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Copyright © 2007 Prentice-Hall. All rights reserved 1
The Adjusting ProcessThe Adjusting ProcessThe Adjusting ProcessThe Adjusting Process
Chapter 3
Copyright © 2007 Prentice-Hall. All rights reserved 2
Objective 1Objective 1Objective 1Objective 1
Distinguish accrual accounting from cash-basis accounting
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Accrual Basis Vs. Cash BasisAccrual Basis Vs. Cash BasisAccrual Basis Vs. Cash BasisAccrual Basis Vs. Cash Basis
Accrual Basis
Revenues are recognized when
earned and expenses are recognized when
incurred.
Cash Basis
Revenues are recognized when
cash is received and expenses recorded when cash is paid.
Not GAAPNot GAAP
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S3-1S3-1S3-1S3-1
• Service revenue:(a)Cash basis $600
(b)Accrual basis (600+500) $1,100
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Accounting PeriodAccounting PeriodAccounting PeriodAccounting Period
• Managers adopt an artificial period of time to evaluate performance– Monthly– Quarterly– Semiannually– Annually
Interim Statements
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Recognizing Revenues and Recognizing Revenues and ExpensesExpenses
Recognizing Revenues and Recognizing Revenues and ExpensesExpenses
Three new basic accounting principles
• Revenue Recognition
• Matching
• Time Period
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Objective 2Objective 2Objective 2Objective 2
Apply the revenue and matching principles
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Revenue PrincipleRevenue PrincipleRevenue PrincipleRevenue Principle
• When is revenue recognized?– When it is earned– Not necessarily when cash is received
• How much revenue should be recognized?– Cash value of item transferred to customer
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S3-3S3-3S3-3S3-3
a. When should revenue be recorded?When the magazines are mailed to customers
b. How much revenue should be recorded?As of March, three month’s revenue should be recognized
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The Matching PrincipleThe Matching PrincipleThe Matching PrincipleThe Matching Principle
• Measure all expenses incurred during the accounting period
• When are expenses recognized?– Match the expenses against the revenues
earned during the period
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Adjusting EntriesAdjusting EntriesAdjusting EntriesAdjusting Entries
• At the end of an accounting period, ask yourself these questions:– Have I recorded all revenues earned during
this accounting period?– Have I recognized all expenses incurred
during this accounting period?
• If the answer is “No”, you need to prepare an adjusting entry
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S3-4S3-4S3-4S3-4
Jan 1 – Paid rent for the entire year
GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
Jan 1 Prepaid Rent 3,600
Cash 3,600
Prepaid rent for 1 year
Prepaid rent is an asset – this will benefit the company
in the future. Since you have not occupied the
apartment yet, it is not an expense yet
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S3-4S3-4S3-4S3-4Prepaid Rent
Jan 1 3,600 300 Jan 31300 Feb 28300 Mar 31300 Apr 30300 May 31300 Jun 30300 Jul 31300 Aug 31300 Sep 30
Bal 900Bal 900
Rent Expense
300300300300300300300300300
Bal 2,700Bal 2,700
Each month, we’ll recognize rent expense; and each month, we’ll reduce the
prepaid account until the year is over
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The Time Period ConceptThe Time Period ConceptThe Time Period ConceptThe Time Period Concept
• Requires that accounting information be reported at regular intervals
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Adjusting EntriesAdjusting EntriesAdjusting EntriesAdjusting Entries
• Prepared at end of an accounting period
• Recorded to bring an asset or liability account balance to its proper amount– Recognize all revenues when earned– Recognize all expenses incurred
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Objective 3Objective 3Objective 3Objective 3
Make adjusting entries
Copyright © 2007 Prentice-Hall. All rights reserved 17
Adjusting EntriesAdjusting EntriesAdjusting EntriesAdjusting Entries
At the end of an accounting period, ask yourself these questions:
• Have I recognized all revenues earned this period?
• Have I recorded all expenses incurred this period?
If the answer is “No”, you need to prepare an adjusting entry
Copyright © 2007 Prentice-Hall. All rights reserved 18
Adjusting EntriesAdjusting EntriesAdjusting EntriesAdjusting Entries
Five categories
• Prepaid expenses
• Depreciation
• Accrued revenues
• Accrued expenses
• Unearned revenues
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Adjusting Prepaid ExpensesAdjusting Prepaid ExpensesAdjusting Prepaid ExpensesAdjusting Prepaid Expenses
Resources paid for prior to receiving the actual benefits
Prepaid AssetPrepaid Asset
Used up portion = Expense
Used up portion = Expense
Unused portion = Prepaid
Unused portion = Prepaid
Copyright © 2007 Prentice-Hall. All rights reserved 20
S3-5S3-5S3-5S3-5GENERAL JOURNAL
DATE DESCRIPTION REF DEBIT CREDIT
Apr 1 Prepaid Rent 3,000
Cash 3,000
Prepaid rent for 6 months
4/1 3,000
Prepaid Rent
Copyright © 2007 Prentice-Hall. All rights reserved 21
S3-5S3-5S3-5S3-5GENERAL JOURNAL
DATE DESCRIPTION REF DEBIT CREDIT
Apr 30 Rent Expense 500
Prepaid Rent 500
To record rent for April
4/1 3,000
Prepaid Rent
4/30 500
Rent Expense
4/30 500
Bal 2,500
Rent is $500 per month
($3,000/6)
Copyright © 2007 Prentice-Hall. All rights reserved 22
Depreciation - process of allocating the cost of a plant asset to expense over its expected useful life
Straight-LineDepreciation Expense
= Asset Cost
Useful Life
Adjusting for DepreciationAdjusting for DepreciationAdjusting for DepreciationAdjusting for DepreciationLong term
plant assets except for land are
depreciated
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S3-6S3-6S3-6S3-6GENERAL JOURNAL
DATE DESCRIPTION REF DEBIT CREDIT
May 1 Computer Equipment 36,000
Cash 36,000
Purchased computer
5/1 36,000
Computer Equipment
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DepreciationDepreciationDepreciationDepreciation
• Depreciation, for accounting purposes, is not an attempt to assign a market value to assets
• It is merely a systematic way of allocating some of the cost of the asset to each period that asset helps the company earn revenue
• Accumulated Depreciation– A contra asset account– Represents the amount of depreciation that has been
taken over the life of the asset to date
Copyright © 2007 Prentice-Hall. All rights reserved 25
S3-6S3-6S3-6S3-6GENERAL JOURNAL
DATE DESCRIPTION REF DEBIT CREDIT
May 31 Depreciation Expense,
Computer Equipment 1,000
Accumulated Depreciation,
Computer Equipment 1,000
To record depreciation for May
Accumulated depreciation isa contra asset account
Accumulated depreciation isa contra asset account
Income Statement Account
Balance Sheet Account
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S3-6S3-6S3-6S3-6
5/31 1,000
Accumulated Depreciation,Computer Equipment
5/31 1,000
Depreciation Expense,Computer Equipment
Bal 1,000
5/1 36,000
Computer Equipment
Bal 1,000
Copyright © 2007 Prentice-Hall. All rights reserved 27
Book ValueBook ValueBook ValueBook Value
• Reported on balance sheet
• Cost minus accumulated depreciation
Your CompanyBalance SheetMay 31, 20XX
AssetsCash $XXXX ...
Computer Equipment $ 36,000 Less: Accumulated Depreciation (1,000) 35,000
Total Assets $XXXX
Book Value
S3-6S3-6S3-6S3-6
Your CompanyBalance SheetJune 30, 20XX
AssetsCash $XXXX ...
Computer Equipment $ 36,000 Less: Accumulated Depreciation (2,000) 34,000
Total Assets $XXXX
Book Value
S3-6S3-6S3-6S3-6Notice: accumulated
depreciation increases each accounting period. The book
value gradually gets smaller
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Accrued ExpensesAccrued ExpensesAccrued ExpensesAccrued Expenses
Costs incurred in a period that are both unpaid and unrecorded
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S3-8S3-8S3-8S3-8GENERAL JOURNAL
DATE DESCRIPTION REF DEBIT CREDIT
Dec 31 Interest Expense 700
Interest Payable 700
To record accrued interest
12/31 700
Interest Expense700 12/31
Interest PayableWhen you borrow money, interest
expense is accumulating everyday. At the end of an accounting
period, you need to figure out how much interest has accrued and
recognize the expense. You also have to recognize that you must pay that money sometime in the
future.
Copyright © 2007 Prentice-Hall. All rights reserved 32
Accrued RevenuesAccrued RevenuesAccrued RevenuesAccrued Revenues
Revenues earned in a period that are both unrecorded and not yet received
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Accrued RevenuesAccrued RevenuesAccrued RevenuesAccrued Revenues
• Your lawn maintenance company agrees to provide 30 hours of work at $60 per hour for Company A. It is also agreed that you will bill them when the work had been completed
• As of May 31, you have worked 20 hours on this contract. The 20 hours’ worth of revenues earned in May, must be recorded in May, even though you haven’t billed your customer yet
Copyright © 2007 Prentice-Hall. All rights reserved 34
Accrued RevenuesAccrued RevenuesAccrued RevenuesAccrued RevenuesGENERAL JOURNAL
DATE DESCRIPTION REF DEBIT CREDIT
May 31 Accounts Receivable 1,200
Service Revenue 1,200
To record accrued revenues
5/31 1,200
Accounts Receivable1,200 5/31
Service Revenue
How much revenue was earned in May? $60 x 20 = $1200
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Unearned RevenueUnearned RevenueUnearned RevenueUnearned Revenue
Cash received in advance of providing products or services
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S 3-9S 3-9S 3-9S 3-9GENERAL JOURNAL
DATE DESCRIPTION REF DEBIT CREDIT
Dec 31 Unearned Subscription
Revenue 5,000
Subscription Revenue 5,000
To record revenue earned
When the money is received, the company debits cash and credits Unearned Revenue (a liability recognizing that the company owes their customer a service or
product)
At the end of an accounting period, you must determine how
much of that unearned revenue has actually
been earned
Copyright © 2007 Prentice-Hall. All rights reserved 37
TipsTipsTipsTips
• An adjusting entry will NEVER involve a debit or credit to Cash
• Each adjusting entry will affect at least one balance sheet account and one income statement account
Copyright © 2007 Prentice-Hall. All rights reserved 38
SummarySummarySummarySummary
Prepaid expenses
Depreciation
Accrued revenues
Debit Expense
Credit Asset (Prepaid)
Debit Depreciation Expense
Credit Accumulated Depreciation
Debit Receivable
Credit Revenue
Copyright © 2007 Prentice-Hall. All rights reserved 39
SummarySummarySummarySummary
Accrued expenses
Unearned revenues
Debit Expense
Credit Liability
Debit Liability (Unearned)
Credit Revenue
E3-19 aE3-19 aE3-19 aE3-19 a
Unearned Rent Revenue Rent Revenue
10/1 4,000 12/31 1,00012/31 1,000
Bal. 3,000
GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
Dec 31 Unearned Rent Revenue 1,000
Rent Revenue 1,000
To record revenue earned
This is an example of unearned revenues:$4,000 /12 = $333.33 per month3 months have expired. $333.33 x 3 = $1,000
E3-19 bE3-19 bE3-19 bE3-19 b
Salaries Expense Salaries Payable
12/31 3,00012/31 3,000
GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
Dec 31 Salary Expense 3,000Salary Payable 3,000
To record accrued salaries
This is an example of accrued expenses.The company owes employees salaries for two days’ work – Monday and Tuesday
E3-19cE3-19cE3-19cE3-19c
Supplies Supplies Expense 3,100 12/31 1,900
12/31 1,900Bal. 1,200
GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
Dec 31 Supplies Expense 1,900Supplies 1,900
To record supplies used
How much of the supplies have been used up? We stared with $3,100 and ended up with $1,200. The rest was used up
GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
Dec 31 Depreciation Expense,Equipment 2,500
Accumulated Depreciation,Equipment 2,500
To record depreciation
Accumulated Depreciation
E3-19dE3-19dE3-19dE3-19d
12/31 2,500 12/31 2,500Depreciation Expense
E3-19fE3-19fE3-19fE3-19f
Prepaid Insurance Insurance ExpenseBal 1,200 12/31 200
12/31 200
Bal. 1,000
GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
Dec 31 Insurance Expense 200Prepaid Insurance 200
To record insurance expired
Copyright © 2007 Prentice-Hall. All rights reserved 45
Objective 4Objective 4Objective 4Objective 4
Prepare an adjusted trial balance
S 3-10S 3-10S 3-10S 3-10Scissors Hair Stylists
WorksheetDecember 31, 2005
Trial Balance
Adjustments
AdjustedTrial Balance
Account Title Dr. Cr. Dr. Cr. Dr. Cr.Cash 400 Supplies 700 Equipment 17,000 Accum. depr. - Equip. 1,000 Accounts payable 200 Interest payable Note payable 3,000 Suzanne Byrd, capital 6,000 Service revenue 12,000 Rent expense 4,000 Supplies expense Depreciation expense Interest expense 100 Totals 22,200 22,200
a. 500
a. 500
b. 1,000
b. 1,000
c. 100
c. 100
400200
17,000
4,000500
1,000200
23,300
2,000200100
3,0006,000
12,000
23,3001,600 1,600
S3-11S3-11 S3-11S3-11Scissors Hair StylistsWorksheet
December 31, 2005
AdjustedTrial Balance
Account Title Dr. Cr.Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Suzanne Byrd, capital Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals
400200
17,000
4,000500
1,000200
23,300
2,000200100
3,0006,000
12,000
23,300
Net Income $6,300
S3-12S3-12 S3-12S3-12Scissors Hair StylistsWorksheet
December 31, 2005
AdjustedTrial Balance
Account Title Dr. Cr.Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Suzanne Byrd, capital Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals
400200
17,000
4,000500
1,000200
23,300
2,000200100
3,0006,000
12,000
23,300
Total Assets = $15,600
Copyright © 2007 Prentice-Hall. All rights reserved 49
Scissors Hair StylistsWorksheet
December 31, 2005
AdjustedTrial Balance
Account Title Dr. Cr.Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Suzanne Byrd, capital Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals
400200
17,000
4,000500
1,000200
23,300
2,000200100
3,0006,000
12,000
23,300
Income Statement Accounts
Balance Sheet Accounts
Copyright © 2007 Prentice-Hall. All rights reserved 50
Objective 5Objective 5Objective 5Objective 5
Prepare the financial statements from the adjusted trial balance
Copyright © 2007 Prentice-Hall. All rights reserved 51
Scissors Hair StylistsWorksheet
December 31, 2005
AdjustedTrial Balance
Account Title Dr. Cr.Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Suzanne Byrd, capital Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals
400200
17,000
4,000500
1,000200
23,300
2,000200100
3,0006,000
12,000
23,300
Income Statement Accounts
Scissors Hair Stylists
Income Statement
For the Year Ended December 31, 2005
Service revenue $12,000
Expenses:
Rent expense $ 4,000
Supplies expense 500
Depreciation expense 1,000
Interest expense 200
Total Expenses 5,700
Net Income $ 6,300
Copyright © 2007 Prentice-Hall. All rights reserved 52
Scissors Hair StylistsWorksheet
December 31, 2005
AdjustedTrial Balance
Account Title Dr. Cr.Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Suzanne Byrd, capital Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals
400200
17,000
4,000500
1,000200
23,300
2,000200100
3,0006,000
12,000
23,300
Scissors Hair Stylists
Statement of Owner's Equity
For the Year Ended December 31, 2005
S. Byrd, Capital, Jan. 1, 2005 $ 6,000
Add: Net Income 6,300
S. Byrd, Capital, Dec. 31, 2005 $12,300
Copyright © 2007 Prentice-Hall. All rights reserved 53
Scissors Hair StylistsWorksheet
December 31, 2005
AdjustedTrial Balance
Account Title Dr. Cr.Cash Supplies Equipment Accum. depr. - Equip. Accounts payable Interest payable Note payable Suzanne Byrd, capital Service revenue Rent expense Supplies expense Depreciation expense Interest expense Totals
400200
17,000
4,000500
1,000200
23,300
2,000200100
3,0006,000
12,000
23,300
Balance Sheet Accounts
Scissors Hair StylistsBalance
December 31, 2005Assets Liabilities
Cash $ 400 Accounts payable $ 200 Supplies 200 Interest payable 100
Equipment $17,000 Note payable 3,000 Less:
Accumulated Depreciation 2,000 15,000
Total Liabilities $ 3,300
Owner's EquityS. Byrd, Capital 12,300
Total Assets $15,600 $ 15,600
Copyright © 2007 Prentice-Hall. All rights reserved 54
End of Chapter 3End of Chapter 3End of Chapter 3End of Chapter 3