This document discusses adjusting entries and the accrual basis of accounting. It explains that adjusting entries are necessary to adhere to the accrual basis and matching principle. This involves recognizing revenues and expenses in the periods they are earned or incurred, rather than when cash is received or paid. The document outlines the nature and purpose of various adjusting entry types, including prepaid expenses, unearned revenues, accrued revenues, and accrued expenses. It provides examples of adjusting entries for each type to properly state account balances and prepare an adjusted trial balance in accordance with accrual accounting.

1. Adjusting the Accounts
CHAPTER 3

2. Objective
 Accrual basis of accounting Vs cash basis accounting
 Reason for adjusting entries
 Prepare adjusting entries for deferrals
 Prepare adjusting entries for accruals
 The nature and purpose of an adjusted trial balance

3. Time period
 Fiscal year Vs Calendar Years
 Accounting time periods are generally a month, a quarter or a year
 Accounting period that is one year in length is a fiscal year

4. Accrual Vs Cash basis accounting
 Cash basis accounting : companies record transaction when they
receive cash
 Accrual basis accounting: companies record transactions that
change a company’s financial statements in the periods in which the
events occur
 Cash basis simple but does not match expenses with revenue
 Accrual basis adheres to the matching principle (match revenue
with expense)
 Accrual basis is in accordance with GAAP and IFRS

5. Recognizing Revenues and Expenses

6. Adjusting Entries
 Ensures that revenue and expense recognition principles are
followed
 Adjusting entries are required each time financial statements are
prepared.
 Every adjusting entry will include one income statement account
and one balance sheet account
Result from the passage of time
• Not triggered by a new transaction or exchange

7. Adjusting Entries
 Correcting entries: Correct recording errors that the firm detects at the
end of the period
Types of adjusting entries
• Deferrals
Unearned Revenues
Prepaid Expenses
• Accruals
Accrued Revenues
 Accrued Expenses

8. Prepaid Expense
 Prepaid expenses are expenses paid in cash and recorded as assets
before they are used or consumed.
 Prepaid expenses expire with the passage of time or through use
and consumption.
 An asset-expense account relationship exists with prepaid
expenses.
 Prior to adjustment, assets are overstated and expenses are
understated.
 Adjusting entry result in an increase (debit) to an expense account
and decrease (credit) to an asset account.

9. Prepaid Expense
Dugan, Ltd. recorded payment of $36,000 on January 11, 2013 for
a 12- month rent contract . Dugan makes an adjusting entry at the
end of the quarter for equal allocation of this rent payment. Dugan
will record the $9,000 rent expense on March 31, 2013 [or
($36,000/12) x 3 months]

10. Prepaid Expense
 Depreciation: process of allocating the cost of an asset to
expense over its useful life
 A company buys equipment with cash for $5000 and assume that
depreciation on the equipment is $40 a month.
 Initial entry: Equipment (dr) 5000, Cash (cr) 5000
 Every month : Depreciation expense (dr) 40, Accumulated
depreciation (cr) 40
 At the end of year: Depreciation expense $480 to income
statement; Accumulated depreciation $480 to balance sheet (as
negative asset)

11. Unearned Revenue
 Unearned revenues are revenues received and recorded as
liabilities before they are earned.
 Unearned revenues are subsequently earned by performing a
service or providing a good to a customer.
 A liability-revenue account relationship exists with unearned
revenues.
 Prior to adjustment, liabilities are overstated and revenues are
understated.
 Adjusting entry result in an decrease (debit) to a liability account
and increase (credit) to a revenue account.

12. Unearned Revenue
 On Feb. 20, Dugan received $22,000 from a customer for future
merchandise shipments. Dugan will deliver half on March 31 and half
on June 30 . When Dugan delivers half on March 31, the company
will recognize the revenue and record the merchandise cost of
$5,000.

13. Accrued Revenue
 Accrued revenues may accumulate with the passing of time or
through services performed but not billed or collected.
An asset-revenue account relationship exists with accrued
revenues.
Prior to adjustment, assets and revenues are understated.
Adjusting entry result in an increase (debit) to an asset
account and increase (credit) to a revenue account.

14. Accrued Revenue
 On January 1, 2013, Dugan, Ltd. sold $6,000 of services and
allowed a client to pay with a note payable over 12 months time,
with interest accruing quarterly at a rate of 10% per annum. Dugan
would record an adjusting entry to recognize interest revenue on
March 31 equal to $150 or ($6,000 x 10% x 3/12)

15. Accrued Expenses
 Accrued expenses are expenses incurred but not yet paid.
A liability-expense account relationship exists.
Prior to adjustment, liabilities and expenses are understated.
Adjusting entry result in an increase (debit) to an expense account
and increase (credit) to a liability account.

16. Accrued Expenses
 Dugan Ltd. buys an equipment on March 1 for $120,000 by signing
a 8%, 5-year, note payable. At the end of March Dugan records the
accrued interest for March on the bank loan for the equipment :
Interest expense = $120,000 x 8% x 1/12 = $800

17. Adjusting Entries
Asset
Unadjusted Balance Credit Adjusting Entry
(-)
Expense
Debit Adjusting Entry
(+)
Prepaid Expenses
Liability
Unadjusted BalanceDebit Adjusting Entry
(-)
Revenue
Credit Adjusting
Entry (+)
Unearned Revenues

18. Adjusting Entries
Asset
Debit Adjusting
Entry (+)
Accrued Revenues
Revenue
Credit
Adjusting
Entry (+)
Accrued Expenses
Expense
Debit Adjusting
Entry (+)
Liability
Credit
Adjusting
Entry (+)

19. Summary of Adjusting Entries
1.Prepaid Assets and Assets overstated Dr. Expenses
expenses expenses Expenses understated Cr. Assets
2.Unearned Liabilities and Liabilities overstated Dr. Liabilities
revenues revenues Revenues understated Cr. Revenues
3.Accrued Assets and Assets understated Dr. Assets
revenues revenues Revenues understated Cr. Revenues
4.Accrued Expenses and Expenses understated Dr. Expenses
expenses liabilities Liabilities understated Cr. Liabilities
Type of Account Accounts before Adjusting
Adjustment Relationship Adjustment Entry

20. Adjusted Trial Balance
 An Adjusted Trial Balance is prepared after all adjusting entries
have been journalized and posted.
It shows the balances of all accounts at the end of the accounting
period and the effects of all financial events that have occurred
during the period.
It proves the equality of the total debit and credit balances in the
ledger after all adjustments have been made.
Financial statements can be prepared directly from the adjusted
trial balance.

21. Transactions
 On October 4, Pioneer pays $600 for a one-year insurance policy that will
expire next year on September 30.
On October 1, Pioneer purchases office equipment costing $5,000 by
signing a 3-month, 12%, $5,000 note payable.
 On October 2, Pioneer receives a $1,200 cash advance from R. Knox a
client, for advertising services that are expected to be completed by
December 31.
 On October Pioneer Advertising performed services that were not billed to
clients on or before October 31.
 On October 9, Pioneer hires four employees to begin work on October 15.
Each employee is to receive a weekly salary of $500 for a 5-day work week,
payable every 2 weeks --- first payment made on October 26.