Chapter 2: The adjusting process

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Acconting cycle

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Quick check- overview chapter 1
What is the accounting term of these definitions?
1. A list of all a company’s accounts with their account
numbers.
2. A system of accounting where every transaction
affects at least two accounts.
3. Summary device that is shaped like a capital “T” with
debits posted on the left side of the vertical line and
credits on the right side of the vertical line. A
“shorthand” version of a ledger.
4. A list of all the ledger accounts with their balances at
a point in time.

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Quick check- overview chapter 1
Answer:
1. A list of all a company’s accounts with their account
numbers.  Chart of accounts
2. A system of accounting where every transaction
affects at least two accounts.  Double – entry
system
3. Summary device that is shaped like a capital “T” with
debits posted on the left side of the vertical line and
credits on the right side of the vertical line. A
“shorthand” version of a ledger.  T - account
4. A list of all the ledger accounts with their balances at
a point in time.  The trial balance
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Learning objective
 Differentiate between accrual and cash-basis
accounting.
 Define and apply the accounting period concept,
revenue recognition and matching principles, and
time period concept.
 Explain why adjusting entries are needed
 Journalize and post adjusting entries
 Explain the purpose of and prepare an adjusted trial
balance
 Prepare the financial statements from the adjusted
trial balance
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Chapter’s contents
2.1 Accrual Accounting Versus Cash-Basis
Accounting
2.2 Other Accounting Principles
2.3 Why We Adjust the Accounts
2.4 Two Categories of Adjusting Entries
2.5 The Adjusted Trial Balance
2.6 The Financial Statements
2.7 Ethical Issues in Accrual Accounting

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 2.1 Accrual Accounting Versus Cash-
Basis Accounting
Look at the picture, explain the difference between
the accrual basis and the cash basis:

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2.1 Accrual Accounting Versus Cash-
Basis Accounting
Accrual basis Cash basis
Records the effect of each Records only cash receipts
transaction as it occurs, and cash payments, that
that is: is:
• Revenues are recorded • Revenues are recorded
when earned when cash is received
• Expenses are recorded • Expenses are recorded
when incurred. when cash is paid

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 2.1 Accrual Accounting Versus Cash-
Basis Accounting
Example 1: Smart Touch purchased $200 of office
supplies on account on May 15, 2013, and paid the
account in full on June 3, 2013. On the accrual basis,
the business records this transaction as follows:

 Under the cash basis, the company would only

recognize expense on June 3, 2013.

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 2.1 Accrual Accounting Versus Cash-
Basis Accounting
 Example 2: Smart Touch performed service and
earned revenue on May 20,2013, but did not collect
cash until June 5, 2013. Under the accrual basis, the
business records:

 Under the cash basis, the business would record no

revenue until the cash receipt, which in this case
would be on June 5.
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 2.1 Accrual Accounting Versus Cash-
Basis Accounting
Quick check: Which system of accounting is used in each of
these case?
1. A business sold goods to Roy on 7th December on credit.
The business recognizes this sale on 7th December.
2. A dentist receives fees from patient, 100$ on giving
services. The dentist accounts for his fee only when cash
received.
3. A internet service provider receives advance of $400 this
month for services that he will provide in next month. He
recognizes the income in the next month, when he
provides service for it. (but records it as an advance
immediately).

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 2.1 Accrual Accounting Versus Cash-
Basis Accounting
Answer:
1. Accrual basis
2. Cash basis
3. Accrual basis.

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 2.2 Other Accounting Principles
2.2.1 The Accounting Period Concept
2.2.2 The Revenue Recognition Principle
2.2.3 The Matching Principle
2.2.4 The Time-Period Concept

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The Accounting Period Concept and
The Time-Period Concept
 The time period (or periodicity) concept assumes
that the economic life of a business can be divided
into artificial time periods — generally a month, a
quarter, or a year.
The basic accounting period is one year, and
most businesses prepare annual financial
statements.
 Calendar year: from January 1 through December
31.
 Fiscal year: which ends on a date other than
December 31.
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 The Revenue Recognition
Principle
 Record revenue when it has been earned

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 The Revenue Recognition
Principle
 The amount of revenue to record.
Record revenue for the actual value of the item or service
transferred to the customer.

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The Matching Principle
 measures all the expenses incurred during the period,
and
 matches the expenses against the revenues of the
period.

Revenues expenses
earned are offset incurred in
this month against.... earning the
revenue

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Self check
1. Applying the revenue recognition principle
Northwest Magazine sells subscriptions for $36 for 12
issues. The company collects cash in advance and then
mails out the magazines to subscribers each month.
Requirement:
Apply the revenue recognition principle to determine
a. when Northwest Magazine should record revenue
for this situation.
b. the amount of revenue Northwest Magazine
should record for three issues.

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Self check
2. Applying the matching principle
Suppose on January 1 you prepaid apartment rent of
$5,700 for the full year.
Requirement: At July 31, what are your two account
balances for this situation?

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2.3 Why We Adjust the Accounts?

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2.3 Why We Adjust the Accounts?

 The trial balance omit various revenue and expense

transactions.
Ex: Unearned revenues, accrued expenses, prepaid
expenses,…
 So accrual accounting requires adjusting entries at
the end of the period.

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2.4 Two Categories of Adjusting Entries
Prepaid/deferrals Accrual
• The cash payment • Records an expense
occurs before an before the cash
expense is recorded payment.
• Or the cash receipt • Or it records the
occurs before the revenue before the cash
revenue is earned is received.
• Three types: • Two types:
Prepaid expenses  Accrued expenses
Depreciation  Accrued revenues
Unearned revenues

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 Practice in group
Classify these adjusting entries which are prepaid or accrual:
a) Dr Rent expense f) Dr Accounts receivable
Cr Prepaid rent Cr Service revenue
b) Dr Interest expense g) Dr Depreciation expense
Cr Interest payable Cr Accumulated
c) Dr Unearned service revenue depreciation
Cr Service revenue
d) Dr Salary expense
Cr Salary payable
e) Dr Supplies expense
Cr Supplies

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Answer
 Prepaid: a, c, e, g
 Accrual: b, d, f

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2.4 Two Categories of Adjusting Entries
Adjusting Entries

Prepaid Expenses
Asset (prepaid) Expense

Unadjusted Credit Debit

Balance Adjusting Adjusting
Entry (-) Entry (+)

Ex: Smart Touch prepays three months’ office rent of $3,000

($1,000 per month three months) on May 1, 2013. Prepare the
journal entry on May 1, 2013 and the adjusting entries on
May 31, 2013.

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2.4 Two Categories of Adjusting Entries
Prepaid Expenses

Answer :
• On May 1, 2013, the journal entry:
Dr Prepaid rent $3,000
Cr Cash $3,000
• On May 31, 2013, the adjusting entries:
Dr Rent expense $1,000
Cr Prepaid rent 1,000

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2.4 Two Categories of Adjusting Entries
Contra Adjusting Entries
asset
Depreciation
Accumulated depreciation Depreciation expense

Credit Debit
Adjusting Adjusting
Entry (-) Entry (+)

Ex: On May 3, Smart Touch purchased furniture for $18,000,

the depreciation for each month is $300. Prepare the journal
entry on May 3, 2013 and the adjusting entries on May 31,
2013.

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2.4 Two Categories of Adjusting Entries
Depreciation

Answer:
• On May 3, 2013, the journal entry:
Dr Furniture $18,000
Cr Cash 18,000
• On May 31, 2013, the adjusting entries:
Dr Depreciation expense - furniture $300
Cr Accumulated depreciation - furniture 300

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2.4 Two Categories of Adjusting Entries
Accrued expenses
Liability Expense
Credit Debit
Adjusting Adjusting
Entry (-) Entry (+)

Ex 1: Smart Touch pays its employee a monthly salary of

$1,800—half on the 15th and half on the first day of the next
month. Prepare the journal entry on May 15, 2013 and the
adjusting entries on May 31, 2013.

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2.4 Two Categories of Adjusting Entries
Accrued expenses

Answer:
• On May 15, 2013, the journal entry:
Dr Salary expense $900
Cr Cash $900
• On May 31, 2013, the adjusting entries:
Dr Salary expense $900
Cr Salary payable $900

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2.4 Two Categories of Adjusting Entries
Adjusting Entries

Accrued revenues
Assets (Accounts Receivable) Revenues

Debit Credit
Adjusting Adjusting
Entry (+) Entry (-)

Ex: Smart Touch is hired on May 15 to perform e-learning

services. Under this agreement, Smart Touch will earn $800
monthly. During May, Smart Touch will earn half a month’s
fee, $400. Prepare the adjusting entries on May 31, 2013.
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2.4 Two Categories of Adjusting Entries
Accrued revenues

The adjusting entries on May 31, 2013.

Dr Accounts receivable $400

Cr Service revenue $400

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2.4 Two Categories of Adjusting Entries
Adjusting Entries

Unearned revenues
Assets (Accounts Receivable) Revenues

Debit Credit
Adjusting Adjusting
Entry (+) Entry (-)

Ex: A law firm engages Smart Touch to provide e-learning

services, agreeing to pay $600 in advance monthly. Smart
Touch collects the first amount on May 21. Prepare the
journal entry on May 21, 2013 and the adjusting entries on
May 31, 2013.
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2.4 Two Categories of Adjusting Entries
Unearned revenues
Ex: Answer:
• On May 21, 2013, the journal entry:
Dr Cash $600
Cr Unearned service revenue $600
• On May 31, 2013, the adjusting entries:
Dr Unearned service revenue $200
Cr Service revenue $200

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2.4 Two Categories of Adjusting Entries
 Smart Touch at May 31
 Information for adjustments at May 31, 2013:
a) Prepaid rent expired, $1,000.
b) Supplies used, $100.
c) Depreciation on furniture, $300.
d) Depreciation on building, $200.
e) Accrued salary expense, $900.
f) Accrued interest on note, $100.
g) Accrued service revenue, $400.
h) Service revenue that was collected in advance and
now has been earned, $200.
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2.4 Two Categories of Adjusting Entries
 Adjusting entry
a) Dr Rent expense ($3,000 x 1/3) $1,000
Cr Prepaid rent $1000
b) Dr Supplies expense 100
Cr Supplies 100
c) Dr Depreciation expense - furniture $300
Cr Accumulated depreciation - furniture $300
d) Dr Depreciation expense - building $200
Cr Accumulated depreciation - building $200

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2.4 Two Categories of Adjusting Entries
 Adjusting entry
e) Dr Salary expense $900
Cr Salary payable $900
f) Dr Interest expense 100
Cr Interest payable 100
g) Dr Accounts receivable $400
Cr Service revenue $400
h) Dr Unearned service revenue $200
Cr Service revenue $200

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2.4 Two Categories of Adjusting Entries
 Ledger Accounts in T-account form
ASSETS LIABILITIES
Cash Accounts payable
Bal 4,800 Bal 18,200
Accounts receivable Salary payable
2,200 (e) 900
(g) 400
Bal 2,600 Bal 900
Supplies Interest payable
700 (b) 100 (f) 100
Bal 600 Bal 100
Prepaid rent Unearned service revenue
3,000 (a) 1,000 (h) 200 600
Bal 2,000 Bal 400
Furniture Notes payable
Bal 18,000 Bal 20,000
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2.4 Two Categories of Adjusting Entries
 Ledger Accounts in T-account form
Building
Bal 48,000
Accumulated depreciation - furniture
(c) 300
Bal 300
Accumulated depreciation - building
(d) 200
Bal 200

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2.4 Two Categories of Adjusting Entries
 Ledger Accounts in T-account form
OWNER’S EQUITY REVENUES

Bright, capital Service Revenue

Bal 33, 7,000
200
(g) 400
(h) 200
Bal 7,600
Bright, drawing
Bal 1,000

EXPENSES
Rent expense Salary expense
(a)1,000 900
(e) 900
Bal Bal 1,800
1,000

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2.4 Two Categories of Adjusting Entries
 Ledger Accounts in T-account form

Supplies expense Depreciation expense - furniture

(b) 100 (c) 300

Bal 100 Bal 300
Depreciation expense - Interest expense
building

(d) 200 (f) 100

Bal 200 Bal 100
Utilities expense
Bal 400

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2.5 The Adjusted Trial Balance

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2.6 The Financial Statements
SMART TOUCH LEARNING
Income Statement
Month Ended May 31, 2013
Revenue:
Service Revenue 7,600
Expenses:
Salary expense 1,800
Rent expense 1,000
Utilities expense 400
Depreciation expense - furniture
300

Depreciation expense - building 200

Interest expense 100
Supplies expense 100
Total expense 3,900
Net income 3,700

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2.6 The Financial Statements
SMART TOUCH LEARNING
Statement of Owner's Equity
Month Ended May 31, 2013

Bright, capital , May 1, 2013 33,200

Net income 3,700

36,900

Drawing (1,000)

Bright, capital , May 31, 2013 35,900

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 2.6 The Financial Statements
SMART TOUCH LEARNING
Balance Sheet
May 31, 2013
Assets Liabilities

Cash 4,800 Accounts payable 18,200

Accounts receivable 2,600 Salary payable 900

Supplies 600 Interest payable 100

Prepaid rent 2,000 Unearned service revenue 400

Furniture 18,000 Notes payable 20,000

Less: Accumulated depreciation
- furniture 300 17,700 Total Liabilities 39,600

Building 48,000 Owner's equity

Less: Accumulated depreciation

- Building 200 47,800 Bright, capital 35,900
Total Liabilities and owner's
Total assets 75,500 equity 75,500

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2.7 Ethical Issues in Accrual
Accounting
 Self - study

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Quick check - end chapter 2
1. Adjusting the accounts is the process of
a. subtracting expenses from revenues to measure net
income.
b. recording transactions as they occur during the
period.
c. updating the accounts at the end of the period.
d. zeroing out account balances to prepare for the next
period.

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Quick check - end chapter 2
2. Which types of adjusting entries are natural
opposites?
a. Net income and net loss
b. Expenses and revenues
c. Prepaids and accruals
d. Prepaids and depreciation

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Quick check - end chapter 2
2. Which types of adjusting entries are natural
opposites?
a. Net income and net loss
b. Expenses and revenues
c. Prepaids and accruals
d. Prepaids and depreciation

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Quick check - end chapter 2
3. Get Fit Now gains a client who prepays $540 for a
package of six physical training ses- sions. Get Fit Now
collects the $540 in advance and will provide the training
later. After four training sessions, what should Get Fit
Now report on its income statement?
a. Service revenue of $360
b. Service revenue of $540
c. Unearned service revenue of $360
d. Cash of $180

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Quick check - end chapter 2
4. Assume you prepay Get Fit Now for a package of six
physical training sessions. Which type of account should
you have in your records?
a. Accrued revenue
b. Accrued expense
c. Prepaid expense
d. Unearned revenue

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Quick check - end chapter 2
5. The adjusted trial balance shows
a. amounts that may be out of balance.
b. amounts ready for the financial statements.
c. assets, liabilities, and owner’s equity only.
d. revenues and expenses only.

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THANK FOR YOUR ATTENTION
Try your best – No pain No gain

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