Accounting Principles

Thirteenth Edition
Weygandt ● Kimmel ● Kieso

Chapter 3

Adjusting the Accounts

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Chapter Outline
Learning Objectives
LO 1 Explain the accrual basis of accounting and the reasons
for adjusting entries.
LO 2 Prepare adjusting entries for deferrals.
LO 3 Prepare adjusting entries for accruals.
LO 4 Describe the nature and purpose of an adjusted trial
balance.

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Accrual-Basis and Adjusting Entries
Accountants divide the economic life of a business into
artificial time periods (Time Period Assumption).

Generally a
Alternative terminology
• month,
The time period assumption is also
• quarter, or called the periodicity assumption.
• year.
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Fiscal and Calendar Years (1 of 5)
• Monthly and quarterly time periods are called interim
periods
• Most large companies must prepare both quarterly
and annual financial statements
• Fiscal Year = Accounting time period that is one year
in length
• Calendar Year = January 1 to December 31

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Fiscal and Calendar Years (2 of 5)
The time period assumption states that:
a. companies must wait until the calendar year is
completed to prepare financial statements.
b. companies use the fiscal year to report financial
information.
c. the economic life of a business can be divided into
artificial time periods.
d. companies record information in the time period in
which the events occur.

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Accrual- versus Cash-Basis Accounting (1
of 2)
Accrual-Basis Accounting
• Transactions recorded in the periods in which the events
occur
• Companies recognize revenues when they perform
services (rather than when they receive cash)
• Expenses are recognized when incurred (rather than when
paid)
• In accordance with generally accepted accounting
principles (GAAP)

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Accrual- versus Cash-Basis Accounting (2
of 2)
Cash-Basis Accounting
• Revenues recognized when cash is received
• Expenses recognized when cash is paid
• Cash-basis accounting is not in accordance with generally
accepted accounting principles (GAAP)

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Recognizing Revenues and Expenses (1 of 3)

Revenue Recognition Principle

Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.

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Recognizing Revenues and Expenses (2 of 3)

Expense Recognition Principle

(Matching Principle)
Companies recognize expenses
in the period in which they
make efforts (consume assets
or incur liabilities) to generate
revenue.

“Let the expenses follow

the revenues.”

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Fiscal and Calendar Years (4 of 5)
Which of the following statements about the accrual basis
of accounting is false?
a. Events that change a company’s financial statements are
recorded in the periods in which the events occur.
b. Revenue is recognized in the period in which services are
performed.
c. This basis is in accordance with generally accepted
accounting principles.
d. Revenue is recorded only when cash is received, and
expense is recorded only when cash is paid.

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The Need for Adjusting Entries (1 of 3)
Adjusting Entries
• Ensure that the revenue recognition and expense
recognition principles are followed.
• Necessary because the trial balance may not contain
up-to-date and complete data.
• Required every time a company prepares financial
statements.
• Will include one income statement account and one
balance sheet account.

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The Need for Adjusting Entries (2 of 3)
Adjusting entries are made to ensure that:
a. expenses are recognized in the period in which they are
incurred.
b. revenues are recorded in the period in which services are
performed.
c. balance sheet and income statement accounts have correct
balances at the end of an accounting period.
d. All the responses above are correct.

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Types of Adjusting Entries
Deferrals Accruals
1. Prepaid Expenses. Expenses 1. Accrued Revenues. Revenues
paid in cash before they are for services performed but not
used or consumed. yet received in cash or recorded.
2. Unearned Revenues. Cash 2. Accrued Expenses. Expenses
received before services are incurred but not yet paid in cash
performed. or recorded.

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Do It! 1: Timing Concepts (2 of 2)
Below is a list of timing concepts in the (a) Monthly and quarterly time periods.
left column, with a description of the
concept in the right column. There are (b) Efforts (expenses) should be recognized in the
more descriptions provided than period in which a company uses assets or
concepts. Match the description to the incurs liabilities to generate results
concept (revenues).
(c) Accountants divide the economic life of a
1. f Accrual-basis accounting. business into artificial time periods.
2. e Calendar year.
(d) Companies record revenues when they
3. c Time period assumption. receive cash and record expenses when they
4. b Expense recognition principle. pay out cash.
(e) An accounting time period that starts on
January 1 and ends on December 31.
(f) Companies record transactions in the period in
which the events occur.
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Adjusting Entries for Deferrals
Deferrals are expenses or revenues that are recognized
at a date later than the point when cash was originally
exchanged. There are two types:
• Prepaid expenses
• Unearned revenues

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Prepaid Expenses (1 of 5)
Payments of expenses that are recorded as an asset to show
the service or benefit the company will receive in the future.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

• insurance • rent
• supplies • equipment
• advertising • buildings

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Prepaid Expenses (2 of 5)
• Expire either with the passage of time or through use
• Adjusting entry:
o Increase (debit) to an expense account and
o Decrease (credit) to an asset account

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Prepaid Expenses (3 of 5)

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Adjustment for Supplies (1 of 2)
Illustration: Pioneer Advertising purchased
supplies costing $2,500 on October 5.
Pioneer recorded the payment by increasing
(debiting) the asset Supplies. This account
shows a balance of $2,500 in the October 31
trial balance. An inventory count at the close
of business on October 31 reveals that
$1,000 of supplies are still on hand.

Oct. 31 Supplies Expense 1,500

Supplies 1,500

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Adjustment for Supplies (2 of 2)

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Adjustment for Insurance (1 of 2)
Illustration: On October 4, Pioneer Advertising
paid $600 for a one-year fire insurance policy.
Coverage began on October 1. Pioneer recorded
the payment by increasing (debiting) Prepaid
Insurance. This account shows a balance of
$600 in the October 31 trial balance. Insurance
of $50 ($600 ÷ 12) expires each month.

Oct. 31 Insurance Expense 50

Prepaid Insurance 50

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Adjustment for Insurance (2 of 2)

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Depreciation (1 of 4)
• Buildings, equipment, and motor vehicles (assets that
provide service for many years) are recorded as assets,
rather than an expense, on the date acquired
• Depreciation is the process of allocating the cost of an
asset to expense over its useful life
• Depreciation does not attempt to report the actual
change in the value of the asset
o Allocation concept, not a valuation concept

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Adjustment for Depreciation (2 of 4)
Illustration: For Pioneer Advertising, assume
that depreciation on the equipment is $480 a
year, or $40 per month.

Oct. 31

Depreciation Expense 40
Accumulated Depreciation 40

Accumulated Depreciation is called a

contra asset account.

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Adjustment for Depreciation (3 of 4)

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Depreciation (4 of 4)
Statement Presentation
• Accumulated Depreciation is a contra asset account (credit)
• Offsets related asset account on the balance sheet
• Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation
Equipment $5,000
Less: Accumulated depreciation—equipment 40
$4,960

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Prepaid Expenses (4 of 5)
Accounting for Prepaid Expenses
Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Insurance, Prepaid expense Assets Dr. Expenses
supplies, originally overstated. Cr. Assets or
advertising, rent, recorded Expenses Contra Assets
Depreciation in asset accounts understated.
have been used.

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Unearned Revenues (1 of 5)
Receipt of cash that is recorded as a liability because the
service has not been performed.

Cash receipt BEFORE revenue recorded

Unearned revenues often occur in regard to:

• Rent • Magazine subscriptions
• Airline tickets • Customer deposits

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Unearned Revenues (2 of 5)
• Adjusting entry is made to record the revenue for services
performed during the period and to show the liability that
remains at the end of the period
• Results in a decrease (debit) to a liability account and an
increase (credit) to a revenue account

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Unearned Revenues (3 of 5)
Illustration: Pioneer Advertising received
$1,200 on October 2 from R. Knox for
advertising services expected to be
completed by December 31. Unearned
Service Revenue shows a balance of
$1,200 in the October 31 trial balance.
Analysis reveals that the company
performed $400 of services in October.

Oct. 31 Unearned Service Revenue 400

Service Revenue 400

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Unearned Revenues (4 of 5)

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Unearned Revenues (5 of 5)
Accounting for Unearned Revenue
Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Rent, magazine Unearned revenues Liabilities Dr. Liabilities
subscriptions, recorded in liability overstated. Cr. Revenues
customer deposits accounts are now Revenues
for future service recognized as understated.
revenue for services
performed.

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Do It! 2: Adjusting Entries for Deferrals (1 of 5)

The ledger of Hammond Company, on March 31, 2020, includes these selected accounts before
adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200

An analysis of the accounts shows the following.

1. Insurance expires at the rate of $100 per month.
2. Supplies on hand total $800.
3. The equipment depreciates $200 a month.
4. During March, services were performed for $4,000 of the unearned service revenue reported.
Prepare the adjusting entries for the month of March.
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Do It! 2: Adjusting Entries for Deferrals (2 of 5)

The ledger of Hammond Company, on March 31, 2020, includes these selected accounts before
adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200

Prepare the adjusting entries for the month of March.

1. Insurance expires at the rate of $100 per month.

Insurance Expense 100

Prepaid Insurance 100
(To record insurance expired)

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Do It! 2: Adjusting Entries for Deferrals (3 of 5)

The ledger of Hammond Company, on March 31, 2020, includes these selected accounts before
adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200

Prepare the adjusting entries for the month of March.

2. Supplies on hand total $800.

Supplies Expense 2,000

Supplies 2,000
(To record supplies used)

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Do It! 2: Adjusting Entries for Deferrals (4 of 5)

The ledger of Hammond Company, on March 31, 2020, includes these selected accounts before
adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200

Prepare the adjusting entries for the month of March.

3. The equipment depreciates $200 a month.

Depreciation Expense 200

Accumulated Depreciation—Equipment 200
(To record monthly depreciation)

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Do It! 2: Adjusting Entries for Deferrals (5 of 5)

The ledger of Hammond Company, on March 31, 2020, includes these selected accounts before
adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200

Prepare the adjusting entries for the month of March.

4. During March, services were performed for $4,000 of the unearned service revenue reported.

Unearned Service Revenue 4,000

Service Revenue 4,000
(To record revenue for services performed)

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Adjusting Entries for Accruals
Accruals are made to record,
• Revenues for services performed but not yet recorded at
the statement date
• Expenses incurred but not yet paid or recorded at the
statement date

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Accrued Revenues (1 of 5)
Revenues for services performed but not yet received in cash
or recorded.

Revenue recorded BEFORE cash receipt

Accrued revenues often occur in regard to:

• Rent
• Interest
• Services

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Accrued Revenues (2 of 5)
• Adjusting entry records the receivable that exists and
records the revenues for services performed.
• Adjusting entry:
o Increases (debits) an asset account and
o Increases (credits) a revenue account

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Accrued Revenues (3 of 5)
Illustration: In October Pioneer Advertising
performed services worth $200 that were
not billed to clients on or before October 31.
Oct. 31
Accounts Receivable 200
Service Revenue 200
(To record revenue for services performed)
On November 10, Pioneer receives cash of $200 for the services
performed. The journal entry on the 10th is:
Cash 200
Accounts Receivable 200
(To record cash collected on account)
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Accrued Revenues (4 of 5)

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Accrued Revenues (5 of 5)
Accounting for Accrued Revenues
Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Interest, Services performed Assets Dr. Assets
rent, services but not yet received understated. Cr. Revenues
In cash or recorded. Revenues
understated.

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Accrued Expenses (1 of 7)
Expenses incurred but not yet paid in cash or recorded.

Expense recorded BEFORE cash payment

Accrued expenses often occur in regard to:

• Rent • Taxes
• Interest • Salaries

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Adjusting Accrued Expenses (2 of 7)
• Adjusting entry records the obligation and recognizes
the expense.
• Adjusting entry:
o Increase (debit) an expense account and
o Increase (credit) a liability account

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Accrued Expenses (3 of 7)
Accrued Interest
Illustration: Pioneer Advertising signed a three-month note
payable in the amount of $5,000 on October 1. The note requires
Pioneer to pay interest at an annual rate of 12%.

Face Value Annual Time in Terms

of Note × Interest Rate × of One Year = Interest
$5,000 × 12% × 1 = $50
12

Oct. 31 Interest Expense 50

Interest Payable 50

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Accrued Expenses (4 of 7)

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Accrued Expenses (5 of 7)
Accrued Salaries and Wages
Illustration: Pioneer Advertising paid salaries and wages on October 26; the
next payment of salaries will not occur until November 9. The employees
receive total salaries of $2,000 for a five-day work week, or $400 per day.

On October 31, the salaries and wages for three remaining working days
(October 29 to 31) represent an accrued expense and a related liability.
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Accrued Expenses (6 of 7)

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Accrued Expenses (7 of 7)
Accounting for Accrued Expenses
Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Interest, Expenses have Expenses Dr. Expenses
rent, salaries been incurred but understated. Cr. Liabilities
not yet paid in Liabilities
cash or recorded. understated.

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Summary of Basic Relationships
Accounts Before
Type of Adjustment Adjustment Adjusting Entry
Prepaid expenses Assets overstated. Dr. Expense
Expenses understated. Cr. Assets or Contra
Assets
Unearned revenues Liabilities overstated. Dr. Liabilities
Revenues understated. Cr. Revenues
Accrued revenues Assets understated. Dr. Assets
Revenues understated. Cr. Revenues
Accrued expenses Expenses understated. Dr. Expenses
Liabilities understated. Cr. Liabilities

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Do It! 3: Adjusting Entries for Accruals (1 of 3)

Micro Computer Services began operations on August 1, 2020. At

the end of August 2020, management prepares monthly financial
statements. The following information relates to August.
1. At August 31, the company owed its employees $800 in salaries
and wages that will be paid on September 1.
2. On August 1, the company borrowed $30,000 from a local bank
on a 15-year mortgage. The annual interest rate is 10%.
3. Revenue for services performed but unrecorded for August
totaled $1,100.
Prepare the adjusting entries needed at August 31, 2020.

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Do It! 3: Adjusting Entries for Accruals (2 of 3)
Prepare the adjusting entries needed at August 31, 2020.
1. At August 31, the company owed its employees $800 in salaries
and wages that will be paid on September 1.
Salaries and Wages Expense 800
Salaries and Wages Payable 800
(To record accrued salaries)

2. On August 1, the company borrowed $30,000 from a local bank

on a 15-year mortgage. The annual interest rate is 10%.
Interest Expense 250
Interest Payable 250
(To record accrued interest)
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Do It! 3: Adjusting Entries for Accruals (3 of 3)

Prepare the adjusting entries needed at August 31, 2020.

3. Revenue for services performed but unrecorded for August
totaled $1,100.
Accounts Receivable 1,100
Service Revenue 1,100
(To record revenue for services performed)

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Adjusted Trial Balance (1 of 4)
• Prepared after adjusting entries are journalized and posted
• Proves equality of debit and credit balances
• Basis for the preparation of financial statements

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Adjusted Trial Balance (2 of 4)

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Adjusted Trial Balance (3 of 4)
Which of the following statements is incorrect concerning the
adjusted trial balance?
a. An adjusted trial balance proves the equality of the total debit
balances and the total credit balances in the ledger after all
adjustments are made.
b. The adjusted trial balance provides the primary basis for the
preparation of financial statements.
c. The adjusted trial balance lists the account balances segregated
by assets and liabilities.
d. The adjusted trial balance is prepared after the adjusting entries
have been journalized and posted.

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Appendix : Financial Reporting
Concepts (1 of 2)
Qualities of Useful Information
Two fundamental qualities
1. Relevance
• Make a difference in a business decision
• Provides information that has predictive value and
confirmatory value

2. Faithful Representation
• Information accurately depicts what really happened.

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Qualities of Useful Information
Enhancing Qualities
• Comparability results when different companies use the
same accounting principles.
• Consistency means that a company uses the same
accounting principles and methods from year to year.
• Information is verifiable if independent observers, using the
same methods, obtain similar results.
• For accounting information to have relevance, it must be
timely.
• Information has the quality of understandability if it is
presented in a clear and concise fashion.
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Copyright
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