Adjusting Accounts For

Financial Statements
Chapter 3

Wild and Shaw

Fundamental Accounting Principles
25th Edition

Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Chapter 3 Learning Objectives
CONCEPTUAL
C1 Explain the importance of periodic reporting and the role of accrual accounting.

ANALYTICAL
A1 Compute and analyze profit margin.

PROCEDURAL
P1 Prepare adjusting entries for deferral of expenses.
P2 Prepare adjusting entries for deferral of revenues.
P3 Prepare adjusting entries for accrued expenses.
P4 Prepare adjusting entries for accrued revenues.
P5 Prepare financial statements from an adjusted trial balance.
P6 Appendix 3A—Explain the alternatives in accounting for prepaids.

© McGraw-Hill Education 3-2

 Learning Objective C1

Explain the importance of

periodic reporting and the role
of accrual accounting.

© McGraw-Hill Education 3-3

 The Accounting Period
• Useful information must reach decision makers
frequently
• Reports must be prepared at regular intervals
• Time period assumption: activities can be divided
into time intervals (month, quarterly, semi-annually,
annually)
• Most corporations use a year as primary accounting
period
• Annual financial statements/ Interim financial
statements
4
 The Accounting Period
Exhibit
3.1

© McGraw-Hill Education 3-5

Learning Objective C1: Explain the importance of periodic reporting and the role of accrual accounting.
Accrual Basis versus Cash Basis
Accrual Basis Cash Basis
Revenues are recorded Revenues are recorded
when products or when cash is received and
services are delivered, expenses are recorded
and records expenses when cash is paid.
when incurred.

© McGraw-Hill Education 3-6

Learning Objective C1: Explain the importance of periodic reporting and the role of accrual accounting.
Accrual Basis versus Cash Basis
Accrual Basis Example (1 of 2)
Exhibit
3.2

On the accrual basis, $100 of insurance expense

is recognized in 2021, $1,200 in 2022, and
$1,100 in 2023.
The expense is matched with the periods
benefited by the insurance coverage.
© McGraw-Hill Education 3-7
Learning Objective C1: Explain the importance of periodic reporting and the role of accrual accounting.
Accrual Basis versus Cash Basis
Cash Basis Example (2 of 2)
Exhibit
3.3

On December 1, 2021, FastForward paid $2,400 cash for a 24

month business insurance policy.

Using the cash basis, the entire $2,400 would be recognized

as insurance expense in 2021. No insurance expense from
this policy would be recognized for the 2022 or 2023 periods
covered by the policy.
© McGraw-Hill Education 3-8
Learning Objective C1: Explain the importance of periodic reporting and the role of accrual accounting.
 Recognizing Revenues
The revenue recognition principle
requires that revenue be recorded
when the goods or services are
provided to customers and at an
amount expected to be received
from customers.

© McGraw-Hill Education 3-9

Learning Objective C1: Explain the importance of periodic reporting and the role of accrual accounting.
 Recognizing Expenses
The expense recognition (or matching)
principle requires that expenses be recorded
in the same accounting period as the
revenues that are recognized as a result of
those expenses. This matching of expenses
with the revenue benefits is a major part of
the adjusting process.

© McGraw-Hill Education 3-10

Learning Objective C1: Explain the importance of periodic reporting and the role of accrual accounting.
 Framework for Adjustments
• Adjusting entry meaning:
To record a missing transaction which will affect
one or more income statement account & one
or more balance sheet account.
BUT NEVER AFFECTS THE CASH ACCOUNT

11
 Framework for Adjustments
There are four types of adjustments for transactions
that extend over more than one period.

Adjustments are made using a 3-step process:

Step 1: Determine what the current account balance equals.
Step 2: Determine what the current account balance should
equal.
Step 3: Record an adjusting entry to get from step 1 to step 2.

© McGraw-Hill Education 3-12

Learning Objective C1: Explain the importance of periodic reporting and the role of accrual accounting.
Exercises

13
Exercises

14
 Learning Objective P1

Prepare adjusting entries for

deferral of expenses.

© McGraw-Hill Education 3-15

 Prepaid (Deferred) Expenses
Prepaid expenses are assets paid for in advance of
receiving their benefits.
Examples: Prepaid Insurance, Prepaid Rent, Supplies

Exhibit
3.5

Learning Objective P1: Prepare adjusting entries for deferral of expenses. © McGraw-Hill Education 3-16
 Adjusting for Prepaid Insurance
Step 1
Step 1: Determine current balance:
• FastForward paid $2,400 to cover insurance for 24 months
that began on December 1, 2021.
• FastForward recorded the expenditure as Prepaid Insurance
on December 1.

PREPAID INSURANCE
24-month policy
Beginning 12/01
$2,400

Learning Objective P1: Prepare adjusting entries for deferral of expenses. © McGraw-Hill Education 3-17
 Adjusting for Prepaid Insurance
Step 2
Step 2: Balance in prepaid insurance should equal $2,300.
On 12/31, $100 for one month’s worth of insurance has expired.

PREPAID INSURANCE INSURANCE EXPENSE

$2,400 $100
$100
$2,400/24 months = $100

Insurance Expense is debited $100 to recognize the amount of insurance

coverage for December and Prepaid Insurance is credited for $100 to reduce
it’s balance to $2,300.

Learning Objective P1: Prepare adjusting entries for deferral of expenses. © McGraw-Hill Education 3-18
 Adjusting for Prepaid Insurance
Step 3
(Balance Sheet) (Income Statement)
PREPAID INSURANCE INSURANCE EXPENSE
$2,400 adj. $100
$100 adj.
Bal. $2,300
The Income Statement will
The Balance Sheet will show show $100 (1 month) of
$2,300 (23 months) of insurance expired!
Prepaid Insurance remaining!
© McGraw-Hill Education 3-19
Learning Objective P1: Prepare adjusting entries for deferral of expenses.
 Adjusting Entry for
Prepaid Insurance
The general journal adjustment on Dec. 31 and
general ledger account balances are as follows:

Prepaid Insurance 128 Insurance Expense 637

Dec. 1 2,400 Dec. 31 100 Dec. 31 100
Bal. 2,300

Dec. 31 Insurance Expense 100

Prepaid Insurance 100
To record first month's expired insurance
Learning Objective P1: Prepare adjusting entries for deferral of expenses. © McGraw-Hill Education 3-20
 Adjusting for Supplies
Steps 1 and 2
Step 1: FastForward purchased $9,720 of supplies in
December. Some of these supplies were used during
December.
Step 2: A physical count performed on 12/31 shows that
unused supplies equal $8,670.

SUPPLIES
Purchases during December $9,720

Learning Objective P1: Prepare adjusting entries for deferral of expenses. © McGraw-Hill Education 3-21
 Adjusting for Supplies Step 3
Step 3: Adjusting entry reduces Supplies by $1,050 or the difference
between the beginning balance and the physical count on 12/31.
(Balance Sheet) (Income Statement)
SUPPLIES SUPPLIES EXPENSE
$9,720 adj. $1,050
$1,050 adj.
Bal. $8,670
The Income Statement will
The Balance Sheet will show show $1,050 (1 month) of
$8,670 of supplies remaining! Supplies expired!

Learning Objective P1: Prepare adjusting entries for deferral of expenses. © McGraw-Hill Education 3-22
 Adjusting Entry – Supplies
We’ve seen the adjustment in the T-accounts but
we need to record the adjustment on Dec. 31
in the General Journal
Supplies 126 Supplies Expense 652
Dec. 9,720 Dec. 31 1,050 Dec. 31 1,050
Bal. 8,670

Dec. 31 Supplies Expense 1,050

Supplies 1,050
To record supplies used
Learning Objective P1: Prepare adjusting entries for deferral of expenses. © McGraw-Hill Education 3-23
 Depreciation
Instead of expensing the cost of a plant asset
(equipment, building, cars, etc.) in the year it
is purchased we allocate, or spread out, the
cost over their expected useful lives. This is
called depreciation.
The formula for straight-line depreciation is:

Straight-Line Asset Cost - Salvage Value

Depreciation =
Useful Life

Learning Objective P1: Prepare adjusting entries for deferral of expenses. © McGraw-Hill Education 3-24
 Adjusting for Depreciation – Step 1
• FastForward purchased equipment on Dec. 1 for
$26,000.
• It has an estimated useful life of five years.
• The equipment is expected to be worth about
$8,000 at the end of five years.
• They purchased the equipment on Dec. 1 but it is
now Dec. 31.
Because FastForward expects the equipment to be worth $8,000
when the five years are over, only $18,000 of the cost will be
spread over the next 5 years (60 months).
Learning Objective P1: Prepare adjusting entries for deferral of expenses. © McGraw-Hill Education 3-25
 Straight-Line Depreciation
Step 1: FastForward purchased equipment
on December 1 for $26,000.
Your text here
FORMULA:
Calculate Net Cost (amount to depreciate).
Original Salvage Net Cost
Cost Value =
$26,000 $8,000 = $18,000

Learning Objective P1: Prepare adjusting entries for deferral of expenses. © McGraw-Hill Education 3-26
 Adjusting for Depreciation – Step 2
• Equipment has a useful life of 5 years. The equipment
is expected to be worth $8,000 at the end of five
years. FastForward is using straight-line depreciation.
$18,000 ($26,000 – $8,000) of the cost needs to be
spread over the next 60 months.
One month = $18,000 / 60 = $300.

© McGraw-Hill Education 3-27

Learning Objective P1: Prepare adjusting entries for deferral of expenses.
 Adjusting for Depreciation – Step 3
Depreciation adjustment reflected in our
T-accounts looks like this:
Equipment Depreciation Expense
12/1 26,000 12/31 300

Accumulated Depreciation
12/31 300

• Record adjusting entry for $300 for one month.

• The depreciation amount of $300 is credited to the
Accumulated Depreciation account instead of the
asset account.
Learning Objective P1: Prepare adjusting entries for deferral of expenses. © McGraw-Hill Education 3-28
 Adjusting Entry for Depreciation
Equipment Depreciation Expense
12/1 26,000 12/31 300

Accumulated Depreciation-Equipment
12/31 300

Dec. 31 Depreciation Expense 300

Accumulated Depreciation - Equipment 300
To record monthly equipment depreciation

Learning Objective P1: Prepare adjusting entries for deferral of expenses. © McGraw-Hill Education 3-29
 Depreciation – Balance Sheet
Exhibit
3.7

On February 28, 2022, after three months of

depreciation have been taken, the Equipment is shown
at its $25,100 book value, or net of accumulated
depreciation.

Learning Objective P1: Prepare adjusting entries for deferral of expenses. © McGraw-Hill Education 3-30
Exercise

31
32
33
34
 Learning Objective P2

Prepare adjusting entries for

deferral of revenues.

© McGraw-Hill Education 3-35

 Deferral of Revenue
Unearned revenue is cash received in
advance of providing products or services.

Exhibit
3.8

Learning Objective P2: Prepare adjusting entries for deferral of revenues. © McGraw-Hill Education 3-36
 Adjusting for Unearned Revenues –
Steps 1 and 2
Step 1: FastForward’s client paid a 60-day fee in advance
covering the period from 12/27 – 2/24 and recorded:
Dec. 26 Cash 3,000
Unearned Consulting Revenue 3,000
Received advance payment for services
Step 2: FastForward earns payment as time passes.
At 12/31, 5 days’ service is earned, 5/60 × $3,000 =
$250.
Step 3: Adjusting entry reduces liability, Unearned
Consulting Revenue, by $250 for 5 days’ of revenue.
Consulting Revenue of $250 is earned.
Learning Objective P2: Prepare adjusting entries for deferral of revenues. © McGraw-Hill Education 3-37
 Adjusting for Unearned Revenue –
Step 3
(Balance Sheet) (Income Statement)
UNEARNED CONSULTING
REVENUE CONSULTING REVENUE

$3,000 12/26 $5,800

12/31 $250 250 12/31
$2,750 12/31 Bal.
$6,050 12/31 Bal.

The Balance Sheet will show The Income Statement will

$2,750 of Unearned Consulting show $6,050 total Consulting
Revenue unearned. Revenue earned.
Learning Objective P2: Prepare adjusting entries for deferral of revenues. © McGraw-Hill Education 3-38
 Adjusting Entry for Unearned Revenue
Adjusting entry recorded on Dec. 31 transfers $250
from unearned to earned consulting revenue.

Dec. 31 Unearned Consulting Revenue 250

Consulting Revenue 250
To record earned revenue received in advance

Learning Objective P2: Prepare adjusting entries for deferral of revenues. © McGraw-Hill Education 3-39
Exercise

40
41
 Learning Objective P3

Prepare adjusting entries for

accrued expenses.

© McGraw-Hill Education 3-42

 Accrued Expense
Accrued expenses are costs incurred in a
period that are
both unpaid and unrecorded.

Exhibit
3.9

Learning Objective P3: Prepare adjusting entries for accrued expenses. © McGraw-Hill Education 3-43
 Adjusting for Accrued Salaries –
Steps 1, 2, and 3
Step 1: FastForward pays its employee $70 per day, or
$350 for a five-day work week. Salaries are paid every
two weeks on a Friday.
Step 2: 12/31 is a Wednesday, so three day’s salaries are
owed at year end which equals $70 × 3 = $210.
Step 3: Adjusting entry increases a liability, Salaries
Payable, and increases Salaries Expense for $210 with
the following journal entry:

Dec. 31 Salaries Expense 210

Salaries Payable 210
To record three days' accrued salaries
Learning Objective P3: Prepare adjusting entries for accrued expenses. © McGraw-Hill Education 3-44
 Adjusting for Accrued Salaries –
Financial Statements
(Balance Sheet) (Income Statement)
SALARIES PAYABLE SALARIES EXPENSE

$210 12/31 adj. $1,400

12/31 adj. 210

$210 12/31 Bal.

12/31 Bal. $1,610

The Income Statement will

The Balance Sheet will show
show $1,610 total Salaries
$210 of Salaries Payable owed.
Expense.

Learning Objective P3: Prepare adjusting entries for accrued expenses. © McGraw-Hill Education 3-45
 Future Cash Payment of Accrued Expenses
Accrued expenses at the end of one period result in a
cash payment in a future period.
On 12/31, FastForward recorded accrued salaries of
$210.
On 1/9 of the next year, the following entry will reduce
the accrued liability, salaries payable, and record the
expense for 7 days of work in January.
Jan 9 Salaries Payable (3 x $70) 210
Salaries Expense (7 x $70) 490
Cash 700
To record earned revenue received in advance
© McGraw-Hill Education 3-46
Learning Objective P3: Prepare adjusting entries for accrued expenses.
47
 Learning Objective P4

Prepare adjusting entries for

accrued revenues.

© McGraw-Hill Education 3-48

 Accrued Revenue
Accrued revenues are revenues earned in a period that
are both unrecorded and not yet received in cash or
other assets.

Exhibit
3.11

Learning Objective P4: Prepare adjusting entries for accrued revenues. © McGraw-Hill Education 3-49
 Adjusting for Accrued Services Revenue –
Steps 1, 2, and 3
Step 1: On 12/12, FastForward’s customer agreed to pay
$2,700 on 1/10 of the next year for future services over
the next 30 days.
Step 2: On 12/31, 20 days worth of services have been
provided and earned which totals $1,800 ($2,700 ×
20/30 days).
Step 3: Adjusting entry increases an asset, Accounts
Receivable, and increases the Consulting Revenue
account for $1,800 with the following journal entry:
Dec. 31 Accounts Receivable 1,800
Consulting Revenue 1,800
To record 20 days' accrued revenue.
Learning Objective P4: Prepare adjusting entries for accrued revenues. © McGraw-Hill Education 3-50
 Adjusting for Accrued Services Revenue
– Financial Statements
(Balance Sheet) (Income Statement)
ACCOUNTS RECEIVABLE CONSULTING REVENUE

adj. $1,800 $6,050

1,800 adj.
Bal. $1,800 $7,850 Bal.

The Income Statement will

The Balance Sheet will show
show $7,850 total
$1,800 of Accounts Receivable.
Consulting Revenue

Learning Objective P4: Prepare adjusting entries for accrued revenues. © McGraw-Hill Education 3-51
 Future Cash Receipt of Accrued Revenues
Accrued revenue at the end of one period results in a cash
receipt in a future period.
On 12/31, FastForward recorded accrued revenue earned of
$1,800.
On 1/10 of the next year, the following entry will reduce the
accounts receivable, record revenue earned for 10 days and
receipt of $2,700 cash.

Jan. 10 Cash 2,700

Accounts Receivable (20 days) 1,800
Consulting Revenue (10 days) 900
To record earned revenue received in advance
Learning Objective P4: Prepare adjusting entries for accrued revenues. © McGraw-Hill Education 3-52
 Links to Financial Statements
Exhibit
3.12

© McGraw-Hill Education 3-53

Learning Objective P4: Prepare adjusting entries for accrued revenues.
 Learning Objective P5

Prepare financial statements

from an adjusted trial balance.

© McGraw-Hill Education 3-54

 Adjusted Trial Balance
Exhibit
3.13

© McGraw-Hill Education 3-55

Learning Objective P5: Prepare financial statements from an adjusted trial balance.
 Steps for Preparing Financial
Statements from an Adjusted Trial
Balance
Step 1— Prepare income statement using revenue and expense
accounts from adjusted trial balance.
Step 2—Prepare statement of owner’s equity using capital and
withdrawals accounts from adjusted trial balance; and
pull net income from step 1.
Step 3—Prepare balance sheet using asset and liability accounts
from adjusted trial balance; and pull updated capital
balance from step 2.
Step 4—Prepare statement of cash flows from changes in cash
flows for the period (illustrated later in the book).
© McGraw-Hill Education 3-56
Learning Objective P5: Prepare financial statements from an adjusted trial balance.
 Preparing Financial Statements from an Adjusted Trial Balance

Exhibit
3.14

Learning Objective P5: Prepare financial statements from an adjusted trial balance. © McGraw-Hill Education 3-57
 Learning Objective A1

Compute and analyze profit

margin.

© McGraw-Hill Education 3-58

 Profit Margin
The profit margin ratio measures the company’s net
income to net sales.
Exhibit
Profit Net income 3.15
=
Margin Net sales

Visa and Mastercard’s Profit Margin

Exhibit
3.16

© McGraw-Hill Education 3-59

Learning Objective A1: Compute and analyze profit margin.
 Learning Objective P6

Appendix 3A
Explain the alternatives in
accounting for prepaids.

© McGraw-Hill Education 3-60

 Alternative Accounting for Prepayments
An alternative method is to record all prepaid expenses
with debits to expense accounts.

Exhibits
3A.1 & 3A.2
The adjusting entry depends on how the original payment
was recorded.

© McGraw-Hill Education 3-61

Learning Objective P6: Explain the alternatives in accounting for prepaids.
Alternative Accounting for Prepayments
– Account Balances Exhibit
3A.3

© McGraw-Hill Education 3-62

Learning Objective P6: Explain the alternatives in accounting for prepaids.
 Alternative Accounting for Revenues
An alternative method is to record all revenues to a liability account or
a revenue account.

Exhibits
3A.4 & 3A.5
The adjusting entry depends on how the original receipt
was recorded.

© McGraw-Hill Education 3-63

Learning Objective P6: Explain the alternatives in accounting for prepaids.
 Alternative Accounting
for Revenues – Account Balances
Exhibit
3A.6

© McGraw-Hill Education 3-64

Learning Objective P6: Explain the alternatives in accounting for prepaids.
End of Chapter 3

© McGraw-Hill Education 3-65