Electronic Presentations in
Microsoft® PowerPoint®
Adjusting Accounts
for Financial
Statements
CHAPTER 4
© 2007 McGraw-Hill Ryerson Ltd.
Learning Objectives
1.
2.
3.
Describe the purpose of adjusting
accounts at the end of the period.
Explain how the time period, matching,
and revenue recognition principles affect
the adjusting process.
Explain accrual accounting and cash
basis accounting and how accrual
accounting adds to the usefulness of
financial statements.
© 2007 McGraw-Hill Ryerson Ltd.
Learning Objectives
4.
5.
6.
Prepare and explain adjusting entries for
prepaid expenses, amortization,
unearned revenues, accrued expenses,
and accrued revenues.
Explain how accounting adjustments link
to financial statements.
Explain and prepare an adjusted trial
balance.
© 2007 McGraw-Hill Ryerson Ltd.
Learning Objectives
7.
8.
9.
Prepare financial statements from an
adjusted trial balance.
Explain and prepare correcting entries.
(Appendix 4A)
Identify and explain two alternatives in
recording prepaids and unearned
revenues. (Appendix 4B)
© 2007 McGraw-Hill Ryerson Ltd.
The Accounting Cycle
9 Prepare
1 Analyze
transactions
22
Journalize
post-closing
trial balance
8
Close
3
Post
7 Prepare
4 Prepare
statements
unadjusted
trial balance
5
6 Prepare
Adjust
adjusted
trial balance
© 2007 McGraw-Hill Ryerson Ltd.
Adjusting the Accounts
Financial information must be timely and
accurate to be useful to decision makers.


Financial statements need to be
prepared at regular intervals (periods).
Accounts need to be adjusted (updated)
to ensure all revenues, expenses,
assets, and liabilities are recorded.
© 2007 McGraw-Hill Ryerson Ltd.
GAAP and the Adjusting Process
Adjustments are based on three generally
accepted accounting principles:
 Time
period principle.
 Revenue recognition principle.
 Matching principle.
© 2007 McGraw-Hill Ryerson Ltd.
Accounting Principles
Time Period Principle
Assumes that the organization’s activities can be
divided into specific time periods such as:
 Months
 Quarters
 Years
© 2007 McGraw-Hill Ryerson Ltd.
Accounting Principles
Revenue Recognition Principle
Revenue is recorded at the time it is earned
regardless of whether cash or another asset has
been exchanged.
Matching Principle
Expenses are to be matched in the same
accounting period as the revenues they helped
to earn.
© 2007 McGraw-Hill Ryerson Ltd.
Cash vs. Accrual Basis
Accrual Basis
Revenues and expenses are recognized
when earned or incurred regardless of when
cash is received or paid.
Consistent with GAAP.
Cash Basis
Revenues and expenses are recognized
when cash is received or paid.
Not consistent with GAAP.
© 2007 McGraw-Hill Ryerson Ltd.
Adjustments
Types:
 Prepaid
expenses
 Amortization
 Unearned revenues
 Accrued expenses
 Accrued revenues
© 2007 McGraw-Hill Ryerson Ltd.
Prepaid Expenses
Costs paid in cash and recorded as assets
before they are used are called prepaid
expenses.

These costs expire with the passage of time
or through use and consumption, e.g.,
insurance, supplies.
© 2007 McGraw-Hill Ryerson Ltd.
Prepaid Expenses–Example
On January 1, a company purchases an insurance
policy that covers three months and costs $1,800.


The policy will benefit the company for three months and
will be expired at the end of three months.
The cost of the policy should be spread over the time
period it benefits the organization. (matching principle).
January
$600
$1,800
February
$600
© 2007 McGraw-Hill Ryerson Ltd.
March
$600
Prepaid Expenses — Example
The entry to record the purchase of the insurance
policy would be: Prepaid Insurance 1,800
Cash
1,800
$
January
1
$600,
$1,800
February
$600
8
0
0
Jan. 1
Prepaid Insurance
1,800
© 2007 McGraw-Hill Ryerson Ltd.
March
$600
Cash
1,800
Prepaid Expenses — Example
The entry to record the expiry of the insurance for
January would be: Insurance Expense 600
Prepaid Insurance
600
January
$
$600 1
,
8
0
0
Jan. 1
Jan.31
balance
$1,800
February
$600
Prepaid Insurance
1,800
600
1,200
March
$600
Insurance Expense
© 2007 McGraw-Hill Ryerson Ltd.
600
Prepaid Expenses — Example
The entry to record the expiry of the insurance for
February would be: Insurance Expense 600
Prepaid Insurance
600
January
$
$600 1
,
8
0
0
Jan. 1
Jan.31
Feb.28
balance
$1,800
February
$600
Prepaid Insurance
1,800
600
600
600
March
$600
Insurance Expense
© 2007 McGraw-Hill Ryerson Ltd.
600
600
Prepaid Expenses — Example
The entry to record the expiry of the insurance for
March would be: Insurance Expense 600
Prepaid Insurance
600
January$
1
$600 ,
8
0
0
Jan. 1
Jan.31
Feb.28
Mar.31
balance
$1,800
February
$600
Prepaid Insurance
1,800
600
600
600
0
March
$600
Insurance Expense
© 2007 McGraw-Hill Ryerson Ltd.
600
600
600
Amortization
Amortization is the process of allocating the
costs of assets over their useful lives.


Companies acquire capital assets such as equipment,
buildings, vehicles, and patents to generate revenues.
These assets are expected to provide benefits for
more than one period.
Straight-Line
Amortization
Expense
Asset Cost - Salvage Value
=
Useful Life
© 2007 McGraw-Hill Ryerson Ltd.
Amortization - Example
On January 1,2011, a company purchased a piece of
equipment for $72,000. The equipment is expected to
have a useful life of four years and have a salvage value
of $8,000.
Straight-Line
Amortization
Expense
Asset Cost - Salvage Value
=
Useful Life
$72,000 - $8,000
=
4 years
=
$16,000/year
© 2007 McGraw-Hill Ryerson Ltd.
Amortization - Example
The entry to record the purchase of the equipment
would be:
Equipment 72,000
Cash
72,000
Equipment
72,000
Cash
1/1/11
© 2007 McGraw-Hill Ryerson Ltd.
72,000
Amortization - Example
The entry to record amortization at the end of the first year
would be:
Amortization Expense, Equipment 16,000
Accumulated Amortization, Equipment 16,000
Amortization Expense,
Accumulated
Equipment
Amortization, Equipment
16,000
12/31/11
16,000
© 2007 McGraw-Hill Ryerson Ltd.
Amortization - Example
The entry to record amortization at the end of the second
year would be:
Amortization Expense, Equipment 16,000
Accumulated Amortization, Equipment 16,000
Amortization Expense,
Equipment
16,000
Accumulated
Amortization, Equipment
12/31/11
16,000
12/31/12
16,000
balance
32,000
© 2007 McGraw-Hill Ryerson Ltd.
Amortization - Example
The entry to record amortization at the end of the third year
would be:
Amortization Expense, Equipment 16,000
Accumulated Amortization, Equipment 16,000
Amortization Expense,
Equipment
16,000
12/31/11
12/31/12
12/31/13
balance
Accumulated
Amortization, Equipment
16,000
16,000
16,000
48,000
© 2007 McGraw-Hill Ryerson Ltd.
Amortization - Example
The entry to record amortization at the end of the fourth
year would be:
Amortization Expense, Equipment 16,000
Accumulated Amortization, Equipment 16,000
Amortization Expense,
Equipment
16,000
12/31/11
12/31/12
12/31/13
12/31/14
balance
Accumulated
Amortization, Equipment
16,000
16,000
16,000
16,000
64,000
© 2007 McGraw-Hill Ryerson Ltd.
Amortization - Example
Partial Balance Sheet
December 31
2011
2012
2013
2014
Equipment
$72,000 $72,000 $72,000 $72,000
Less: Accumulated Amortization
16,000 32,000 48,000 64,000
Equipment-net
$56,000 $40,000 $24,000 $8,000
Equipment
72,000
Accumulated
Amortization, Equipment
01/01/11
12/31/11
12/31/12
12/31/13
12/31/14
© 2007 McGraw-Hill Ryerson Ltd.
16,000
16,000
16,000
16,000
Unearned Revenues
Cash received in advance of providing
products and services.
 The
company has an obligation to
provide goods or services.
 Unearned revenues are liabilities.
© 2007 McGraw-Hill Ryerson Ltd.
Unearned Revenues — Example
On March 1, a company received a $12,000 payment
from a customer for maintenance services to be provided
over the next two months.
The entry to record the receipt of cash would be:
Cash
12,000
Unearned Revenue
12,000
Cash
12,000
Unearned Revenue
Mar.1
12,000
© 2007 McGraw-Hill Ryerson Ltd.
Unearned Revenues - Example
On March 31, $6,000 of this revenue had been earned.
The entry to record the earned revenue would be:
Unearned Revenue
6,000
Maintenance Revenue
6,000
$12,000/2months= $6,000/month
Unearned Revenue
Maintenance Revenue
12,000 Mar.1
6,000
Mar.31
6,000
6,000 balance
© 2007 McGraw-Hill Ryerson Ltd.
Unearned Revenues - Example
By April 30, another $6,000 of this unearned revenue had
been earned.
The entry to record the earned revenue would be:
Unearned Revenue
6,000
Maintenance Revenue
6,000
$12,000/2months= $6,000/month
Unearned Revenue
12,000
6,000
6,000
0
Maintenance Revenue
Mar.1
Mar.31
Apr.30
balance
© 2007 McGraw-Hill Ryerson Ltd.
6,000
6,000
Accrued Expenses
Costs incurred in a period that are both
unpaid and unrecorded.

Adjusting entries must be made to record the
expense for the period and the related liability
at the balance sheet date.

Examples: interest, wages, rent, taxes
© 2007 McGraw-Hill Ryerson Ltd.
Accrued Expenses - Example
On December 31, $1,200 of interest has accrued
on a company’s bank loan. The payment of the
interest is not due until January 1.
The December 31 entry to record the accrued
interest would be:
Interest Expense
1,200
Interest Payable
1,200
© 2007 McGraw-Hill Ryerson Ltd.
Accrued Expenses - Example
In December, a company incurred $3,700 of utilities
expense. The company had not received the utility
bill at December 31.
The December 31 entry to record the accrued utilities
expense would be:
Utilities Expense
3,700
Utilities Payable
3,700
© 2007 McGraw-Hill Ryerson Ltd.
Accrued Revenues
Revenues earned in a period that are both
unrecorded and not yet received in cash.
Adjusting entries must be made to record the
revenue for the period and the related asset
at the balance sheet date.
 Examples: fees earned, interest earned, rent
earned

© 2007 McGraw-Hill Ryerson Ltd.
Accrued Revenues - Example
On December 31, $16,500 of consulting fees
have been earned but have not been recorded
or billed to the client.
The entry to record the accrued consulting fees
earned would be:
Accounts Receivable
16,500
Consulting Fees Earned
16,500
© 2007 McGraw-Hill Ryerson Ltd.
Adjustments & Financial Statements
Adjustments are only made when financial
statements are prepared.
 Affect both the income statement and the
balance sheet.
 Do not affect cash.

© 2007 McGraw-Hill Ryerson Ltd.
Mini-Quiz
Q If the year-end adjusting entry to record
A
accrued wages was not recorded, how would
this affect the company’s financial statements?
Would the balance sheet balance?
Wages expense-understated
Net income-overstated
Owner’s equity-overstated
Wages payable-understated
The balance sheet would balance since
liabilities would be overstated and owner’s
equity would be understated.
© 2007 McGraw-Hill Ryerson Ltd.
Trial Balance
Unadjusted Trial Balance
Prepared before adjustments are recorded.
Adjusted Trial Balance
Used to prepare financial statements.
Prepared after adjustments are recorded and
posted.
© 2007 McGraw-Hill Ryerson Ltd.
Financial Statement Preparation


Adjusting entries bring the accounts up-to-date.
The adjusted trial balance is used to prepare the
financial statements in the following order:




Income Statement
Statement of Owner’s Equity
Balance Sheet
Cash Flow Statement
© 2007 McGraw-Hill Ryerson Ltd.
Review
Q When and why are adjusting entries
A
prepared?
They are prepared when a company
wishes to issue financial statements.
Adjusting entries bring the account
balances up-to-date.
© 2007 McGraw-Hill Ryerson Ltd.
Appendix 4A
Correcting Errors
Errors found before posting
 Draw a line through the incorrect information.
 Insert correct information above the original
entry.
Errors found after posting
Two alternatives:
1. Prepare a single correcting entry.
2. Reverse the original entry and record the
correct entry.
© 2007 McGraw-Hill Ryerson Ltd.
Correcting Errors — Example
A payment of $1,200 for Salaries Expense is
erroneously posted to Interest Expense.
The original entry was recorded as:
Interest Expense
1,200
Cash
1,200
The original should have been recorded as:
Salaries Expense
1,200
Cash
1,200
© 2007 McGraw-Hill Ryerson Ltd.
Correcting Errors — Example
Alternative 1 -Prepare a single correcting entry.
The original entry was recorded as:
Interest Expense
1,200
Cash
1,200
The correcting entry would be:
Salaries Expense
1,200
Interest Expense
1,200
© 2007 McGraw-Hill Ryerson Ltd.
Correcting Errors — Example
Alternative 2 -Reverse the original entry and enter
the correct entry.
The original entry was recorded as:
Interest Expense
1,200
Cash
1,200
The entry to reverse this would be:
Cash
1,200
Interest Expense
1,200
The correct entry would be:
Salaries Expense
1,200
Cash
1,200
© 2007 McGraw-Hill Ryerson Ltd.
Appendix 4B: Alternatives in Recording
Prepaids and Unearned Revenues
Prepaid Expenses


Often recorded as assets when paid.
Adjusting entries transfer expired portion to
expense accounts at period end.
Alternative Treatment


Record as an expense when paid.
Adjusting entries transfer unused portion of
prepaid from the expense to the asset account.
© 2007 McGraw-Hill Ryerson Ltd.
Appendix 4B: Alternatives in Recording
Prepaids and Unearned Revenues
Example:
On January 1, a company purchases an
insurance policy that covers 3 months and costs
$1,800.
On January 31, $600 ($1,800 x 1/3) of the policy
has expired and $1,200 ($1,800 x 2/3) remains
unexpired.
© 2007 McGraw-Hill Ryerson Ltd.
Prepaids- Example
Payment Recorded as an Asset
Payment Recorded as an Expense
Jan.1
Insurance Expense 1,800
Cash
1,800
Prepaid Insurance
Cash
1,800
1,800
Jan.31 Insurance Expense
Prepaid Insurance
Prepaid Insurance
1,800
600
1,200
600
600
Prepaid Insurance
Jan.1
Jan.31
balance
Insurance Expense
600
600
Prepaid Insurance 1,200
Insurance Expense
1,200
Jan.1
Jan.31
balance
1,200
1,200
Insurance Expense
1,800
1,200
600
© 2007 McGraw-Hill Ryerson Ltd.
Appendix 4B: Alternatives in Recording
Prepaids and Unearned Revenues
Unearned Revenues


Often recorded as liabilities when cash is
received.
Adjusting entries transfer earned portion to
revenue accounts at period end.
Alternative Treatment


Record as revenues when cash is received.
Adjusting entries transfer unearned portion of
the payment from the revenue account to the
unearned account.
© 2007 McGraw-Hill Ryerson Ltd.
Alternatives in Accounting for Prepaids
and Unearned Revenues-Appendix 4B
Example:
On March 1, a company received a $12,000
payment from a customer for maintenance
services to be provided over the next two
months.
On March 31, $6,000 ($12,000/2) of the revenue
has been earned and $6,000 ($12,000/2)
remains unearned.
© 2007 McGraw-Hill Ryerson Ltd.
Unearned Revenues- Example
Receipt Recorded as a Liability
Mar.1
Receipt Recorded as a Revenue
Cash
12,000
Unearned Revenue
12,000
Mar.31 Unearned Revenue 6000
Maintenance Revenue
6000
Unearned Revenue
12,000
6,000
6,000
Maintenance Revenue
6,000
6,000
Cash
12,000
Maintenance Revenue
12,000
Maintenance Revenue
Unearned Revenue
Unearned Revenue
Mar.1
Mar.31
balance
6,000
6,000
Maintenance Revenue
Mar.1
12,000
Mar.31
6,000
balance
6,000
© 2007 McGraw-Hill Ryerson Ltd.
6,000
6,000
End of Chapter
© 2007 McGraw-Hill Ryerson Ltd.