Chapter 3

Adjusting the
Accounts
Financial Accounting, IFRS Edition
Weygandt Kimmel Kieso
Slide
3-1
 Adjusting
Adjusting the
the Accounts
Accounts

The Adjusted Trial

The Basics of
Timing Issues Balance and
Adjusting Entries
Financial Statements

Fiscal and calendar Types of adjusting Preparing the

years entries adjusted trial balance
Accrual- vs. cash- Adjusting entries for Preparing financial
basis accounting deferrals statements
Recognizing Adjusting entries for
revenues and accruals
expenses Summary of
journalizing and
posting

Slide
3-2
 Timing
Timing Issues
Issues

Accountants divide the economic life of a business into

artificial time periods (Time Period Assumption).

.....
Jan. Feb. Mar. Apr. Dec.

Generally a month, a quarter, or a year

Fiscal year vs. calendar year
Also known as the “Periodicity Assumption”

Slide
3-3 SO 1 Explain the time period assumption.
 Timing
Timing Issues
Issues

Accrual- vs. Cash-Basis Accounting

Accrual-Basis Accounting
Transactions recorded in the periods in which the
events occur.

Revenues are recognized when earned, rather than

when cash is received.

Expenses are recognized when incurred, rather than

when paid.

Slide
3-4
SO 2 Explain the accrual basis of accounting.
 Timing
Timing Issues
Issues

Accrual- vs. Cash-Basis Accounting

Cash-Basis Accounting
Revenues are recognized when cash is received.

Expenses are recognized when cash is paid.

Cash-basis accounting is not in accordance with

International Financial Reporting Standards (IFRS).

Slide
3-5 SO 2 Explain the accrual basis of accounting.
 Timing
Timing Issues
Issues

Recognizing Revenues and Expenses

Revenue Recognition Principle

Companies recognize
revenue in the accounting
period in which it is earned.

In a service enterprise,
revenue is considered to be
earned at the time the service
is performed.

Slide
3-6 SO 2 Explain the accrual basis of accounting.
 Timing
Timing Issues
Issues

Recognizing Revenues and Expenses

Expense Recognition Principle – (Matching Principle)
Match expenses with
revenues in the period when
the company makes efforts to
generate those revenues.

“Let the expenses follow

the revenues.”

Slide
3-7 SO 2 Explain the accrual basis of accounting.
 Timing
Timing Issues
Issues

IFRS relationships in Illustration 3-1

revenue and expense

recognition

Slide
3-8 SO 2 Explain the accrual basis of accounting.
 The
The Basics
Basics of
of Adjusting
Adjusting Entries
Entries

Adjusting entries make it possible to report correct

amounts on the statement of financial position
and on the income statement.

A company must make adjusting entries every time

it prepares financial statements.

Slide
3-9 SO 3 Explain the reasons for adjusting entries.
 The
The Basics
Basics of
of Adjusting
Adjusting Entries
Entries

Revenues - recorded in the period in which they are

earned.
earned

Expenses - recognized in the period in which they

are incurred.
incurred

Adjusting entries - needed to ensure that the

revenue recognition and expense recognition are
followed.

Slide
3-10 SO 3 Explain the reasons for adjusting entries.
 Types
Types of
of Adjusting
Adjusting Entries
Entries

Types of Adjusting Entries Illustration 3-2

Categories of adjusting entries

Deferrals Accruals
1. Prepaid Expenses. 3. Accrued Revenues.
Expenses paid in cash and Revenues earned but not yet
recorded as assets before received in cash or
they are used or consumed. recorded.

2. Unearned Revenues. 4. Accrued Expenses.

Revenues received in cash Expenses incurred but not
and recorded as liabilities yet paid in cash or recorded.
before they are earned.

Slide
3-11 SO 4 Identify the major types of adjusting entries.
 Types
Types of
of Adjusting
Adjusting Entries
Entries
Illustration 3-3

Trial Balance –
Illustrations are
based on the
October 31, trial
balance of
Pioneer
Advertising
Agency Inc.

Slide
3-12 SO 4 Identify the major types of adjusting entries.
 Types
Types of
of Adjusting
Adjusting Entries
Entries

Adjusting Entries for Deferrals

Deferrals are either:

Prepaid expenses

OR

Unearned revenues.

Slide
3-13 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”

Payment of cash that is recorded as an asset because

service or benefit will be received in the future.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

insurance rent
supplies maintenance on equipment
advertising fixed assets (depreciation)

Slide
3-14 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”

Prepaid Expenses
Costs that expire either with the passage of time or
through use.

Adjusting entries (1) to record the expenses that apply

to the current accounting period, and (2) to show the
unexpired costs in the asset accounts.

Slide
3-15 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”

Adjusting entries for prepaid expenses

Illustration 3-4

Increases (debits) an expense account and

Decreases (credits) an asset account.

Slide
3-16 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”
Illustration: Pioneer Advertising Agency purchased advertising
supplies costing $2,500 on October 5. Pioneer recorded the
payment by increasing (debiting) the asset Advertising 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 Advertising supplies expense 1,500

Advertising supplies 1,500
Illustration 3-5

Slide
3-17 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”
Illustration: On October 4, Pioneer Advertising Agency 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
Illustration 3-6

Slide
3-18 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”

Depreciation
Buildings, equipment, and vehicles (long-lived assets)
are recorded as assets, rather than an expense, in the
year acquired.

Companies report a portion of the cost of a long-lived

asset as an expense (depreciation) during each period
of the asset’s useful life.

Slide
3-19 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”
Illustration: Pioneer Advertising estimates depreciation on the
office equipment to be $480 a year, or $40 per month.

Oct. 31 Depreciation expense 40

Accumulated depreciation 40

Illustration 3-7

Slide
3-20 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”

Depreciation (Statement Presentation)

Accumulated Depreciation is a contra asset account.
Appears just after the account it offsets (Equipment) on
the statement of financial position.

Illustration 3-8

Slide
3-21 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”

Summary Illustration 3-9

Slide
3-22 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Unearned
“Unearned Revenues”
Revenues”

Receipt of cash that is recorded as a liability because the

revenue has not been earned.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

rent magazine subscriptions
airline tickets customer deposits
school tuition

Slide
3-23 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Unearned
“Unearned Revenues”
Revenues”

Unearned Revenues
Company makes an adjusting entry to record the revenue
that has been earned and to show the liability that remains.

The adjusting entry for unearned revenues results in a

 decrease (a debit) to a liability account and an

 increase (a credit) to a revenue account.

Slide
3-24 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Unearned
“Unearned Revenues”
Revenues”

Adjusting entries for unearned revenues

Illustration 3-10

Decrease (a debit) to a liability account and

Increase (a credit) to a revenue account.

Slide
3-25 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Unearned
“Unearned Revenues”
Revenues”
Illustration: Pioneer Advertising Agency 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 earned $400 of those fees in October.

Oct. 31 Unearned service revenue 400

Service revenue 400

Illustration 3-11

Slide
3-26 SO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Unearned
“Unearned Revenues”
Revenues”

Summary
Illustration 3-12

Slide
3-27 SO 5 Prepare adjusting entries for deferrals.
 Types
Types of
of Adjusting
Adjusting Entries
Entries

Adjusting Entries for Accruals

Made to record:

Revenues earned and

OR

Expenses incurred

in the current accounting period that have not been

recognized through daily entries.

Slide
3-28 SO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Revenues”
Revenues”
Revenues earned but not yet received in cash or
recorded.

Adjusting entry results in:

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

rent
interest
services performed

Slide
3-29 SO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Revenues”
Revenues”

Accrued Revenues
An adjusting entry serves two purposes:

(1) It shows the receivable that exists, and

(2) It records the revenues earned.

Slide
3-30 SO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Revenues”
Revenues”

Adjusting entries for accrued revenues

Illustration 3-13

Increases (debits) an asset account and

Increases (credits) a revenue account.

Slide
3-31 SO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Revenues”
Revenues”

Illustration: In October Pioneer Advertising Agency earned

$200 for advertising services that had not been recorded.

Oct. 31 Accounts Receivable 200

Service Revenue 200

Illustration 3-14

Slide
3-32 SO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Revenues”
Revenues”

Summary
Illustration 3-15

Slide
3-33 SO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Expenses”
Expenses”

Expenses incurred but not yet paid in cash or recorded.

Adjusting entry results in:

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

rent taxes
interest salaries

Slide
3-34 SO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Expenses”
Expenses”

Accrued Expenses
An adjusting entry serves two purposes:

(1) It records the obligations, and

(2) It recognizes the expenses.

Slide
3-35 SO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Expenses”
Expenses”

Adjusting entries for accrued expenses

Illustration 3-16

Increases (debits) an expense account and

Increases (credits) a liability account.

Slide
3-36 SO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Expenses”
Expenses”
Illustration: Pioneer Advertising Agency 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%.
Illustration 3-17

Oct. 31 Interest expense 50

Interest payable 50
Illustration 3-18

Slide
3-37 SO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Expenses”
Expenses”
Illustration: Pioneer Advertising Agency last paid salaries 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. Thus, accrued salaries at
October 31 are $1,200 ($400 x 3 days).
Illustration 3-19

Slide
3-38 SO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Expenses”
Expenses”
Illustration: Pioneer Advertising Agency last paid salaries 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. Thus, accrued salaries at
October 31 are $1,200 ($400 x 3 days).

Oct. 31 Salaries expense 1,200

Salaries payable 1,200
Illustration 3-20

Slide
3-39 SO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Expenses”
Expenses”

Summary
Illustration 3-21

Slide
3-40 SO 6 Prepare adjusting entries for accruals.
 The
The Adjusted
Adjusted Trial
Trial Balance
Balance

After all adjusting entries are journalized and posted the

company prepares another trial balance from the ledger
accounts (Adjusted Trial Balance).

Its purpose is to prove the equality of debit balances and

credit balances in the ledger.

Slide
3-41 SO 7 Describe the nature and purpose of an adjusted trial balance.
 The
The Adjusted
Adjusted Trial
Trial Balance
Balance

Illustration 3-24
Adjusted trial balance

Slide
3-42 SO 7
 Preparing
Preparing Financial
Financial Statements
Statements

Financial
FinancialStatements
Statementsare
areprepared
prepareddirectly
directlyfrom
fromthe
the
Adjusted
AdjustedTrial
Trial Balance.
Balance.

Statement Retained
Income
of Financial Earnings
Statement
Position Statement

Slide
3-43 SO 7 Describe the nature and purpose of an adjusted trial balance.
 Preparing
Preparing Financial
Financial Statements
Statements
Illustration 3-25
Preparation of
the income
statement and
retained earnings
statement from
the adjusted trial
balance

Slide
3-44 SO 7
 Preparing
Preparing Financial
Financial Statements
Statements
Illustration 3-26

Slide
3-45 SO 7