Ch03 adjusting the accounts

Chapter 3-1

Chapter 3-2

Adjusting theAccounts

Accounting Principles, Ninth Edition

Chapter 3-3

1. Explain the time period assumption.2. Explain the accrual basis of accounting.3. Explain the reasons for adjusting entries.4. Identify the major types of adjusting entries.5. Prepare adjusting entries for deferrals.6. Prepare adjusting entries for accruals.7. Describe the nature and purpose of an adjusted

trial balance.

Study ObjectivesStudy Objectives

Chapter 3-4

Types of Types of adjusting entriesadjusting entriesAdjusting entries Adjusting entries for deferralsfor deferralsAdjusting entries Adjusting entries for accrualsfor accrualsSummary of Summary of journalizing and journalizing and postingposting

Timing IssuesTiming Issues

Fiscal and Fiscal and calendar yearscalendar yearsAccrual- vs. cash-Accrual- vs. cash-basis accountingbasis accountingRecognizing Recognizing revenues and revenues and expensesexpenses

Preparing the Preparing the adjusted trial adjusted trial balancebalancePreparing Preparing financial financial statementsstatements

The Basics of The Basics of Adjusting EntriesAdjusting Entries

The Adjusted The Adjusted Trial Balance and Trial Balance and

Financial Financial StatementsStatements

Adjusting the AccountsAdjusting the Accounts

Chapter 3-5

Generally a month, a quarter, or a year.Fiscal year vs. calendar yearAlso known as the “Periodicity Assumption”


Accountants divide the economic life of a business into artificial time periods (Time Period Assumption).

SO 1 Explain the time period assumption.SO 1 Explain the time period assumption.

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

Chapter 3-6

The time period assumption states that:The time period assumption states that:a.a. revenue should be recognized in the

accounting period in which it is earned.b. expenses should be matched with revenues.c. the economic life of a business can be divided

into artificial time periods.d. the fiscal year should correspond with the

calendar year.

ReviewReview


SO 1 Explain the time period assumption.SO 1 Explain the time period assumption.

Chapter 3-7

Accrual-Basis AccountingTransactions recorded in the periods in which the events occurRevenues are recognized when earned, rather than when cash is received. Expenses are recognized when incurred, rather than when paid.


Accrual- vs. Cash-Basis Accounting

SO 2 Explain the accrual basis of accounting.SO 2 Explain the accrual basis of accounting.

Chapter 3-8

Cash-Basis AccountingRevenues are recognized when cash is received.Expenses are recognized when cash is paid. Cash-basis accounting is not in accordance with generally accepted accounting principles (GAAP).


Accrual- vs. Cash-Basis Accounting


Chapter 3-9

Revenue Recognition Principle


Recognizing Revenues and Expenses


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.

Chapter 3-10

Matching Principle


Recognizing Revenues and Expenses


Match expenses with revenues in the period when the company makes efforts to generate those revenues.

“Let the expenses follow the revenues.”

Chapter 3-11



GAAP relationships in revenue and expense recognition

Illustration 3-1

Chapter 3-12 SO 2 Explain the accrual basis of accounting.SO 2 Explain the accrual basis of accounting.

Chapter 3-13

One of the following statements about the accrual basis of accounting is false. That statement is:

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 it is earned.

c. The accrual basis of accounting is in accord with generally accepted accounting principles.

d. Revenue is recorded only when cash is received, and expenses are recorded only when cash is paid.

ReviewReview



Chapter 3-14

Adjusting entries make it possible to report correct amounts on the balance sheet and on the income statement.

A company must make adjusting entries every time it prepares financial statements.

The Basics of Adjusting EntriesThe Basics of Adjusting Entries

SO 3 Explain the reasons for adjusting entries.SO 3 Explain the reasons for adjusting entries.

Chapter 3-15

RevenuesRevenues - recorded in the period in - recorded in the period in which they are earnedwhich they are earned.Expenses Expenses - recognized in the period in - recognized in the period in which they are incurredwhich they are incurred.Adjusting entriesAdjusting entries - needed to ensure - needed to ensure that the that the revenue recognitionrevenue recognition and and matching principlesmatching principles are followed. are followed.

The Basics of Adjusting EntriesThe Basics of Adjusting Entries


Chapter 3-16

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 they are earned.c. balance sheet and income statement

accounts have correct balances at the end of an accounting period.

d. all of the above.

ReviewReview



Chapter 3-17

Types of Adjusting EntriesTypes of Adjusting Entries

1. Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed.

Deferrals3. Accrued Revenues.

Revenues earned but not yet received in cash or recorded.

4. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded.

2. Unearned Revenues. Revenues received in cash and recorded as liabilities before they are earned.

Accruals

SO 4 Identify the major types of adjusting entries.SO 4 Identify the major types of adjusting entries.

Illustration 4-2Categories of adjusting entries

Chapter 3-18

Trial BalanceTrial Balance – Each account is analyzed to determine whether it is complete and up-to-date.

Illustration 3-3

Trial BalanceTrial Balance

SO 4 Identify the major types of adjusting entries.SO 4 Identify the major types of adjusting entries.

Chapter 3-19

Deferrals are either: Prepaid expenses

OR

Unearned revenues.

Adjusting Entries for DeferralsAdjusting Entries for Deferrals

SO 5 Prepare adjusting entries for deferrals.SO 5 Prepare adjusting entries for deferrals.

Chapter 3-20

Payment of cash that is recorded as an asset because Payment of cash that is recorded as an asset because service or benefit will be received in the future.service or benefit will be received in the future.

Adjusting Entries for “Prepaid Adjusting Entries for “Prepaid Expenses”Expenses”

insuranceinsurancesuppliessuppliesadvertisingadvertising

Cash Payment Expense RecordedBEFORE


rentrentmaintenance on maintenance on equipmentequipmentfixed assets fixed assets (depreciation)(depreciation)

Prepayments often occur in regard to:Prepayments often occur in regard to:

Chapter 3-21

Prepaid ExpensesCosts 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.



Chapter 3-22



Adjusting entries for prepaid expenses

Increases (debits) an expense account and Decreases (credits) an asset account.

Illustration 3-4

Chapter 3-23

Illustration: Pioneer Advertising Agency purchased advertising supplies costing $2,500 on October 5. Sierra 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.

Advertising supplies 1,500Advertising supplies expense

1,500Oct. 31

Illustration 3-5



Chapter 3-24

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 theOctober 31 trial balance. Insurance of $50 ($600 / 12) expires each month.

Prepaid insurance 50Insurance expense 50Oct. 31

Illustration 3-6



Chapter 3-25

DepreciationBuildings, 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 (Matching Principle).



Chapter 3-26

Illustration: Pioneer Advertising estimates depreciation on the office equipment to be $480 a year, or $40 per month.

Accumulated depreciation

40Depreciation expense 40Oct. 31

Illustration 3-7



Chapter 3-27

Depreciation (Statement Presentation)Accumulated Depreciation is a contra asset account.Appears just after the account it offsets (Equipment) on the balance sheet. Illustration 3-8



Chapter 3-28

Summary Illustration 3-9



Chapter 3-29

Receipt of cash that is recorded as a liability Receipt of cash that is recorded as a liability because the revenue has not been earned.because the revenue has not been earned.

Adjusting Entries for “Unearned Adjusting Entries for “Unearned Revenues”Revenues”

rentrentairline ticketsairline ticketsschool tuitionschool tuition

Cash Receipt Revenue RecordedBEFORE

magazine subscriptionsmagazine subscriptionscustomer depositscustomer deposits

Unearned revenues often occur in regard to:Unearned revenues often occur in regard to:


Chapter 3-30

Unearned RevenuesCompany 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.



Chapter 3-31 SO 5 Prepare adjusting entries for deferrals.SO 5 Prepare adjusting entries for deferrals.

Adjusting entries for unearned revenues

Decrease (a debit) to a liability account and Increase (a credit) to a revenue account.


Illustration 3-10

Chapter 3-32


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.

Service revenue 400Unearned service revenue 400Oct. 31

Illustration 3-11


Chapter 3-33

Summary


Illustration 3-12


Chapter 3-34 SO 5 Prepare adjusting entries for deferrals.SO 5 Prepare adjusting entries for deferrals.

Chapter 3-35

Made to record: Revenues earned and

OR

Expenses incurred

in the current accounting period that have not been recognized through daily entries.

Adjusting Entries for AccrualsAdjusting Entries for Accruals

SO 6 Prepare adjusting entries for accruals.SO 6 Prepare adjusting entries for accruals.

Chapter 3-36

Revenues earned but not yet received in cash or Revenues earned but not yet received in cash or recorded.recorded.

Adjusting Entries for “Accrued Adjusting Entries for “Accrued Revenues”Revenues”

rentrentinterestinterestservices performedservices performed

BEFORE

Accrued revenues often occur in regard to:Accrued revenues often occur in regard to:

Cash ReceiptRevenue Recorded

Adjusting entry results in:Adjusting entry results in:


Chapter 3-37

Accrued RevenuesAn adjusting entry serves two purposes:

(1) It shows the receivable that exists, and

(2) It records the revenues earned.



Chapter 3-38

Adjusting entries for accrued revenues

Increases (debits) an asset account and Increases (credits) a revenue account.



Illustration 3-13

Chapter 3-39

Illustration: In October Pioneer Advertising Agency earned $200 for advertising services that had not been recorded.

Service Revenue 200Accounts Receivable 200Oct. 31

Illustration 3-14



Chapter 3-40

SummaryIllustration 3-15



Chapter 3-41

Expenses incurred but not yet paid in cash or Expenses incurred but not yet paid in cash or recorded.recorded.

Adjusting Entries for “Accrued Adjusting Entries for “Accrued Expenses”Expenses”

rentrentinterestinterest

BEFORE

Accrued expenses often occur in regard to:Accrued expenses often occur in regard to:

Cash PaymentExpense Recorded

taxestaxessalariessalaries

Adjusting entry results in:Adjusting entry results in:


Chapter 3-42

Accrued ExpensesAn adjusting entry serves two purposes:

(1) It records the obligations, and

(2) It recognizes the expenses.



Chapter 3-43

Adjusting entries for accrued expenses

Increases (debits) an expense account and Increases (credits) a liability account.



Illustration 3-16

Chapter 3-44 SO 6 Prepare adjusting entries for accruals.SO 6 Prepare adjusting entries for accruals.

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%.

Interest payable 50Interest expense 50Oct. 31

Illustration 3-18

Illustration 3-17


Chapter 3-45 SO 6 Prepare adjusting entries for accruals.SO 6 Prepare adjusting entries for accruals.

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).

Salaries payable 1,200Salaries expense 1,200Oct. 31

Illustration 3-20


Chapter 3-46

SummaryIllustration 3-21



Chapter 3-47

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.

The Adjusted Trial BalanceThe Adjusted Trial Balance

SO 7 Describe the nature and purpose of an adjusted trial balance.SO 7 Describe the nature and purpose of an adjusted trial balance.

Chapter 3-48


Chapter 3-49

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.

Review Review QuestionQuestion

SO 7 SO 7 Describe the nature and purpose of an adjusted trial Describe the nature and purpose of an adjusted trial balance.balance.


Chapter 3-50

Financial Statements are prepared directly from the Adjusted Trial Balance.

Balance Sheet

Income Statemen

t

Owner’s Equity

Statement

Preparing Financial StatementsPreparing Financial Statements

SO 7 Describe the nature and purpose of an adjusted trial balance.SO 7 Describe the nature and purpose of an adjusted trial balance.

Chapter 3-51

Preparing Financial StatementsPreparing Financial Statements

Illustration 3-25 Preparation of the incomestatement and owner’sequity statement from theadjusted trial balance

Chapter 3-52

Preparing Financial StatementsPreparing Financial StatementsIllustration 3-26

Chapter 3-53

Some companies use an alternative treatment for prepaid expenses and unearned revenues.

When a company prepays an expense, it debits that amount to an expense account.

When a company receives payment for future services, it credits the amount to a revenue account.

Alternative Treatment of Prepaid Alternative Treatment of Prepaid Expenses and Unearned RevenuesExpenses and Unearned Revenues

SO 8 Prepare adjusting entries for the alternative treatment of SO 8 Prepare adjusting entries for the alternative treatment of deferrals.deferrals.

Chapter 3-54

Illustration: Pioneer Advertising purchased supplies on October 5 for $2,500 and debited AdvertisingSupplies Expense for the full amount. What if an inventoryof $1,000 of advertising supplies remains on October 31?

Alternative Treatment for “Prepaid Alternative Treatment for “Prepaid Expenses”Expenses”


Advertising supplies expense

1,000Advertising supplies 1,000Oct. 31

Illustration 3A-1

Chapter 3-55

Alternative Treatment for “Prepaid Alternative Treatment for “Prepaid Expenses”Expenses”


Adjustment approaches—a comparisonIllustration 3A-2

Chapter 3-56

Illustration: Assume that Pioneer Advertising received $1,200 for future services on October 2 and credited the entire amount to Service Revenue. If at the statement date Pioneer has not performed $800 of the services, it would make an adjusting entry.

Alternative Treatment for “Unearned Alternative Treatment for “Unearned Revenues”Revenues”


Unearned service revenue 800Service revenue 800Oct. 31

Illustration 3A-4

Chapter 3-57 SO 8 Prepare adjusting entries for the alternative treatment of SO 8 Prepare adjusting entries for the alternative treatment of

deferrals.deferrals.

Adjustment approaches—a comparisonIllustration 3A-5

Alternative Treatment for “Unearned Alternative Treatment for “Unearned Revenues”Revenues”

Chapter 3-58 SO 8 Prepare adjusting entries for the alternative treatment of SO 8 Prepare adjusting entries for the alternative treatment of

deferrals.deferrals.

Summary of Additional Adjustment Summary of Additional Adjustment RelationshipsRelationships

Illustration 3A-7

Chapter 3-59

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Ch03 adjusting the accounts

Business

Transcript of Ch03 adjusting the accounts