Adjusting Entries
Measuring Business Income
 Accounting
period assumption
 Cash accounting versus accrual
accounting
 Matching principle
 Materiality concept
Adjusting Entries
 Journal
entries that update the
general ledger accounts to state
revenues, expenses, assets, and
liabilities more accurately
 Involve
– One balance sheet account
– One income statement account
– Never cash
Adjusting Process
 Identify
the accounts requiring
adjustment
 Determine unadjusted balances
 Determine correct (adjusted)
balances for each account
 Prepare adjusting entry to bring
accounts in agreement with
adjusted balances
Deferrals
 A cash
payment or receipt occurred
in current period
 Must defer a portion of expense or
revenue until a future period
Deferrals
 Two
situations
– Pay a cost of benefit in advance and
allocate cost as expenses to periods
that receive benefit
Deferrals
 Two
situations
– Pay a cost of benefit in advance and
allocate cost as expenses to periods
that receive benefit
– Receive a cash revenue in advance
and allocate amounts as revenues to
periods in which revenues earned
Prepaid Insurance
 Dec.
1, paid $600 for 12 month
insurance premium recording as
asset, Prepaid Insurance
 At Dec. 31
– Prepaid Insurance balance $600
– Insurance Expense balance $0
Prepaid Insurance
 As
of Dec. 31, one month’s
insurance has expired and become
expense
 Correct Dec. 31 balance
– Prepaid Insurance $550
– Insurance Expense $50
Prepaid Insurance
 Adjusting
entry
– Debit Insurance Expense $50
»Increases Insurance Expense to
correct balance $50
– Credit Prepaid Insurance $50
»Decreases Prepaid Insurance to
correct balance $550
Depreciation Expense
 Similar
to prepaid insurance but for
long-term asset
 Decrease in asset not recorded in
asset account
 Recorded as increase in contra
asset - Accumulated Depreciation
Depreciation Expense
Before
Balance Sheet
$26,000
Trucks
400
Accum Deprec
After
$26,000
800
Income Statement
Depreciation expense
$0
$400
Unearned Revenues
 Dec.
1, received $600 for 6 month
rent recording as liability, Unearned
Rent
 At Dec. 31
– Unearned Rent balance $600
– Rent Revenue balance $0
Unearned Revenues
 As
of Dec. 31, one month’s rent
has been earned and become
revenue
 Correct Dec. 31 balance
– Unearned Revenue $500
– Rent Revenue $100
Unearned Revenues
 Adjusting
entry
– Debit Unearned Rent $100
»Decreases Unearned Rent to
correct balance $500
– Credit Rent Revenue $100
»Increases Rent Revenue to correct
balance $100
Accruals
 Recognize
revenues and expenses
that have accumulated (accrued)
during the accounting period but
have not been recorded
Accrued Revenues
 Dec.11,
received 30-day, 15% note
from customer.
 At Dec. 31
– Interest Revenue balance $0
– Interest Receivable balance $0
Accrued Revenues
 As
of Dec. 31, 20 days interest has
been earned and become revenue
 $1,200 x 0.15 x 20/360 = $10
 Correct Dec. 31 balance
– Interest Revenue $10
– Interest Receivable $10
Accrued Revenues
 Adjusting
entry
– Debit Interest Receivable $10
»Increases Interest Receivable to
correct balance $10
– Credit Interest Revenue $10
»Increases Interest Revenue to
correct balance $10
Accrued Expenses
 Employees
paid Friday for 5-day
work week at $1,000 per week
 At Dec. 31, a Tuesday
– Wages Expense balance $50,000 represents past weeks wages
– Wages Payable balance $0
Accrued Expenses
 As
of Dec. 31, 2 days wages have
been incurred and become
expense
 Correct Dec. 31 balance
– Wages Expense $50,200
– Wages Payable $200
Accrued Expenses
 Adjusting
entry
– Debit Wages Expense $200
»Increases Wages Expense to
correct balance $50,200
– Credit Wages Payable $200
»Increases Wages Payable to
correct balance $200
Summarize Adjustments
Analyzing Information
 Use
questions to compare
companies
Income Statement
 Which
company has the higher
revenues?
 Which company has the higher
percentage change in revenues?
 Which company has the lower
percentage of expenses to
revenues?
Balance Sheet
 Which
company has the higher
assets?
 What is the percentage change in
assets for each company?
 Is the percent of total liabilities to
total liabilities plus owners’ equity
increasing or decreasing? Which
company is more risky?
Integrative Analysis
 Are
companies operating efficiently
by using least amount of assets to
generate a given level of revenues?
– Calculate total asset turnover
 Are
companies operating efficiently
by using least amount of assets to
generate a given net income?
– Calculate return on assets