3
The Adjusting Process
3-1
The Adjusting Process
After studying this chapter, you should be able to:
3-2
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.
1
Describe the nature of
the adjusting process.
3-3
1
Under the accrual basis of
accounting, revenues are
reported in the income
statement in the period in
which they are earned.
3-4
1
Revenue Recognition Concept
The accounting concept supporting
the reporting of revenues when
they are earned regardless of when
cash is received is called the
revenue recognition concept.
3-5
1
Matching Principle
The accounting concept supporting
reporting revenues and related
expenses in the same period is
called the matching concept, or
matching principle.
3-6
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.
3-7
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.
3-8
1
The Adjusting Process
The analysis and updating of
accounts at the end of the period
before the financial statements are
prepared is called the adjusting
process.
3-9
1
Example Exercise 3-1
Accounts Requiring Adjustment
Indicate with a Yes or No whether or not each of the
following accounts normally requires an adjusting entry.
a. Cash
No
Yes
b. Prepaid Rent
c. Wages Expense Yes
d. Office Equipment
No
e. Accounts Receivable Yes
f. Unearned Rent
Yes
Follow My Example 3-1
Left click the mouse for the answers.
Follow My Example 6-1
For Practice: PE 3-1A, PE 3-1B
3-10
3-10
1
Types of Accounts
Requiring Adjustment
Prepaid expenses are the
advance payment of future
expenses and are recorded
as assets when cash is paid.
3-11
1
Types of Accounts
Requiring Adjustment
Unearned revenues are the
advance receipt of future
revenues and are recorded
as liabilities when cash is
received.
3-12
1
Exhibit 1
3-13
Type of Adjustments: Prepaid
Expenses and Unearned Revenues
1
Types of Accounts
Requiring Adjustment
Accrued revenues are unrecorded
revenues that have been earned
and for which cash has yet to be
received.
3-14
1
Types of Accounts
Requiring Adjustment
Accrued expenses are unrecorded
expenses that have been incurred
and for which cash has not been
paid.
3-15
1
Exhibit 2
3-16
Type of Adjustments: Accrued
Revenues and Expenses
1
Example Exercise 3-2
Type of Adjustment
Classify the following items as (1) prepaid expense, (2) unearned
revenue, (3) accrued expense, or (4) accrued revenue.
a. Wages owed but not
paid.
b. Supplies on hand.
c. Fees received but not yet
earned.
d. Fees earned but not yet
received.
Follow My Example 3-2
Follow
My Example 6-1
a. Accrued expense
b. Prepaid expense
c. Unearned revenue
d. Accrued revenue
For Practice: PE 3-2A, PE 3-2B
3-17
3-17
2
Journalize entries for
accounts requiring
adjustment.
3-18
2
Exhibit 3
3-19
Unadjusted Trial Balance for NetSolutions
2
Exhibit 4
3-20
Expanded Chart of Accounts for NetSolutions
2
Prepaid Expenses
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.
Supplies (balance on trial balance) $2,000
Supplies on hand, December 31
– 760
Supplies used
$1,240
3-21
2
Supplies
Bal.
3-22
2,000 Dec. 31
760
14
Supplies Expense
1,240 Bal.
Dec. 31
800
1,240
2,040
55
2
Prepaid Expenses
The debit balance of $2,400 in
NetSolutions’ Prepaid
Insurance account represents
the December 1 prepayment of
insurance for 12 months.
3-23
2
Prepaid Insurance
Bal.
2,400 Dec. 31
2,200
3-24
15
200
Insurance Expense
Dec. 31 200
56
2
Impact of Omitting Adjusting Entries
3-25
2
Example Exercise 3-3
Example Exercise 3-3
Adjustment for Prepaid Expenses
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……………………… 6,750
Prepaid Insurance……………………
6,750
Insurance expired ($6,400 +
$3,600 – $3,250).
For Practice: PE 3-3A, PE 3-3B
3-26
3-26
2
Unearned Revenues
The December 31 unadjusted
trial balance of NetSolutions
indicates a balance in the
unearned rent account of $360.
3-27
2
Unearned Rent
Dec. 31
120 Bal.
3-28
23
360
Rent Revenue
42
2
Unearned Rent
Dec. 31
120 Bal.
Bal.
3-29
23
360
240
Rent Revenue
Dec. 31
42
120
2
Impact of Omitting Adjusting Entry
3-30
2
Example Exercise 3-4
Adjustment for Unearned Revenue
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……………………………. 22,600
Fees Earned…………………………..
22,600
Fees earned ($44,900 – $22,300).
For Practice: PE 3-4A, PE 3-4B
3-31
3-31
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.
3-32
2
Accounts Receivable 12
Bal.
2,220
Dec. 31
500
Bal.
2,720
3-33
Fees Earned
Bal.
41
16,340
2
Accounts Receivable 12
Bal.
2,220
Dec. 31
500
Bal.
2,720
3-34
Fees Earned
Bal.
Dec. 31
Bal.
41
16,340
500
16,840
2
Impact of Omitting Adjusting Entry
3-35
2
Example Exercise 3-5
Adjustment for Accrued Revenues
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……………………. 13,680
Fees Earned…………………………..
13,680
Accrued fees.
For Practice: PE 3-5A, PE 3-5B
3-36
3-36
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.
3-37
2
Wages Payable
3-38
22
Wages Expense
Bal.
4,275
Dec. 31
250
Bal.
4,525
51
2
Wages Payable
Dec. 31
3-39
22
250
Wages Expense
Bal.
4,275
Dec. 31
250
Bal.
4,525
51
2
The journal entry for the payment of wages
on January 10 is shown below.
After
posting
3-40
2
Exhibit 5
3-41
Accrued Wages
2
Impact of Omitting Adjusting Entry
3-42
2
Example Exercise 3-6
Adjustment for Accrued Expenses
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……………………….. 10,000
Salaries Payable……………………..
10,000
Accrued salaries [($12,500 ÷ 5
days) × 4 days].
For Practice: PE 3-6A, PE 3-6B
3-43
3-43
2
Fixed Assets
Fixed assets, or plant assets,
are physical resources that are
owned and used by a business
and are permanent or have a
long life.
3-44
2
Depreciation
As time passes, a fixed
asset loses its ability to
provide useful services.
This decrease in usefulness
is called depreciation.
3-45
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
Accumulated Depreciation—Store
Equipment
Accumulated Depreciation—Office
Equipment
Store Equipment
Office Equipment
3-46
2
NetSolutions estimates the
depreciation on its office
equipment to be $50 for
the month of December.
3-47
2
Depreciation Expense
Dec. 31
50
3-48
53
Accum. Depr.—Office Equip.
19
2
Depreciation Expense
Dec. 31
50
3-49
53
Accum. Depr.—Office Equip. 19
Dec. 31
50
2
NetSolutions’ balance sheet would
show office equipment at cost, less
accumulated depreciation.
Office equipment
Less accumulated
depreciation
$1,800
50
$1,750
Book
value
3-50
2
Impact of Omitting Adjusting Entry
3-51
2
Example Exercise 3-7
Adjustment for Depreciation
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………...……….. 4,250
Accumulated Depreciation—
Equipment…………………………..
Depreciation on equipment.
4,250
For Practice: PE 3-7A, PE 3-7B
3-52
3-52
3
Summarize the
adjustment process.
3-53
3
Exhibit 7
3-54
Adjusting Entries—NetSolutions
(continued)
3
Exhibit 7
Adjusting Entries—NetSolutions (continued)
.
3-55
3
Exhibit 8
3-56
Ledger with Adjusting Entries—NetSolutions
(continued)
3
Exhibit 8
3-57
Ledger with Adjusting Entries—NetSolutions
(continued)
3
Exhibit 8
3-58
Ledger with Adjusting Entries—NetSolutions
(continued)
(continued)
3
Exhibit 8
3-59
Ledger with Adjusting Entries—NetSolutions
(concluded)
3
Example Exercise 3-8
Effect of Omitting Adjustments
For the year ending December 31, 2010, Mann
Medical Co. mistakenly omitted adjusting
entries for (1) $8,600 of unearned revenue that
was earned, (2) earned revenue of $12,500 that
was not billed, and (3) accrued wages of $2,900.
Indicate the combined effect of the errors on (a)
revenues, (b) expenses, and (c) net income for
2010.
3-60
3-60
Example Exercise 3-8 (continued)
3
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
3-61
3-61
4
Prepare an adjusted
trial balance.
3-62
4
The purpose of the adjusted trial
balance is to verify the equality
of the total debit and credit
balances before the financial
statements are prepared.
3-63
4
Exhibit 9
3-64
Adjusted Trial Balance—NetSolutions
4
Example
Exercise
3-9 3-9
Example
Exercise
Effect of Errors on Adjusted Trial Balance
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 totals 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.
(continued)
3-65
3-65
Example Exercise 3-9 (continued)
4
Example
Exercise
3-9 3-9
Example
Exercise
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.
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).
3-66
3-66
For Practice: PE 3-9A, PE 3-9B
3-67