1. The Adjusting Process
LO 1 – Understanding the Nature of the Adjusting Process

2. Nature of the Adjusting Process
LO 1
Nature of the Adjusting Process
The life of a business is divided into time periods (month, quarter, year) to provide management and owners up-to-date information about the performance of the business.
Managers and owners need regular reports on the business‘s performance. To this end, the life of the business is divided into time periods. It is usually necessary to update the business’s accounts so that financial statements contain accurate and complete information. This updating of accounts is called the adjustment process.

3. Nature of the Adjusting Process
The accounting period concept requires that revenues and expenses be reported in the proper period.
When preparing financial statements, the economic life of the business is divided into time periods. To determine the proper period, accountants use generally accepted accounting principles.

4. Nature of the Adjusting Process
Under the accrual basis of accounting, revenues are reported on the income statement in the period in which they are earned.
Generally accepted accounting principles require the accrual basis of accounting when recording the transactions of the business. Accrual basis accounting is supported by two other generally accepted accounting principles: the revenue recognition principle and the matching principle.

5. Nature of the Adjusting Process
The accounting concept supporting the reporting of revenues when they are earned regardless of when cash is received is called the revenue recognition concept.
The revenue recognition concept requires revenues to be recorded as they are earned rather than when they are collected in cash. For example, revenue is recorded when services are provided to customers or goods are delivered to the customers. Cash may or may not be received from customers during the same period.

6. Nature of the Adjusting Process
LO 1
Nature of the Adjusting Process
The accounting concept supporting reporting revenues and related expenses in the same period is called the matching concept, or matching principle.
The matching principle supports accrual basis accounting by ensuring expenses are reported in the same period as the revenues to which they relate. For example, utility expenses incurred during the month of December are recorded and matched against December revenues, even though the utility bill may not be paid until January.

7. The Adjusting Process Some expenses are not recorded daily.
LO 1
The Adjusting Process
Under the accrual basis, some of the accounts need updating at the end of the accounting period 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.
At the end of the accounting period, many of the account balances in the ledger are reported in the financial statements without change. Some accounts, however, require updating.

8. LO 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.
This process of updating account balances so that we can report accurate financial statements is known as the adjusting process.

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

10. Types of Accounts Requiring Adjustment
LO 1
Types of Accounts Requiring Adjustment
Prepaid expenses are the advance payment of future expenses and are recorded as assets when cash is paid.
Prepaid expenses are the advance payment of future expenses and are recorded as assets when cash is paid. Supplies is an example of a prepaid, or a deferred, expense that requires adjustment before accurate financial statements can be prepared. When we buy supplies, they are recorded by debiting an asset. Over time, as supplies are used, the cost of the used supplies becomes an expense. An adjusting entry is made in order to reflect this expiration of supplies and to update the balance of the asset account Supplies.

11. Prepaid Expenses LO 1 (continued)
In the case of prepaid expenses, we pay before using up the asset. Therefore, we record the prepayment by debiting an asset.
(continued)

12. Prepaid Expenses LO 1 (concluded)
Once the asset is consumed either by time passage or usage, the expired amount gets reported on the income statement, as an expense. The unused amount gets reported on the balance sheet as an asset.
(concluded)

13. Types of Accounts Requiring Adjustment
LO 1
Types of Accounts Requiring Adjustment
Unearned revenues are the advance receipt of future revenues and are recorded as liabilities when cash is received.
For unearned revenues, we get paid before providing services.

14. Unearned Revenues LO 1 (continued)
We record the prepayment by crediting a liability, Unearned Revenue.
(continued)

15. Unearned Revenues LO 1 (concluded)
The portion of the liability that is earned is reported on the income statement as a revenue. The portion of the liability that is unearned is reported on the balance sheet as a liability.
(concluded)

16. Types of Accounts Requiring Adjustment
LO 1
Types of Accounts Requiring Adjustment
Accrued revenues are unrecorded revenues that have been earned and for which cash has yet to be received.
Accrued or unpaid revenues are revenues that have been earned, but we have neither recorded or been paid for them, or recorded them--for example, interest revenue earned on a note receivable, or accounts receivable.

17. Accrued Revenues LO 1 (continued)
No journal entry has been recorded even though revenues have been earned.
(continued)

18. Accrued Revenues LO 1 (concluded)
Accrued revenues are earned in the current period and therefore are reported as earned revenue in the current income statement. Cash for these revenues will not be received until the next period; therefore, they are reported as receivables on the balance sheet.
(concluded)

19. Types of Accounts Requiring Adjustment
LO 1
Types of Accounts Requiring Adjustment
Accrued expenses are unrecorded expenses that have been incurred and for which cash has not yet been paid.
Accrued expenses are expenses that have been incurred but have not yet been paid for or recorded in the accounts. For example, wages payable due to employees at the end of the period is an example of an accrued expense.

20. Accrued Expenses LO 1 (continued)
No journal entry has been recorded even though an expense has been incurred.
(continued)

21. Accrued Expenses LO 1 (concluded)
Accrued expenses are expenses that are incurred in the current period and therefore are reported as expenses on the current income statement. They have not been paid for; therefore, they are reported as liabilities on the balance sheet.
(concluded)