1. Chapter 3
The Adjusting Process

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

3. 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.

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

5. 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.

6. 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.

7. 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.

8. Example Exercise 3-1 Accounts Requiring Adjustment
Indicate with a Yes or No whether or not each of the following accounts normally requires an adjusting entry.
Cash d. Office Equipment
Prepaid Rent e. Accounts Receivable
Wages Expense f. Unearned Rent

9. Cash d. Office Equipment Prepaid Rent e. Accounts Receivable
Example Exercise 3-1 (continued)
Cash d. Office Equipment
Prepaid Rent e. Accounts Receivable
Wages Expense f. Unearned Rent No No
Yes
Yes
Yes
Yes

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

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

12. Type of Adjustments: Prepaid Expenses and Unearned Revenues
Exhibit 1

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

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

15. Type of Adjustments: Accrued Revenues and Expenses
Exhibit 2

16. Example Exercise 3-2 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.
a. Accrued expense
c. Unearned revenue
b. Prepaid expense
d. Accrued revenue

17. 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 – 760
Supplies used $1,240

18. Supplies Supplies Expense Dec. 31 1,240 Bal. 800 Dec. 31 1,240 76014 55
Dec. 31 1,240
Bal. 800
Dec. 31 1,240
760
2,040

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

20. Prepaid Insurance 15
Insurance Expense 56
Bal. 2,400
Dec
Dec
2,200

21. Example Exercise 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).

22. Example Exercise 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.
Unearned Fees……………………………. 22,600
Fees Earned………………………….. 22,600
Fees earned ($44,900 – $22,300).

23. Example Exercise 3-5 Follow My Example 3-5 Adjustment for Accrued Fees
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.

24. Example Exercise 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 ÷ days) × 4 days].

25. 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.

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

27. 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

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

29. Depreciation Expense 53
Accum. Depr.—Office Equip. 19
Dec

30. Depreciation Expense 53
Accum. Depr.—Office Equip. 19
Dec
Dec

31. NetSolutions’ balance sheet would show office equipment at cost, less accumulated depreciation.
Book value

32. Example Exercise 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.

33. Exhibit 7
Adjusting Entries—NetSolutions

34. Adjusting Entries—NetSolutions (continued)
Exhibit 7
Adjusting Entries—NetSolutions (continued) .

35. Example Exercise 3-8
Effect of Omitting Adjustments
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 2010.

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

37. 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.

38. Exhibit 9
Adjusted Trial Balance—NetSolutions

39. THE END