Adjusting Entries

Measuring Business Income

 Accounting period assumption

 Cash accounting versus accrual
accounting
 Matching principle
 Materiality concept
 Adjusting Entries

 Journal entries that update the general

ledger accounts to state revenues,
expenses, assets, and liabilities more
accurately
 Involve
– One balance sheet account
– One income statement account
– Never cash
 Adjusting Process

 Identify the accounts requiring

adjustment
 Determine unadjusted balances
 Determine correct (adjusted) balances
for each account
 Prepare adjusting entry to bring accounts
in agreement with adjusted balances
 Deferrals

 A cash payment or receipt occurred

in current period
 Must defer a portion of expense or
revenue until a future period
 Deferrals

 Two situations
– Pay a cost of benefit in advance and
allocate cost as expenses to periods
that receive benefit
 Deferrals

 Two situations
– Pay a cost of benefit in advance and
allocate cost as expenses to periods
that receive benefit
– Receive a cash revenue in advance
and allocate amounts as revenues to
periods in which revenues earned
 Prepaid Insurance

 Dec. 1, paid $600 for 12 month

insurance premium recording as
asset, Prepaid Insurance
 At Dec. 31
– Prepaid Insurance balance $600
– Insurance Expense balance $0
 Prepaid Insurance

 As of Dec. 31, one month’s

insurance has expired and become
expense
 Correct Dec. 31 balance
– Prepaid Insurance $550
– Insurance Expense $50
 Prepaid Insurance

 Adjusting entry
– Debit Insurance Expense $50
»Increases Insurance Expense to
correct balance $50
– Credit Prepaid Insurance $50
»Decreases Prepaid Insurance to
correct balance $550
 Depreciation Expense

 Similar to prepaid insurance but for

long-term asset
 Decrease in asset not recorded in
asset account
 Recorded as increase in contra
asset - Accumulated Depreciation
 Depreciation Expense
Before After
Balance Sheet
Trucks $26,000 $26,000
Accum Deprec 400 800

Income Statement

Depreciation expense $0 $400

 Unearned Revenues

 Dec. 1, received $600 for 6 month

rent recording as liability, Unearned
Rent
 At Dec. 31
– Unearned Rent balance $600
– Rent Revenue balance $0
 Unearned Revenues

 As of Dec. 31, one month’s rent

has been earned and become
revenue
 Correct Dec. 31 balance
– Unearned Revenue $500
– Rent Revenue $100
 Unearned Revenues

 Adjusting entry
– Debit Unearned Rent $100
»Decreases Unearned Rent to
correct balance $500
– Credit Rent Revenue $100
»Increases Rent Revenue to correct
balance $100
 Accruals

 Recognize revenues and expenses

that have accumulated (accrued)
during the accounting period but
have not been recorded
 Accrued Revenues

 Dec.11, received 30-day, 15% note

from customer.
 At Dec. 31
– Interest Revenue balance $0
– Interest Receivable balance $0
 Accrued Revenues

 As of Dec. 31, 20 days interest has

been earned and become revenue
 $1,200 x 0.15 x 20/360 = $10
 Correct Dec. 31 balance
– Interest Revenue $10
– Interest Receivable $10
 Accrued Revenues

 Adjusting entry
– Debit Interest Receivable $10
»Increases Interest Receivable to
correct balance $10
– Credit Interest Revenue $10
»Increases Interest Revenue to
correct balance $10
 Accrued Expenses

 Employees paid Friday for 5-day

work week at $1,000 per week
 At Dec. 31, a Tuesday
– Wages Expense balance $50,000 -
represents past weeks wages
– Wages Payable balance $0
 Accrued Expenses

 As of Dec. 31, 2 days wages have

been incurred and become
expense
 Correct Dec. 31 balance
– Wages Expense $50,200
– Wages Payable $200
 Accrued Expenses

 Adjusting entry
– Debit Wages Expense $200
»Increases Wages Expense to
correct balance $50,200
– Credit Wages Payable $200
»Increases Wages Payable to
correct balance $200
Summarize Adjustments
 Analyzing Information

 Use questions to compare

companies
 Income Statement

 Which company has the higher

revenues?
 Which company has the higher
percentage change in revenues?
 Which company has the lower
percentage of expenses to
revenues?
 Balance Sheet

 Which company has the higher assets?

 What is the percentage change in
assets for each company?
 Is the percent of total liabilities to total
liabilities plus owners’ equity increasing
or decreasing? Which company is
more risky?
 Integrative Analysis

 Are companies operating efficiently by

using least amount of assets to generate
a given level of revenues?
– Calculate total asset turnover
 Are companies operating efficiently by
using least amount of assets to generate
a given net income?
– Calculate return on assets