Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Prepared by: Debbie Musil Kwantlen Polytechnic University Chapter 3 Adjusting the Accounts

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Adjusting the Accounts Timing issues Timing issues Selecting an accounting time periodSelecting an accounting time period Accrual versus cash basis of accountingAccrual versus cash basis of accounting Revenue and expense recognitionRevenue and expense recognition Basics of adjusting entries Basics of adjusting entries Types of adjusting entriesTypes of adjusting entries Prepayments and accrualsPrepayments and accruals Adjusted trial balance and financial statements Adjusted trial balance and financial statements

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Time Periods The economic life of a business can be divided into time periods The economic life of a business can be divided into time periods Generally a month, quarter, or yearGenerally a month, quarter, or year Periods of less than one year are called interim periods Periods of less than one year are called interim periods Period of one year is called a fiscal year Period of one year is called a fiscal year

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Accrual Basis of Accounting Revenue recognized when service performed Revenue recognized when service performed Not necessarily when cash receivedNot necessarily when cash received Expense recorded when services or goods are used or consumed Expense recorded when services or goods are used or consumed Not necessarily when cash paidNot necessarily when cash paid

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Cash Basis of Accounting Revenue recorded when cash received Revenue recorded when cash received Expense recorded when cash paid Expense recorded when cash paid Often leads to misleading financial statements Often leads to misleading financial statements Used by some smaller businesses Used by some smaller businesses For companies with few receivables and payablesFor companies with few receivables and payables

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Revenue Recognition Revenue is recognized when there is an increase in assets or a decrease in liabilities as a result of a contract with a customer Revenue is recognized when there is an increase in assets or a decrease in liabilities as a result of a contract with a customer Service business: revenue is usually earned at the time the service is performedService business: revenue is usually earned at the time the service is performed Merchandising business: revenue is usually earned when goods are sold and deliveredMerchandising business: revenue is usually earned when goods are sold and delivered

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Expense Recognition Expense is recognized when there is a decrease in assets or an increase in liabilities Expense is recognized when there is a decrease in assets or an increase in liabilities Tied to revenue recognition when a direct association exists between costs incurred and earning of revenueTied to revenue recognition when a direct association exists between costs incurred and earning of revenue For long-lived assets, expenses are recognized over the life of the assetFor long-lived assets, expenses are recognized over the life of the asset Otherwise expenses are reported in period incurredOtherwise expenses are reported in period incurred

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. The Accounting Cycle Analyze business transactions 1 Journalize the transactions 2 Post to general ledger accounts 3 Prepare a trial balance 4 Journalize & post adjusting entries 5 Prepare adjusted trial balance 6 Prepare financial statements 7 Journalize & post closing entries 8 Prepare post-closing trial balance 9

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Adjusting Entries - Basics Required for the preparation of financial statements Required for the preparation of financial statements To ensure that revenue and expense recognition criteria are followedTo ensure that revenue and expense recognition criteria are followed Make it possible to accurately report assets, liabilities and owner’s equityMake it possible to accurately report assets, liabilities and owner’s equity Part of the accounting cycle Part of the accounting cycle Classified as prepayments or accruals Classified as prepayments or accruals

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Adjusting Entries – Prepayments Prepaid Expenses: expenses paid in cash and recorded (as assets) before they are used or consumed Prepaid Expenses: expenses paid in cash and recorded (as assets) before they are used or consumed Unearned Revenues: cash received and recorded (as a liability) before earned Unearned Revenues: cash received and recorded (as a liability) before earned

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Adjusting Entries - Accruals Required where items are not yet recorded in the accounts Required where items are not yet recorded in the accounts Accrued Expenses: expenses incurred but not yet paid in cash Accrued Expenses: expenses incurred but not yet paid in cash Accrued Revenues: revenues earned but not yet received in cash Accrued Revenues: revenues earned but not yet received in cash

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Prepaid Expenses Expire through the passage of time or as an asset is used up Expire through the passage of time or as an asset is used up Portion used up is an expense of the periodPortion used up is an expense of the period Prior to adjustment, assets are overstated and expenses are understated Prior to adjustment, assets are overstated and expenses are understated Adjusting entry: Adjusting entry: Dr. An expense account (to increase) Dr. An expense account (to increase) Cr. An asset account (to decrease) Examples: supplies, rent, insurance Examples: supplies, rent, insurance

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Depreciation The allocation of the cost of long-lived assets to expense over their useful lives The allocation of the cost of long-lived assets to expense over their useful lives The portion of the asset that is used up (or expires) in each period is reported as an expenseThe portion of the asset that is used up (or expires) in each period is reported as an expense Straight-line depreciation: Straight-line depreciation: Annual depreciation expense =Annual depreciation expense = Cost ÷ Estimated useful life

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Depreciation – Recording Adjusting entry: Adjusting entry: Dr. Depreciation expense (to increase) Dr. Depreciation expense (to increase) Cr. Accumulated depreciation (to increase) Contra account: An account that is offset against a related account Contra account: An account that is offset against a related account Contra asset account: offset against an assetContra asset account: offset against an asset Contra liability account: offset against a liabilityContra liability account: offset against a liability

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Depeciation – Presentation Accumulated depreciation is deducted from the cost of the asset on the balance sheet Accumulated depreciation is deducted from the cost of the asset on the balance sheet This difference is called the Carrying Amount This difference is called the Carrying Amount

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Unearned Revenues Cash received before revenue is earned is recorded as a liability Cash received before revenue is earned is recorded as a liability Subsequently earned by performing a service or providing a good Subsequently earned by performing a service or providing a good Prior to adjustment, liabilities are overstated and revenues are understated Prior to adjustment, liabilities are overstated and revenues are understated Adjusting entry: Adjusting entry: Dr. A liability account (to decrease) Dr. A liability account (to decrease) Cr. A revenue account (to increase) Examples: subscriptions, customer deposits Examples: subscriptions, customer deposits

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. CreditAdjusting Entry (-) Unadjusted Balance Liability Debit Adjusting Entry (-) Unadjusted Balance Adjusting Entries for Prepayments Prepaid Expenses Unearned Revenues Asset Expense Debit Adjusting Entry (+) CreditAdjusting Entry (-) Unadjusted Balance Revenue CreditAdjusting Entry (+)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Accrued Revenues Accrue with the passage of time or result from services performed but not billed or collected Accrue with the passage of time or result from services performed but not billed or collected Prior to adjustment, assets and revenues are understated Prior to adjustment, assets and revenues are understated Adjusting entry: Adjusting entry: Dr. An asset account (to increase) Dr. An asset account (to increase) Cr. A revenue account (to increase) Examples: accounts receivable, rent receivable, and interest receivable Examples: accounts receivable, rent receivable, and interest receivable

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Accrued Expenses Expenses incurred but not yet paid or recorded Expenses incurred but not yet paid or recorded Prior to adjustment, liabilities and expenses are understated Prior to adjustment, liabilities and expenses are understated Adjusting entry: Adjusting entry: Dr. An expense account (to increase) Dr. An expense account (to increase) Cr. A liability account (to increase) Examples: accounts payable, rent payable, salaries payable, and interest payable Examples: accounts payable, rent payable, salaries payable, and interest payable

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. CreditAdjusting Entry (-) Unadjusted Balance Expense Debit Adjusting Entry (+) Adjusting Entries for Accruals Accrued Revenues Accrued Expenses Asset Revenue Debit Adjusting Entry (+) CreditAdjusting Liability CreditAdjusting

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Adjusted Trial Balance Prepared after adjusting entries have been journalized and posted Prepared after adjusting entries have been journalized and posted Proves that total debit and credit balances are equal after all adjustments have been made Proves that total debit and credit balances are equal after all adjustments have been made Provides all data needed for preparing financial statements Provides all data needed for preparing financial statements

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Preparing the Income Statement The income statement is prepared from the revenue and expense accounts

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Preparing the Statement of Owner’s Equity The statement of owner’s equity is derived from the owner’s capital and drawing accounts and Profit from the Income statement From Income statement

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Preparing the Balance Sheet The balance sheet is prepared from the asset and liability accounts and the Statement of owner’s equity From Statement of owner’s equity

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Appendix 3A: Alternative Treatment of Prepayments Prepaid Expenses: Prepaid Expenses: Record initial transaction as an expenseRecord initial transaction as an expense Adjust at end of period for amount that has not been used upAdjust at end of period for amount that has not been used up Unearned Revenues: Unearned Revenues: Record initial transaction as revenueRecord initial transaction as revenue Adjust at end of period for services not yet provided or goods not yet deliveredAdjust at end of period for services not yet provided or goods not yet delivered

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