The Adjusting Process

3 The Adjusting Process

1 Describe the nature of the adjusting process. 3-2

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

1 Revenue Recognition Concept The accounting concept supporting the reporting of revenues when they are earned regardless of when cash is received is called therevenue recognition concept.

1 Matching Principle The accounting concept supporting reporting revenues and related expenses in the same period is called the matching concept, or matching principle.

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

1 The Adjusting Process Under the accrual basis, at the end of the accounting period some of the accounts need updating for the following reasons: • Some expenses are not recorded daily. • Some revenues and expenses are incurred as time passes rather than as separate transactions. • Some revenues and expenses may be unrecorded.

1 The Adjusting Process The analysis and updating of accounts at the end of the period before the financial statements are prepared is called theadjusting process.

Follow My Example 3-1 Left click the mouse for the answers. Follow My Example 6-1 For Practice: PE 3-1A, PE 3-1B 1 Example Exercise 3-1 Accounts Requiring Adjustment Indicate with a Yes or No whether or not each of the following accounts normally requires an adjusting entry. • Cash d. Office Equipment • Prepaid Rent e. Accounts Receivable • Wages Expense f. Unearned Rent No No Yes Yes Yes Yes 3-9

1 Types of Accounts Requiring Adjustment Prepaid expenses are the advance payment of future expenses and are recorded as assets when cash is paid.

1 Types of Accounts Requiring Adjustment Unearned revenues are the advance receipt of future revenues and are recorded as liabilities when cash is received.

1 Type of Adjustments: Prepaid Expenses and Unearned Revenues Exhibit 1

1 Types of Accounts Requiring Adjustment Accrued revenues are unrecorded revenues that have been earned and for which cash has yet to be received.

1 Types of Accounts Requiring Adjustment Accrued expenses are unrecorded expenses that have been incurred and for which cash has not been paid.

1 Type of Adjustments: Accrued Revenues and Expenses Exhibit 2

Follow My Example 3-2 For Practice: PE 3-2A, PE 3-2B 1 Example Exercise 3-2 Type of Adjustment Classify the following items as (1) prepaid expense, (2) unearned revenue, (3) accrued expense, or (4) accrued revenue. • Wages owed but not c. Fees received but not yet paid. earned. • Supplies on hand. d. Fees earned but not yet received. Follow My Example 6-1 a. Accrued expense c. Unearned revenue b. Prepaid expense d. Accrued revenue 3-16

2 Journalize entries for accounts requiring adjustment. 3-17

2 Exhibit 3 Unadjusted Trial Balance for NetSolutions

2 Exhibit 4 Expanded Chart of Accounts for NetSolutions

2 Prepaid Expenses NetSolutions’ Supplies account 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

760 2,040 2 Supplies Expense Supplies 14 55 Bal. 2,000 Bal. 800 Dec. 31 1,240 Dec. 31 1,240

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

2,200 2 Prepaid Insurance Insurance Expense 15 56 Dec. 31 200 Bal. 2,400 Dec. 31 200

2 Impact of Omitting Adjusting Entries

Follow My Example 3-3 Insurance Expense……………………… 6,750 Prepaid Insurance…………………… 6,750 Insurance expired ($6,400 + $3,600 – $3,250). For Practice: PE 3-3A, PE 3-3B 2 Example Exercise 3-3 Example Exercise 3-3 Adjustment for Prepaid Expenses The prepaid insurance account had a beginning balance of $6,400 and was debited for $3,600 of premiums paid during the year. Journalize the adjusting entry required at the end of the year assuming the amount of unexpired insurance related to future periods is $3,250. 3-25

2 Unearned Revenues The December 31 unadjusted trial balance of NetSolutions indicates a balance in the unearned rent account of $360.

2 Unearned Rent Rent Revenue 23 42 Dec. 31 120 Bal. 360

Unearned Rent 23 240 Dec. 31 120 Bal. 360 Bal. 2 Rent Revenue 42 Dec. 31 120

2 Impact of Omitting Adjusting Entry

Follow My Example 3-4 Unearned Fees……………………………. 22,600 Fees Earned………………………….. 22,600 Fees earned ($44,900 – $22,300). For Practice: PE 3-4A, PE 3-4B 2 Example Exercise 3-4 Adjustment for Unearned Revenue The balance in the unearned fees account, before adjustment at the end of the year, is $44,900. Journalize the adjusting entry required if the amount of unearned fees at the end of the year is $22,300. 3-30

2 Accrued Revenues NetSolutions signed an agreement with Danker Co. on December 15 to provide services at $20 per hour. As of December 31, NetSolutions had provided 25 hours of assistance.

Bal. 2,720 2 Fees Earned Accounts Receivable 12 41 Bal. 2,220 Bal. 16,340 Dec. 31 500

Bal. Bal. 2,720 16,840 2 Fees Earned Accounts Receivable 12 41 Bal. 2,220 Bal. 16,340 Dec. 31 500 Dec. 31 500

Follow My Example 3-5 Accounts Receivable……………………. 13,680 Fees Earned………………………….. 13,680 Accrued fees. For Practice: PE 3-5A, PE 3-5B 2 Example Exercise 3-5 Adjustment for Accrued Revenues At the end of the current year, $13,680 of fees have been earned but have not been billed to clients. Journalize the adjusting entry to record the accrued fees. 3-35

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

Bal. 4,525 2 22 Wages Payable Wages Expense 51 Bal. 4,275 Dec. 31 250

Bal. 4,525 2 22 Wages Payable Wages Expense 51 Dec. 31 250 Bal. 4,275 Dec. 31 250

2 The journal entry for the payment of wages on January 10 is shown below. After posting

Exhibit 5 2 Accrued Wages

Follow My Example 3-6 Salaries Expense……………………….. 10,000 Salaries Payable…………………….. 10,000 Accrued salaries [($12,500 ÷ 5 days) × 4 days]. For Practice: PE 3-6A, PE 3-6B 2 Example Exercise 3-6 Adjustment for Accrued Expenses Sanregret Realty Co. pays weekly salaries of $12,500 on Friday for a five-day week ending on that day. Journalize the necessary adjusting entry at the end of the accounting period, assuming that the period ends on Thursday. 3-42

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

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

2 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 Accumulated Depreciation—Store Equipment Office Equipment Accumulated Depreciation—Office Equipment

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

2 Depreciation Expense Accum. Depr.—Office Equip. 19 53 Dec. 31 50

2 Depreciation Expense Accum. Depr.—Office Equip. 19 53 Dec. 31 50 Dec. 31 50

2 NetSolutions’ balance sheet would show office equipment at cost, less accumulated depreciation. Office equipment $1,800 Less accumulated depreciation 50 $1,750 Book value

The Adjusting Process