Ch03 wrd25e instructor

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The Adjusting

The Adjusting

ProcessProcess

Chapter 3Chapter 3

Learning ObjectivesLearning Objectives

1.1. Describe the nature of the adjusting process.Describe the nature of the adjusting process.

2.2. Journalize entries for accounts requiring Journalize entries for accounts requiring adjustment.adjustment.

3.3. Summarize the adjustment process.Summarize the adjustment process.

4.4. Prepare an adjusted trial balance.Prepare an adjusted trial balance.

5.5. Describe and illustrate the use of vertical Describe and illustrate the use of vertical analysis in evaluating a company’s analysis in evaluating a company’s performance and financial condition.performance and financial condition.


Learning Objective

Learning ObjectiveDescribe the nature of the adjusting

Describe the nature of the adjusting process.process.

11

Nature of the Adjusting ProcessNature of the Adjusting Process

o The The accounting period concept accounting period concept requires that requires that revenues and expenses be reported in the revenues and expenses be reported in the proper period.proper period.


o Under the Under the accrual basis of accountingaccrual basis of accounting, , revenues are reported on the income revenues are reported on the income statement in the period in which they are statement in the period in which they are earned.earned.


o The accounting concept supporting the The accounting concept supporting the reporting of revenues when they are earned reporting of revenues when they are earned regardless of when cash is received is called regardless of when cash is received is called the the revenue recognition conceptrevenue recognition concept..


o The accounting concept supporting reporting The accounting concept supporting reporting revenues and related expenses in the same revenues and related expenses in the same period is called the period is called the matching conceptmatching concept, or , or matching principlematching principle..


o Under the Under the cash basis of accountingcash basis of accounting, revenues , revenues and expenses are reported on the income and expenses are reported on the income statement in the period in which cash is statement in the period in which cash is received or paid.received or paid.

The Adjusting ProcessThe Adjusting Process

o Under the accrual basis, some of the accounts Under the accrual basis, some of the accounts need updating at the end of the accounting need updating at the end of the accounting period for the following reasons:period for the following reasons: Some expenses are not recorded daily.Some expenses are not recorded daily.

Some revenues and expenses are incurred as time Some revenues and expenses are incurred as time passes rather than as separate transactions.passes rather than as separate transactions.

Some revenues and expenses may be unrecorded.Some revenues and expenses may be unrecorded.


o The analysis and updating of accounts at the The analysis and updating of accounts at the end of the period before the financial end of the period before the financial statements are prepared is called the statements are prepared is called the adjusting adjusting processprocess. .


o The analysis and updating of accounts at the The analysis and updating of accounts at the end of the period before the financial end of the period before the financial statements are prepared is called the adjusting statements are prepared is called the adjusting process. process.

o The journal entries that bring the accounts up The journal entries that bring the accounts up to date at the end of the accounting period are to date at the end of the accounting period are called called adjusting entriesadjusting entries..

Types of Accounts Requiring AdjustmentTypes of Accounts Requiring Adjustment

o Prepaid expensesPrepaid expenses are the advance payment of are the advance payment of future expenses and are recorded as assets future expenses and are recorded as assets when cash is paid.when cash is paid.

PREPAID PREPAID EXPENSESEXPENSES

(continued)


(concluded)


o Unearned revenues Unearned revenues are the advance receipt of are the advance receipt of future revenues and are recorded as liabilities future revenues and are recorded as liabilities when cash is received.when cash is received.

UNEARNED UNEARNED REVENUESREVENUES

(continued)


(concluded)


o Accrued revenues Accrued revenues are unrecorded revenues are unrecorded revenues that have been earned and for which cash has that have been earned and for which cash has yet to be received.yet to be received.

ACCRUED ACCRUED REVENUESREVENUES

(continued)

(concluded)

ACCRUED ACCRUED REVENUESREVENUES


o Accrued expenses Accrued expenses are unrecorded expenses are unrecorded expenses that have been incurred and for which cash has that have been incurred and for which cash has yet to be paid. yet to be paid.

ACCRUED ACCRUED EXPENSESEXPENSES

(continued)

ACCRUED ACCRUED EXPENSESEXPENSES

(concluded)


Learning Objective

Learning ObjectiveJournalize entries for accounts

Journalize entries for accounts requiring adjustment.

requiring adjustment.

22

ADJUSTING ADJUSTING ENTRIESENTRIES


Prepaid ExpensesPrepaid Expenses

o NetSolutions’ supplies account has a balance of NetSolutions’ supplies account has a balance of $2,000 on the unadjusted trial balance. Some of $2,000 on the unadjusted trial balance. Some of these supplies have been used. On December these supplies have been used. On December 31, a count reveals that the amount of supplies 31, a count reveals that the amount of supplies on hand is $760.on hand is $760.

Supplies (balance on trial balance) $2,000Supplies on hand, December 31 – 760Supplies used $1,240


Assets = Liabilities + Owner’s Equity (Expense)

Accounting Equation Impact

decrease

increase

Prepaid InsurancePrepaid Insurance

o The debit balance of $2,400 in NetSolutions’ The debit balance of $2,400 in NetSolutions’ prepaid insurance account represents the prepaid insurance account represents the December 1 prepayment of insurance for 12 December 1 prepayment of insurance for 12 months.months.



decrease

increase

PREPAID PREPAID INSURANCEINSURANCE

Impact of Omitting Adjusting EntriesImpact of Omitting Adjusting Entries

Unearned RevenuesUnearned Revenues

o The credit balance of $360 in NetSolutions’ The credit balance of $360 in NetSolutions’ unearned rent account represents the receipt unearned rent account represents the receipt of three months’ rent on December 1 for of three months’ rent on December 1 for December, January, and February. At the end of December, January, and February. At the end of December, one month’s rent has been earned.December, one month’s rent has been earned.


Assets = Liabilities + Owner’s Equity (Revenue)


decreaseincrease

Impact of Omitting Adjusting EntryImpact of Omitting Adjusting Entry

Accrued RevenuesAccrued Revenues

o NetSolutions signed an agreement with Danker NetSolutions signed an agreement with Danker Co. on December 15 to provide services at a Co. on December 15 to provide services at a rate of $20 per hour. As of December 31, rate of $20 per hour. As of December 31, NetSolutions had provided 25 hours of NetSolutions had provided 25 hours of services. The revenue will be billed on January services. The revenue will be billed on January 15.15.


Assets = Liabilities + Owner’s Equity (Revenue)


increase increase

Impact of Omitting Adjusting EntryImpact of Omitting Adjusting Entry

Accrued Expenses: Accrued Wages Accrued Expenses: Accrued Wages

Accrued WagesAccrued Wages

o NetSolutions pays it employees biweekly. NetSolutions pays it employees biweekly. During December, NetSolutions paid wages of During December, NetSolutions paid wages of $950 on December 13 and $1,200 on $950 on December 13 and $1,200 on December 27. As of December 31, December 27. As of December 31, NetSolutions owes $250 of wages to employees NetSolutions owes $250 of wages to employees for Monday and Tuesday, December 30 and 31.for Monday and Tuesday, December 30 and 31.

ACCRUED WAGESACCRUED WAGES



increaseincrease

Accrued WagesAccrued Wages

o NetSolutions paid wages of $1,275 on January NetSolutions paid wages of $1,275 on January 10. This payment includes the $250 of accrued 10. This payment includes the $250 of accrued wages recorded on December 31.wages recorded on December 31.

IMPACT OF IMPACT OF OMITTING OMITTING ADJUSTING ADJUSTING

ENTRYENTRY

Depreciation ExpenseDepreciation Expense

o Fixed assets, or plant assets, are physical Fixed assets, or plant assets, are physical resources that are owned and used by a resources that are owned and used by a business and are permanent or have a long business and are permanent or have a long life.life.

o As time passes, a fixed asset loses its ability to As time passes, a fixed asset loses its ability to provide useful services. This decrease in provide useful services. This decrease in usefulness is called usefulness is called depreciationdepreciation..


o All fixed assets, except land, lose their All fixed assets, except land, lose their usefulness and , thus, are said to usefulness and , thus, are said to depreciatedepreciate..

o As a fixed asset depreciates, a portion of its As a fixed asset depreciates, a portion of its cost should be recorded as an expense. This cost should be recorded as an expense. This periodic expense is called periodic expense is called depreciationdepreciation expenseexpense..


o The fixed asset account is not decreased The fixed asset account is not decreased (credited) when making the related adjusting (credited) when making the related adjusting entry. This is because both the original cost of entry. This is because both the original cost of a fixed asset and the depreciation recorded a fixed asset and the depreciation recorded since its purchase are reported on the balance since its purchase are reported on the balance sheet. Instead, an account entitled sheet. Instead, an account entitled Accumulated Depreciation Accumulated Depreciation is increased is increased (credited).(credited).

o Accumulated depreciation accounts are called Accumulated depreciation accounts are called contra accountscontra accounts, or , or contra asset accountscontra asset accounts..


o Normal titles for fixed asset accounts and their Normal titles for fixed asset accounts and their related contra asset accounts are as follows:related contra asset accounts are as follows:


o NetSolutions estimates the depreciation on its NetSolutions estimates the depreciation on its office equipment to be $50 for the month of office equipment to be $50 for the month of December.December.

DEPRECIATION DEPRECIATION EXPENSEEXPENSE



increase

increase


o The difference between the original cost of the The difference between the original cost of the office equipment and the balance in the office equipment and the balance in the accumulated depreciation—office equipment accumulated depreciation—office equipment account is called the account is called the book value book value of the asset of the asset (or (or net book valuenet book value). It is computed as shown ). It is computed as shown below.below.

Book Value of Asset = Cost of the Asset – Accumulated Depreciation of Asset

Book Value of Off. Equip. = Cost of Off. Equip. – Acc. Deprec. of Office Equip.

Book Value of Off. Equip.= $1,800 – $50

Book Value of Off. Equip.= $1,750

IMPACT OF IMPACT OF OMITTING OMITTING ADJUSTING ADJUSTING

ENTRYENTRY


Learning Objective

Learning ObjectiveSummarize the adjustment process.

Summarize the adjustment process.

33

SUMMARY OF SUMMARY OF ADJUSTMENT ADJUSTMENT

PROCESSPROCESS

(continued)

(continued)


PROCESSPROCESS

(continued)


PROCESSPROCESS

(continued)


PROCESSPROCESS

(concluded)


PROCESSPROCESS



(continued)

LEDGER WITH LEDGER WITH ADJUSTING ADJUSTING

ENTRIESENTRIES

LEDGER LEDGER WITH WITH


LEDGER WITH LEDGER WITH ADJUSTING ADJUSTING

ENTRIESENTRIES


Learning Objective

Learning ObjectivePrepare an adjusted trial balance.

Prepare an adjusted trial balance.

44

Adjusted Trial BalanceAdjusted Trial Balance

o The purpose of the The purpose of the adjusted trial balanceadjusted trial balance is to is to verify the equality of the total debit and credit verify the equality of the total debit and credit balances before the financial statements are balances before the financial statements are prepared.prepared.

ADJUSTED TRIAL ADJUSTED TRIAL BALANCEBALANCE


Learning Objective

Learning ObjectiveDescribe and illustrate the use of

Describe and illustrate the use of

vertical analysis in evaluating a

vertical analysis in evaluating a

company’s performance and

company’s performance and financial condition

financial condition

55

Vertical AnalysisVertical Analysis

o Comparing each item in a financial statement Comparing each item in a financial statement with a total amount from the same statement is with a total amount from the same statement is referred to as referred to as verticalvertical analysisanalysis..


$12,500= .067 or 6.7%

$187,500


$3,000= .02 or 2%

$150,000


The Adjusting

The Adjusting

ProcessProcess

The EndThe End

Ch03 wrd25e instructor

Education

adjusting processunder

adjusting processthe

unrecorded revenues

adjustmentaccrued revenues

reporting of revenues

reporting revenues

unrecorded expenses

adjustmentunearned revenues