0. 3 - The Adjusting Process. After studying this chapter, you should be able to:. Describe the nature of the adjusting process. Journalize entries for accounts requiring adjustment. Summarize the adjustment process. Prepare an adjusted trial balance. 0.
3 - The Adjusting Process
After studying this chapter, you should be able to:
Objective 1 - Describe the nature of the adjusting process.
Under the cash basis ofaccounting, revenues and expenses are reported in the income statement in the period in which cash is received or paid. E.g. Some Government Accounting
Under the accrual basis ofaccounting, revenues are reported in the income statement in the period in which they are earned.
Our focus in the course will be on the accrual basis ofaccounting i..e. revenues are reported in the income statement in the period in which they are earned.
The accounting concept that supports this approachtoreporting of revenues is called therevenue recognition concept.
Expenses are reported in the same period as the revenue to which they relate.
The accounting concept that supports reporting revenues and related expenses in the same period is called the matching concept, or matching principle.
Some accounts may need to updated at the end of an accounting period e.g. Supplies vs Supplies Expense
The analysis and updating of accounts at the end of the period before the financial statements are prepared is called the adjusting process.
The journal entries that bring the accounts up to date at the end of the accounting period are called adjusting entries.
Items That Need Adjusting - 1
Prepaid expenses, sometimes referred 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 the business.
“Cash is paid for the service/expense before the service/expense is used”
Items That Need Adjusting - 2
Unearned revenues, sometimes referred to as deferred revenues, are items that have been initially recorded as liabilities but are expected to become revenues over time or through the normal operations of the business.
“Cash is collected before service is rendered”
Items That Need Adjusting - 3
Accrued revenues, sometimes referred to as accrued assets (accrued means unpaid), are revenues that have been earned but have not been recorded in the accounts.
“Services rendered for which cash has not yet been collected”
Items That Need Adjusting - 4
Accrued expenses, sometimes referred to as accrued liabilities, are expenses that have been incurred but have not been recorded in the accounts.
“The service has been used or the expense incurred, but the cash has not been paid”
Classify the following items as (1) prepaid expense, (2) unearned revenue, (3) accrued expense, or (4) accrued revenue.
Journalize entries for accounts requiring adjustment.
Adjusting Process for Prepaid Expenses (1)
NetSolutions’ Suppliesaccount has a balance of $2,000 in the unadjusted trial balance. Some of these supplies have been used. On December 31, a count reveals that $760 of supplies are on hand.
Supplies (balance on trial balance) $2,000
Supplies on hand, December 31 – 760
Supplies used $1,240
Dec. 31 Supplies Expense 1 240 00
Supplies 1 240 00
Supplies used ($2,000 – $760)
Dec. 31 1,240
Dec. 31 1,240
Adjusting Process for Prepaid Expenses (2)
The debit balance of $2,400 in NetSolutions’ PrepaidInsuranceaccount represents the December 1 prepayment of insurance for 12 months.
31 Insurance Expense 200 00
Prepaid Insurance 200 00
Insurance expired ($2,400/12).
Dec. 31 200
Dec. 31 200
Adjusting Process for Unearned Revenue
On December 1, the tenant prepaid three months’ rent for use of an office building owned by NetSolutions. As of December 31, only $120 has been earned.
31 Unearned Rent 120 00
Rent Revenue 120 00
Rent earned ($360/3 months)
Dec. 31 120
Dec. 31 120
Adjusting Process for Accrued Revenues
NetSolutions provided $500 in services during December for which the customer has not been billed.
31 Accounts Receivable 500 00
Fees Earned 500 00
Adjusting Process for Accrued Expenses
Assuming that wages were last paid on Friday, December 27th, and at the end of December, outstanding/accrued wages amounted to $250. (e.g. This is for Monday & Tuesday, Dec 30th & 31st.) Without this adjusting entry, Wages Expenseis understated.
31 Wages Expense 250 00
Wages Payable 250 00
Dec. 31 250
Dec. 31 250
Adjusting Process for Depreciation Expenses
Physical resources that are owned and used by a business and are permanent or have a long life are called fixed assets, orplant assets.
As time passes, a fixed asset loses its ability to provide useful services (by being used in the business i.e. an expenses) This decrease (or expense) in usefulness is called depreciation.
Instead of the assets account being credited, a contra account is established that normally carries a credit balance and appears as a deduction on the balance sheet
Normal titles for fixed asset accounts andtheir relatedcontra assetaccounts are asfollows:
Fixed Asset Contra Asset
Land None—Land is not depreciated
Buildings Accumulated Depreciation— Buildings
Store Equipment Accumulate Depreciation—Store
Office Equipment Accumulated Depreciation—Office
NetSolutions estimates the depreciation on its office equipment to be $50 for the month of December.
31 Depreciation Expense 50 00
Accum. Depreciation— Office Equipment 50 00
Depreciation of office equipment.
Accum. Depr.—Office Equip.
Dec. 31 50
Dec. 31 50
NetSolutions’ balance sheet would show the office equipment at cost, less the accumulated depreciation.
Office equipment $1,800
depreciation 50 $1,750
Book Value or Net Book Value
Summarize the adjustment process
See pages 116 – 120 and exhibit 8 for Ledger with adjusting entries
Prepare an adjusted trial balance.
The purpose of the adjustedtrial balanceis to verify the equality of the total debit balances and total credit balances before the financial statements are prepared.