Wey_AP_8e_Ch03_Revised

8/9/2019 Wey_AP_8e_Ch03_Revised

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Chapter

3-1


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Chapter

3-2

CHAPTERCHAPTER33

ADJUSTING THEADJUSTING THE

ACCOUNTSACCOUNTS

Accounting Principles, Eighth Edition


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Chapter

3-3

1. Explain the time period assumption.

2. Explain the accrual basis of accounting.

3. Explain the reasons for adjusting entries.

4. Identify the major types of adjusting entries.

5. Prepare adjusting entries for deferrals.

6. Prepare adjusting entries for accruals.

7. Describe the nature and purpose of an adjustedtrial balance.

StudyObjectivesStudyObjectives


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Chapter

3-4

Adjustingthe AccountsAdjustingthe Accounts

Timing IssuesTiming Issues

The Basics ofThe Basics of

AdjustingAdjusting

EntriesEntries

The AdjustedThe Adjusted

Trial Balance andTrial Balance and

FinancialFinancial

StatementsStatements

Time periodTime period

assumptionassumption

Fiscal andFiscal and

calendar yearscalendar years

AccrualAccrual-- vs. cashvs. cash--basis accountingbasis accounting

RecognizingRecognizing

revenues andrevenues and

expensesexpenses

Types of adjustingTypes of adjusting

entriesentries

Adjusting entriesAdjusting entries

for deferralsfor deferrals

Adjusting entriesAdjusting entriesfor accrualsfor accruals

Summary ofSummary of

journalizing andjournalizing and

postingposting

Preparing thePreparing the

adjusted trialadjusted trial

balancebalance

PreparingPreparing

financialfinancialstatementsstatements


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Chapter

3-5

Generally a month, a quarter, or a year.Fiscal year vs. calendar year

Also known as the Periodicity Assumption

TimingIssuesTimingIssues

Accountants divide the economic life of abusiness into artificial time periods(Time Period Assumption).

LO 1 Explainthetime periodassumption.LO 1 Explainthetime periodassumption.

Jan. Feb. Mar. Apr. Dec......


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Chapter

3-6

The time period assumption states that:The time period assumption states that:

a.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 dividedinto artificial time periods.

d. the fiscal year should correspond with thecalendar year.

ReviewReview


LO 1 Explainthetime periodassumption.LO 1 Explainthetime periodassumption.


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Chapter

3-8

Cash-BasisAccounting

Revenues are recognized when cash is received.

Expenses are recognized when cash is paid.

Cash-basis accounting is not in accordance withgenerally accepted accounting principles (GAAP).


Accrual- vs.Cash-BasisAccounting

LO 2 Explaintheacc

rual basisofacc

ounting.LO 2 Explaintheacc

rual basisofacc

ounting.


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Chapter

3-9

RevenueRecognition Principle


RecognizingRevenuesand Expenses

LO 2 Explaintheacc

rual basisofacc


rual basisofacc

ounting.

Companies recognize

revenue in the accountingperiod in which it isearned.

In a service enterprise,revenue is considered tobe earned at the time theservice is performed.


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Chapter

3-10

Matching Principle


RecognizingRevenuesand Expenses

LO 2 Explaintheacc

rual basisofacc


rual basisofacc

ounting.

Match expenses with

revenues in the periodwhen the company makesefforts to generatethose revenues.

Lettheexpenses followtherevenues.


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Chapter

3-11


LO 2 Explainthe accrual basis of accounting.LO 2 Explainthe accrual basis of accounting.

GAAP relationshipsinrevenue andexpense recognition

Illustration3Illustration3--11


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Chapter

3-12

One of the following statements about the accrual basisof accounting is false. That statement is:

a. Events that change a companys financialstatements are recorded in the periods in whichthe events occur.

b. Revenue is recognized in the period in which it isearned.

c. The accrual basis of accounting is in accord withgenerally accepted accounting principles.

d. Revenue is recorded only when cash is received, andexpenses are recorded only when cash is paid.

ReviewReview


LO 2 Explainthe accrual basis of accounting.LO 2 Explainthe accrual basis of accounting.


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Chapter

3-13

Adjusting entries make it possible to reportcorrect amounts on the balancesheetand onthe incomestatement.

A company must make adjusting entriesevery time it prepares financial statements.

The Basicsof AdjustingEntriesThe Basicsof AdjustingEntries

LO 3 Explainthe reasonsforadjustingentries.LO 3 Explainthe reasonsforadjustingentries.


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Chapter

3-14

RevenuesRevenues -- recorded in the period in whichrecorded in the period in whichthey are earnedthey are earned.

ExpensesExpenses-- recognized in the period in whichrecognized in the period in whichthey are incurredthey are incurred.

AdjustingentriesAdjustingentries -- needed to ensure that theneeded to ensure that therevenue recognitionrevenue recognition andand matching principlesmatching principles

are followed.are followed.

The Basics ofAdjustingEntriesThe Basics ofAdjustingEntries

LO 3 Explainthereasonsfor adjustingentries.LO 3 Explainthereasonsfor adjustingentries.


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Chapter

3-15

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 anaccounting period.

d. all of the above.

ReviewReview


LO 3 Explainthe reasonsfor adjustingentries.LO 3 Explainthe reasonsfor adjustingentries.


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Chapter

3-16

Types of AdjustingEntriesTypes of AdjustingEntries

1. PrepaidExpenses.Expenses paid in cash and

recorded as assets beforethey are used or consumed.

Deferrals

3. AccruedRevenues.Revenues earned but not

yet received in cash orrecorded.

4. AccruedExpenses.Expenses incurred but not

yet paid in cash orrecorded.

2. UnearnedRevenues.Revenues received in cash

and recorded as liabilitiesbefore they are earned.

Accruals

LO 4 Identifythemajortypes ofadjustingentries.LO 4 Identifythemajortypes ofadjustingentries.


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Chapter

3-17

TrialBalanceTrialBalance Each account is analyzed to determinewhether it is complete and up-to-date.

Pho x Co t g - J . 31 t (b fo d ust g t s)Acct. No. Accou t D b t C dit

00 Cash 50,000$

05 ccounts receiva le 35,000

0 Prepaid insurance

2,000

20 Equipment 24,000

30 nvestments 300,000200 ccounts paya le 20,000$

2

0 Unearned revenue 24,000220 Note payale 200,000

300 ustin, capital 40,000400 Sales

37,000

42

,000$ 42

,000$

TialBala ceTialBala ce

LO4 Ide tify the ma o types of ad usti ge ties.LO4 Ide tify the ma o types of ad usti ge ties.


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Chapter

3-18

Deferrals are either:

Prepaid expenses

OR

Unearned revenues.

AdjustingEntriesfor DeferralsAdjustingEntriesfor Deferrals

LO 5LO 5 Prepare adjustingentriesfordeferrals.Prepare adjustingentriesfordeferrals.


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Chapter

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PrepaidExpenses

Costs that expire either with the passage of timeor through use.

Adjusting entries (1) to record the expenses thatapply to the current accounting period, and (2) toshow the unexpired costs in the asset accounts.

AdjustingEntriesfor PrepaidExpensesAdjustingEntriesfor PrepaidExpenses



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Chapter

3-21



Adjusting entries for prepaid expenses

Increases (debits) an expense account and

Decreases (credits) an asset account.



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Chapter

3-22

ExampleExample(Insurance)(Insurance):: On Jan. 1On Jan. 1stst, Phoenix Consulting paid, Phoenix Consulting paid12,000 for 12 months of insurance coverage. how the12,000 for 12 months of insurance coverage. how the

journal entry to record the payment on Jan. 1journal entry to record the payment on Jan. 1stst..

Cash 12,000

Prepaid Insurance 12,000Jan. 1

Debit Credit

Prepaid Insurance

12,00012,000 12,00012,000

Debit Credit

Cash




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Chapter

3-23

ExampleExample(Insurance)(Insurance):: On Jan. 1On Jan. 1stst, Phoenix Consulting paid, Phoenix Consulting paid12,000 for 12 months of insurance coverage. how the12,000 for 12 months of insurance coverage. how the

adjusting journal entryadjusting journal entry re uired at Jan. 31re uired at Jan. 31stst..

Prepaid Insurance 1,000

Insurance Expense 1,000Jan. 31

Debit Credit

Prepaid Insurance

12,00012,000 1,0001,000

Debit Credit

Insurance Expense

1,0001,000

11,00011,000




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Chapter

3-24

Depreciation

Buildings, e uipment, and vehicles (long-livedassets) are recorded as assets, rather than an

expense, in the year ac uired.Companies report a portion of the cost of a long-lived asset as an expense (depreciation) duringeach period of the assets useful life (Matching

Principle).




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Chapter

3-25

ExampleExample(Depreciation)(Depreciation):: On Jan. 1On Jan. 1stst, Phoenix Consulting, Phoenix Consultingpaid 24,000 for e uipment that has an estimated usefulpaid 24,000 for e uipment that has an estimated usefullife of 20 years. how the journal entry to record thelife of 20 years. how the journal entry to record thepurchase of the e uipment on Jan. 1purchase of the e uipment on Jan. 1stst..

Cash 24,000E uipment 24,000Jan. 1

Debit Credit

E uipment

24,00024,000 24,00024,000

Debit Credit

Cash




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Chapter

3-26

ExampleExample(Depreciation)(Depreciation):: On Jan. 1On Jan. 1stst, Phoenix Consulting, Phoenix Consultingpaid 24,000 for e uipment that has an estimated usefulpaid 24,000 for e uipment that has an estimated usefullife of 20 years. how thelife of 20 years. how the adjusting journal entryadjusting journal entry re uiredre uiredat Jan. 31at Jan. 31stst.. ($24,000 / 20 yrs. / 12months = $100)($24,000 / 20 yrs. / 12months = $100)

Accumulated Depreciation 100Depreciation Expense 100Jan. 31

Debit Credit

Depreciation Expense

100100 100100

Debit Credit

Accumulated Depreciation




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Chapter

3-27

Depreciation(StatementPresentation)

Accumulated Depreciation is a contra asset account.

Appears just after the account it offsets

(E uipment) on the balance sheet.



Balance Sheet an.

AssetsE uipment

Accumulated Depreciation ( )

et E uipment 9


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Chapter

3-28

Receipt of cash that is recorded as a liability becauseReceipt of cash that is recorded as a liability becausethe revenue has not been earned.the revenue has not been earned.

AdjustingEntriesfor UnearnedRevenuesAdjustingEntriesfor UnearnedRevenues

rentrent

airline ticketsairline ticketsschool tuitionschool tuition

Cash Receipt Revenue RecordedBEFORE

magazine subscriptionsmagazine subscriptions

customer depositscustomer deposits

Unearned revenues often occur in regard to:Unearned revenues often occur in regard to:



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Chapter

3-29

UnearnedRevenues

Company makes an adjusting entry to record therevenue that has been earned and to show the

liability that remains.

The adjusting entry for unearned revenues resultsin a decrease (a debit) to a liability account and anincrease (a credit) to a revenue account.




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Chapter

3-30

LO 5LO 5 Prepare adjusting

ent

riesfor

deferrals.Prepare a

djusting

ent

riesfor

deferrals.

Adjusting entries for unearned revenues

Decrease (a debit) to a liability account and

Increase (a credit) to a revenue account.




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Chapter

3-32

Example:Example: On Jan. 1On Jan. 1stst, Phoenix Consulting received 24,000, Phoenix Consulting received 24,000from Arcadia High chool for 3 months rent in advance.from Arcadia High chool for 3 months rent in advance.

how thehow the adjusting journal entryadjusting journal entry re uired on Jan. 31re uired on Jan. 31stst..

Rent Revenue 8,000

Unearned Rent Revenue 8,000Jan. 31

Debit Credit

Rent Revenue

8,0008,000 24,00024,000

Debit Credit

Unearned Rent Revenue

8,0008,000

16,00016,000




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Chapter

3-33

Made to record:

Revenues earned and

OR

Expenses incurred

in the current accounting period that have not

been recognized through daily entries.

AdjustingEntriesfor AccrualsAdjustingEntriesfor Accruals

LO 6LO 6 Prepare adjustingentriesfor accruals.Prepare adjustingentriesfor accruals.


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Chapter

3-34

Revenues earned but not yet received in cash orRevenues earned but not yet received in cash orrecorded.recorded.

AdjustingEntriesfor AccruedRevenuesAdjustingEntriesfor AccruedRevenues

rentrentinterestinterest

services performedservices performed

BEFORE

Accrued revenues often occur in regard to:Accrued revenues often occur in regard to:

Cash ReceiptRevenue Recorded

Adjusting entry results in:Adjusting entry results in:



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Chapter

3-35

AccruedRevenues

An adjusting entry serves two purposes:

(1) It shows the receivable that exists, and

(2) It records the revenues earned.




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Chapter

3-36

Adjusting entries for accrued revenues

Increases (debits) an asset account and

Increases (credits) a revenue account.





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Chapter

3-37

Example:Example: On Jan. 1On Jan. 1stst, Phoenix Consulting invested, Phoenix Consulting invested300,000 in securities that return 5% interest per year.300,000 in securities that return 5% interest per year.how the journal entry to record the investment on Jan. 1how the journal entry to record the investment on Jan. 1stst..

Cash 300,000

Investments 300,000Jan. 1


Debit Credit

Investments

300,000300,000 300,000300,000

Debit Credit

Cash



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Chapter

3-38

Example:Example: On Jan. 1On Jan. 1stst, Phoenix Consulting invested, Phoenix Consulting invested300,000 in securities that return 5% interest per year.300,000 in securities that return 5% interest per year.how thehow the adjusting journal entryadjusting journal entry re uired on Jan. 31re uired on Jan. 31stst..

($300,000x 5% / 12months = $1,250)($300,000x5% / 12months = $1,250)

Interest Revenue 1,250Interest Receivable 1,250Jan. 31

Debit Credit

Interest Receivable

1,2501,250 1,2501,250

Debit Credit

Interest Revenue




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Chapter

3-39

Expenses incurred but not yet paid in cash orExpenses incurred but not yet paid in cash orrecorded.recorded.

AdjustingEntriesfor AccruedExpensesAdjustingEntriesfor AccruedExpenses

rentrentinterestinterest

BEFORE

Accrued expenses often occur in regard to:Accrued expenses often occur in regard to:

Cash PaymentExpense Recorded

taxestaxessalariessalaries

Adjusting entry results in:Adjusting entry results in:



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Chapter

3-40

AccruedExpenses


(1) It records the obligations, and

(2) It recognizes the expenses.




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Chapter

3-41

Adjusting entries for accrued expenses

Increases (debits) an expense account and

Increases (credits) a liability account.





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Chapter

3-42

Notes Payable 200,000Cash 200,000Jan. 2

Debit Credit

Cash

200,000200,000 200,000200,000

Debit Credit

Notes Payable

Example:Example: On Jan. 2On Jan. 2ndnd, Phoenix Consulting borrowed 200,000, Phoenix Consulting borrowed 200,000at a rate of % per year. Interest is due on first of eachat a rate of % per year. Interest is due on first of eachmonth. how the journal entry to record the borrowing onmonth. how the journal entry to record the borrowing onJan. 2Jan. 2ndnd..


LO 6LO 6 Prepareadjustingentriesforaccruals.Prepareadjustingentriesforaccruals.


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Chapter

3-43

Example:Example: On Jan. 2On Jan. 2ndnd, Phoenix Consulting borrowed 200,000, Phoenix Consulting borrowed 200,000at a rate of % per year. Interest is due on first of eachat a rate of % per year. Interest is due on first of eachmonth. how themonth. how the adjusting journal entryadjusting journal entry re uired on Jan. 31re uired on Jan. 31stst..($200,000x 9% / 12months = $1,500)($200,000x 9% / 12months = $1,500)

Interest Payable 1,500Interest Expense 1,500Jan. 31

Debit Credit

Interest Expense

1,5001,500 1,5001,500

Debit Credit

Interest Payable




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Chapter

3-44

AccruedExpenses


(1) It records the obligations, and

(2) it recognizes the expenses.




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Chapter

3-45

After all adjusting entries are journalized andposted the company prepares another trialbalance from the ledger accounts (Adjusted Trial

Balance).

Its purpose is to prove the e uality of debitbalances and credit balances in the ledger.

TheAdjusted TrialBalanceTheAdjusted TrialBalance

LO 7LO 7 Describethenatureand purpose ofanadjustedtrial balance.Describethenatureand purpose ofanadjustedtrial balance.


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Chapter

3-46

Which of the following statements is incorrectconcerning the adjusted trial balance?

a. An adjusted trial balance proves the e uality of thetotal debit balances and the total credit balances inthe ledger after all adjustments are made.

b. The adjusted trial balance provides the primarybasis for the preparation of financial statements.

c. The adjusted trial balance lists the account balancessegregated by assets and liabilities.

d. The adjusted trial balance is prepared after theadjusting entries have been journalized and posted.

ReviewReview


LO 7LO 7 Describethenature andpurpose of anadjustedtrial balance.Describethenature andpurpose of anadjustedtrial balance.


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Chapter

3-47

Financial tatements are prepared directly from theAdjusted Trial Balance.

Balanceheet

Incometatement

tatementof CashFlows

OwnersE uity

tatement

PreparingFinancialStatementsPreparingFinancialStatements



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Chapter

3-48

Income Statement

For the Month Ended Jan. 31, 2008

Revenues:

Sales 137 000$

Interest revenue 1 250

Rent revenue 8 000

Total revenue 146 250

Expenses:

Interest expense 1 500

Depreciation expense 100Insurance expense 1 000

Total expenses 2 600

Net income 143 650$

Income Statement

Preparing inancialStatementsPreparing inancialStatements

LO7LO7 Describe the nature andpurpose ofan adjustedtrialbalance.Describe the nature andpurpose ofan adjustedtrialbalance.

djustedTrialBalance Debit CreditCash 50 000$

Accounts receivable 35 000

Interest receivable 1 250

Prepaid insurance 11 000

Equipment 24 000

Accumulated depreciation 100$

Investments 300

000Accounts payable 20 000

Interest payable 1 500

Unearned revenue 16 000

Note payable 200 000

Austin capital 40 000

Sales 137 000

Interest revenue 1 250

Rent revenue 8 000Interest expense 1 500

Depreciation expense 100

Insurance expense 1 000

423 850$ 423 850$


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Chapter

3-49

Statement of Owner's quity

For the onth nded Jan. 31, 2008

Austin, Capital, Jan. 1 40,000$

+ Net income 143,650

- Drawings 0

Austin, Capital, Jan. 31 183,650$

Statement ofOwners Equity

PreparingFinancialStatementsPreparingFinancialStatements


djustedTrialBalance Deb it CreditCash 50,000$

Accounts receivable 35,000

Interest receivable 1,250

Prepaid insurance 11,000

Equipment 24,000

Accumulateddepreciation 100$

Investments 300,000Accounts payable 20,000

Interest payable 1,500

Unearned revenue 16,000

Note payable 200,000

Austin, capital 40,000

Sales 137,000

Interest revenue 1,250

Rent revenue 8,000Interest expense 1,500

Depreciation expense 100

Insurance expense 1,000

423,850$ 423,850$


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Chapter

3-51

Some companies use an alternativetreatment for prepaid expenses andunearned revenues.

When a company prepays an expense, itdebits that amount to anexpenseaccount.

When a company receives payment for

future services, it credits the amount to arevenueaccount.

LO 8 Prepareadjustingentriesforthealternativetreatmentofdeferrals.LO 8 Prepareadjustingentriesforthealternativetreatmentofdeferrals.

Alternative Treatmentof PrepaidExpensesandUnearnedRevenues


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Chapter

3-52

ExampleExample(Insurance)(Insurance):: On Dec. 1On Dec. 1stst, Phoenix Consulting paid, Phoenix Consulting paid12,000 for 12 months of insurance coverage. Show the12,000 for 12 months of insurance coverage. Show the

journal entry to record the payment on Dec. 1journal entry to record the payment on Dec. 1stst..

Cash 12,000

Insurance Expense 12,000Dec. 1

Debit Credit

Insurance Expense

12,00012,000 12,00012,000

Debit Credit

Cash

Alternative Treatmentfor PrepaidExpenses

LO 8 Prepare adjustingentriesforthe alternativetreatmentofdeferrals.LO 8 Prepare adjustingentriesforthe alternativetreatmentofdeferrals.


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Chapter

3-53

ExampleExample(Insurance)(Insurance):: On Dec. 1On Dec. 1stst, Phoenix Consulting paid, Phoenix Consulting paid12,000 for 12 months of insurance coverage. Show the12,000 for 12 months of insurance coverage. Show the

adjusting journal entryadjusting journal entry required at Dec. 31required at Dec. 31stst..

Insurance Expense 11,000

Prepaid Insurance 11,000Dec. 31

Debit Credit

Insurance Expense

12,000 11,000

Debit Credit

Prepaid Insurance

Alternative Treatmentfor PrepaidExpenses

11,00011,000

1,000



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Chapter

3-54

Example:Example: On Dec. 1On Dec. 1stst, Phoenix Consulting received 24,000, Phoenix Consulting received 24,000from Arcadia High School for 3 months rent in advance.from Arcadia High School for 3 months rent in advance.Show the journal entry to record the receipt on Dec. 1Show the journal entry to record the receipt on Dec. 1stst..

Rent Revenue 24,000

Cash 24,000Dec. 1

Debit Credit

Cash

24,00024,000 24,00024,000

Debit Credit

Rent Revenue

AlternativeAlternativeTreatmentfor UnearnedRevenuesTreatmentfor UnearnedRevenues



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Chapter

3-55

Example:Example: On Dec. 1On Dec. 1stst, Phoenix Consulting received 24,000, Phoenix Consulting received 24,000from Arcadia High School for 3 months rent in advance.from Arcadia High School for 3 months rent in advance.Show theShow the adjusting journal entryadjusting journal entry required on Dec. 31required on Dec. 31stst..

Unearned Rent Revenue 16,000

Rent Revenue 16,000Dec. 31

Debit Credit

Unearned Rent Revenue

16,00016,000 24,00024,000

Debit Credit

Rent Revenue

16,00016,000

8,0008,000

Alternative Treatmentfor UnearnedRevenuesAlternative Treatmentfor UnearnedRevenues



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Chapter

3-56

Summaryof Basic Relationshipsfor Deferrals

Illustration3AIllustration3A--77



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Chapter

3-57

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