Chapter 9 - Adjusting Entries Summary Page
Section 9.1 - Adjusting for supplies
Office supplies are both an asset and an expense. Accordingly, the value of supplies that are physically used up
over the course of the fiscal period must be allocated to an expense account at the end of each period. Don’t
forget that a business purchases an asset but uses up or consumes an expense.
As you know, the accounting entry for the initial (or additional) purchase of office supplies is as follows:
18 - Supplies (asset) - dr -100
---------- Bank / A/P - cr - 100
Purchased supplies
Now let’s assume that a business had $100 of supplies on hand at the start of the period, purchased an additional
$50 of supplies over the course of the period, while a year-end physical inventory count determined $70 of
supplies on hand as of the last day of the period. The adjusting entry is as follows:
31 - Supplies Expense - dr - 80
---------- Supplies - cr - 80
Adjusting entry for supplies
Adjusting for prepaid expenses
Let’s assume that a business with a fiscal year-end of December 31 purchases a fully prepaid 12-month property
insurance policy for $1200 on September 1. The initial purchase of the insurance policy on September 1 (an
asset) appears as follows:
1 - Prepaid Insurance - dr - 1200
---------- Bank/AP - cr - 1200
Purchased insurance
A simple calculation reveals that the business has used up 4/12 (September 1 - December 31) or $400 of the
$1200 insurance policy as of the last day of the fiscal period. Accordingly, the adjusting entry prepared on the
last day of the period, indicating the amount of insurance that has expired during the period is as follows:
31 - Insurance Expense - dr - 400
---------- Prepaid Insurance - cr - 400
Adjusting entry for insurance
The same calculations and entries would be used for the initial purchase and year-end adjustment of rent
(Prepaid Rent and Rent Expense) and licenses (Prepaid Licenses and License Expense).
Adjusting for late-arriving purchase invoices
Let’s assume that two purchase invoices (bills) arrive on January 3 representing advertising services and hydro
usage incurred in the month of December for a business with a fiscal year end of December 31. The adjusting
entry, backdated and recorded as of December 31, is as follows:
31 - Advertising Expense - dr - 400
Hydro Expense - dr - 200
---------- Accounts Payable - cr - 600
Adjusting entry for late-arriving purchase invoices
Section 9.5 - Adjusting for depreciation of fixed assets
While not as obvious as the previous scenarios involving supplies and prepaid expenses, the year-end
calculation of depreciation on certain fixed assets is also properly classified as an adjusting entry.
Straight-line Method of Depreciation
The straight-line method of depreciation is the easiest method for calculating the loss in value of depreciable
assets over time. Using this method, the depreciation expense is identical from year to year (p. 346). The
formula is as follows:
annual depreciation expense using straight-line method =
cost of asset - estimated residual value of asset
estimated useful life of asset (in years)
The cost of an asset is the original purchase price paid by the business for that asset. The estimated residual
value of an asset is the predicted scrap (parts) or resale value of that asset once it is no longer operational at the
end of its life. The estimated useful life of an asset is the predicted life of that asset (in years) before it is
expected to break down and lose all functionality.
Part-year depreciation
Please note that under the straight-line method, depreciation of assets purchased midway through the fiscal
period should be prorated (adjusted for time) in both year one and the final year of the asset’s life in order to
take into account the precise loss in value and purchase date of the asset.
Example of straight-line depreciation with part-year depreciation
Let’s assume that an automobile is purchased on October 1 for $24,000 with an estimated residual value of
$4000 and an estimated useful life of 10 years. The business uses a fiscal year end of December 31. Annual
depreciation expense for the asset would normally be $2000 (24,000 - 4,000 / 10).
The adjusting entry in year one, taking into account the precise date of purchase of the asset (part-year
depreciation - see above), is as follows:
31 - Depreciation Expense - Automobile - dr - 500 (3/12 of $2,000)
---------- Accumulated Depreciation - Automobile - cr - 500
Adjusting entry for depreciation
The adjusting entry in year two is as follows:
31 - Depreciation Expense - Automobile - dr - 2000
---------- Accumulated Depreciation - Automobile - cr - 2000
Adjusting entry for depreciation
Declining-balance Method of Depreciation
For income tax purposes, the Canada Revenue Agency (CRA) prefers a somewhat more complicated method
of calculating annual depreciation expense. This method is known as the declining-balance method of
depreciation and results in declining annual depreciation expense figures for all depreciable assets. In other
words, annual depreciation expense will be lower and lower from year to year under this method. The formula is
as follows:
annual depreciation expense using declining-balance method
= net book value of asset x fixed rate of depreciation
The net book value (NBV) of an asset represents the current or up-to-date or remaining or undepreciated value
of the asset. Net book value can easily be calculated by subtracting the accumulated depreciation from the
original purchase price. Net book value can also be calculated by subtracting the previous year's annual
depreciation expense from the previous year's updated net book value. The fixed rate of depreciation to be
employed under this method refers to the specific rate (percentage) of capital cost allowance or CCA
(depreciation) established by the Canada Revenue Agency for each available class of fixed asset (p. 345).
The 50% Rule
You should also be aware that the CRA allows the use of something called the “50% Rule” under the
declining-balance method for asset purchases carried out midway through the fiscal period (p. 347). This rule
requires year one depreciation to be prorated by 50%, regardless of the actual date of purchase, so as to take into
account the approximate loss of value of the asset in its first year of use.
Sections 9.2 & 9.5 - Adjusting entries and the work sheet
Don’t forget that all of the above adjusting entries must first be recorded on the work sheet (p. 317 & p. 342)
and not in the general journal as one would expect.
Summary of adjusting entries
All adjusting entries (* other than late arriving purchase invoices) possess the following characteristics:
1. Each item involved is both an asset and an expense.
2. You buy the asset, you use up the expense.
3. In the adjusting entry you debit the expense, you credit the asset.
4. The amount used up over the course of the period is included in the adjusting entry.
5. Adjusting entries are always recorded as of the last day of the period. (*)