This document discusses adjusting accounts for financial statements. It covers adjusting the accounts at the end of an accounting period to ensure revenues, expenses, assets, and liabilities are accurately recorded. Key adjustments include prepaid expenses, depreciation, unearned revenues, accrued expenses, and accrued revenues. Adjusting entries are necessary to prepare accurate financial statements in accordance with accounting principles like the revenue recognition and matching principles.

1. AAddjjuussttiinngg
AAccccoouunnttss ffoorr
FFiinnaanncciiaall
SSttaatteemmeennttss
CHAPTER
3
PowerPoint Slides to accompany
Fundamental Accounting Principles, 14ce
Prepared by
Joe Pidutti, Durham College

2. LLeeaarrnniinngg OObbjjeeccttiivveess
1. Describe the purpose of adjusting
accounts at the end of the period. (LO1)
2. Explain how the timeliness, matching,
and revenue recognition principles affect
the adjusting process. (LO2)
3. Explain accrual accounting and cash
basis accounting and how accrual
accounting adds to the usefulness of
financial statements. (LO3)
2 © 2013 McGraw-Hill Ryerson Limited.

3. LLeeaarrnniinngg OObbjjeeccttiivveess
4. Prepare and explain adjusting entries for
prepaid expenses, depreciation, unearned
revenues, accrued expenses, and accrued
revenues. (LO4)
5. Explain how accounting adjustments link
to financial statements. (LO5)
6. Explain and prepare an adjusted trial
balance. (LO6)
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4. LLeeaarrnniinngg OObbjjeeccttiivveess
7. Prepare financial statements from an
adjusted trial balance. (LO7)
8. Explain and prepare correcting entries.
(Appendix 3A) (LO8)
9. Identify and explain an alternative in
recording prepaids and unearned
revenues. (Appendix 3B) (LO9)
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5. TThhee AAccccoouunnttiinngg CCyyccllee
Prepare
post-closing
trial balance
9 1
Analyze
transactions
Journalize
Close
Post
Prepare
unadjusted
trial balance
Prepare
statements
Prepare
adjusted
trial balance
Adjust
2
3
4
8
6
5
LO 1
7
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6. AAddjjuussttiinngg tthhee AAccccoouunnttss
Financial information must be timely and
accurate to be useful to decision makers.
• Financial statements need to be
prepared at regular intervals (periods).
• Accounts need to be adjusted (updated)
to ensure all revenues, expenses,
assets, and liabilities are recorded.
LO 1
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7. GAAP aanndd tthhee AAddjjuussttiinngg PPrroocceessss
Adjustments are based on three generally
accepted accounting principles:
• Timeliness principle.
• Revenue recognition principle.
• Matching principle.
LO 2
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8. AAccccoouunnttiinngg PPrriinncciipplleess
Timeliness Principle
Assumes that the organization’s activities can be
divided into specific time periods such as:
• Months
• Quarters
• Years
Requires that financial statements be presented
at least annually.
LO 2
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9. AAccccoouunnttiinngg PPrriinncciipplleess
Revenue Recognition Principle
Revenue is recognized (reported) in the time
period when it is earned regardless when the
cash is received.
Matching Principle
Expenses are to be matched in the same
accounting period as the revenues they helped
to earn.
9 LO 2
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10. CCaasshh vvss.. AAccccrruuaall BBaassiiss
Accrual Basis
• Revenues and expenses are recognized
when earned or incurred regardless of when
cash is received or paid.
• Consistent with GAAP.
Cash Basis
• Revenues and expenses are recognized
when cash is received or paid.
• Not consistent with GAAP.
LO 3
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11. AAddjjuussttiinngg AAccccoouunnttss
• Accounts are adjusted at the end of each
accounting period to bring an asset or
liability account to its proper amount.
• Adjusting entries also update the related
expense or revenue accounts.
• These adjustments are necessary for the
preparation of financial statements.
LO 4
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12. AAddjjuussttmmeennttss
Types:
• Prepaid expenses
• Depreciation
• Unearned revenues
• Accrued expenses
• Accrued revenues
12 LO 4
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13. PPrreeppaaiidd EExxppeennsseess
• Costs paid in advance of receiving their
benefits.
• They are recorded as assets.
• As these assets are used, their costs
become expenses.
• These costs expire with the passage of
time or through use and consumption,
e.g., insurance, supplies.
13 LO 4
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14. Prepaid Expenses–Example
On January 1, a company purchases an insurance
policy that covers three months and costs $1,800.
• The policy will benefit the company for three months and
will be expired at the end of three months.
• The cost of the policy should be spread over the time
period it benefits the organization. (matching principle).
$1,800
January February March
$600 $600 $600
14 LO 4
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15. Prepaid Expenses–Example
The entry to record the purchase of the insurance
policy would be: Prepaid Insurance 1,800
Cash 1,800
$1,800
1,800
January February March $600 $600 $600
$Prepaid Insurance
Cash
Jan. 1 1,800 1,800
15 LO 4
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16. Prepaid Expenses–Example
The entry to record the expiry of the insurance for
January would be: Insurance Expense 600
Prepaid Insurance 600
$1,800
January February March
$600 $600 $600
$1,800
Prepaid Insurance Insurance Expense
Jan. 1 1,800
Jan.31 600 600
balance 1,200
16 LO 4
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17. Prepaid Expenses–Example
The entry to record the expiry of the insurance for
February would be: Insurance Expense 600
Prepaid Insurance 600
$1,800
January February March
$600 $600 $600
$1,800
Prepaid Insurance Insurance Expense
Jan. 1 1,800
Jan.31 600 600
Feb.28 600 600
balance 600
17 LO 4
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18. Prepaid Expenses–Example
The entry to record the expiry of the insurance for
March would be: Insurance Expense 600
Prepaid Insurance 600
$1,800
1,800
January February March $600 $600 $600
$Prepaid Insurance Insurance Expense
Jan. 1 1,800
Jan.31 600 600
Feb.28 600 600
Mar.31 600 600
balance 0
18 LO 4
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19. DDeepprreecciiaattiioonn
• Companies acquire assets such as
equipment, buildings, vehicles, and patents
to generate revenues.
• These assets are expected to provide
benefits for more than one accounting
period.
• Depreciation is the process of allocating the
costs of assets over their expected useful
lives.
19 LO 4
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20. DDeepprreecciiaattiioonn
• Depreciation is based on the matching
principle where the cost of an asset is
matched over the time the asset helped
earn the revenue.
Straight-Line
Depreciation
Expense
=
Asset cost – Estimated residual value
Estimated useful life
20 LO 4
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21. Depreciation - Example
On January 1, 2014, a company purchased a piece of
equipment for $72,000. The equipment is expected to
have a useful life of four years and have a residual value
of $8,000.
=
$72,000 - $8,000
4 years
= $16,000/year
Straight-Line
Depreciation
Expense
=
Asset cost – Estimated residual value
Estimated useful life
21 LO 4
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22. Depreciation - Example
The entry to record the purchase of the
equipment would be:
Cash 72,000
Cash
Equipment 72,000
Equipment
72,000 1/1/14 72,000
22 LO 4
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23. Depreciation - Example
The entry to record Depreciation at the end of the
first year would be:
Depreciation Expense, Equipment 16,000
Accumulated Depreciation, Equip. 16,000
Depreciation Expense,
Accumulated
Depreciation, Equipment
Equipment
16,000 12/31/14 16,000
23 LO 4
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24. Depreciation - Example
The entry to record Depreciation at the end of the
second year would be:
Depreciation Expense, Equipment 16,000
Accumulated 16,000 Depreciation, Equip.
Depreciation Expense,
Depreciation, Equipment
12/31/14 16,000
16,000 12/31/15 16,000
balance 32,000
Equipment
Accumulated
24 LO 4
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25. Depreciation - Example
The entry to record Depreciation at the end of the
third year would be:
Depreciation Expense, Equipment 16,000
Accumulated Depreciation, Equip. 16,000
Depreciation Expense,
Depreciation, Equipment
12/31/14 16,000
12/31/15 16,000
16,000 12/31/16 16,000
balance 48,000
Equipment
Accumulated
25 LO 4
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26. Depreciation - Example
The entry to record Depreciation at the end of the
fourth year would be:
Depreciation Expense, Equipment 16,000
Accumulated Depreciation, Equip. 16,000
Depreciation Expense,
Depreciation, Equipment
12/31/14 16,000
12/31/15 16,000
12/31/16 16,000
16,000 12/31/17 16,000
balance 64,000
Equipment
Accumulated
26 LO 4
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27. Depreciation - Example
Partial Balance Sheet
December 31
2014 2015 2016 2017
Equipment $72,000 $72,000 $72,000 $72,000
Less: Accumulated Depreciation 16,000 32,000 48,000 64,000
Equipment-net $56,000 $40,000 $24,000 $8,000
Depreciation, Equipment
72,000 01/01/14
12/31/14 16,000
12/31/15 16,000
12/31/16 16,000
12/31/17 16,000
Equipment
Accumulated
27 LO 4
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28. UUnneeaarrnneedd RReevveennuueess
Cash received in advance of providing products
and services.
• The company has an obligation to provide
goods or services.
• Unearned revenues are liabilities.
• As products and services are provided, the
amount of unearned revenues becomes
earned revenues.
28 LO 4
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29. Unearned Revenues — Example
On March 1, a company received a $12,000
payment from a customer for maintenance
services to be provided over the next two
months.
The entry to record the receipt of cash would be:
Cash 12,000
Unearned Revenue 12,000
Unearned Revenue
Cash
12,000 Mar.1 12,000
29 LO 4
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30. Unearned Revenues - Example
On March 31, $6,000 of this revenue had been
earned.
The entry to record the earned revenue would be:
Unearned Revenue 6,000
Maintenance Revenue
Maintenance Revenue
Unearned Revenue
12,000 Mar.1
6,000 Mar.31 6,000
6,000 balance
6,000
$12,000/2months= $6,000/month
30 LO 4
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31. Unearned Revenues - Example
By April 30, another $6,000 of this unearned revenue had
been earned.
The entry to record the earned revenue would be:
Unearned Revenue 6,000
Maintenance Revenue
Maintenance Revenue
Unearned Revenue
12,000 Mar.1
6,000 Mar.31 6,000
6,000 Apr.30 6,000
0 balance
6,000
$12,000/2months= $6,000/month
31 LO 4
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32. AAccccrruueedd EExxppeennsseess
Costs incurred in a period that are both
unpaid and unrecorded.
• Adjusting entries must be made to record the
expense for the period and the related liability
at the balance sheet date.
• Examples: interest, wages, rent, taxes
32 LO 4
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33. Accrued Expenses - Example
On December 31, $1,200 of interest has accrued
on a company’s bank loan. The payment of the
interest is not due until January 1.
The December 31 entry to record the accrued
interest would be:
Interest Expense 1,200
Interest Payable
1,200
33 LO 4
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34. Accrued Expenses - Example
In December, a company incurred $3,700 of utilities
expense. The company had not received the utility
bill at December 31.
The December 31 entry to record the accrued utilities
expense would be:
Utilities Expense 3,700
Accounts Payable
3,700
34 LO 4
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35. AAccccrruueedd RReevveennuueess
Revenues earned in a period that are both
unrecorded and not yet received in cash.
• Adjusting entries must be made to record the
revenue for the period and the related asset
at the balance sheet date.
• Examples: fees earned, interest earned, rent
earned
35 LO 4
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36. Accrued Revenues - Example
On December 31, $16,500 of consulting fees
have been earned but have not been recorded
or billed to the client.
The entry to record the accrued consulting fees
earned would be:
Accounts Receivable 16,500
Consulting Fees Earned 16,500
36 LO 4
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37. AAddjjuussttmmeennttss && FFiinnaanncciiaall
SSttaatteemmeennttss
• Adjustments are only made when financial
statements are prepared.
• Affect both the income statement and the
balance sheet.
• Do not affect cash.
LO 5
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38. MMiinnii--QQuuiizz
Q If the year-end adjusting entry to record
accrued wages was not recorded, how would
this affect the company’s financial statements?
Would the balance sheet balance?
A Wages expense-understated
Net income-overstated
Equity-overstated
Wages payable-understated
The balance sheet would balance since
liabilities would be overstated and equity would
be understated.
38 © 2013 McGraw-Hill Ryerson Limited.

39. TTrriiaall BBaallaannccee
Unadjusted Trial Balance
• A listing of accounts and balances that is
prepared before adjustments are recorded.
Adjusted Trial Balance
• A listing of accounts and balances that is
prepared after adjustments are recorded and
posted to the ledger.
• It is used to prepare financial statements.
LO 6
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40. S Financial Sttaatteemmeenntt PPrreeppaarraattiioonn
• Adjusting entries bring the accounts up-to-date.
• The adjusted trial balance is used to prepare the
financial statements in the following order:
• Income Statement
• Statement of Changes in Equity
• Balance Sheet
• Statement of Cash Flows
LO 7
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41. RReevviieeww
Q When and why are adjusting entries
prepared?
A They are prepared when a company
wishes to issue financial statements.
Adjusting entries bring the account
balances up-to-date.
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42. EEnndd ooff CChhaapptteerr
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