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Chapter 3
Adjusting the Accounts
Learning Objectives
After studying this chapter, you should be able to:
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1.
Explain the time period assumption.
2.
Explain the accrual basis of accounting.
3.
Explain the reasons for adjusting entries.
4.
Identify the major types of adjusting entries.
5.
Prepare adjusting entries for deferrals.
6.
Prepare adjusting entries for accruals.
7.
Describe the nature and purpose of an adjusted trial balance.
Preview of Chapter 3
Financial Accounting
IFRS Edition, 2e
Weygandt Kimmel Kieso
3-3
Timing Issues
Accountants divide the economic life of a business into
artificial time periods (Time Period Assumption).
.....
Jan.
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Feb.
Mar.
Apr.

Generally a month, a quarter, or a year.

Also known as the “Periodicity Assumption”
Dec.
LO 1 Explain the time period assumption.
Preview of Chapter 3
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Timing Issues
Fiscal and Calendar Years
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
Monthly and quarterly time periods are called interim
periods.

Most large companies must prepare both quarterly and
annual financial statements.

Fiscal Year = Accounting time period that is one year in
length.

Calendar Year = January 1 to December 31.
LO 1 Explain the time period assumption.
Timing Issues
Question
The time period assumption states that:
a. revenue should be recognized in the accounting
period in which a performance obligation is satisfied.
b. expenses should be matched with revenues.
c. the economic life of a business can be divided into
artificial time periods.
d. the fiscal year should correspond with the calendar
year.
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LO 1 Explain the time period assumption.
Preview of Chapter 3
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Timing Issues
Accrual- vs. Cash-Basis Accounting
Accrual-Basis Accounting
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
Transactions recorded in the periods in which the
events occur.

Revenues are recognized when the services are
performed, rather than when cash is received.

Expenses are recognized when incurred, rather than
when paid.
LO 2 Explain the accrual basis of accounting.

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CEH
Timing Issues
Accrual- vs. Cash-Basis Accounting
Cash-Basis Accounting
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
Revenues recognized when cash is received.

Expenses recognized when cash is paid.

Cash-basis accounting is not in accordance with
International Financial Reporting Standards (IFRS).
LO 2 Explain the accrual basis of accounting.
Preview of Chapter 3
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Timing Issues
Recognizing Revenues and Expenses
Revenue Recognition Principle
Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.
In a service enterprise,
revenue is considered to be
earned at the time the service
is performed.
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LO 2 Explain the accrual basis of accounting.
Timing Issues
Recognizing Revenues and Expenses
Expense Recognition Principle
Match expenses with
revenues in the period when
the company makes efforts to
generate those revenues.
“Let the expenses follow
the revenues.”
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LO 2 Explain the accrual basis of accounting.
Timing Issues
Illustration 3-1
IFRS relationships in revenue
and expense recognition
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LO 2 Explain the accrual basis of accounting.
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LO 2 Explain the accrual basis of accounting.
Timing Issues
Question
Which of the following statements about the accrual basis of
accounting is false.
a. Events that change a company’s financial statements
are recorded in the periods in which the events occur.
b. Revenue is recognized in the period in which services
are performed.
c. The accrual basis is in accord with IFRS.
d. Revenue is recorded only when cash is received, and
expenses are recorded only when cash is paid.
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LO 2 Explain the accrual basis of accounting.
A list of concepts is provided in the left column below, with a
description of the concept in the right column below. There are more
descriptions provided than concepts. Match the description of the
concept to the concept.
f
e
c
b
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LO 2
Preview of Chapter 3
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The Basics of Adjusting Entries
Adjusting Entries
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
Ensure that the revenue recognition and expense
recognition principles are followed.

Necessary because the trial balance may not contain
up-to-date and complete data.

Required every time a company prepares financial
statements.

Will include one income statement account and one
statement of financial position account.
LO 3 Explain the reasons for adjusting entries.
1B 2013 = eco =10 yrs
Dr (car); cr (cash) = 10B
1 Jan 2013

At the end 2013
31 dec
Deprc exp; acc depre = 10B/10yrs
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The Basics of Adjusting Entries
Question
Adjusting entries are made to ensure that:
a. expenses are recognized in the period in which they
are incurred.
b. revenues are recorded in the period in which services
are provided.
c. statement of financial position and income statement
accounts have correct balances at the end of an
accounting period.
d. all of the above.
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LO 3 Explain the reasons for adjusting entries.
The Basics of Adjusting Entries
Types of Adjusting Entries
Illustration 3-2
Categories of adjusting entries
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Deferrals
Accruals
1. Prepaid Expenses.
Expenses paid in cash before
they are used or consumed.
3. Accrued Revenues.
Revenues for services
performed but not yet
received in cash or recorded.
2. Unearned Revenues.
Cash received before services
are performed.
4. Accrued Expenses.
Expenses incurred but not yet
paid in cash or recorded.
LO 4 Identify the major types of adjusting entries.
The Basics of Adjusting Entries
Types of Adjusting Entries
Trial Balance –
Each account is
analyzed to
determine whether
it is complete and
up-to-date.
Illustration 3-3
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LO 4 Identify the major types of adjusting entries.
The Basics of Adjusting Entries
Adjusting Entries for Deferrals
Deferrals are either:

Prepaid expenses
OR

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Unearned revenues.
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Prepaid Expenses
Payment of cash, that is recorded as an asset because
service or benefit will be received in the future.
Cash Payment
BEFORE
Expense Recorded
Prepayments often occur in regard to:
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
insurance

rent

supplies

equipment

advertising

buildings
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Prepaid Expenses

Expire either with the passage of time or through use.

Adjusting entry:
►
Increase (debit) to an expense account and
►
Decrease (credit) to an asset account.
Illustration 3-4
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LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration: Pioneer Advertising Agency
purchased supplies costing $2,500 on
October 5. Pioneer recorded the payment
by increasing (debiting) the asset
Supplies. This account shows a balance
of $2,500 in the October 31 trial balance.
An inventory count at the close of
business on October 31 reveals that
$1,000 of supplies are still on hand.
Oct. 31
Supplies expense
Supplies
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1,500
1,500
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration 3-5
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LO 5
The Basics of Adjusting Entries
Illustration: On October 4, Pioneer
Advertising paid $600 for a one-year fire
insurance policy. Coverage began on
October 1. Pioneer recorded the payment
by increasing (debiting) Prepaid
Insurance. This account shows a balance
of $600 in the October 31 trial balance.
Insurance of $50 ($600 ÷ 12) expires each
month.
Oct. 31
Insurance expense
50
Prepaid insurance
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50
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration 3-6
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LO 5
The Basics of Adjusting Entries
Depreciation
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
Buildings, equipment, and vehicles (assets with long
lives) are recorded as assets, rather than an expense,
in the year acquired.

Depreciation allocates a portion of the asset’s cost as
an expense during each period of the asset’s useful life.

Depreciation does not attempt to report the actual
change in the value of the asset.
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration: For Pioneer Advertising, assume
that depreciation on the equipment is $480 a
year, or $40 per month.
Oct. 31
Depreciation expense
Accumulated depreciation
40
40
Accumulated Depreciation is called a contra
asset account.
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LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration 3-7
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LO 5
The Basics of Adjusting Entries
Statement Presentation

Accumulated Depreciation is a contra asset account
(credit).

Appears just after the account it offsets (Equipment) on
the statement of financial position.

Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.
Illustration 3-8
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LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration 3-9
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LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Unearned Revenues
Receipt of cash that is recorded as a liability because service
has not be performed.
Cash Receipt
BEFORE
Revenue Recorded
Unearned revenues often occur in regard to:
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
Rent

Magazine subscriptions

Airline tickets

Customer deposits
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Unearned Revenues

Adjusting entry is made to record the revenue for
services performed and to show the liability that remains.

Results in a decrease (debit) to a liability account and
an increase (credit) to a revenue account.
Illustration 3-10
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LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration: Pioneer Advertising received $1,200 on October 2 from
R. Knox for advertising services expected to be completed by
December 31. Unearned Service Revenue shows a balance of
$1,200 in the October 31 trial balance. Analysis reveals that the
company earned $ 400 of those fees in October.
Oct. 31
Unearned service revenue
Service revenue
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400
400
LO 5 Prepare adjusting entries for deferrals.
The Basics of Adjusting Entries
Illustration 3-11
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LO 5
The Basics of Adjusting Entries
Illustration 3-12
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LO 5 Prepare adjusting entries for deferrals.
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LO 5
The Basics of Adjusting Entries
Adjusting Entries for Accruals
Accruals are made to record

Revenues for services performed
OR

Expenses incurred
in the current accounting period that have not been
recognized through daily entries.
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LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Accrued Revenues
Revenues for services performed but not yet received in cash
or recorded.
Revenue Recorded
BEFORE
Cash Receipt
Accrued revenues often occur in regard to:
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
Interest

Services performed

Rent
LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Accrued Revenues

Adjusting entry shows the receivable that exists and
records the revenues for services performed.

Adjusting entry:
►
Increases (debits) an asset account and
►
Increases (credits) a revenue account.
Illustration 3-13
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LO 6
The Basics of Adjusting Entries
Illustration: In October Pioneer Advertising
Agency recognized $200 for advertising
services performed but not recorded.
Oct. 31
Accounts receivable
200
Service revenue
200
On November 10, Pioneer receives cash of
$
200 for the services performed.
Nov. 10
Cash
200
Accounts receivable
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200
LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Illustration 3-14
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LO 6
The Basics of Adjusting Entries
Illustration 3-15
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LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Accrued Expenses
Expenses incurred but not yet paid in cash or recorded.
Expense Recorded
BEFORE
Cash Payment
Accrued expenses often occur in regard to:
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
Rent

Taxes

Interest

Salaries
LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Accrued Expenses

Adjusting entry records the obligation and recognizes the
expense.

Adjusting entry:
►
Increase (debit) an expense account and
►
Increase (credit) a liability account.
Illustration 3-16
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LO 6
The Basics of Adjusting Entries
Illustration: Pioneer Advertising signed a three-month note
payable in the amount of $5,000 on October 1. The note requires
Pioneer to pay interest at an annual rate of 12%.
Illustration 3-17
Oct. 31
Interest expense
Interest payable
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50
50
LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Illustration 3-18
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LO 6
The Basics of Adjusting Entries
Illustration: Pioneer Advertising last paid salaries on October 26;
the next payment of salaries will not occur until November 9. The
employees receive total salaries of $2,000 for a five-day work
week, or $400 per day. Thus, accrued salaries at October 31 are
$1,200 ($ 400 x 3 days).
Illustration 3-19
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LO 6 Prepare adjusting entries for accruals.
The Basics of Adjusting Entries
Illustration 3-20
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LO 6
The Basics of Adjusting Entries
Illustration 3-21
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LO 6 Prepare adjusting entries for accruals.
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LO 6 Prepare adjusting entries for accruals.
Micro Computer Services Inc. began operations on August 1,
2014. At the end of August 2014, management attempted to
prepare monthly financial statements. The following information
relates to August. Prepare the adjusting journal entries needed at
August 31, 2014. (Amounts are in Chinese yuan.)
1. At August 31, the company owed its employees ¥8,000 in
salaries and wages that will be paid on September 1.
Salaries and wages expense
Salaries and wages payable
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8,000
8,000
LO 6
Micro Computer Services Inc. began operations on August 1,
2014. At the end of August 2014, management attempted to
prepare monthly financial statements. The following information
relates to August. Prepare the adjusting journal entries needed at
August 31, 2014. (Amounts are in Chinese yuan.)
2. At August 1, the company borrowed ¥300,000 from a local
bank on a 15-year mortgage. The annual interest rate is 10%.
Interest expense
(¥ 300,000 x 10% x 1/12)
Interest payable
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2,500
2,500
LO 6
Micro Computer Services Inc. began operations on August 1,
2014. At the end of August 2014, management attempted to
prepare monthly financial statements. The following information
relates to August. Prepare the adjusting journal entries needed at
August 31, 2014. (Amounts are in Chinese yuan.)
3. Revenue for services performed but unrecorded for August
totaled ¥11,000.
Accounts receivable
Service revenue
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11,000
11,000
LO 6
The Basics of Adjusting Entries
Summary of Basic Relationships
Illustration 3-22
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LO 6 Prepare adjusting entries for accruals.
Preview of Chapter 3
3-61
The Adjusted Trial Balance
Adjusted Trial Balance
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
Prepared after all adjusting entries are journalized and
posted.

Purpose is to prove the equality of debit balances and
credit balances in the ledger.

Is the primary basis for the preparation of financial
statements.
LO 7 Describe the nature and purpose of an adjusted trial balance.
The Basics of Adjusting Entries
Types of Adjusting Entries
Trial Balance –
Each account is
analyzed to
determine whether
it is complete and
up-to-date.
Illustration 3-3
3-63
LO 4 Identify the major types of adjusting entries.
Illustration 3-25
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The Adjusted Trial Balance
Question
Which of the following statements is incorrect concerning the
adjusted trial balance?
a. An adjusted trial balance proves the equality of the total debit
balances and the total credit balances in the ledger after all
adjustments are made.
b. The adjusted trial balance provides the primary basis for the
preparation of financial statements.
c. The adjusted trial balance lists the account balances
segregated by assets and liabilities.
d. The adjusted trial balance is prepared after the adjusting
entries have been journalized and posted.
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LO 7
Preparing Financial Statements
Financial Statements are prepared directly from the
Adjusted Trial Balance.
Income
Statement
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Retained
Earnings
Statement
Statement
of Financial
Position
LO 7 Describe the nature and purpose of an adjusted trial balance.
Illustration 3-26
3-67
LO 7
Illustration 3-27
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LO 7
Exercises & Problems
Exercises: E3-4, 3-5, 3-10, 3-13
Problems: P3-1A, 3-5A
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