© 2013 McGraw-Hill Ryerson Limited. Adjusting Accounts Accounts are adjusted at the end of each accounting period to bring an asset or liability account to its proper amount. Adjusting entries also update the related expense or revenue accounts. These adjustments are necessary for the preparation of financial statements. LO 4 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Adjustments Types: Prepaid expenses Depreciation Unearned revenues Accrued expenses Accrued revenues LO 4 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Prepaid Expenses Costs paid in advance of receiving their benefits. They are recorded as assets. As these assets are used, their costs become expenses. These costs expire with the passage of time or through use and consumption, e.g., insurance, supplies. LO 4 © 2013 McGraw-Hill Ryerson Limited.

Prepaid Expenses–Example On January 1, a company purchases an insurance policy that covers three months and costs $1,800. The policy will benefit the company for three months and will be expired at the end of three months. The cost of the policy should be spread over the time period it benefits the organization. (matching principle). $600 $1,800 January February March LO 4 © 2013 McGraw-Hill Ryerson Limited.

Prepaid Expenses–Example The entry to record the purchase of the insurance policy would be: Prepaid Insurance 1,800 Cash 1,800 $1,800 $1,800 LO 4 © 2013 McGraw-Hill Ryerson Limited.

Prepaid Expenses–Example The entry to record the expiry of the insurance for January would be: Insurance Expense 600 Prepaid Insurance 600 $1,800 $1,800 LO 4 © 2013 McGraw-Hill Ryerson Limited.

Prepaid Expenses–Example The entry to record the expiry of the insurance for February would be: Insurance Expense 600 Prepaid Insurance 600 $1,800 $1,800 LO 4 © 2013 McGraw-Hill Ryerson Limited.

Prepaid Expenses–Example The entry to record the expiry of the insurance for March would be: Insurance Expense 600 Prepaid Insurance 600 $1,800 $1,800 LO 4 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Depreciation Companies acquire assets such as equipment, buildings, vehicles, and patents to generate revenues. These assets are expected to provide benefits for more than one accounting period. Depreciation is the process of allocating the costs of assets over their expected useful lives. LO 4 © 2013 McGraw-Hill Ryerson Limited.

Asset cost – Estimated residual value Depreciation Depreciation is based on the matching principle where the cost of an asset is matched over the time the asset helped earn the revenue. Straight-Line Depreciation Expense = Asset cost – Estimated residual value Estimated useful life LO 4 © 2013 McGraw-Hill Ryerson Limited.

Depreciation - Example On January 1, 2014, a company purchased a piece of equipment for $72,000. The equipment is expected to have a useful life of four years and have a residual value of $8,000. Straight-Line Depreciation Expense = Asset cost – Estimated residual value Estimated useful life = $72,000 - $8,000 4 years = $16,000/year LO 4 © 2013 McGraw-Hill Ryerson Limited.

Depreciation - Example The entry to record the purchase of the equipment would be: Equipment 72,000 Cash 72,000 LO 4 © 2013 McGraw-Hill Ryerson Limited.

Depreciation - Example The entry to record Depreciation at the end of the first year would be: Depreciation Expense, Equipment 16,000 Accumulated Depreciation, Equip. 16,000 LO 4 © 2013 McGraw-Hill Ryerson Limited.

Depreciation - Example The entry to record Depreciation at the end of the second year would be: Depreciation Expense, Equipment 16,000 Accumulated Depreciation, Equip. 16,000 LO 4 © 2013 McGraw-Hill Ryerson Limited.

Depreciation - Example The entry to record Depreciation at the end of the third year would be: Depreciation Expense, Equipment 16,000 Accumulated Depreciation, Equip. 16,000 LO 4 © 2013 McGraw-Hill Ryerson Limited.

Depreciation - Example The entry to record Depreciation at the end of the fourth year would be: Depreciation Expense, Equipment 16,000 Accumulated Depreciation, Equip. 16,000 LO 4 © 2013 McGraw-Hill Ryerson Limited.

Depreciation - Example LO 4 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Unearned Revenues Cash received in advance of providing products and services. The company has an obligation to provide goods or services. Unearned revenues are liabilities. As products and services are provided, the amount of unearned revenues becomes earned revenues. LO 4 © 2013 McGraw-Hill Ryerson Limited.

Unearned Revenues — Example On March 1, a company received a $12,000 payment from a customer for maintenance services to be provided over the next two months. The entry to record the receipt of cash would be: Cash 12,000 Unearned Revenue 12,000 LO 4 © 2013 McGraw-Hill Ryerson Limited.

Unearned Revenues - Example On March 31, $6,000 of this revenue had been earned. The entry to record the earned revenue would be: Unearned Revenue 6,000 Maintenance Revenue 6,000 $12,000/2months= $6,000/month LO 4 © 2013 McGraw-Hill Ryerson Limited.

Unearned Revenues - Example By April 30, another $6,000 of this unearned revenue had been earned. The entry to record the earned revenue would be: Unearned Revenue 6,000 Maintenance Revenue 6,000 $12,000/2months= $6,000/month LO 4 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Accrued Expenses Costs incurred in a period that are both unpaid and unrecorded. Adjusting entries must be made to record the expense for the period and the related liability at the balance sheet date. Examples: interest, wages, rent, taxes LO 4 © 2013 McGraw-Hill Ryerson Limited.

Accrued Expenses - Example On December 31, $1,200 of interest has accrued on a company’s bank loan. The payment of the interest is not due until January 1. The December 31 entry to record the accrued interest would be: Interest Expense 1,200 Interest Payable 1,200 LO 4 © 2013 McGraw-Hill Ryerson Limited.

Accrued Expenses - Example In December, a company incurred $3,700 of utilities expense. The company had not received the utility bill at December 31. The December 31 entry to record the accrued utilities expense would be: Utilities Expense 3,700 Accounts Payable 3,700 LO 4 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Accrued Revenues Revenues earned in a period that are both unrecorded and not yet received in cash. Adjusting entries must be made to record the revenue for the period and the related asset at the balance sheet date. Examples: fees earned, interest earned, rent earned LO 4 © 2013 McGraw-Hill Ryerson Limited.

Accrued Revenues - Example On December 31, $16,500 of consulting fees have been earned but have not been recorded or billed to the client. The entry to record the accrued consulting fees earned would be: Accounts Receivable 16,500 Consulting Fees Earned 16,500 LO 4 © 2013 McGraw-Hill Ryerson Limited.