CH 03

Accounting Principles
Chapter 3
Adjusting the Accounts

Accrual-Basis and Adjusting Entries
Accountants divide the economic life of a business into
artificial time periods (Time Period Assumption).
.....
Jan. Feb. Mar. Apr. Dec.
Generally a
ALTERNATIVE TERMINOLOGY
• month, The time period assumption
is also called the
• quarter, or periodicity assumption.
• year.
LO 1 2
Fiscal and Calendar Years
• Monthly and quarterly time periods are called interim
periods
• Most large companies must prepare both quarterly
and annual financial statements
• Fiscal Year = Accounting time period that is one year
in length
• Calendar Year = January 1 to December 31
LO 1 3
The time period assumption states that:
a. companies must wait until the calendar year is
completed to prepare financial statements.
b. companies use the fiscal year to report financial
information.
c. the economic life of a business can be divided
into artificial time periods.
d. companies record information in the time period
in which the events occur.
LO 1 4
Accrual- versus Cash-Basis Accounting
Accrual-Basis Accounting
• Transactions recorded in the periods in which the
events occur
• Companies recognize revenues when they perform
services (rather than when they receive cash)
• Expenses are recognized when incurred (rather than
when paid)
• Accrual-basis accounting is in accordance with IFRS.
LO 1 5
Accrual- versus Cash-Basis Accounting
Cash-Basis Accounting
• Revenues recognized when cash is received
• Expenses recognized when cash is paid
• Cash-basis accounting is not in accordance with IFRS.
LO 1 6
Recognizing Revenues and Expenses
Revenue Recognition Principle
Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.
LO 1 7
Recognizing Revenues and Expenses
Expense Recognition Principle
Companies recognize expenses in the
period in which they make efforts
(consume assets or incur liabilities)
to generate revenue.
“Let the expenses follow

the revenues.”
LO 1 8
Time Period Assumption
Economic life of business can be

divided into artificial time periods.
Revenue Recognition Expense Recognition

Principle Principle
Recognize revenue in the Recognize expense in the period
accounting period in which the that efforts are made to generate
performance obligation is satisfied. revenue.
Revenue and Expense

Recognition
In accordance with IFRS
LO 1 9
Which of the following statements about the accrual basis of
accounting is false?
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 services
are performed.
c. This basis is in accordance with generally accepted
accounting principles.
d. Revenue is recorded only when cash is received, and
expense is recorded only when cash is paid.
LO 1 10
The Need for Adjusting Entries
Adjusting Entries
• Ensure that the revenue recognition and expense
recognition principles are followed.
• Necessary because the trial balance may not contain
up-to-date and complete data.
• Required every time a company prepares financial
statements.
• Will include one income statement account and one
balance sheet account.
LO 1 11
The Need for Adjusting Entries
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
services are performed.
c. balance sheet and income statement accounts
have correct balances at the end of an
accounting period.
d. All the responses above are correct.
LO 1 12
Types of Adjusting Entries
Deferrals Accruals
1. Prepaid Expenses. Expenses 1. Accrued Revenues.
paid in cash before they are Revenues for services
used or consumed. performed but not yet
received in cash or recorded.
2. Unearned Revenues. 2. Accrued Expenses.
Cash received before Expenses incurred but not
services are performed. yet paid in cash or recorded.
LO 1 13
DO IT! 1 Timing Concepts
Below is a list of timing concepts (a) Monthly and quarterly time periods.
in the left column, with a (b) Efforts (expenses) should be recognized in
description of the concept in the the period in which a company uses assets
right column. There are more or incurs liabilities to generate results
(revenues).
descriptions provided than
(c) Accountants divide the economic life of a
concepts. Match the description
business into artificial time periods.
to the concept
(d) Companies record revenues when they
f Accrual-basis accounting.
1. ___ receive cash and record expenses when
e Calendar year.
2. ___ they pay out cash.
(e) An accounting time period that starts on
3. ___
c Time period assumption. January 1 and ends on December 31.
4. ___
b Expense recognition (f) Companies record transactions in the
principle. period in which the events occur.
LO 1 14
Adjusting Entries for Deferrals
Deferrals are expenses or revenues that are recognized
at a date later than the point when cash was originally
exchanged. There are two types:
• Prepaid expenses
• Unearned revenues
Journalize
Trial
Analyze Journalize Post
Balance
and Post
AJEs
Adjusted
Financial Closing Post-Closing
Trial
Balance Statements Entries Trial Balance
LO 2 15
Prepaid Expenses
Payments of expenses that are recorded as an asset to
show the service or benefit the company will receive in
the future.
Cash Payment BEFORE Expense Recorded
Prepayments often occur in regard to:

• insurance • rent
• supplies • equipment
• advertising • buildings
LO 2 16
Prepaid Expenses
• Expire either with the passage of time or through use
• Adjusting entry:
 Increase (debit) to an expense account and
 Decrease (credit) to an asset account
Asset Expense
Unadjusted Credit Debit
Balance Adjusting Adjusting
Entry (-) Entry (+)
LO 2 17
Pioneer Advertising
Trial Balance
October 31, 2023
Debit Credit
Cash $15,200
Supplies 2,500
Prepaid Insurance Subsequent 600
Equipment examples are 5,000
Notes Payable based on the $ 5,000
Accounts Payable October 31 trial 2,500
Unearned Revenue balance from 1,200
Owner’s Capital Chapter 2. 10,000
Owner’s Drawings 500
Service Revenue 10,000
Salaries and Wages Expense 4,000
Rent Expense 900
$28,700 $28,700
LO 2 18
Supplies
Illustration: Pioneer Advertising purchased
supplies costing $2,500 on October 5.
Pioneer recorded the payment by
increasing (debiting) the asset Supplies.
This account shows a balance of $2,500 in
the October 31 trial balance. An inventory
count at the close of business on October
31 reveals that $1,000 of supplies are still
on hand.
Oct. 31 Supplies Expense 1,500
Supplies 1,500
LO 2 19
Supplies
LO 2 20
Insurance
Illustration: On October 4, Pioneer
Advertising paid $600 for a one-year fire
insurance policy. Coverage began on
October 1. Pioneer recorded the payment
by increasing (debiting) Prepaid Insurance.
This account shows a balance of $600 in
the October 31 trial balance. Insurance of
$50 ($600 ÷ 12) expires each month.
Oct. 31 Insurance Expense 50

Prepaid Insurance 50
LO 2 21
Insurance
LO 2 22
Depreciation
• Buildings, equipment, and motor vehicles (assets
that provide service for many years) are recorded as
assets, rather than an expense, on the date acquired
• Depreciation is the process of allocating the cost of
an asset to expense over its useful life
• Depreciation does not attempt to report the actual
change in the value of the asset
 Allocation concept, not a valuation concept
LO 2 23
Depreciation
Illustration: For Pioneer Advertising,
assume that depreciation on the equipment
is $480 a year, or $40 per month.
Oct. 31
Depreciation Expense 40
Accumulated Depreciation 40
Accumulated Depreciation is called a

contra asset account.
LO 2 24
LO 2 25
Depreciation
Statement Presentation
• Accumulated Depreciation is a contra asset account
(credit)
• Offsets related asset account on the balance sheet
• Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation
Equipment $5,000
Less: Accumulated depreciation—equipment 40
$4,960
LO 2 26
Prepaid Expenses
Accounting for Prepaid Expenses
Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Insurance, Prepaid expense Assets Dr. Expenses
supplies, originally recorded overstated. Cr. Assets
advertising, rent, in asset accounts Expenses or Contra
depreciation have been used. understated. Assets
LO 2 27
Unearned Revenues
Receipt of cash that is recorded as a liability because the
service has not been performed.
Cash Receipt BEFORE Revenue Recorded
Unearned revenues often occur in regard to:

• Rent • Magazine subscriptions
• Airline tickets • Customer deposits
LO 2 28
Unearned Revenues
• Adjusting entry is made to record the revenue for
services performed during the period and to show
the liability that remains at the end of the period
• Results in a decrease (debit) to a liability account and
an increase (credit) to a revenue account
Liability Revenue
Debit Unadjusted Credit
Adjusting Balance Adjusting
Entry (-) Entry (+)
LO 2 29
Unearned Revenues
Illustration: Pioneer Advertising received
$1,200 on October 2 from R. Knox for
advertising services expected to be
completed by December 31. Unearned
Service Revenue shows a balance of
$1,200 in the October 31 trial balance.
Analysis reveals that the company
performed $400 of services in October.
Oct. 31 Unearned Service Revenue 400

Service Revenue 400
LO 2 30
Unearned Revenue
LO 2 31
Unearned Revenue
Accounting for Unearned Revenue
Accounts
Rent, Unearned revenues Liabilities Dr. Liabilities
magazine recorded in liability overstated. Cr. Revenues
subscriptions, accounts are now Revenues
customer recognized as understated.
deposits for revenue for services
future service performed.
LO 2 32
DO IT! 2 Adjusting Entries for Deferrals
The ledger of Hammond Company, on March 31, 2023, includes these selected
accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
An analysis of the accounts shows the following.
1. Insurance expires at the rate of $100 per month.
2. Supplies on hand total $800.
3. The equipment depreciates $200 a month.
4. During March, services were performed for $4,000 of the unearned service
revenue reported.
Prepare the adjusting entries for the month of March.
LO 2 33
Debit Credit
Supplies 2,800
Equipment 25,000
1. Insurance expires at the rate of $100 per month.
Insurance Expense 100
LO 2 34
Debit Credit
Supplies 2,800
Equipment 25,000
2. Supplies on hand total $800.
Supplies Expense 2,000
Supplies 2,000
LO 2 35
Debit Credit
Supplies 2,800
Equipment 25,000
3. The equipment depreciates $200 a month.
Accumulated Depreciation—Equipment 200
LO 2 36
Debit Credit
Supplies 2,800
Equipment 25,000
4. During March, services were performed for $4,000 of the unearned service
revenue reported.
LO 2 37
Adjusting Entries for Accruals
Accruals are made to record,
• Revenues for services performed but not yet
recorded at the statement date
• Expenses incurred but not yet paid or recorded at the
statement date
Journalize
Trial
Balance
and Post
AJEs
Adjusted
Financial Closing Post-Closing
Trial
Balance Statements Entries Trial Balance
LO 3 38
Accrued Revenues
Revenues for services performed but not yet received in
cash or recorded.
Revenue Recorded BEFORE Cash Receipt
Accrued revenues often occur in regard to:

• Rent
• Interest
• Services
LO 3 39
Accrued Revenues
• Adjusting entry records the receivable that exists and
records the revenues for services performed.
 Increases (debits) an asset account and
 Increases (credits) a revenue account
Asset Revenue
Debit Credit
Adjusting Adjusting
Entry (+) Entry (+)
LO 3 40
Accrued Revenues
Illustration: In October Pioneer Advertising
performed services worth $200 that were
not billed to clients on or before October 31.
Oct. 31
Accounts Receivable200
Service Revenue 200
On November 10, Pioneer receives cash of $200 for the
services performed. The journal entry on the 10 th is:
Cash 200
Accounts Receivable 200
LO 3 41
Accrued Revenues
LO 3 42
Accrued Revenues
Accounting for Accrued Revenues
Accounts
Interest, Services performed Assets Dr. Assets
rent, services but not yet received understated. Cr. Revenues
In cash or recorded. Revenues
understated.
LO 3 43
Accrued Expenses
Expenses incurred but not yet paid in cash or recorded.
Expense Recorded BEFORE Cash Payment
Accrued expenses often occur in regard to:

• Rent • Taxes
• Interest • Salaries
LO 3 44
Accrued Expenses
• Adjusting entry records the obligation and recognizes
the expense.
 Increase (debit) an expense account and
 Increase (credit) a liability account
Expense Liability
Debit Credit
Adjusting Adjusting
Entry (+) Entry (+)
LO 3 45
Accrued Expenses
Accrued Interest
Illustration: Pioneer Advertising signed a three-month note
payable in the amount of $5,000 on October 1. The note
requires Pioneer to pay interest at an annual rate of 12%.
Face Value Annual Time in Terms

of Note x Interest Rate x of One Year = Interest
$5,000 x 12% x 1/12 = $50
Oct. 31 Interest Expense 50

Interest Payable 50
LO 3 46
Accrued Expenses
LO 3 47
Accrued Expenses
Accrued Salaries and Wages
Illustration: Pioneer Advertising paid salaries and wages on
October 26; the next payment of salaries will not occur until
November 9. The employees receive total salaries of $2,000
for a five-day work week, or $400 per day.
LO 3 48
Accrued Expenses
LO 3 49
Accrued Expenses
Accounting for Accrued Revenues
Accounts
Interest, Expenses have Expenses Dr. Expenses
rent, salaries been incurred but understated. Cr. Liabilities
not yet paid in Liabilities
cash or recorded. understated.
LO 3 50
Summary of Basic Relationships
Type of Adjustment Accounts Before Adjustment Adjusting Entry
Prepaid expenses Assets overstated. Dr. Expense
Expenses understated. Cr. Assets or
Contra Assets
Unearned revenues Liabilities overstated. Dr. Liabilities

Revenues understated. Cr. Revenues
Accrued revenues Assets understated. Dr. Assets

Revenues understated. Cr. Revenues
Accrued expenses Expenses understated. Dr. Expenses

Liabilities understated. Cr. Liabilities
LO 3 51
DO IT! 3 Adjusting Entries Accruals
Micro Computer Services began operations on August 1, 2023. At
the end of August 2022, management prepares monthly financial
statements. The following information relates to August.
1. At August 31, the company owed its employees $800 in
salaries and wages that will be paid on September 1.
2. On August 1, the company borrowed $30,000 from a local
bank on a 15-year mortgage. The annual interest rate is 10%.
3. Revenue for services performed but unrecorded for August
totaled $1,100.
Prepare the adjusting entries needed at August 31, 2023.
LO 3 52
1. At August 31, the company owed its employees $800 in
salaries and wages that will be paid on September 1.
Salaries and Wages Expense 800
Salaries and Wages Payable 800
2. On August 1, the company borrowed $30,000 from a local
bank on a 15-year mortgage. The annual interest rate is 10%.
Interest Expense 250
Interest Payable 250
LO 3 53
3. Revenue for services performed but unrecorded for August
totaled $1,100.
Accounts Receivable 1,100
LO 3 54
Adjusted Trial Balance
• Prepared after adjusting entries are journalized and
posted
• Proves equality of debit and credit balances
• Basis for the preparation of financial statements
Trial Journalize and

Balance Post AJEs
Adjusted Prepare
Closing Post-Closing
Trial Financial Entries Trial Balance
Balance Statements
LO 4 55
Pioneer Advertising
October 31, 2023
Debit Credit
Cash $15,200
Accounts Receivable 200
Supplies 1,000
Equipment 5,000
Accumulated Depreciation $ 40
Notes Payable 5,000
Accounts Payable 2,500
Unearned Service Revenue 800
Salaries and Wages Payable 1,200
Interest Payable 50
Owner’s Capital 10,000
Owner’s Drawings 500
Salaries and Wages Expense 5,200
Supplies Expense 1,500
Rent Expense 900
Insurance Expense 50
Interest Expense 50
$30,190 $30,190
ILLUSTRATION 3.25
LO 4 56
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
LO 4
adjusting entries have been journalized and posted.57
Preparing Financial Statements
Financial Statements are prepared directly from the
Adjusted Trial Balance.
Owner’s
Income Balance
Equity
Statement Sheet
Statement
LO 4 58
Pioneer Advertising
Income Statement
October 31, 2023
Revenues
Service Revenue $10,600
Expenses
Salaries and wages expenses $5,200
Supplies expense 1,500
Rent expense 900
Insurance expense 50
Interest expense 50
Depreciation expense 40
Total expenses 7,740
Net income $2,860
59
Pioneer Advertising
Owner’s Equity Statement
For the Month Ended October 31, 2023
Owner’s capital, October 1 $ -0-
Add: Investments 10,000
Net income 2,860
12,860
Less: Owner’s Drawings 500
Owner’s capital, October 31 $12,360
60
Pioneer Advertising
Financial Position
October 31, 2023
Owner’s Equity and Liabilities
Assets
Owner’s Equity
Cash $15,200 Owner’s capital $12,360
Accounts Receivable 200 Liabilities
Supplies 1,000 Notes payable $ 5,000
Prepaid Insurance 550 Accounts payable 2,500
Equipment $5,000 Unearned service revenue 800
Less: Accu. Depre.- equip. 40 4,960 Salaries and wages payable 1,200
Total Assets $21,910 Interest payable 50
Total liabilities 9,550
Total Owner’s Equity $21,910
and liabilities
61
DO IT! 4 Trial Balance
Skolnick Co. was organized on April 1, 2023. The company prepares quarterly
financial statements. The adjusted trial balance at June 30 are shown below.
Debit Credit
Cash $ 6,700 Accumulated Depreciation $ 850
Accounts Receivable 600 Notes Payable 5,000
Prepaid Rent 900 Accounts Payable 1,510
Supplies 1,000 Salaries and Wages Payable 400
Equipment 15,000 Interest Payable 50
Owner’s Drawings 600 Unearned Rent Revenue 500
Salaries and Wages Expense 9,400 Owner’s Capital 14,000
Rent Expense 1,500 Service Revenue 14,200
Depreciation Expense 850 Rent Revenue 800
Supplies Expense 200
Utilities Expense 510
Interest Expense 50
$37,310 $37,310
LO 4 62
a. Determine the net income for the quarter April 1 to June 30.
Revenues
Service revenue $14,200
Rent revenue 800
Total revenues $15,000
Expenses
Salaries and wages expense 9,400
Rent expense 1,500
Depreciation expense 850
Utilities expense 510
Supplies expense 200
Interest expense 50
Total expenses 12,510
Net income $ 2,490
LO 4 63
b. Determine the total assets and total liabilities at June 30, 2023.
Assets Liabilities
Cash $ 6,700 Notes Payable $5,000
Accounts Receivable 600 Accounts Payable 1,510
Prepaid Rent 900 Salaries and Wages Payable 400
Supplies 1,000 Interest Payable 50
Equipment 15,000 Unearned Rent Revenue 500
Accumulated Depreciation (850)
Total assets $23,350 Total liabilities $7,460
LO 4 64
c. Determine the amount of owner’s capital at June 30, 2023.
Owner’s capital, April 1 $ 0

Add: Investments 14,000
Net income 2,490
Less: Owner’s drawings 600
Total assets $15,890
LO 4 65
Summary of Additional Adjustments
ILLUSTRATION 3A.7
Prepaid Expenses
Reason for Accounts Balances Adjusting
Adjustment Before Adjustment Entry
(a) Prepaid expenses Assets overstated. Dr. Expenses
initially recorded in Expenses understated. Cr. Assets
asset accounts have
been used.
(b) Prepaid expenses Assets understated. Dr. Assets
initially recorded in Expenses overstated. Cr. Expenses
expense accounts have
not been used.
LO 5 66
Summary of Additional Adjustments
ILLUSTRATION 3A.7
Unearned Revenues
Reason for Accounts Balances Adjusting
Adjustment Before Adjustment Entry
(a) Unearned revenues Liabilities Dr. Liabilities
initially recorded in overstated. Cr. Revenues
liability accounts are now Revenues
recognized as revenue. understated.
(b) Unearned revenues Liabilities Dr. Revenues
initially recorded in understated. Cr. Liabilities
revenue accounts are still Revenues
unearned. overstated.
LO 5 67

CH 03

Uploaded by

Copyright:

Available Formats

CH 03

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

CH 03

Uploaded by

Copyright:

Available Formats

Accounting Principles

Adjusting the Accounts

“Let the expenses follow

Economic life of business can be

Revenue Recognition Expense Recognition

Revenue and Expense

In accordance with IFRS

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

Oct. 31 Insurance Expense 50

Accumulated Depreciation is called a

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

Oct. 31 Unearned Service Revenue 400

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

Face Value Annual Time in Terms

Oct. 31 Interest Expense 50

Unearned revenues Liabilities overstated. Dr. Liabilities

Accrued revenues Assets understated. Dr. Assets

Accrued expenses Expenses understated. Dr. Expenses

Trial Journalize and

Owner’s capital, April 1 $ 0

You might also like