Accounting

John Wiley & Sons, Inc.

 PREVIEW OF CHAPTER 3
ADJUSTING THE
ACCOUNTS

The Adjusted Trial Accrual vs. Cash

The Basics of
Timing Issues Balance and Basis of
Adjusting Entries Financial Statements
Accounting
 Time Period  Types of  Preparing the
assumption adjusting entries adjusted trial

balance
 Fiscal and Adjusting entries
calendar years for prepayments  Preparing

financial
Recognizing Adjusting entries

statements
revenues and for accruals
expenses  Summary
 TIME-PERIOD ASSUMPTION

 The time period (or periodicity) assumption assumes

that the economic life of a business can be divided into
artificial time periods.
 Accounting time periods are generally a month, a
quarter, or a year.
 The accounting time period of one year in
length is usually known as a fiscal year.
 The accounting period used by most
businesses coincides with the calendar
year (January 1 to December 31).
 REVENUE RECOGNITION
PRINCIPLE
 The revenue recognition principle states
that revenue should be recognized in the
accounting period in which it is earned.
 In a service business, revenue is considered
to be earned at the time the service is
performed.
 THE MATCHING PRINCIPLE

 The practice of expense recognition is

referred to as the matching principle.
 The matching principle dictates that efforts
(expenses) be matched with accomplishments
(revenues).

Revenues expenses
earned are offset incurred in
this month against.... earning the
revenue
 ADJUSTING ENTRIES

Adjusting entries are made in order for:

1 Revenues to be recorded in the period in
which they are earned, and for......
2 Expenses to be recognized in the period in
which they are incurred.
 ADJUSTING ENTRIES

Adjusting entries are required each time

financial statements are prepared.
Adjusting entries can be classified as
1 defferals (prepaid expenses or
unearned revenues) or
2 accruals (accrued revenues or accrued
expenses)
Definition Accrual: An Accrual is an
expense that has not been paid or a
revenue that has no been received
Examples of Accruals:
Expenses:
Salaries, interest, taxes
Revenue:
Services (performed on account)
 TYPES OF
ADJUSTING ENTRIES

Accruals
1 Accrued Revenues - revenues earned but not
yet received in cash or recorded
2 Accrued Expenses - expenses incurred but
not yet paid in cash or recorded
Definition Deferral: A Deferral is
delay in recognition of an expense
already paid or or a revenue already
received.
Examples of Accruals:
Expenses:
Supplies, insurance, rent (tenant)
Revenue:
Subscription, rent (landlord)
 TYPES OF
ADJUSTING ENTRIES

Deferrals
1 Prepaid Expenses - expenses paid in cash
and recorded as assets before they are used
or consumed
2 Unearned Revenues - revenues received in
cash and recorded as liabilities before they
are earned
 Accruals cash after the event 
Employee salary, Utility bill, Owe money on a note

Deferrals cash before the event 

Office supplies, Prepaid Expenses
Unearned revenue
 ILLUSTRATION 3-3
TRIAL BALANCE
PIONEER ADVERTISING AGENCY, INC.
Trial Balance
October 31, 2001
Debit Credit
Cash $ 15,200
Advertising Supplies The Trial Balance 2,500
Prepaid Insurance is the starting place 600
Office Equipment 5,000
Notes Payable for adjusting $ 5,000
Accounts Payable 2,500
Unearned Revenue
entries. 1,200
Common Stock 10,000
Retained Earnings -0-
Dividends 500
Service Revenue 10,000
Salaries Expense 4,000
Rent Expense 900
$ 28,700 $ 28,700
 PREPAYMENTS/
DEFERRALS

 Prepayments/Deferrals are either

prepaid expenses or unearned revenues.
 Adjusting entries for prepayments are
required to record the portion of the
prepayment that represents
1 the expense incurred or
2 the revenue earned in the current
accounting period.
 ILLUSTRATION 3-4
ADJUSTING ENTRIES FOR PREPAYMENTS

Adjusting Entries
Prepaid Expenses
Asset Expense
Unadjusted Credit Debit
Balance Adjusting Adjusting
Entry (-) Entry (+)
Unearned Revenues
Liability Revenue
Debit Unadjusted Credit
Adjusting Balance Adjusting
Entry (-) Entry (+)
 PREPAID EXPENSES

 Prepaid expenses are expenses paid in

cash and recorded as assets before they
are used or consumed.
 Prepaid expenses expire with the
passage of time or through use and
consumption.
 An asset-expense account relationship
exists with prepaid expenses.
 PREPAID EXPENSES

 Prior to adjustment, assets are overstated

and expenses are understated.
 The adjusting entry results in a debit to an
expense account and a credit to an asset
account.
 Examples of prepaid expenses include
supplies, insurance, and depreciation.
 ADJUSTING ENTRIES FOR PREPAYMENTS
SUPPLIES

October 31, an inventory count reveals that $1,000 of

Adjustment $2,500 of supplies arestill on hand.

Date Account Titles and Explanation Debit Credit

Journal Oct. 31 Advertising Supplies Expense 1,500
Advertising Supplies 1,500
Entry (To record supplies used)

Advertising Supplies Advertising Supplies Expense

Posting Oct. 5 2,500 Oct. 31 1,500 Oct. 31 1,500
31 1,000
 ADJUSTING ENTRIES FOR PREPAYMENTS
INSURANCE

October 31, an analysis of the policy reveals that $50 of

Adjustment insurance expires each month.

Date Account Titles and Explanation Debit Credit

Oct. 31 Insurance Expense 50
Journal Prepaid Insurance 50
Entry (To record insurance
expired)

Prepaid Insurance 10 Insurance Expense 63

Posting Oct. 4 600 Oct. 31 50 Oct. 31 50
31 550
 UNEARNED REVENUES

Unearned revenues are revenues

received and recorded as liabilities
before they are earned.
Unearned revenues are subsequently
earned by rendering a service to a
customer.
A liability-revenue account relationship
exists with unearned revenues.
 UNEARNED REVENUES

 Prior to adjustment, liabilities are

overstated and revenues are understated.
 The adjusting entry results in a debit to a
liability account and a credit to a revenue
account.
 Examples of unearned revenues include
rent, magazine subscriptions, and customer
deposits for future services.
 ADJUSTING ENTRIES FOR PREPAYMENTS
UNEARNED REVENUES

October 31, analysis reveals that, of $1,200 in fees, $400

Adjustment has been earned in October.

Date Account Titles and Explanation Debit Credit

Journal Oct. 31 Unearned Revenue 400
Service Revenue 400
Entry (To record revenue for services
provided

Unearned Revenue Service Revenue

Posting Oct. 31 400 Oct. 2 1,200 Oct. 31 10,000
31 800 31 400
 ACCRUALS

The second category of adjusting entries

is accruals.
Adjusting entries for accruals are
required to record revenues earned and
expenses incurred in the current period.
The adjusting entry for accruals will
increase both a balance sheet and an
income statement account.
 ILLUSTRATION 3-10
ADJUSTING ENTRIES FOR ACCRUALS

Adjusting Entries
Accrued Revenues
Asset Revenue
Debit Credit
Adjusting Adjusting
Entry (+) Entry (+)
Accrued Expenses
Expense Liability
Debit Credit
Adjusting Adjusting
Entry (+) Entry (+)
 ACCRUED REVENUES

 Accrued revenues may accumulate with the

passing of time or through services
performed but not billed or collected.
 An asset-revenue account relationship
exists with accrued revenues.
 Prior to adjustment, assets and revenues
are understated.
 The adjusting entry requires a debit to an
asset account and a credit to a revenue
account.
 ADJUSTING ENTRIES FOR ACCRUALS
ACCRUED REVENUES

October 31, the agency earned $200 in fees for

Adjustment advertising services that were not billed to clients before
October 31.

Date Account Titles and Explanation Debit Credit

Journal Oct. 31 Accounts Receivable
Service Revenue
200
200
Entry (To accrue fees earned but
not billed or collected)

Service Revenue
Accounts Receivable Oct. 31 10,000
Oct. 31 200 31 400
Posting 31 200
31 10,600
 ACCRUED EXPENSES

 Accrued expenses are expenses incurred

but not paid yet.
 A liability-expense account relationship
exists
 Prior to adjustment, liabilities and expenses
are understated
 The Adjusting Entry results in a debit to an
expense account and a credit to a liability
account
 ADJUSTING ENTRIES FOR ACCRUALS
ACCRUED INTEREST

October 31, the portion of the interest to be accrued on a

Adjustment 3-month note payable is calculated to be $50.

Date Account Titles and Explanation Debit Credit

Journal Oct. 31 Interest Expense 50
Interest Payable 50
Entry (To accrue interest on notes
payable)

Interest Expense Interest Payable

Posting Oct. 31 50 Oct. 31 50
 ADJUSTING ENTRIES FOR ACCRUALS
ACCRUED SALARIES

Adjustment October 31, accrued salaries are calculated to be $1,200.

Date Account Titles and Explanation Debit Credit

Journal Oct. 31 Salaries Expense 1,200
Salaries Payable 1,200
Entry (To record accrued salaries)

Salaries Expense
Oct. 26 4,000 Salaries Payable
Posting 31 1,200 Oct. 31 1,200
31 5,200
 ILLUSTRATION 3-14
SUMMARY OF ADJUSTING ENTRIES
Type of Account Accounts before Adjusting
Adjustment Relationship Adjustment Entry

1 Prepaid Assets and Assets overstated Dr. Expenses

expenses expenses Expenses understated Cr. Assets
2 Unearned Liabilities and Liabilities overstated Dr. Liabilities
revenues revenues Revenues understated Cr. Revenues
3 Accrued Assets and Assets understated Dr. Assets
revenues revenues Revenues understated Cr. Revenues
4 Accrued Expenses and Expenses understated Dr. Expenses
expenses liabilities Liabilities understated Cr. Liabilities
 ADJUSTED TRIAL BALANCE

 An Adjusted Trial Balance is prepared after all

adjusting entries have been journalized and posted.
 It shows the balances of all accounts at the end of
the accounting period and the effects of all financial
events that have occurred during the period.
 It proves the equality of the total debit and credit
balances in the ledger after all adjustments have
been made.
 Financial statements can be prepared directly from
the adjusted trial balance.
 ILLUSTRATION 3-18
TRIAL BALANCE AND ADJUSTED TRIAL BALANCE COMPARED

PIONEER ADVERTISING AGENCY, INC.

Trial Balances
October 31, 2001
Before After
Adjustment Adjustment
Debit Credit Debit Credit
Cash $ 15,200 $ 15,200
Accounts Receivable 200
Advertising Supplies 2,500 1,000
Prepaid Insurance 600 550
Office Equipment 5,000 5,000
Accumulated Depreciation - Office Equipment $ 40
Notes Payable $ 5,000 5,000
Accounts Payable 2,500 2,500
Interest Payable 50
Unearned Revenue 1,200 800
Salaries Payable 1,200
Common Stock 10,000 10,000
Retained Earnings –0– –0–
Dividends 500 500
Service Revenue 10,000 10,600
Salaries Expense 4,000 5,200
Advertising Supplies Expense 1,500
Rent Expense 900 900
Insurance Expense 50
Interest Expense 50
Depreciation Expense 40
$ 28,700 $ 28,700 $ 30,190 $ 30,190
 ACCRUAL BASIS OF
ACCOUNTING
 The revenue recognition and matching
principles are used under the accrual basis
of accounting.
 Under cash-basis accounting, revenue is
recorded only when cash is received, and
expenses are recorded only when paid.
 Generally accepted accounting principles
require accrual basis accounting because
the cash basis often causes misleading
financial statements.