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1. Adjusting the Accounts
CHAPTER 3
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2. Learning Objectives
After studying this chapter, you should be able to:
 Explain the time period assumption.
 Explain the accrual basis and cash basis of accounting.
 Identify the major types of adjusting entries.
 Prepare adjusting entries for deferrals.
 Prepare adjusting entries for accruals.
 Describe the Depreciation and what causes.
 Factors effecting Depreciation.
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4. The Time Period Assumption
The time period assumption in accounting allows a company activities to be
divided into informal time
 periods so it can produce financial information which individuals can use to
make decisions. It can be :
• Monthly
• Quarterly
• Annually
• Financial statements prepared less than a year is called Interim periods.
• Any twelve months adopted by a company is called Fiscal year
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6. Timing Issues
◆ Monthly and quarterly time periods are called
interim periods.
◆ Public 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.
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7. The Adjusting Process
The journal entries that bring the accounts up to
date at the end of the accounting period are called
adjusting entries.
All adjusting entries affect at least one income
statement account and one balance sheet
account.
Thus, an adjusting entry will always involve a
revenue or an expense account and an asset or a
liability account.
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8. Matching Principle
 The accounting concept that supports
reporting revenues and related expenses in
the same period is called the matching
concept, or matching principle.
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10. Accrual- versus Cash-Basis Accounting
Accrual-Basis Accounting
Transactions recorded in the periods in which
the events occur.
◆ Companies recognize revenues when they
perform services (rather than when cash is
received.
◆ Expenses are recognized when incurred
(rather than when paid).
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11. Cash-Basis Accounting
• Revenues recognized when cash is
received.
• Expenses recognized when cash is paid.
• Cash-basis accounting is not in accordance
with generally accepted accounting
principles (GAAP).
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12. The Basics of Adjusting Entries
Adjusting Entries
◆ 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.
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13. Types of Adjusting Entries
Types of Adjusting Entries
Deferrals:
1. Prepaid expenses: Expenses paid in cash before they are
used or consumed.
2. Unearned revenues: Cash received before services are
performed.
Accruals:
1. Accrued revenues: Revenues for services performed but
not yet received in cash or
recorded.
2. Accrued expenses: Expenses incurred but not yet paid in
cash or recorded.
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14. Subsequent sections give examples of each
type of adjustment. Each example
is based on the October 31 trial balance of
Pioneer Advertising Agency Inc. from
Chapter 2, reproduced
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15. Adjusting Entries for Deferrals
Deferrals are expenses or revenues that are
recognized at a date later than the point when
cash was originally exchanged.
The two types of deferrals are prepaid expenses
and unearned revenues.
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17. SUPPLIES
Supplies The purchase of supplies, such as paper and envelopes,
results in an increase (a debit) to an asset account. During the
accounting period, the company uses supplies. Rather than record
supplies expense as the supplies are used, companies recognize
supplies expense at the end of the accounting period.
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18. Example
1. Recall from trail balance that Pioneer Advertising Agency
Inc. purchased supplies costing $2,500 on October 1.
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.
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19. SOLUTION
Given Oct 1 Purchased supplies $250
Oct 31 supplies on hand $ 1000
, the cost of supplies used is $1,500
 ($2,500 - $1,000). This use of supplies decreases an
asset, Supplies. It also decreases stockholders’
equity Supplies Expense.
 After adjustment, the asset account Supplies shows a
balance of $1,000,
which is equal to the cost of supplies on hand at the
statement date. In addition,
 Supplies Expense shows a balance of $1,500
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21. INSURANCE
 INSURANCE Companies purchase insurance to protect themselves
from losses due to fire, theft, and unforeseen events. Insurance
must be paid in advance, often for more than one year.
Example On October 1, 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.
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22. Solution
This account shows a balance of $600 in the
October 31 trial balance. ($600 / 12) Insurance of $50 expires
each month.
• The expiration of prepaid insurance decreases an asset,
Prepaid Insurance. It also decreases stockholders’ equity by
increasing an expense account, Insurance Expense
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23. Adjusting accounts
_
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24. ACCRUED SALARIES AND WAGES
Companies pay for some types of expenses, such
as employee salaries and wages, after the
services have been performed.
Example 1.
At October 31, the salaries and wages for days
represent an accrued expense and a related
liability to Pioneer. The employees receive total
salaries and wages of $2,000 for a five-day work
week, or $400 per day. Thus,
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25. Solution
 accrued salaries and wages at October 31 are ($400 * 3)=
$1200. This accrual so increases a liability, Salaries and
Wages Payable. It also decreases stockholders’
equity by increasing an expense account, Salaries and Wages
Expense, as
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26. DEPRECIATION
A company typically owns a variety of assets that
have long lives, such as buildings, equipment, and
motor vehicles. The period of service is referred
to as the useful life of the asset.
• Depreciation is the process of allocating the
cost of an asset to expense over its useful life.
• Accumulated Depreciation is called a contra
asset account.
Example.
For Pioneer Advertising, assume that
depreciation on the equipment is $480
in a one year .
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27. Solution
 The balance in the Accumulated Depreciation—
Equipment account will increase $40 each month.
Ex.2
De.31 The equipment cost $18,000 net cost by 4 year
calculate months in the assets useful life gives as ?
Cost 18,000/48month= $375
 Dec31 Depreciation expense…… $375
accumulated DE………………$375
to record monthly equipment depreciation.
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28. ADJUSTMENT FOR DEPRECIATION
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29. Adjustment
 Before Adjustment
Equipment, net = $5,000
 Adjustment
deduct $375 from equipment to the depreciation expense
 After Adjustment
equipment net = $ 4625 so report $4625 in equipment net of
accumulated depreciation.
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30. CAUSES OF DEPRECIATION
1. Physical depreciation - erosion, rust, and decay
2. Economic factors - obsolescence; inadequacy
3. The time factor - lease,
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31. Methods of Calculating Depreciation
1) Straight Line Method Fixed Installment Method
 Amount of depreciation is the same for every year
Yearly depreciation = (cost - estimated disposal 1) /number of expected years of
use.
Example 1: A motor lorry was bought for $22,000 and keep it for 4 years and then sell it
for $2,000.
 the depreciation to be charged would be :
• Depreciation
• = ($22,000 - $2,000/4
• = $5,000 depreciation each year for 4 years
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32. Example
A machine is bought for $10,000 and
depreciation is to be charged at 20%, the
calculations for the first three years would be as
follows:
Cost
1st year: depreciation (20% of $10,000) =2,000
2nd year: depreciation (20% of $8,000) =1,600
3rd year: depreciation (20% of $6,400) =1,280
Cost not yet apportioned, end of year 3= 5,120
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