WEYGANDT. KIESO. KIMMEL. TRENHOLM. KINNEAR. BARLOW. ATKINS PRINCIPLES OF FINANCIAL ACCOUNTING CANADIAN EDITION Chapter 3 Adjusting the Accounts Prepared by: Debbie Musil Kwantlen Polytechnic University 1

Copyright John Wiley & Sons Canada, Ltd.2 Chapter 3: Adjusting the Accounts Study Objectives 1.Explain accrual basis accounting, and when to recognize revenues and expenses. 2.Prepare adjusting entries for prepayments. 3.Prepare adjusting entries for accruals. 4.Describe the nature and purpose of an adjusted trial balance, and prepare one. 5.Prepare adjusting journal entries for the alternative treatment of prepayments.

Copyright John Wiley & Sons Canada, Ltd.3 Timing issues – Selecting an accounting time period – Accrual versus cash basis of accounting – Revenue and expense recognition Basics of adjusting entries – Types of adjusting entries – Prepayments and accruals Adjusted trial balance and financial statements Adjusting the Accounts

Time Periods Copyright John Wiley & Sons Canada, Ltd.4 The economic life of a business can be divided into time periods – Generally a month, quarter, or year Periods of less than one year are called interim periods Period of one year is called a fiscal year

Accrual Versus Cash Basis Accounting Copyright John Wiley & Sons Canada, Ltd.5 Accrual basis: – Events are recorded in the period when they occur – Not when the cash is paid or received Cash basis: – Revenue recorded when cash is received – Expenses recorded when cash is paid

Revenue Recognition Copyright John Wiley & Sons Canada, Ltd.6 Revenue is recognized when there is an increase in assets or a decrease in liabilities as a result of business activities with customers Revenue recognition criteria provides guidance: – Generally when the service is performed or when goods are sold and delivered

Expense Recognition Copyright John Wiley & Sons Canada, Ltd.7 Expenses are decreases in assets or increases in liabilities from business activities Represent a decrease in owner’s equity Expense recognition criteria provides guidance: – Tied 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 asset – Otherwise expenses are reported in period incurred

The Accounting Cycle Copyright John Wiley & Sons Canada, Ltd.8

Adjusting Entries- Basics Copyright John Wiley & Sons Canada, Ltd.9 Required for the preparation of financial statements – To ensure that revenue and expense recognition criteria are followed – Make it possible to accurately report assets, liabilities and owner’s equity Part of the accounting cycle Classified as prepayments or accruals

Copyright John Wiley & Sons Canada, Ltd.10 1.Explain accrual basis accounting, and when to recognize revenues and expenses. 2.Prepare adjusting entries for prepayments. 3.Prepare adjusting entries for accruals. 4.Describe the nature and purpose of an adjusted trial balance, and prepare one. 5.Prepare adjusting journal entries for the alternative treatment of prepayments. Chapter 3: Adjusting the Accounts Study Objectives

Adjusting Entries- Prepayments Copyright John Wiley & Sons Canada, Ltd.11 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 revenue earned

Prepaid Expenses Copyright John Wiley & Sons Canada, Ltd.12 Expire through the passage of time or as an asset is used up – Portion used up is an expense of the period Prior to adjustment, assets are overstated and expenses are understated Adjusting entry: Dr. An expense account (to increase) Cr. An asset account (to decrease) Examples: supplies, rent, insurance

Depreciation Copyright John Wiley & Sons Canada, Ltd.13 The allocation of the cost of long-lived assets to expense over its expected useful life – The portion of the asset that is used up (or expires) in each period is reported as an expense Straight-line depreciation: Annual depreciation expense = Cost ÷ Estimated useful life

Depreciation- Recording Copyright John Wiley & Sons Canada, Ltd.14 Adjusting entry: Dr. Depreciation expense (to increase) Cr. Accumulated depreciation (to increase) Contra asset account: An account with the opposite balance (credit) compared to its related asset account – Deducted from its related asset on the balance sheet

Depreciation- Presentation Copyright John Wiley & Sons Canada, Ltd.15 Accumulated depreciation is deducted from the cost of the asset on the balance sheet This difference is called the Carrying Amount

Unearned Revenues Copyright John Wiley & Sons Canada, Ltd.16 Cash received before revenue is earned is recorded as a liability Subsequently earned by performing a service or providing a good Prior to adjustment, liabilities are overstated and revenues are understated Adjusting entry: Dr. A liability account (to decrease) Cr. A revenue account (to increase) Examples: subscriptions, tickets for sporting and entertainment events, customer deposits

Adjusting Entries for Prepayments Copyright John Wiley & Sons Canada, Ltd.17

Copyright John Wiley & Sons Canada, Ltd.18 1.Explain accrual basis accounting, and when to recognize revenues and expenses. 2.Prepare adjusting entries for prepayments. 3.Prepare adjusting entries for accruals. 4.Describe the nature and purpose of an adjusted trial balance, and prepare one. 5.Prepare adjusting journal entries for the alternative treatment of prepayments. Chapter 3: Accounting Principles Study Objectives

Adjusting Entries- Accruals Copyright John Wiley & Sons Canada, Ltd.19 Required where items are not yet recorded in the accounts Accrued Revenues: – Revenues earned but not yet received in cash or recorded Accrued Expenses: – Expenses incurred but not yet paid in cash or recorded

Accrued Revenues Copyright John Wiley & Sons Canada, Ltd.20 Accrue with the passage of time or result from services performed but not billed or collected Prior to adjustment, assets and revenues are understated Adjusting entry: Dr. An asset account (to increase) Cr. A revenue account (to increase) Examples: accounts receivable, rent receivable, and interest receivable

Accrued Expenses Copyright John Wiley & Sons Canada, Ltd.21 Expenses incurred but not yet paid or recorded Prior to adjustment, liabilities and expenses are understated Adjusting entry: Dr. An expense account (to increase) Cr. A liability account (to increase) Examples: accounts payable, rent payable, salaries payable, and interest payable

Adjusting Entries for Accruals Copyright John Wiley & Sons Canada, Ltd.22

Copyright John Wiley & Sons Canada, Ltd.23 1.Explain accrual basis accounting, and when to recognize revenues and expenses. 2.Prepare adjusting entries for prepayments. 3.Prepare adjusting entries for accruals. 4.Describe the nature and purpose of an adjusted trial balance, and prepare one. 5.Prepare adjusting journal entries for the alternative treatment of prepayments. Chapter 3: Adjusting the Accounts Study Objectives

Preparing the Adjusted Trial Balance Copyright John Wiley & Sons Canada, Ltd.24

Adjusted Trial Balance Copyright John Wiley & Sons Canada, Ltd.25 Prepared after adjusting entries have been journalized and posted Proves that total debit and credit balances are equal after all adjustments have been made Provides all data needed for preparing financial statements

Preparing the Income Statement and Statement of Owner’s Equity Copyright John Wiley & Sons Canada, Ltd. 26 To: Balance Sheet – Owner’s equity The income statement is prepared from the revenue and expense accounts. The statement of owner’s equity is prepared from the owner’s capital and drawing accounts and Profit from the Income statement.

Preparing the Balance Sheet Copyright John Wiley & Sons Canada, Ltd.27 The balance sheet is prepared from the asset and liability accounts and the Statement of owner’s equity

Copyright John Wiley & Sons Canada, Ltd.28 1.Explain accrual basis accounting, and when to recognize revenues and expenses. 2.Prepare adjusting entries for prepayments. 3.Prepare adjusting entries for accruals. 4.Describe the nature and purpose of an adjusted trial balance, and prepare one. 5.Prepare adjusting journal entries for the alternative treatment of prepayments. Chapter 3: Adjusting the Accounts Study Objectives

Appendix 3A: Alternative Treatment of Prepayments Copyright John Wiley & Sons Canada, Ltd.29 Prepaid Expenses: – Record initial transaction as an expense – Adjust at end of period for amount that has not been used up Unearned Revenues: – Record initial transaction as revenue – Adjust at end of period for services not yet provided or goods not yet delivered

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