Adjusting the
Accounts
Chapter
3-1
Timing
Timing Issues
Issues
Accountants divide the economic life of a
business into artificial time periods
(Time Period Assumption).
Also known as the “Periodicity Assumption”
Generally, accounting time periods are a month,
a quarter or a year.
Monthly and quarterly time periods are called
interim periods.
Fiscal year (begins with the first day of a month
and ends twelve months later on the last day of
Chapter
a month) vs. calendar year (Jan 1-Dec 31)
3-2
Timing
Timing Issues
Issues
Accrual-Basis vs. Cash-Basis Accounting
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.
Chapter
3-3
Timing
Timing Issues
Issues
Accrual-Basis vs. Cash-Basis Accounting
Cash-Basis Accounting
Revenues are recognized when cash is received.
Expenses are recognized when cash is paid.
Simple method, but produces misleading financial
statements
Cash-basis accounting is not in accordance with
generally accepted accounting principles (GAAP).
Chapter
3-4
Timing
Timing Issues
Issues
Recognizing Revenues and Expenses
Revenue Recognition Principle
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
3-5
Timing
Timing Issues
Issues
Recognizing Revenues and Expenses
Matching Principle
Match expenses with revenues in the period when
the company makes efforts to generate those
revenues.
“Let the expenses follow the revenues.”
Chapter
3-6
The
The Basics
Basics of
of Adjusting
Adjusting Entries
Entries
Adjusting entries:
Ensures that the revenue recognition and matching principles are
followed.
Makes it possible to report correct amounts on the balance sheet
and on the income statement.
Made every time financial statements are prepared since trial
balance may not contain complete and up-to-date data (due to
unrecorded transactions, inefficiency in recording transactions, etc).
Two types of adjusting entries:
1. Deferrals (Prepaid Expenses and Unearned Revenues)
2. Accruals (Accrued Revenues and Accrued Expenses)
Chapter
3-7
Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”
Prepaid expenses or prepayments are payments of cash that is recorded as an
asset because service or benefit will be received in the future. Example:
supplies, insurance, advertising, purchase of buildings, etc.
Cash Payment BEFORE Expense Recorded
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
3-8
Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”
Adjusting entries for prepaid expenses
Increases (debits) an expense account and
Decreases (credits) an asset account.
Chapter
3-9
Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”
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.
Chapter
3-10
Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”
Depreciation (Statement Presentation)
Accumulated Depreciation is a contra asset account
(normal balance being credit).
Appears just after the account it offsets (Equipment) on
the balance sheet.
Contra account is used since it discloses both the original
cost and the total cost that has expired to date.
Chapter
3-11
Adjusting
Adjusting Entries
Entries for
for “Unearned
“Unearned Revenues”
Revenues”
Unearned or deferred revenue is the receipt of cash
that is recorded as a liability because the revenue has not been earned.
Example: tuition fees, magazine subscriptions, airline tickets, etc.
Cash Receipt BEFORE Revenue Recorded
Company makes an adjusting entry to record the
revenue that has been earned and to show the liability
that remains.
Chapter
3-12
Adjusting
Adjusting Entries
Entries for
for “Unearned
“Unearned Revenues”
Revenues”
Adjusting entries for unearned revenues
Decrease (a debit) to a liability account and
Increase (a credit) to a revenue account.
Chapter
3-13
Adjusting
Adjusting Entries
Entries for
for “Deferrals”
“Deferrals”
Summary
Chapter
3-14
Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Revenues”
Revenues”
Accrued revenue is the revenue earned but not yet received in cash
or recorded. Example: rent, interest, services performed, etc.
Revenue Recorded BEFORE Cash Receipt
Adjusting entries for accrued revenues serve two
purposes:
1.Shows the receivable that exists
2.Records the revenues earned
Chapter
3-15
Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Revenues”
Revenues”
Adjusting entries for accrued revenues
Increases (debits) an asset account and
Increases (credits) a revenue account.
Chapter
3-16
Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Expenses”
Expenses”
Accrued expenses or accrued liabilities is the expense incurred but not
yet paid in cash or recorded. Example: salaries, rent, interest, taxes, etc.
Expense Recorded BEFORE Cash Payment
Adjusting entries for accrued expenses serve two
purposes:
1.Records the obligation that exists
2.Recognizes the expenses
Chapter
3-17
Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Expenses”
Expenses”
Adjusting entries for accrued expenses
Increases (debits) an expense account and
Increases (credits) a liability account.
Chapter
3-18
Adjusting
Adjusting Entries
Entries for
for “Accruals”
“Accruals”
Summary
Chapter
3-19
The
The Adjusted
Adjusted Trial
Trial Balance
Balance
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.
Adjusted Trial Balance contains all data that a
company needs to prepare financial statements like
income statement, owner’s equity statement and
balance sheet.
Chapter
3-20
