Chapter

3-1
 CHAPTER 3

ADJUSTING THE
ACCOUNTS

Accounting Principles, Eighth Edition

Chapter
3-2
 Timing
Timing Issues
Issues

Accountants divide the economic life of a

business into artificial time periods
(Time Period Assumption).
.....
Jan. Feb. Mar. Apr. Dec.

Generally a month, a quarter, or a year.

Fiscal year vs. calendar year
Also known as the “Periodicity
Chapter Assumption” LO 1 Explain the time period assumption.
3-3 LO 1 Explain the time period assumption.
 Timing
Timing Issues
Issues
Review
The time period assumption states that:
a. revenue should be recognized in the
accounting period in which it is earned.
b. expenses should be matched with revenues.
c. the economic life of a business can be divided
into artificial time periods.
d. the fiscal year should correspond with the
calendar year.

Chapter
3-4 LO 1 Explain the time period assumption.
 Timing
Timing Issues
Issues

Accrual- 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
3-5 LO 2 Explain the accrual basis of accounting.
 Timing
Timing Issues
Issues

Accrual- vs. Cash-Basis Accounting

Cash-Basis Accounting
Revenues are recognized when cash is
received.
Expenses are recognized when cash is paid.
Cash-basis accounting is not in accordance
with generally accepted accounting
principles (GAAP).

Chapter
3-6 LO 2 Explain the accrual basis of accounting.
 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
Chapter performed.
3-7 LO 2 Explain the accrual basis of accounting.
 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
Chapter
3-8 revenues.” LO 2 Explain the accrual basis of accounting.
 Timing
Timing Issues
Issues

GAAP
relationships in
revenue and
expense
recognition

Illustration 3-1

Chapter
3-9 LO 2 Explain the accrual basis of accounting.
 Timing
Timing Issues
Issues
Review
One of the following statements about the accrual
basis of accounting is false. That statement is:
a. Events that change a company’s financial
statements are recorded in the periods in which
the events occur.
b. Revenue is recognized in the period in which it is
earned.
c. This basis is in accord with generally accepted
accounting principles.
d. Revenue is recorded only when cash is received,
and expense is recorded only when cash is paid.
Chapter
3-10 LO 2 Explain the accrual basis of accounting.
 The
The Basics
Basics of
of Adjusting
Adjusting Entries
Entries

Adjusting entries make it possible to

report correct amounts on the balance
sheet and on the income statement.

A company must make adjusting entries

every time it prepares financial
statements.

Chapter
3-11 LO 3 Explain the reasons for adjusting entries.
 The
The Basics
Basics of
of Adjusting
Adjusting Entries
Entries

Revenues - recorded in the period in

which they are earned.
earned
Expenses - recognized in the period in
which they are incurred.
incurred
Adjusting entries - needed to ensure
that the revenue recognition and
matching principles are followed.

Chapter
3-12 LO 3 Explain the reasons for adjusting entries.
 Timing
Timing Issues
Issues
Review
Adjusting entries are made to ensure that:
a. expenses are recognized in the period in
which they are incurred.
b. revenues are recorded in the period in
which they are earned.
c. balance sheet and income statement
accounts have correct balances at the end
of an accounting period.
d. all of the above.
Chapter
3-13 LO 3 Explain the reasons for adjusting entries.
 Types
Types of
of Adjusting
Adjusting Entries
Entries

Deferrals Accruals
1. Prepaid Expenses. 3. Accrued Revenues.
Expenses paid in cash Revenues earned but not
and recorded as assets yet received in cash or
before they are used or recorded.
consumed.
2. Unearned Revenues. 4. Accrued Expenses.
Revenues received in Expenses incurred but
cash and recorded as not yet paid in cash or
liabilities before they are recorded.
earned.

Chapter
3-14 LO 4 Identify the major types of adjusting entries.
 Trial
Trial Balance
Balance
Trial Balance – Each account is analyzed to
determine whether it is complete and up-to-date.

Phoenix Consulting - J an. 31st (before adjusting entries)

Acct. No. Account Debit Credit
100 Cash $ 50,000
105 Accounts receivable 35,000
110 Prepaid insurance 12,000
120 Equipment 24,000
130 I nvestments 300,000
200 Accounts payable $ 20,000
210 Unearned revenue 24,000
220 Note payable 200,000
300 Austin, capital 40,000
400 Sales 137,000
$ 421,000 $ 421,000

Chapter
3-15 LO 4 Identify the major types of adjusting entries.
 Adjusting
Adjusting Entries
Entries for
for Deferrals
Deferrals

Deferrals are either:

Prepaid expenses or

Unearned revenues.

Chapter
3-16 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid
Expenses”
Expenses”
Payment of cash, that is recorded as an asset because
service or benefit will be received in the future.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

insurance rent
supplies maintenance on
advertising equipment
fixed assets
(depreciation)
Chapter
3-17 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid
Expenses”
Expenses”
Prepaid Expenses
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
3-18 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid
Expenses”
Expenses”
Illustration 3-4
Adjusting entries for prepaid
expenses

Increases (debits) an expense account and

Decreases (credits) an asset account.

Chapter
3-19 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid
Expenses”
Expenses”
Example (Insurance): On Jan. 1 , Phoenix
st

Consulting paid $12,000 for 12 months of insurance

coverage. Show the journal entry to record the
payment on Jan. 1st.
Jan. 1 Prepaid insurance 12,00
Cash 0 12,00
0
Prepaid Insurance Cash
Debit Credit Debit Credit
12,000 12,000

Chapter
3-20 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid
Expenses”
Expenses”
Example (Insurance): On Jan. 1 , Phoenix
st

Consulting paid $12,000 for 12 months of insurance

coverage. Show the adjusting journal entry required at
Jan. 31st.
Jan. 31 Insurance expense 1,000
Prepaid insurance 1,000

Prepaid Insurance Insurance expense

Debit Credit Debit Credit
12,000 1,000 1,000

11,000
Chapter
3-21 LO 5 Prepare adjusting entries for deferrals.
 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
(Matching Principle).

Chapter
3-22 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid
Expenses”
Expenses”
Example (Depreciation): On Jan. 1 , Phoenix
st

Consulting paid $24,000 for equipment that has an

estimated useful life of 20 years. Show the journal
entry to record the purchase of the equipment on Jan.
1st.
Jan. 1 Equipment 24,00
Cash 0 24,00
0
Equipment Cash
Debit Credit Debit Credit
24,000 24,000

Chapter
3-23 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid
Expenses”
Expenses”
Example (Depreciation): On Jan. 1 , Phoenix
st

Consulting paid $24,000 for equipment that has an

estimated useful life of 20 years. Show the adjusting
journal entry required at Jan. 31st. ($24,000 / 20
yrs. / 12 months = $100)
Jan. 31 Depreciation expense 100
Accumulated depreciation 100

Depreciation expense Accumulated

Debit Credit depreciation
Debit Credit
100 100

100
Chapter
3-24 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid
Expenses”
Expenses”
Depreciation (Statement Presentation)
Accumulated Depreciation—is a contra asset
account.
Appears just after the account it offsets
(Equipment) on the balance sheet.

Balance Sheet J an. 31

Assets

Equipment 24,000
Accumulated Depreciation (100)
Net Equipment 23,900

Chapter
3-25 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Unearned
“Unearned
Revenues”
Revenues”
Receipt of cash that is recorded as a liability
because the revenue has not been earned.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

rent magazine subscriptions
airline tickets customer deposits
school tuition

Chapter
3-26 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Unearned
“Unearned
Revenues”
Revenues”
Unearned Revenues
Company makes an adjusting entry to record
the revenue that has been earned and to show
the liability that remains.

The adjusting entry for unearned revenues

results in a decrease (a debit) to a liability
account and an increase (a credit) to a revenue
account.

Chapter
3-27 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Unearned
“Unearned
Revenues”
Revenues”
Illustration 3-10
Adjusting entries for unearned revenues

Decrease (a debit) to a liability account and

Increase (a credit) to a revenue account.
Chapter
3-28 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Unearned
“Unearned
Revenues”
Revenues”
Example: On Jan. 1 , Phoenix Consulting received
st

$24,000 from Arcadia High School for 3 months rent in

advance. Show the journal entry to record the receipt
on Jan. 1st.
Jan. 1 Cash 24,00
Unearned rent 0 24,00
revenue 0
Cash Unearned Rent
Debit Credit DebitRevenue
Credit
24,000 24,000

Chapter
3-29 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for “Unearned
“Unearned
Revenues”
Revenues”
Example: On Jan. 1 , Phoenix Consulting received
st

$24,000 from Arcadia High School for 3 months rent in

advance. Show the adjusting journal entry required on
Jan. 31st.
Jan. 31 Unearned rent revenue 8,000
Rent revenue 8,000

Rent Revenue Unearned Rent

Debit Credit DebitRevenue
Credit
8,000 8,000 24,000

16,000
Chapter
3-30 LO 5 Prepare adjusting entries for deferrals.
 Adjusting
Adjusting Entries
Entries for
for Accruals
Accruals

Made to record:
Revenues earned and

Expenses incurred

in the current accounting period that have not

been recognized through daily entries.

Chapter
3-31 LO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued
Revenues”
Revenues”
Revenues earned but not yet received in cash or
recorded.

Adjusting entry results in:

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

rent
interest
services performed

Chapter
3-32 LO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued
Revenues”
Revenues”
Accrued Revenues
An adjusting entry serves two purposes:

(1) It shows the receivable that exists, and

(2) It records the revenues earned.

Chapter
3-33 LO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued
Revenues”
Revenues”
Illustration 3-13
Adjusting entries for accrued revenues

Increases (debits) an asset account and

Increases (credits) a revenue account.
Chapter
3-34 LO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued
Revenues”
Revenues” st
Example: On Jan. 1 , Phoenix Consulting invested
$300,000 in securities that return 5% interest per year.
Show the journal entry to record the investment on Jan.
1st.
Jan. 1 Investments 300,00
Cash 0 300,000

Investments Cash
Debit Credit Debit Credit
300,000 300,000

Chapter
3-35 LO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued
Revenues”
Revenues” st
Example: On Jan. 1 , Phoenix Consulting invested
$300,000 in securities that return 5% interest per year.
Show the adjusting journal entry required on Jan. 31st.
($300,000 x 5% / 12 months = $1,250)
Jan. 31 Interest receivable 1,250
Interest revenue 1,250

Interest Receivable Interest Revenue

Debit Credit Debit Credit
1,250 1,250

Chapter
3-36 LO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued
Expenses”
Expenses”
Expenses incurred but not yet paid in cash or
recorded.

Adjusting entry results in:

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

rent taxes
interest salaries

Chapter
3-37 LO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued
Expenses”
Expenses”
Accrued Expenses
An adjusting entry serves two purposes:

(1) It records the obligations, and

(2) It recognizes the expenses.

Chapter
3-38 LO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued
Expenses”
Expenses”
Illustration 3-16
Adjusting entries for accrued expenses

Increases (debits) an expense account and

Increases (credits) a liability account.
Chapter
3-39 LO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued
Expenses”
Expenses” nd
Example: On Jan. 2 , Phoenix Consulting borrowed
$200,000 at a rate of 9% per year. Interest is due on first
of each month. Show the journal entry to record the
borrowing on Jan. 2nd.
Jan. 2 Cash 200,00
Notes payable 0 200,000

Cash Notes Payable

Debit Credit Debit Credit
200,000 200,000

Chapter
3-40 LO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued
Expenses”
Expenses” nd
Example: On Jan. 2 , Phoenix Consulting borrowed
$200,000 at a rate of 9% per year. Interest is due on first
of each month. Show the adjusting journal entry required
on Jan. 31st. ($200,000 x 9% / 12 months = $1,500)
Jan. 31 Interest expense 1,500
Interest payable 1,500

Interest Expense Interest Payable

Debit Credit Debit Credit
1,500 1,500

Chapter
3-41 LO 6 Prepare adjusting entries for accruals.
 Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued
Expenses”
Expenses”
Accrued Expenses
An adjusting entry serves two purposes:

(1) It records the obligations, and

(2) it recognizes the expenses.

Chapter
3-42 LO 6 Prepare adjusting entries for accruals.
 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.

Chapter
3-43 LO 7 Describe the nature and purpose of an adjusted trial
 Timing
Timing Issues
Issues
Review
Which of the following statements is incorrect
concerning the adjusted trial balance?
a. An adjusted trial balance proves the equality of the
total debit balances and the total credit balances
in the ledger after all adjustments are made.
b. The adjusted trial balance provides the primary
basis for the preparation of financial statements.
c. The adjusted trial balance lists the account
balances segregated by assets and liabilities.
d. The adjusted trial balance is prepared after the
adjusting entries have been journalized and
Chapter posted.
3-44 LO 7 Describe the nature and purpose of an adjusted trial
 Preparing
Preparing Financial
Financial Statements
Statements

Financial
Financial Statements
Statements areare prepared
prepared directly
directly from
from
the
the Adjusted
Adjusted Trial
Trial Balance.
Balance.

Statemen
Income Statemen
Balance t of
Statemen t of Cash
Sheet Retained
t Flows
Earnings

Chapter
3-45 LO 7 Describe the nature and purpose of an adjusted trial
 Preparing
Preparing Financial
Financial Statements
Statements
Adjusted Trial Balance Debit Credit
Cash $ 50,000 Income
Accounts receivable
I nterest receivable
35,000
1,250 Statement
I ncome Statement
Prepaid insurance 11,000
For the Month Ended J an. 31,
Equipment 24,000
Accumulated depreciation $ 100 Revenues:
I nvestments 300,000 Sales $ 137,000
Accounts payable 20,000 I nterest revenue 1,250
I nterest payable 1,500 Rent revenue 8,000
Unearned revenue 16,000
Total revenue 146,250
Note payable 200,000
Austin, capital 40,000 Expenses:
Sales 137,000 I nterest expense 1,500
I nterest revenue 1,250 Depreciation expense 100
Rent revenue 8,000 I nsurance expense 1,000
I nterest expense 1,500
Total expenses 2,600
Depreciation expense 100
Net income $ 143,650
I nsurance expense 1,000
$ 423,850 $ 423,850

Chapter
3-46 LO 7 Describe the nature and purpose of an adjusted trial
 Preparing
Preparing Financial
Financial Statements
Statements
Adjusted Trial Balance Debit Credit
Cash $ 50,000
Accounts receivable 35,000
I nterest receivable 1,250
Prepaid insurance 11,000
Equipment 24,000
Accumulated depreciation $ 100
I nvestments 300,000
Statement of
Accounts payable 20,000 Owners’ Equity
I nterest payable 1,500
Statement of Owners' Equity
Unearned revenue 16,000
Note payable 200,000
For the Month Ended J an. 31,
Austin, capital 40,000
Sales 137,000 Austin, Capital, J an. 1 $ 40,000
I nterest revenue 1,250 +Net income 143,650
Rent revenue 8,000 - Drawings 0
I nterest expense 1,500 Austin, Capital, J an. 31 $ 183,650
Depreciation expense 100
I nsurance expense 1,000
$ 423,850 $ 423,850

Chapter
3-47 LO 7 Describe the nature and purpose of an adjusted trial
 Preparing
Preparing Financial
Financial Statements
Statements
Adjusted Trial Balance Debit Credit Balance Sheet J an. 31
Cash $ 50,000 Assets
Accounts receivable 35,000
Cash $ 50,000
I nterest receivable 1,250
Accounts receivable 35,000
Prepaid insurance 11,000
Equipment 24,000 I nterest receivable 1,250
Accumulated depreciation $ 100 Prepaid insurance 11,000
I nvestments 300,000 Equipment 24,000
Accounts payable 20,000 Accum. Depreciation (100)
I nterest payable 1,500 I nvestments 300,000
Unearned revenue 16,000
Total assets $ 421,150
Note payable 200,000
Liabilities & Owners' Equity
Austin, capital 40,000
Sales 137,000 Accounts payable $ 20,000
I nterest revenue 1,250 I nterst payable 1,500
Rent revenue 8,000 Unearned revenue 16,000
I nterest expense 1,500 Note payable 200,000
Depreciation expense 100 Austin, capital 183,650
I nsurance expense 1,000
Total liab. & equity $ 421,150
$ 423,850 $ 423,850

Chapter
3-48 LO 7 Describe the nature and purpose of an adjusted trial