Adjusting Accounts

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Accounting Chapter 4

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Adjusting Accounts

  1. 1. Chapter 4
  2. 2. Purpose of Adjusting <ul><li>End of period adjusting allows for the recognition of internal transactions such as the use of supplies and equipment </li></ul><ul><li>In recognition of the revenue recognition principle and the matching principle </li></ul><ul><li>Accrual basis accounting: founded on the revenue recognition principle, the matching principle and the time period principle </li></ul><ul><li>Cash basis accounting: recognizes revenue and expenses when cash is received or paid </li></ul>
  3. 3. Adjusting Entries <ul><li>Recorded to bring an asset or liability account balance to its proper amount </li></ul>Adjustments Prepaid Expenses Amortization Unearned Revenues Accrued expenses Accrued revenues
  4. 4. Prepaid Expenses <ul><li>Refer to items paid for in advance of receiving their benefits. </li></ul><ul><li>The asset account is credited and the related expense account is debited. </li></ul><ul><li>Reflects the amount of the assets used during the period. </li></ul><ul><li>Common accounts: prepaid insurance, supplies </li></ul><ul><li>Example: purchase of a two-year insurance policy for $3 600. </li></ul><ul><li>After one month, a portion of the asset becomes an expense ($3 600 x 1/24). The entry is as follows: </li></ul>To record expired insurance 150 150 Insurance Expense Prepaid Insurance Jan. 31 Credit Debit PR Account Titles and Explanation Date
  5. 5. Amortization <ul><li>Capital assets are long-term tangible assets that are used to produce and sell products and services and intangible assets (eg. Patents) that convey the right to use a product or process. </li></ul><ul><li>Expected to provide benefits for more than one period </li></ul><ul><li>Most capital assets wear out or decline in usefulness as they are used; therefore, an expense must be recorded to match the cost of the asset over the period. </li></ul><ul><li>Amortization is the process of computing expense from matching or allocating the cost of capital assets over their expected useful lives. </li></ul>
  6. 6. Straight-line Amortization <ul><li>Allocates equal amounts of an asset’s net cost over its estimated useful life. </li></ul><ul><li>Example: $30 000 in furniture estimated to have a useful life of 5 years (60 months) and a value of $6000 at the end of its useful life </li></ul>Cost of asset – Estimated value at end of estimated useful life Estimated Useful Life Monthly Amortization = 30000 – 6000 60 = 400
  7. 7. Adjusting Entry <ul><li>Amortization is recorded in a contra account. </li></ul><ul><li>Contra account is linked with another account and has an opposite normal balance to its counterpart </li></ul><ul><li>Reported as a subtraction from the other account’s balance on the balance sheet. </li></ul>To record monthly amortization on furniture 400 400 Amortization Expense, Furniture Accumulated Amortization, Furniture Jan. 31 Credit Debit PR Account Titles and Explanation Date
  8. 8. Unearned Revenues <ul><li>Cash received in advance of providing products and services </li></ul><ul><li>As products and services are provided, it becomes earned revenues. </li></ul><ul><li>Adjusting entry credits revenues and debits unearned revenues </li></ul><ul><li>Example: Customer pays $300 in advance for services to be provided over the next three months. At the end of the first month, an adjusting entry is needed. </li></ul>To record earned portion of revenue received in advance. 100 100 Unearned Revenue Revenue Jan. 31 Credit Debit PR Account Titles and Explanation Date
  9. 9. Accrued Expenses <ul><li>Costs incurred in a period that are both unpaid and unrecorded. </li></ul><ul><li>Adjusting entries debit the expenses and credit liabilities </li></ul><ul><li>Common examples: salaries, interest, rent and taxes </li></ul><ul><li>Example: An employee is paid biweekly. At the end of the month, the employee has worked for three days that have not yet been paid. Employee is paid $90 per day. Adjustment of $270 is needed. </li></ul>To record three days’ accrued salary 270 270 Salaries Expense Salaries Payable Jan. 31 Credit Debit PR Account Titles and Explanation Date
  10. 10. Accrued Revenues <ul><li>Revenues earned in a period that are both unrecorded and not yet received in cash or other assets. </li></ul><ul><li>Adjusting entries debit assets and credit revenues. </li></ul><ul><li>Common examples: fees for services and products, interest and rent. </li></ul><ul><li>Example: A contract of $5400 for services is signed for Jan 15 th to Feb 14 th , (30 days service) payable on Feb 14 th . As of Jan 31 st , $2880 (5400 x 16/30) has been earned. </li></ul>To record 16 days’ accrued revenue. 2880 2880 Accounts Receivable Consulting Revenue Jan. 31 Credit Debit PR Account Titles and Explanation Date
  11. 11. Accrual Adjustments in Later Periods <ul><li>Entry for first biweekly pay in February </li></ul>Paid two weeks salary including three days accrued in January 900 270 630 Salaries Payable Salaries Expense Cash Feb. 9 Credit Debit PR Account Titles and Explanation Date

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