Financial Accounting Chapter 3: The Adjusting Process: The Accrual Basis of Accounting vs. The Cash Basis of Accounting

FINANCIAL ACCOUNTING
Chapter 3: The Adjusting Process
ACG2022
THE ACCRUAL BASIS OF ACCOUNTING VS. THE CASH BASIS OF ACCOUNTING
Cash Basis: In the cash basis of accounting revenues and expenses are only recognized when cash is
received or paid, therefore there are no accounts receivable or accounts payable accounts.
Accrual Basis: In the accrual basis of accounting revenues are recognized (recorded) when earned,
and expenses are recognized when incurred regardless of whether cash been received or paid.
NATURE OF THE ADJUSTING PROCESS
A lot of revenues and expenses are recorded during the period as they occur, but a lot of accounts are
not. For these accounts the accountant must determine when to recognize these accounts, and adjust
them at the end of the accounting period in order to bring them up to date. When dealing with the timing
of revenue and expense recognition there are two terms that must be understood, Accrued and Deferred.
ACCRUED
DEFERRED
Revenues or Expenses
Revenues or Expenses
Accumulated
depreciation
is a contra asset, used to
record the
reduction in
value of the
asset account.
Accrued revenues, sometimes referred to as
Prepaid expenses: sometimes referred
accrued assets, are revenues that have been

earned but have not been recorded in the
accounts.
Fees Earned, Accounting Revenue, Sales
to as deferred expenses, are items that

have been initially recorded as assets
but are expected to become expenses
over time or through the normal
Operations of business.
Building, Automobile(Accumulated Depreciation),
Supplies, and Rent paid in advance
Accrued expenses, sometimes referred to as

accrued liabilities, are expenses that have been
incurred but have not been recorded in the
accounts.
Wages, Legal services. Fees for paper usage in a
copier machine...
Unearned revenues: (deferred revenue) are
items that have been initially recorded as

liabilities but are expected to become revenues
over time or through the normal operations of
To remember what accrued means think of your car,
the business.
if you dont wash it for 2 weeks, its okay. But after 4
Unearned
Gift Card Revenue, Subscription
weeks people start writing wash me on your
Revenue, Rent money received in advance
windowAccrued builds up over time and the
revenue or expense is recognized at the end of the
accounting period!
Accrued Revenue
You have worked all
month on the bookkeeping
for John Smith, now at the
end of the month (May 31,
2014) you bill him for
$2,500. You have accrued
(earned) the revenue since
you have completed the
work.
Accrued Expense
To remember what deferred means think of Rooms

to Go you get a room full of furniture today and
you dont have to pay until 2014Deferred moves
the revenue or expense recognition to a future
accounting period.
Deferred Expense
Your employees have

At the beginning of the
worked 4 days this week year, you purchased
insurance (prepaid
and earned $400 the
Insurance) for the next 12
month ends on
months for $1,200. At the
Thursday, but they will
end of month one you
not be paid until
have used up $100 worth.
payday.
Deferred Revenue
You received $120 on
January 1 for magazine
subscription. (Unearned
Subscription Revenue)
Now you have sent the
first magazine and have
earned one months
revenue.
Carl Horlitz and Dawn McDonough
Page 1
FINANCIAL ACCOUNTING
Chapter 3: The Adjusting Process
ACG2022
JOURNALIZING ADJUSTING ENTRIES

Adjustments must be recorded in the General Journal.
General Journal
Date
May 31
May 31
May 31
Description
Adjusting Entries
Accounts Receivable
Fees Earned
Completed Accounting Work for May, $2,500
Post Ref
Page 1
Credit
Debit
2,500
2,500
Wages Expense
* Wages Payable
Incurred wages for 4 days, amount owed $400
400
* Insurance Expense
Prepaid Insurance
Used up 1 months insurance policy (120012)
100
400
100
May 31
Unearned Subscription Revenue

* Subscription Revenue
Mailed first issue (100-10)
* Indicates a new account created to do the adjustment.
10
10
POSTING THE ADJUSTMENTS TO THE LEDGERS

Starting on page 120 of the textbook is a good example that walks you through the entire adjusting process, from
journalizing, posting to the ledgers, and then the creation of the adjusted trial balance.
ADJUSTED TRIAL BALANCE

After the adjusting entries have been recorded in the journal and posted to the ledgers we create an adjusted trial
balance. Adjusting entries generate new accounts that have may not been used before and these accounts must be
integrated into the adjusted trial balance along with all the accounts on the trial balance before adjustments.
John Smith Company
Trial Balance
May 31, 2013
Cash
Accounts Receivable
Prepaid Insurance
Accounts Payable
Unearned Subscription Revenue
John Smith, Capital
John Smith, Drawing
Fees Earned
Advertising Expense
Rent Expense
Wages Expense
John Smith Company

Adjusted Trial Balance
May 31, 2013
2,700
850
1,200
150
120
3,000
420
4,000
600
475
1025
7,270
7,270
Cash
Accounts Receivable
(850+2500)
Prepaid Insurance
(1200 - 100)
Accounts Payable
Wages Payable
(0+400)
Unearned Subscription Revenue (120-10)
John Smith, Capital
John Smith, Drawing
Fees Earned
(4000+2500)
Subscription Revenue
(0+10)
Advertising Expense
Rent Expense
Wages Expense
(1025+400)
Insurance Expense
(120012)
2,700
3,350
1,100
150
400
110
3,000
420
6,500
10
600
475
1,425
100
10,170
10170
VERTICAL ANALYSIS
By stating each income statement account as a percentage of Revenue and the balance sheet accounts as a
percentage of Total Assets, companies are able to see trends over time, and compare to other companies and to
industry averages.
Carl Horlitz and Dawn McDonough
Page 2

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FINANCIAL ACCOUNTING

Chapter 3: The Adjusting Process

THE ACCRUAL BASIS OF ACCOUNTING VS. THE CASH BASIS OF ACCOUNTING

Accrued revenues, sometimes referred to as

Prepaid expenses: sometimes referred

accrued assets, are revenues that have been

to as deferred expenses, are items that

Accrued expenses, sometimes referred to as

Unearned revenues: (deferred revenue) are

items that have been initially recorded as

To remember what deferred means think of Rooms

Your employees have

Carl Horlitz and Dawn McDonough

JOURNALIZING ADJUSTING ENTRIES

Unearned Subscription Revenue

POSTING THE ADJUSTMENTS TO THE LEDGERS

ADJUSTED TRIAL BALANCE

John Smith Company

Carl Horlitz and Dawn McDonough

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