Chapter 3
The Adjusting Process
Nature of the Adjusting Process

Accounting period concept: allows for the division of the economic life of
the business into time periods.
Determining in which period the revenue and expenses of the business
should be reported.

Accounting Basis:
o Cash basis: revenues and expenses are reported in the income statement
in the period in which cash is received or paid.
o No liabilities or receivables exist on the financial statements.
o Net income or loss is the difference between cash received and cash paid.
o Accrual basis: revenues are reported in the income statement in the
period in which they are earned.
o Liabilities and receivables are reported
o Cash may or may not be received or paid during the time period.
o Revenue recognition concept
 Expenses are reported in the same period as the revenues they are
related
o Matching concept –
 supports the reporting of revenues and the related expenses in the
same period.
o Generally Accepted Accounting Principles require the use of the accrual
basis but some small businesses may use the cash basis
o Adjusting process – the updating of accounts prior to the preparation of
financial statement.
The Adjusting Process:
At the end of the accounting period, many of the balances of accounts in the
ledger can be reported without change in the financial statements.
Some accounts however require updating.
Adjusting entries – the journal entries that bring the accounts up to date at the end
of the accounting period.
All adjusting entries affect at least one income statement account and one
balance sheet account.
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Prof. M. Mari
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Chapter 3
The Adjusting Process
An adjusting entry will always involve revenue or an expense account and
an asset or a liability account.
Types of Accounts requiring adjustment:
1. Prepaid expenses
a. Deferred expenses – or prepaid 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.
b. Supplies and prepaid insurance
2. Unearned revenues
a. Deferred revenues or unearned 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. These are deposits by customers for work to be done in
the future.
b. Unearned rent
3. Accrued revenues:
a. Accrued Revenues or Accrued Assets – some revenues are only
recorded when cash is received. At the end of the accounting
period, there may be items of revenues that have been earned but
have not been recorded
4. Accrued expenses
a. Accrued expenses or accrued liabilities – are expenses that have
been incurred but have not been recorded in the accounts.
b. Wages payable
Recording Adjusting Entries
Supplies
For example: the general ledger shows that the balance in the supplies account is
$2,000. An inventory is conducted of supplies and it is found that only $500 of
supplies is still on hand. Record the adjusting entry for the use of supplies.
Supplies Balance
Supplies inventory
Amount used up
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Prof. M. Mari
$2,000
500
1,500
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Chapter 3
The Adjusting Process
Date
Dec 31
Account
Supplies expense
Supplies
PR
Debit
$1,500
Credit
$1,500
Example 1: the general ledger shows that the balance in the supplies account is $4,000.
An inventory is conducted of supplies and it is found that only $2,500 of supplies is still
on hand. Record the adjusting entry for the use of supplies.
Date
Account
PR
Debit
Credit
Prepaid Insurance:
For example: the general ledger shows that the balance in the prepaid insurance account
is $6,000. The policy was purchased on May 1st for 12 months. Record the adjusting
entry for the insurance expired.
Insurance $6,000/12 = $500 per month X 8 mos = $4,000 expired
Date
Dec 31
Account
Insurance expense
Prepaid insurance
PR
Debit
$4000
Credit
$4000
Example 2: the general ledger shows that the balance in the prepaid insurance account
is $12000. The policy was purchased on Aug 1st for 12 months. Record the adjusting
entry for the insurance expired.
Date
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Prof. M. Mari
Account
PR
3
Debit
Credit
Chapter 3
The Adjusting Process
Unearned fees or revenues:
Unearned fees are a liability account.
For example: the general ledger shows that the balance in the unearned fees account is
$6,000. A review of the entries shows that the balance should be $2,000. Record the
adjusting entries.
Unearned fees account
Should be
Fees earned
Date
Dec 31
Account
Unearned fees
Fees earned
$6,000
2,000
4,000
PR
Debit
$4000
Credit
$4000
Example 3: the general ledger shows that the balance in the unearned fees account is
$7,000. The balance should be $1,000. Record the adjusting entry.
Date
Account
PR
Debit
Credit
Accrued wages –


wages owed to employees but not yet paid.
This occurs because the year-end date falls between pay periods.
For example: Wages are paid on the second and fourth Fridays for the two-week period
ending on those Fridays. The payments were $950 on December 13 and $1,200 on
December 27. The wages accrued for Monday through Thursday is $250. Record the
adjusting entries.
Date
Dec 31
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Prof. M. Mari
Account
Wages expenses
Wages payable
PR
Debit
$250
Credit
$250
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Chapter 3
The Adjusting Process
Example 4: Wages are $5,000 per week. December 31st falls on a Wednesday. Wages
are paid on Friday. Record the adjusting entry.
Date
Account
PR
Debit
Credit
Accrued Revenues or Accrued Assets –


some revenues are only recorded when cash is received.
At the end of the accounting period, there may be items of revenues that have
been earned but have not been recorded.
For example: Revenues earned but not billed to customers are $2,500.
Date
Dec 31
Account
Accounts receivable
Fees earned
PR
Debit
$2,500
Credit
$2,500
Fixed assets – physical resources that are owned by a business and are permanent or have
a long life.
 Depreciation: - reduction in the value of an assets due to its use.

There a portion o the cost of a fixed asset is recorded as an expense each year of
its useful life. Called Depreciation expense.

Accumulated depreciation – the amount of depreciation recorded since its
purchase and is normally reported on the balance sheet.
For example: Depreciation for the period is $1,000.
Date
Dec 31
Account
PR
Depreciation expense
Accumulated depreciation
Debit
Credit
$1,000
$1,000
Example 4: Depreciation for the period is $500. Record the adjusting entry.
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Prof. M. Mari
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Chapter 3
The Adjusting Process
Date
Account
PR
Debit
Credit
Book value = Cost of the asset minus Accumulated depreciation
Summary of the Adjustment Process
Type of Adjustment
Adjusting Entry
Deferred expense
Dr. Expense
Cr. Asset
Deferred revenue
Dr. Liability
Cr. Revenue
Accrued expense
Dr. Expense
Cr. Liabilities
Accrued revenue
Dr. Asset
Cr. Revenue
Fixed assets
Dr. Expense
Cr. Contra Asset
Effect of Omitting
Expenses understated and net
income overstated.
Assets overstated and
shareholder’s equity is overstated
Liability is overstated and
Shareholder’s Equity is
understated.
Revenues are understated and net
income understated
Expense is understated and net
income overstated.
Liability understand and
shareholder’s equity is overstated
Assets understated and
shareholder’s equity understated.
Revenue understated and net
income understated
Expense understated and net
income overstated.
Assets overstated and
shareholder’s equity overstated
After the adjusting entries are recorded in the journal and posted to the
general ledger, an adjusted trial balance is prepared.
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Prof. M. Mari
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