Revenues earned but not yet received in cash or recorded Assets Understated Dr. Assets 4. Accrued Expenses (d) Expenses incurred but not yet paid in cash or recorded Liabilities Understated Cr. Liabilities Each adjusting entry affects a balance sheet account and an income statement account.

Review Chapter Concepts Topic Applied Results Justification 1. Time Period Assumption Economic life of business is divided into time periods. To provide information to prepare financial statements and tax return 2. Revenue Recognition Revenue is recorded in period earned. Requires adjusting entries. To record assets or decreases in liabilities and proper reporting of revenue earned. 3. Matching Principle Record expenses in the period they occur. Requires adjusting entries. To record liabilities or use of assets and expenses incurred in earning revenues. 4. Accrual Basis Accounting Applies revenue recognition principle, matching principle, and time period assumption. To record revenue when earned and expenses when incurred.