1. Adjusting the Accounts
Chapter 4
Adjusting the Accounts

2. Describe the nature of the adjusting process.

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

4. 4-1 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

5. The accounting concept that supports this approach to reporting of revenues is called the revenue recognition concept.

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

7. 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.

8. 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.

9. Adjusting Entries
The journal entries that bring the accounts up to date at the end of the accounting period are called adjusting entries.

10. Adjusting entries--
allow revenues and expenses to be recorded in the correct time period.
are dated the last day of the period.
always involved at least one balance sheet and at least one income statement account.
never involves the Cash account.

11. Accounts Requiring Adjustment
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.

12. Accounts Requiring Adjustment
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.

13. Accounts Requiring Adjusting
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.

14. Accrued expenses, sometimes referred to as accrued liabilities, are expenses that have been incurred but have not been recorded in the accounts.
Adjusting the Accounts

15. Journalize entries for accounts requiring adjustment.

16. Unadjusted Trial Balance for ABC Restaurant

17. Adjusting Process for Prepaid Expenses
ABC Restaurant’ 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.

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

19. Supplies Supplies Expense Bal. 2,000 Dec. 31 1,240 Bal. 800
Dec. 31 Supplies Expense
2007 55
Supplies 14
Supplies used ($2,000 – $760)
Supplies
Supplies Expense 14 55
Bal. 2,000
Dec. 31 1,240
Bal. 800
Dec. 31 1,240
760
2,040 23

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

21. 31 Insurance Expense 56
Prepaid Insurance 15
Insurance expired ($2,400/12).
Prepaid Insurance 15
Insurance Expense 56
Bal. 2,400
Dec
Dec
2,200 25

22. On December 1, the tenant prepaid three months’ rent for use of an office building owned by ABC Restaurant. As of December 31, only $120 has been earned.

23. 31 Unearned Rent 23
Rent Revenue 42
Rent earned ($360/3 months)
Unearned Rent 23
Rent Revenue 42
Dec
Bal. 360
Dec
240
Bal.

24. ABC Restaurant provided $500 in services during December for which the customer has not been billed.

25. 31 Accounts Receivable 12
Fees Earned 41
Accrued fees (25 hrs. x $20)
Accounts Receivable 12
Fees Earned 41
Bal. 2,220
Bal. 16,340
Dec
Dec
2,720
Bal.
16,840
Bal.

26. At the end of December, accrued wages amounted to $250. Without this adjusting entry, Wages Expense is understated.

27. 31 Wages Expense 51
Wages Payable 22
Accrued wages.
Wages Payable
Wages Expense 51 22
Dec
Bal. 4,275
Dec
Bal. 4,525

28. Wages Payable 22
Wages Expense 51
Dec
Bal. 4,275
Dec
Bal. 4,525
Closing entries will be discussed in a later chapter. For now, just be aware that Wages Expense is closed after financial statements are prepared and its balance rolled back to zero.

29. The payment of January 10 wages totaling $1,275 is shown below.
The payment of January 10 wages totaling $1,275 is shown below.
Jan. 10 Wages Expense
Wages Payable
Cash
Paid wages.

30. Dec
Wages Payable
Bal. 4,275
Wages Expense 22 51
Bal. 4,525
Jan. 10 1,025
Jan
The liability is cancelled.
An expense for wages of $1,025 is recorded in the new fiscal year.

31. 4-5 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 have been used
Assets Overstated
Expenses Understated
Dr. Expenses
Cr. Assets
2. Unearned Revenues
(b) Unearned revenues initially recorded in liability accounts 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.

32. Adjusting Entries (Part 1): Prepaids (9:26)
Adjusting Entries (Part 2): Supplies (4:44)

33. 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.

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

35. Definition of 'Depreciation'
Definition of 'Depreciation'
Depreciation is used in accounting to try to match the expense of an asset to the asset's income.
For example, if a company buys a piece of equipment for $1 million and expects it to have a useful life of 10 years, it will be depreciated over 10 years.

36. Every accounting year, the company will expense $100,000 (assuming straight-line depreciation, $1 million/10), which will be matched with the money that the equipment helps to make each year.
Depreciation(5:45)

37. Normal Titles and Related Contra Asset Accounts
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 Accumulate Depreciation— Store Equipment
Office Equipment Accumulated Depreciation— Office Equipment

38. 4-2 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 ,000
Cash ,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 $
Accumulated
Depreciation
15,000

39. ABC Restaurant estimates the depreciation on its office equipment to be $50 for the month of December.

40. 31 Depreciation Expense 53
Accum. Depreciation— Office Equipment 19
Depreciation Expense 53
Accum. Depr.—Office Equip. 19
Dec
Dec

41. ABC Restaurant’ balance sheet would show the office equipment at cost, less the accumulated depreciation.
Office equipment $1,800
Less accumulated
depreciation $1,750
Book value

42. Prepare an adjusted trial balance.

43. Adjusted Trial Balance
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.

44. Adjusted Trial Balance

45. 4-8 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.