NSU EMB 501 Accounting Ch03

Chapter
3-2
CHAPTERCHAPTER 33
ADJUSTING THEADJUSTING THE
ACCOUNTSACCOUNTS
Accounting Principles, Eighth Edition

Chapter
3-3
Generally a month, a quarter, or a year.
Fiscal year vs. calendar year
Also known as the “Periodicity Assumption”
Timing IssuesTiming IssuesTiming IssuesTiming Issues
Accountants divide the economic life of a
business into artificial time periods
(Time Period Assumption).
LO 1 Explain the time period assumption.LO 1 Explain the time period assumption.
Jan. Feb. Mar. Apr. Dec.
. . . . .

Chapter
3-4
The time period assumption states that:The time period assumption states that:
a.a. revenue should be recognized in the accounting
period in which it is earned.
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.
ReviewReview
LO 1 Explain the time period assumption.LO 1 Explain the time period assumption.

Chapter
3-5
Accrual-Basis Accounting
Transactions recorded in the periods in which
the events occur
Revenues are recognized when earned, rather
than when cash is received.
Expenses are recognized when incurred, rather
than when paid.
Accrual- vs. Cash-Basis Accounting
LO 2 Explain the accrual basis of accounting.LO 2 Explain the accrual basis of accounting.

Chapter
3-6
Cash-Basis Accounting
Revenues are recognized when cash is received.
Expenses are recognized when cash is paid.
Cash-basis accounting is not in accordance with
generally accepted accounting principles (GAAP).
Accrual- vs. Cash-Basis Accounting

Chapter
3-7
Revenue Recognition Principle
Recognizing Revenues and Expenses
Companies recognize
revenue in the accounting
period in which it is
earned.
In a service enterprise,
revenue is considered to
be earned at the time the
service is performed.

Chapter
3-8
Matching Principle
Recognizing Revenues and Expenses
Match expenses with
revenues in the period
when the company makes
efforts to generate
those revenues.
“Let the expenses follow
the revenues.”

Chapter
3-9
GAAP relationships
in revenue and
expense recognition
GAAP relationships
in revenue and
expense recognition
Illustration 3-1Illustration 3-1

Chapter
3-10
One of the following statements about the accrual basis
of accounting is false. That statement is:
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 it is
earned.
c. This basis is in accord with generally accepted
accounting principles.
d. Revenue is recorded only when cash is received, and
expense is recorded only when cash is paid.
ReviewReview

Chapter
3-11
Adjusting entries make it possible to report
correct amounts on the balance sheet and
on the income statement.
A company must make adjusting entries
every time it prepares financial statements.
The Basics of Adjusting EntriesThe Basics of Adjusting EntriesThe Basics of Adjusting EntriesThe Basics of Adjusting Entries
LO 3 Explain the reasons for adjusting entries.LO 3 Explain the reasons for adjusting entries.

Chapter
3-12
RevenuesRevenues - recorded in the period in which- recorded in the period in which
they are earnedthey are earned.
ExpensesExpenses - recognized in the period in which- recognized in the period in which
they are incurredthey are incurred.
Adjusting entriesAdjusting entries - needed to ensure that- needed to ensure that
thethe revenue recognitionrevenue recognition andand matchingmatching
principlesprinciples are followed.are followed.
The Basics of Adjusting EntriesThe Basics of Adjusting EntriesThe Basics of Adjusting EntriesThe Basics of Adjusting Entries

Chapter
3-13
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
they are earned.
c. balance sheet and income statement accounts
have correct balances at the end of an
accounting period.
d. all of the above.
ReviewReview

Chapter
3-14
Types of Adjusting EntriesTypes of Adjusting EntriesTypes of Adjusting EntriesTypes of Adjusting Entries
1. Prepaid Expenses.
Expenses paid in cash and
recorded as assets before
they are used or consumed.
Deferrals
3. Accrued Revenues.
Revenues earned but not
yet received in cash or
recorded.
4. Accrued Expenses.
Expenses incurred but not
yet paid in cash or
recorded.
2. Unearned Revenues.
Revenues received in cash
and recorded as liabilities
before they are earned.
Accruals
LO 4 Identify the major types of adjusting entries.LO 4 Identify the major types of adjusting entries.

Chapter
3-15
Trial BalanceTrial Balance – Each account is analyzed to determine
whether it is complete and up-to-date.
Phoenix Consulting - Jan. 31st (before adjusting entries)
Acct. No. Account Debit Credit
100 Cash 50,000$
105 Accounts receivable 35,000
110 Prepaid insurance 12,000
120 Equipment 24,000
130 Investments 300,000
200 Accounts payable 20,000$
210 Unearned revenue 24,000
220 Note payable 200,000
300 Austin, capital 40,000
400 Sales 137,000
421,000$ 421,000$
Trial BalanceTrial BalanceTrial BalanceTrial Balance
LO 4 Identify the major types of adjusting entries.LO 4 Identify the major types of adjusting entries.

Chapter
3-16
Deferrals are either:
Prepaid expenses or
Unearned revenues.
Adjusting Entries for DeferralsAdjusting Entries for DeferralsAdjusting Entries for DeferralsAdjusting Entries for Deferrals
LO 5LO 5 Prepare adjusting entries for deferrals.Prepare adjusting entries for deferrals.

Chapter
3-17
Payment of cash, that is recorded as an asset becausePayment of cash, that is recorded as an asset because
service or benefit will be received in the future.service or benefit will be received in the future.
Adjusting Entries for “Prepaid Expenses”Adjusting Entries for “Prepaid Expenses”Adjusting Entries for “Prepaid Expenses”Adjusting Entries for “Prepaid Expenses”
insuranceinsurance
suppliessupplies
advertisingadvertising
Cash PaymentCash Payment Expense RecordedExpense RecordedBEFORE
rentrent
maintenance on equipmentmaintenance on equipment
fixed assets (depreciation)fixed assets (depreciation)
Prepayments often occur in regard to:Prepayments often occur in regard to:

Chapter
3-18
Prepaid Expenses
Costs that expire either with the passage of time
or through use.
Adjusting entries (1) to record the expenses that
apply to the current accounting period, and (2) to
show the unexpired costs in the asset accounts.

Chapter
3-19
Illustration 3-4
Adjusting entries for prepaid expenses
Increases (debits) an expense account and
Decreases (credits) an asset account.

Chapter
3-20
ExampleExample (Insurance)(Insurance):: On Jan. 1On Jan. 1stst
, Phoenix Consulting paid, Phoenix Consulting paid
$12,000 for 12 months of insurance coverage. Show the$12,000 for 12 months of insurance coverage. Show the
journal entry to record the payment on Jan. 1journal entry to record the payment on Jan. 1stst
..
Cash 12,000
Prepaid insurance 12,000Jan. 1
Debit Credit
Prepaid Insurance
12,00012,000 12,00012,000
Debit Credit
Cash

Chapter
3-21
ExampleExample (Insurance)(Insurance):: On Jan. 1On Jan. 1stst
, Phoenix Consulting paid, Phoenix Consulting paid
$12,000 for 12 months of insurance coverage. Show the$12,000 for 12 months of insurance coverage. Show the
adjusting journal entryadjusting journal entry required at Jan. 31required at Jan. 31stst
..
Prepaid insurance 1,000
Insurance expense 1,000Jan. 31
Debit Credit
Prepaid Insurance
12,00012,000 1,0001,000
Debit Credit
Insurance expense
1,0001,000
11,00011,000

Chapter
3-22
Depreciation
Buildings, equipment, and vehicles (long-lived
assets) are recorded as assets, rather than an
expense, in the year acquired.
Companies report a portion of the cost of a long-
lived asset as an expense (depreciation) during
each period of the asset’s useful life (Matching
Principle).

Chapter
3-23
ExampleExample (Depreciation)(Depreciation):: On Jan. 1On Jan. 1stst
, Phoenix Consulting, Phoenix Consulting
paid $24,000 for equipment that has an estimated usefulpaid $24,000 for equipment that has an estimated useful
life of 20 years. Show the journal entry to record thelife of 20 years. Show the journal entry to record the
purchase of the equipment on Jan. 1purchase of the equipment on Jan. 1stst
..
Cash 24,000
Equipment 24,000Jan. 1
Debit Credit
Equipment
24,00024,000 24,00024,000
Debit Credit
Cash

Chapter
3-24
ExampleExample (Depreciation)(Depreciation):: On Jan. 1On Jan. 1stst
, Phoenix Consulting, Phoenix Consulting
paid $24,000 for equipment that has an estimated usefulpaid $24,000 for equipment that has an estimated useful
life of 20 years. Show thelife of 20 years. Show the adjusting journal entryadjusting journal entry requiredrequired
at Jan. 31at Jan. 31stst
.. ($24,000 / 20 yrs. / 12 months = $100)($24,000 / 20 yrs. / 12 months = $100)
Accumulated depreciation 100
Depreciation expense 100Jan. 31
Debit Credit
Depreciation expense
100100 100100
Debit Credit
Accumulated depreciation
100100

Chapter
3-25
Depreciation (Statement Presentation)
Accumulated Depreciation—is a contra asset
account.
Appears just after the account it offsets
(Equipment) on the balance sheet.
Balance Sheet Jan. 31
Assets
Equipment 24,000
Accumulated Depreciation (100)
Net Equipment 23,900

Chapter
3-26
Receipt of cash that is recorded as a liability becauseReceipt of cash that is recorded as a liability because
the revenue has not been earned.the revenue has not been earned.
Adjusting Entries for “Unearned Revenues”Adjusting Entries for “Unearned Revenues”Adjusting Entries for “Unearned Revenues”Adjusting Entries for “Unearned Revenues”
rentrent
airline ticketsairline tickets
school tuitionschool tuition
Cash ReceiptCash Receipt Revenue RecordedRevenue RecordedBEFORE
magazine subscriptionsmagazine subscriptions
customer depositscustomer deposits
Unearned revenues often occur in regard to:Unearned revenues often occur in regard to:

Chapter
3-27
Unearned Revenues
Company makes an adjusting entry to record the
revenue that has been earned and to show the
liability that remains.
The adjusting entry for unearned revenues results
in a decrease (a debit) to a liability account and an
increase (a credit) to a revenue account.

Chapter
3-28 LO 5LO 5 Prepare adjusting entries for deferrals.Prepare adjusting entries for deferrals.
Illustration 3-10
Adjusting entries for unearned revenues
Decrease (a debit) to a liability account and
Increase (a credit) to a revenue account.

Chapter
3-29
Example:Example: On Jan. 1On Jan. 1stst
, Phoenix Consulting received $24,000, Phoenix Consulting received $24,000
from Arcadia High School for 3 months rent in advance.from Arcadia High School for 3 months rent in advance.
Show the journal entry to record the receipt on Jan. 1Show the journal entry to record the receipt on Jan. 1stst
..
Unearned rent revenue 24,000
Cash 24,000Jan. 1
Debit Credit
Cash
24,00024,000 24,00024,000
Debit Credit
Unearned Rent Revenue

Chapter
3-30
, Phoenix Consulting received $24,000, Phoenix Consulting received $24,000
from Arcadia High School for 3 months rent in advance.from Arcadia High School for 3 months rent in advance.
Show theShow the adjusting journal entryadjusting journal entry required on Jan. 31required on Jan. 31stst
..
Rent revenue 8,000
Unearned rent revenue 8,000Jan. 31
Debit Credit
Rent Revenue
8,0008,000 24,00024,000
Debit Credit
Unearned Rent Revenue
8,0008,000
16,00016,000

Chapter
3-31
Made to record:
Revenues earned and
Expenses incurred
in the current accounting period that have not
been recognized through daily entries.
Adjusting Entries for AccrualsAdjusting Entries for AccrualsAdjusting Entries for AccrualsAdjusting Entries for Accruals
LO 6LO 6 Prepare adjusting entries for accruals.Prepare adjusting entries for accruals.

Chapter
3-32
Revenues earned but not yet received in cash orRevenues earned but not yet received in cash or
recorded.recorded.
Adjusting Entries for “Accrued Revenues”Adjusting Entries for “Accrued Revenues”Adjusting Entries for “Accrued Revenues”Adjusting Entries for “Accrued Revenues”
rentrent
interestinterest
services performedservices performed
BEFORE
Accrued revenues often occur in regard to:Accrued revenues often occur in regard to:
Cash ReceiptCash ReceiptRevenue RecordedRevenue Recorded
Adjusting entry results in:Adjusting entry results in:

Chapter
3-33
Accrued Revenues
An adjusting entry serves two purposes:
(1) It shows the receivable that exists, and
(2) It records the revenues earned.

Chapter
3-34
Illustration 3-13
Adjusting entries for accrued revenues
Increases (debits) an asset account and
Increases (credits) a revenue account.

Chapter
3-35
, Phoenix Consulting invested, Phoenix Consulting invested
$300,000 in securities that return 5% interest per year.$300,000 in securities that return 5% interest per year.
Show the journal entry to record the investment on Jan. 1Show the journal entry to record the investment on Jan. 1stst
..
Cash 300,000
Investments 300,00
0
Jan. 1
Debit Credit
Investments
300,000300,000 300,000300,000
Debit Credit
Cash

Chapter
3-36
, Phoenix Consulting invested, Phoenix Consulting invested
$300,000 in securities that return 5% interest per year.$300,000 in securities that return 5% interest per year.
Show theShow the adjusting journal entryadjusting journal entry required on Jan. 31required on Jan. 31stst
..
($300,000 x 5% / 12 months = $1,250)($300,000 x 5% / 12 months = $1,250)
Interest revenue 1,250
Interest receivable 1,250Jan. 31
Debit Credit
Interest Receivable
1,2501,250 1,2501,250
Debit Credit
Interest Revenue

Chapter
3-37
Expenses incurred but not yet paid in cash orExpenses incurred but not yet paid in cash or
recorded.recorded.
Adjusting Entries for “Accrued Expenses”Adjusting Entries for “Accrued Expenses”Adjusting Entries for “Accrued Expenses”Adjusting Entries for “Accrued Expenses”
rentrent
interestinterest
BEFORE
Accrued expenses often occur in regard to:Accrued expenses often occur in regard to:
Cash PaymentCash PaymentExpense RecordedExpense Recorded
taxestaxes
salariessalaries
Adjusting entry results in:Adjusting entry results in:

Chapter
3-38
Accrued Expenses
(1) It records the obligations, and
(2) It recognizes the expenses.

Chapter
3-39
Illustration 3-16
Adjusting entries for accrued expenses
Increases (debits) an expense account and
Increases (credits) a liability account.

Chapter
3-40
Notes payable 200,000
Cash 200,00
0
Jan. 2
Debit Credit
Cash
200,000200,000 200,000200,000
Debit Credit
Notes Payable
Example:Example: On Jan. 2On Jan. 2ndnd
, Phoenix Consulting borrowed $200,000, Phoenix Consulting borrowed $200,000
at a rate of 9% per year. Interest is due on first of eachat a rate of 9% per year. Interest is due on first of each
month. Show the journal entry to record the borrowing on Jan.month. Show the journal entry to record the borrowing on Jan.
22ndnd
..

Chapter
3-41
Example:Example: On Jan. 2On Jan. 2ndnd
, Phoenix Consulting borrowed $200,000, Phoenix Consulting borrowed $200,000
at a rate of 9% per year. Interest is due on first of eachat a rate of 9% per year. Interest is due on first of each
month. Show themonth. Show the adjusting journal entryadjusting journal entry required on Jan. 31required on Jan. 31stst
..
($200,000 x 9% / 12 months = $1,500)($200,000 x 9% / 12 months = $1,500)
Interest payable 1,500
Interest expense 1,500Jan. 31
Debit Credit
Interest Expense
1,5001,500 1,5001,500
Debit Credit
Interest Payable

Chapter
3-42
Accrued Expenses
(1) It records the obligations, and
(2) it recognizes the expenses.

Chapter
3-43
After all adjusting entries are journalized and
posted the company prepares another trial
balance from the ledger accounts (Adjusted Trial
Balance).
Its purpose is to prove the equality of debit
balances and credit balances in the ledger.
The Adjusted Trial BalanceThe Adjusted Trial BalanceThe Adjusted Trial BalanceThe Adjusted Trial Balance
LO 7LO 7 Describe the nature and purpose of an adjusted trial balance.Describe the nature and purpose of an adjusted trial balance.

Chapter
3-44
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.
ReviewReview

Chapter
3-45
Financial Statements are prepared directly from the
Adjusted Trial Balance.
Financial Statements are prepared directly from the
Adjusted Trial Balance.
Balance
Sheet
Income
Statement
Statement
of Cash
Flows
Statement
of
Retained
Earnings
Preparing Financial StatementsPreparing Financial StatementsPreparing Financial StatementsPreparing Financial Statements

Chapter
3-46
Income Statement
For the Month Ended Jan. 31,
Revenues:
Sales 137,000$
Rent revenue 8,000
Total revenue 146,250
Expenses:
Interest expense 1,500
Depreciation expense 100
Insurance expense 1,000
Total expenses 2,600
Net income 143,650$
Income Statement
Adjusted Trial Balance Debit Credit
Cash 50,000$
Accounts receivable 35,000
Interest receivable 1,250
Equipment 24,000
Accumulated depreciation 100$
Investments 300,000
Accounts payable 20,000
Unearned revenue 16,000
Note payable 200,000
Austin, capital 40,000
Sales 137,000
Rent revenue 8,000
423,850$ 423,850$

Chapter
3-47
Statement of Owners' Equity
For the Month Ended Jan. 31,
Austin, Capital, Jan. 1 40,000$
+ Net income 143,650
- Drawings 0
Austin, Capital, Jan. 31 183,650$
Statement of
Owners’ Equity
Cash 50,000$
Equipment 24,000
Investments 300,000
Sales 137,000
Rent revenue 8,000
423,850$ 423,850$

Chapter
3-48
Cash 50,000$
Equipment 24,000
Investments 300,000
Sales 137,000
Rent revenue 8,000
423,850$ 423,850$
Balance Sheet Jan. 31
Assets
Cash 50,000$
Equipment 24,000
Accum. Depreciation (100)
Investments 300,000
Total assets 421,150$
Liabilities & Owners' Equity
Accounts payable 20,000$
Interst payable 1,500
Total liab. & equity 421,150$

NSU EMB 501 Accounting Ch03

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NSU EMB 501 Accounting Ch03