3 - The Adjusting Process
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.
1
Objective 1 - Describe the nature of the
adjusting process.
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. E.g. Some
Government Accounting
Under the accrual basis of accounting, revenues are
reported in the income statement in the period in
which they are earned.
2
3-1
Our focus in the course will be on the accrual basis of
accounting i..e. revenues are reported in the income
statement in the period in which they are earned.
The accounting concept that supports this approach to
reporting of revenues is called the revenue recognition
concept.
Expenses are reported in the same period as the
revenue to which they relate.
The accounting concept that supports reporting revenues
and related expenses in the same period is called the
matching concept, or matching principle.
3
Some accounts may need to updated at the end
of an accounting period e.g. Supplies vs
Supplies Expense
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.
The journal entries that bring the accounts
up to date at the end of the accounting
period are called adjusting entries.
4
Items That Need Adjusting - 1
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.
“Cash is paid for the service/expense before the
service/expense is used”
5
Items That Need Adjusting - 2
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.
“Cash is collected before service is rendered”
6
Items That Need Adjusting - 3
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.
“Services rendered for which cash has not yet
been collected”
7
Items That Need Adjusting - 4
3-1
Accrued expenses, sometimes
referred to as accrued
liabilities, are expenses that
have been incurred but have
not been recorded in the
accounts.
“The service has been used or the expense
incurred, but the cash has not been paid”
8
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.
9
3-2
Objective 2
Journalize entries for
accounts requiring
adjustment.
10
3-2
11
Adjusting Process for Prepaid Expenses (1) 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.
Supplies (balance on trial balance)
Supplies on hand, December 31
Supplies used
$2,000
– 760
$1,240
12
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 1,240 Bal.
800
Dec. 31 1,240
760
2,040
55
13
Adjusting Process for Prepaid Expenses (2) 3-2
The debit balance of $2,400 in
NetSolutions’ Prepaid
Insurance account represents
the December 1 prepayment of
insurance for 12 months.
14
3-2
31 Insurance Expense
Prepaid Insurance
Insurance expired
56
200 00
15
200 00
($2,400/12).
Prepaid Insurance
Bal.
2,400 Dec. 31
2,200
15
200
Insurance Expense
Dec. 31 200
56
15
Adjusting Process for Unearned Revenue
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.
16
3-2
31 Unearned Rent
Rent Revenue
Rent earned ($360/3
months)
Unearned Rent
Dec. 31
120 Bal.
Bal.
23
360
240
23
42
120 00
Rent Revenue
Dec. 31
120 00
42
120
17
Adjusting Process for Accrued Revenues
3-2
NetSolutions provided $500 in
services during December for
which the customer has not
been billed.
31 Accounts Receivable
Fees Earned
Accrued fees
12
41
500 00
500 00
18
Adjusting Process for Accrued Expenses
3-2
Assuming that wages were last paid on Friday,
December 27th, and at the end of December,
outstanding/accrued wages amounted to $250.
(e.g. This is for Monday & Tuesday, Dec 30th &
31st.) Without this adjusting entry, Wages
Expense is understated.
31 Wages Expense
Wages Payable
Accrued wages.
51
22
250 00
250 00
19
3-2
Wages Payable 22
Dec. 31 250
Wages Expense
Bal.
4,275
Dec. 31
250
Bal.
4,525
51
20
Adjusting Process for Depreciation Expenses
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.
As time passes, a fixed asset loses its ability to
provide useful services (by being used in the
business i.e. an expenses) This decrease (or
expense) in usefulness is called depreciation.
21
Instead of the assets account being credited, a contra
account is established that normally carries a credit
balance and appears as a deduction on the balance sheet
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
22
NetSolutions estimates the depreciation on
its office equipment to be $50 for the
month of December.
31 Depreciation Expense
Accum. Depreciation—
Office Equipment
53
19
3-2
50 00
50 00
Depreciation of
office equipment.
Depreciation Expense
Dec. 31
50
53
Accum. Depr.—Office Equip. 19
Dec. 31
50
23
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 or Net
Book Value
24
3-3
Objective 3
Summarize the
adjustment process
See pages 116 – 120 and exhibit 8 for Ledger with
adjusting entries
25
3-3
26
3-4
Objective 4
Prepare an adjusted
trial balance.
27
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.
28
3-4
29