ADJUSTMENTS

Remember Financial statements should always be … ACCURATE TIMELY UNDERSTANDABLE To make Decisions

Reason for Adjustments An example of the inefficiency of recording transactions:  Each time a waiter used a napkin from the supplies closet, a journal entry debiting Supplies Expense and crediting Supplies for $0.35 (estimated cost of napkin) should be recorded. However, it would be very costly and inefficient to try to keep up with each little transaction like this. So instead, we wait until the end of the accounting period and determine the total amount of supplies used. Then we make an adjusting entry to account for all the supplies used during the period.

Adjusting Entries Why adjust? Can be inefficient and costly to account for certain types of transactions on a daily basis, so we prepare… Adjusting Entries to bring certain account balances up to date at the end of the accounting period

How to Analyze an Adjusting Entry When analyzing an adjusting entry, look for the item that has not been recorded but should have been. This information is often not explicit and must be inferred from the data given. For expenses, look for the amount used For revenue, look for the amount earned

Let’s think back to our restaurant example…(Supplies Adjustments) The beginning balance in the restaurants supplies account was $300. The restaurant purchased $500 worth of supplies during the January, an additional $200 in October. A year-end count of supplies revealed $400 worth of supplies was on hand at year- end. Account for the necessary adjustments.

Adjusting Supplies RULE OF THUMB: Adjusting results in debiting (increase) an expense account and a credit(decrease) to an asset DATEACCOUNT POST REF DEBITCREDIT Dec31Supplies Expense60000 Supplies60000

Class Example - Supplies The Office Supplies on Hand account showed a balance of $3,500 at the beginning of Supplies costing $12,000 were purchased during Supplies of $2,200 were on hand at December 31, Prepare the adjustment.

The Adjustment DATEACCOUNT POST REF DEBITCREDIT Dec31Supplies Expense13,30000 Supplies13,30000 RULE OF THUMB: Adjusting results in debiting (increase) an expense account and a credit(decrease) to an asset

Adjusting Prepaid Expenses Prepaid expenses are future expenses that have been paid in advance

Adjusting Prepaid Expenses You bought insurance on the restaurant building on August 1, 2013 for a 2 year insurance policy at a cost of $ 4800.

Analyzing the Entry Each month, a portion of the prepaid insurance expires. At the end of the fiscal period, the Prepaid account must be updated for the insurance that has expired (been used)

Analyzing the Entry What accounts are involved? When something is “used up” it indicates an expense account. In this case, we need to debit an account called Insurance Expense for the expired insurance. Furthermore, the asset, Prepaid Insurance, has decreased so we will credit this asset.

The Adjustment DATEACCOUNT POST REF DEBITCREDIT Dec31Insurance Expense Prepaid Insurance100000

Class Example - Prepaid Now let’s assume that a business with a fiscal year-end of December 31 purchases a full prepaid 12-month property insurance policy for $36,000 on September 1, Prepare the adjusting entry on December 31, 2010

The Adjustment DATEACCOUNT POST REF DEBITCREDIT Dec31Insurance Expense Prepaid Insurance RULE OF THUMB: Adjusting results in debiting (increase) an expense account and a credit(decrease) to an asset account

Adjusting Late-Arriving Purchase Invoices The journal entry to record is the same as it would be if the invoice arrived on time; however, the date must be recorded as if we received the invoice at the end of the year even though we received it in January Business may act as if the late-arriving invoice arrived just prior to the close of the period and record that invoice as if it had arrived on the final day of the previous period.

The Adjustment DATEACCOUNT POST REF DEBITCREDIT Dec31Advertising Expense40000 Hydro Expense20000 Accounts Payable60000 RULE OF THUMB : Adjusting entry results in a decrease (a debit) to a liability account and an increase (a credit) to an asset account.

Adjusting Unearned Revenue Receipt of cash recorded as a liability before the service is preformed  Rent, airline tickets, magazine subscriptions  Adjusting entry to record the revenue that has been earned and to show the liability that remains

Class Example - Adjusting Unearned Revenue You received $12,000 advance cash on November 1 for a painting job you are to complete over the next three months.

The Initial Entry Initial Entry DATEACCOUNT POST REF DEBITCREDIT Nov1Cash Unearned Paint Revenue On November 1, Cash would be debited and a liability account called Unearned Paint Revenue would be credited. The liability account is credited because you owe the customer. You owe the customer painting services.

The Adjustment DATEACCOUNT POST REF DEBITCREDIT Dec31Unearned Paint Revenue Paint Revenue RULE OF THUMB : Adjusting entry results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account. Each month as you perform catering services, you are earning a portion of the unearned revenue. At the end of the fiscal period, the Unearned Paint Revenue and Paint Revenue accounts must be updated for the revenue that has now been earned.

Remember Adjusting entries are non-cash transactions—the Cash account will never be used in an adjusting entry You are simply updating the accounts When analyzing an adjusting entry, look for the item that has not been recorded but should have been: For expenses, look for the amount used For revenue, look for the amount earned The rule of thumb* *Always involves at least one income statement account and one balance sheet account

Practice Page Exercise 1 Exercise 2 Exercise 6: a-d