3 The Adjusting Process

After studying this chapter, you should be able to: 1. Describe the nature of the adjusting process. 2. Journalize entries for accounts requiring adjustment. 3. Summarize the adjustment process. 4. Prepare an adjusted trial balance.
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3-1

Objective 1 Describe the nature of the adjusting process.

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3-1

Under the accrual basis of accounting, revenues are reported in the income statement in the period in which they are earned.
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3-1

The accounting concept that supports this approach to reporting of revenues is called the revenue recognition concept.

3-1

The accounting concept that supports reporting revenues and related expenses in the same period is called the matching concept, or matching principle.
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3-1

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.
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3-1

The analysis and updating of accounts at the end of the period before the financial statements are prepared is called the adjusting process.
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3-1

The journal entries that bring the accounts up to date at the end of the accounting period are called adjusting entries.

3-1 Example Exercise 3-1 Indicate with a Yes or No whether or not each of the following accounts normally requires an adjusting entry.
a. b. Cash Prepaid Rent c. Wages Expense e. Accounts Receivable d. Office Equipment f. Unearned Rent

Follow My Example 3-1 a. No b. Yes c. Yes d. No e. Yes f. Yes

For Practice: PE 3-1A, PE 3-1B

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Items That Need Adjusting

3-1

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.
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Items That Need Adjusting

3-1

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.
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3-1

Insert Exhibit 1

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Items That Need Adjusting

3-1

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.
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Items That Need Adjusting

3-1

Accrued expenses, sometimes referred to as accrued liabilities, are expenses that have been incurred but have not been recorded in the accounts.
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3-1

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

3-2

Objective 2 Journalize entries for accounts requiring adjustment.

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3-2

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Adjusting Process for Prepaid Expenses

3-2

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.
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3-2

Supplies (balance on trial balance) Supplies on hand, December 31 Supplies used

$2,000 760 $1,240

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3-2
2007

Dec. 31 Supplies Expense Supplies Supplies used ($2,000 $760)

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1 240 00 1 240 00

Bal.

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

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3-2

The debit balance of $2,400 in NetSolutions Prepaid Insurance account represents the December 1 prepayment of insurance for 12 months.
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3-2

31 Insurance Expense Prepaid Insurance Insurance expired ($2,400/12).

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200 00 200 00

Prepaid Insurance Bal. 2,400 Dec. 31 2,200

15 200

Insurance Expense Dec. 31 200

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3-2 Example Exercise 3-3 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. Follow My Example 3-3 Insurance Expense Prepaid Insurance Insurance expired ($6,400 + $3,600 $3,250). For Practice: PE 3-3A, PE 3-3B 6,750 6,750

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3-2

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.
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3-2

31 Unearned Rent Rent Revenue Rent earned ($360/3 months)

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120 00 120 00

Unearned Rent Dec. 31 120 Bal. Bal.

23 360 240

Rent Revenue Dec. 31

42 120

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3-2 Example Exercise 3-4 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. Follow My Example 3-4 Unearned Fees Fees Earned Fees earned ($44,900 $22,300). For Practice: PE 3-4A, PE 3-4B 22,600 22,600

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3-2

NetSolutions provided $500 in services during December for which the customer has not been billed.

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3-2
31 Accounts Receivable Fees Earned Accrued fees (25 hrs. x $20) 12 41 500 00 500 00

Accounts Receivable 12 Bal. 2,220 Dec. 31 500 Bal. 2,720

Fees Earned Bal. Dec. 31 Bal.

41 16,340 500 16,840 30 30

3-2 Example Exercise 3-5 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. Follow My Example 3-5 Accounts Receivable Fees Earned Accrued fees. 13,680 13,680

For Practice: PE 3-5A, PE 3-5B

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3-2

At the end of December, accrued wages amounted to $250. Without this adjusting entry, Wages Expense is understated.
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3-2
31 Wages Expense Wages Payable Accrued wages. 51 22 250 00 250 00

Wages Payable 22 Dec. 31 250

Wages Expense Bal. 4,275 Dec. 31 250 Bal. 4,525

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3-2

Wages Payable 22 Dec. 31 250

Wages Expense Bal. 4,275 Dec. 31 250 Bal. 4,525

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Closing entries will be discussed in a later chapter. For now, just be aware that Wages Expense is closed after financial statements are prepare and its balance rolled back to zero.

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3-2

The payment of January 10 wages totaling $1,275 is shown below.

Jan. 10 Wages Expense Wages Payable Cash 1 025 00 250 00 1 275 00

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3-2

Jan. 10

Wages Payable 22 250 Dec. 31 250

Wages Expense Bal. 4,275 Dec. 31 250 Bal. 4,525 Jan. 10 1,025

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The liability is cancelled.

An expense for wages of $1,025 is recorded in the new fiscal year.

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3-2 Example Exercise 3-6 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. Follow My Example 3-6 Salaries Expense Salaries Payable Accrued salaries ($12,500/5 x 4 days). For Practice: PE 3-6A, PE 3-6B 10,000 10,000

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3-2

Physical resources that are owned and used by a business and are permanent or have a long life are called fixed assets, or plant assets.
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3-2

As time passes, a fixed asset loses its ability to provide useful services. This decrease in usefulness is called depreciation.
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3-2

Normal titles for fixed asset accounts and their related contra asset accounts are as follows:
Fixed Asset Land Buildings Store Equipment Office Equipment Contra Asset NoneLand is not depreciated Accumulated Depreciation Buildings Accumulate DepreciationStore Equipment Accumulated DepreciationOffice Equipment
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3-2

NetSolutions estimates the depreciation on its office equipment to be $50 for the month of December.
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3-2

31 Depreciation Expense Accum. Depreciation Office Equipment Depreciation of office equipment.

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50 00 50 00

Depreciation Expense Dec. 31 50

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Accum. Depr.Office Equip. 19 Dec. 31 50 42 42

3-2

NetSolutions balance sheet would show the office equipment at cost, less the accumulated depreciation.
Office equipment $1,800 Less accumulated depreciation 50 $1,750 Book value
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3-2 Example Exercise 3-7 The estimated amount of depreciation on equipment for the current year is $4,250. Journalize the adjusting entry to record the depreciation. Follow My Example 3-7 Depreciation Expense Accumulated Depreciation Equipment Depreciation on equipment. For Practice: PE 3-7A, PE 3-7B 4,250 4,250

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3-3

Objective 3 Summarize the adjustment process

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3-3

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3-3

(Continued)

Ledger with Adjusting Entries NetSolutions

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(Continued)
Ledger with Adjusting Entries NetSolutions

3-3

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(Continued)
Ledger with Adjusting Entries NetSolutions

3-3

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(Concluded)
Ledger with Adjusting Entries NetSolutions

3-3

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3-3 Example Exercise 3-8 For the year ending December 31, 2008, Mann Medical Co. mistakenly omitted adjusting entries for (1) $8,600 of unearned revenue that was earned, (2) earned revenue that was not billed of $12,500, and (3) accrued wages of $2,900. Indicate the combined effect of the errors on (a) revenues, (b) expenses, and (c) net income for 2008. Follow My Example 3-8 a. Revenues were understated by $21,100 ($8,600 + $12,500). b. Expenses were understated by $2,900. c. Net income was understated by $18,200 ($8,600 +12,500 $2,900). For Practice: PE 3-8A, PE 3-8B

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3-4

Objective 4 Prepare an adjusted trial balance.

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3-4

The purpose of the adjusted trial balance is to verify the equality of the total debit balances and total credit balances before the financial statements are prepared.
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3-4

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3-4 Example Exercise 3-9 For each of the following errors, considered individually, indicate whether the error would cause the adjusted trial balance totals to be unequal. If the error would cause the adjusted trial balance total to be unequal, indicate whether the debit or credit total is higher and by how much. a. The adjustment for accrued fees of $5,340 was journalized as a debit to Accounts Payable for $5,340 and a credit to Fees Earned of $5,340. b. The adjustment for depreciation of $3,260 was journalized as a debit to Depreciation Expense for $3,620 and a credit to Accumulated Depreciation for $3,260.

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3-4

Follow My Example 3-9 a. The totals are equal even though the debit should have been to Accounts Receivable instead of Accounts Payable. b. The totals are unequal. The debit total is higher by $360 ($3,620 $3,260).

For Practice: PE 3-9A, PE 3-9B

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