3
The Adjusting
Process
1
After studying this chapter, you should be
able to:
1. Describe the nature of the adjusting
process.
2. Journalize entries for accounts
requiring adjustment.
3. Summarize the adjustment process.
4. Prepare an adjusted trial balance.
2
3-1
Objective 1
Describe the nature of the
adjusting process.
33
Reporting Revenue and Expense
TWO METHODS
Cash Basis of Accounting
Accrual Basis of Accounting
Cash Basis of Accounting

Revenue reported when cash is received

Expense reported when cash is paid

Does not properly match revenues and expenses
Accrual Basis of Accounting

Revenue reported when earned

Expense reported when incurred

Properly matches revenues and expenses in
determining net income

Requires adjusting entries at end of period

It just sounds mean – it really isn’t
Accrual Basis Vs. Cash Basis
Accrual Basis
Cash Basis
Revenues are
recognized when
earned and expenses
are recognized when
incurred.
Revenues are
recognized when cash is
received and expenses
recorded when cash is
paid.
Not GAAP
Accounting
3-1
Under the accrual basis of
accounting, revenues are
reported in the income
statement in the period in
which they are earned.
8
3-1
The accounting concept that
supports this approach to reporting
of revenues is called the revenue
recognition concept.
9
3-1
The accounting concept that
supports reporting revenues and
related expenses in the same
period is called the matching
concept, or matching principle.
10
3-1
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.
11
3-1
The analysis and updating of
accounts at the end of the period
before the financial statements
are prepared is called the
adjusting process.
12
1
The Adjusting Process
Under the accrual basis, at the end of the accounting period some
of the accounts need updating for the following reasons:
1.
Some expenses are not recorded daily.
2.
Some revenues and expenses are incurred as time passes
rather than as separate transactions.
3.
Some revenues and expenses may be unrecorded.
3-13
1-13
13
3-1
The journal entries that bring
the accounts up to date at the
end of the accounting period
are called adjusting entries.
14
3-1
Example Exercise 3-1
Indicate with a Yes or No whether or not each of the
following accounts normally requires an adjusting entry.
a.
b.
Cash
Prepaid Rent
c. Wages Expense
e. Accounts Receivable
d. Office Equipment f. Unearned Rent
Follow My Example 3-1
a. No
b. Yes
c. Yes
d. No?/Yes
For Practice: PE 3-1A, PE 3-1B
e. Yes
f. Yes
10
15
Items That Need Adjusting
3-1
Prepaid expenses, sometimes referred
to as deferred expenses, are items that
have been initially recorded as assets
but are expected to become expenses
over time or through the normal
operations of the business.
16
Items That Need Adjusting
3-1
Unearned revenues, sometimes
referred to as deferred revenues, are
items that have been initially recorded
as liabilities but are expected to become
revenues over time or through the
normal operations of the business.
17
3-1
Insert Exhibit 1
13
18
Items That Need Adjusting
3-1
Accrued revenues, sometimes
referred to as accrued assets
(accrued means unpaid), are
revenues that have been earned
but have not been recorded in
the accounts.
19
Items That Need Adjusting
3-1
Accrued expenses, sometimes
referred to as accrued
liabilities, are expenses that
have been incurred but have
not been recorded in the
accounts.
20
3-1
16
21
3-1
Example Exercise 3-2
Classify the following items as (1) prepaid expense, (2)
unearned revenue, (3) accrued expense, or (4) accrued
revenue.
a. Wages owed but not c. Fees received but not yet
yet paid.
earned.
b. Supplies on hand.
d. Fees earned but not yet
received.
Follow My Example 3-2
a. Accrued expense
b. Prepaid expense
c. Unearned revenue
d. Accrued revenue
For Practice: PE 3-2A, PE 3-2B
17
22
3-2
Objective 2
Journalize entries for
accounts requiring
adjustment.
23
3-2
19
24
Adjusting Process for Prepaid Expenses
3-2
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.
25
3-2
Supplies (balance on trial balance)
Supplies on hand, December 31
Supplies used
$2,000
– 760
$1,240
26
3-2
2007
Dec. 31 Supplies Expense
Supplies
55
14
1 240 00
1 240 00
Supplies used ($2,000 –
$760)
Bal.
Supplies Expense
Supplies
14
2,000 Dec. 31 Adj
Bal.
800
1,240 Dec. 31 1,240
760
2,040
55
27
22
3-2
The debit balance of $2,400 in
NetSolutions’ Prepaid
Insurance account represents
the December 1 prepayment of
insurance for 12 months.
28
3-2
31 Insurance Expense
Prepaid Insurance
Insurance expired
56
200 00
15
200 00
($2,400/12).
Prepaid Insurance
Insurance Expense
15
Bal.
2,400 Dec. 31Adj 200 Dec. 31 Adj
200
2,200
56
29
24
3-2
Example Exercise 3-3
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.
Follow My Example 3-3
Insurance Expense
Prepaid Insurance
Insurance expired ($6,400 +
$3,600 – $3,250).
For Practice: PE 3-3A, PE 3-3B
6,750
6,750
25
30
3-2
On December 1, the tenant
prepaid three months’ rent
for use of an office building
owned by NetSolutions. As
of December 31, only $120
has been earned.
31
3-2
31 Unearned Rent
Rent Revenue
Rent earned ($360/3
months)
Unearned Rent
Dec. 31Adj 120 Bal.
Bal.
23
360
240
23
42
120 00
Rent Revenue
Dec. 31
Adj.
120 00
42
120
32
27
3-2
Example Exercise 3-4
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.
Follow My Example 3-4
Unearned Fees
Fees Earned
Fees earned ($44,900 –
$22,300).
For Practice: PE 3-4A, PE 3-4B
22,600
22,600
33
28
2
Accrued Revenues
NetSolutions signed an agreement with
Danker Co. on December 15 to
provide services at $20 per hour. As of
December 31, NetSolutions had
provided 25 hours of assistance.
34
3-2
NetSolutions provided (25 hrs
* $20) $500 in services during
December for which the
customer has not been billed.
35
3-2
31 Accounts Receivable
Fees Earned
Accrued fees (25 hrs.
x $20)
Accounts Receivable 12
Bal.
2,220
Dec. 31Adj 500
Bal.
2,720
12
41
500 00
500 00
Fees Earned
41
Bal.
16,340
Dec. 31Adj 500
16,840
Bal.
36
30
3-2
Example Exercise 3-5
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
Fees Earned
Accrued fees.
For Practice: PE 3-5A, PE 3-5B
13,680
13,680
37
31
2
Accrued Expenses
NetSolutions pays it employees biweekly.
During December, NetSolutions paid
wages of $950 on December 13 and
$1,200 on December 27. As of December
31, NetSolutions owes $250 of wages to
employees for Monday and Tuesday.
3-38
1-38
38
3-2
Without this adjusting entry,
Wages Expense is
understated.
39
3-2
31 Wages Expense
Wages Payable
Accrued wages.
Wages Payable 22
Dec. 31Adj 250
51
22
250 00
Wages Expense
Bal.
4,275
Dec. 31Adj250
Bal.
4,525
250 00
51
40
33
3-2
Wages Payable 22
Dec. 31 250
Wages Expense
Bal.
4,275
Dec. 31
250
Bal.
4,525
51
Closing entries will be discussed in a later chapter.
For now, just be aware that Wages Expense is
closed after financial statements are prepared and
its balance rolled back to zero.
41
34
3-2
The payment of January 10 wages totaling
$1,275 is shown below.
Jan. 10 Wages Expense
Wages Payable
Cash
1 025 00
250 00
1 275 00
42
35
3-2
Jan. 10
Wages Payable 22
250 Dec. 31 250
The liability is
cancelled.
Wages Expense
Bal.
4,275
Dec. 31
250
Bal.
4,525
51
Jan. 10 1,025
An expense for
wages of $1,025 is
recorded in the
new fiscal year.
43
36
3-2
Example Exercise 3-6
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.
Follow My Example 3-6
Salaries Expense
Salaries Payable
Accrued salaries ($12,500/5
x 4 days).
For Practice: PE 3-6A, PE 3-6B
10,000
10,000
44
37
3-2
Physical resources that are
owned and used by a business
and are permanent or have a
long life are called fixed
assets, or plant assets.
45
3-2
As time passes, a fixed
asset loses its ability to
provide useful services.
This decrease in
usefulness is called
depreciation.
46
3-2
Normal titles for fixed asset accounts and their
related contra asset accounts are as follows:
Fixed Asset
Contra Asset
Land
Buildings
None—Land is not depreciated
Accumulated Depreciation—
Buildings
Accumulate Depreciation—Store
Equipment
Accumulated Depreciation—Office
Equipment
Store Equipment
Office Equipment
47
3-2
NetSolutions estimates the
depreciation on its office
equipment to be $50 for the
month of December.
48
3-2
31 Depreciation Expense
Accum. Depreciation—
Office Equipment
53
19
50 00
50 00
Depreciation of
office equipment.
Depreciation Expense
Dec. 31Adj
50
53
Accum. Depr.—Office Equip. 19
Dec. 31Adj
50
49
42
3-2
NetSolutions’ balance sheet
would show the office
equipment at cost, less the
accumulated depreciation.
Office equipment $1,800
Less accumulated
depreciation
50 $1,750
Book
value
50
3-2
Example Exercise 3-7
The estimated amount of depreciation on equipment for the
current year is $4,250. Journalize the adjusting entry to
record the depreciation.
Follow My Example 3-7
Depreciation Expense
Accumulated Depreciation—
Equipment
Depreciation on equipment.
For Practice: PE 3-7A, PE 3-7B
4,250
4,250
51
44
3-3
Objective 3
Summarize the
adjustment process
52
3-3
46
53
3-3
(Continued)
Ledger with
Adjusting
Entries—
NetSolutions
47
54
(Continued)
3-3
Ledger with
Adjusting
Entries—
NetSolutions
48
55
(Continued)
3-3
Ledger with
Adjusting
Entries—
NetSolutions
56
49
(Concluded)
3-3
Ledger with
Adjusting
Entries—
NetSolutions
57
50
3-3
Example Exercise 3-8
For the year ending December 31, 2008, Mann Medical Co.
mistakenly omitted adjusting entries for (1) $8,600 of
unearned revenue that was earned, (2) earned revenue that
was not billed of $12,500, and (3) accrued wages of $2,900.
Indicate the combined effect of the errors on (a) revenues,
(b) expenses, and (c) net income for 2008.
Follow My Example 3-8
a. Revenues were understated by $21,100 ($8,600 +
$12,500).
b. Expenses were understated by $2,900.
c. Net income was understated by $18,200 ($8,600
+12,500 – $2,900).
For Practice: PE 3-8A, PE 3-8B
51
58
3-4
Objective 4
Prepare an adjusted
trial balance.
59
3-4
The purpose of the adjusted
trial balance is to verify the
equality of the total debit
balances and total credit
balances before the financial
statements are prepared.
60
3-4
54
61
3-4
Example Exercise 3-9
For each of the following errors, considered individually,
indicate whether the error would cause the adjusted trial
balance totals to be unequal. If the error would cause the
adjusted trial balance total to be unequal, indicate whether
the debit or credit total is higher and by how much.
a. The adjustment for accrued fees of $5,340 was
journalized as a debit to Accounts Payable for
$5,340 and a credit to Fees Earned of $5,340.
b. The adjustment for depreciation of $3,260 was
journalized as a debit to Depreciation Expense for
$3,620 and a credit to Accumulated Depreciation for
$3,260.
62
55
3-4
Follow My Example 3-9
a. The totals are equal even though the debit should
have been to Accounts Receivable instead of
Accounts Payable.
b. The totals are unequal. The debit total is higher by
$360 ($3,620 – $3,260).
For Practice: PE 3-9A, PE 3-9B
63
56
64