Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Prepared by: Debbie Musil Kwantlen University College Chapter 3 Adjusting the Accounts

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Revenue Recognition Principle Revenue should be recognized in the accounting period in which it is earned Revenue should be recognized in the accounting period in which it is earned Generally, revenue is recognized when sales effort is substantially complete and collection is reasonable certain Generally, revenue is recognized when sales effort is substantially complete and collection is reasonable certain Matching Principle The practice of expense recognition The practice of expense recognition Efforts (expenses) are matched with accomplishments (revenues) Efforts (expenses) are matched with accomplishments (revenues)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Accrual Basis of Accounting Adheres to the revenue recognition and matching principles Adheres to the revenue recognition and matching principles Revenue recorded when earned Revenue recorded when earned 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, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Cash Basis of Accounting Revenue recorded only when cash received Revenue recorded only when cash received Expense recorded only when cash paid Expense recorded only 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 Usually with few receivables and payablesUsually with few receivables and payables

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Adjusting Entries – Prepayments Prepaid Expenses: costs paid and recorded (as assets) before they are used or consumed Prepaid Expenses: costs paid and recorded (as assets) before they are used or consumed Amortization: allocation of cost of a long- lived asset to expense over its useful life Amortization: allocation of cost of a long- lived asset to expense over its useful life Unearned Revenues: cash received and recorded (as liabilities) before earned Unearned Revenues: cash received and recorded (as liabilities) before earned

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 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 Revenues: revenues earned but not yet received in cash (an asset) Accrued Revenues: revenues earned but not yet received in cash (an asset) Accrued Expenses: expenses incurred but not yet paid in cash (a liability) Accrued Expenses: expenses incurred but not yet paid in cash (a liability)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 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 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, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Amortization 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 To match the cost of a long-term asset to the revenue it generates each periodTo match the cost of a long-term asset to the revenue it generates each period An estimate of the cost that has expired An estimate of the cost that has expired Straight-line amortization: Straight-line amortization: Annual amortization expense =Annual amortization expense = Cost ÷ Estimated useful life

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Amortization – Recording Adjusting entry: Adjusting entry: Dr. Amortization expense (to increase) Dr. Amortization expense (to increase) Cr. Accumulated amortization (to increase) Contra account: Contra account: An account that is offset against a related accountAn 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, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Amortization – Presentation Accumulated amortization is deducted from the cost of the asset on the balance sheet Accumulated amortization is deducted from the cost of the asset on the balance sheet This difference is called Net Book Value This difference is called Net Book Value

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Unearned Revenues Revenue received before it is earned and recorded as a liability Revenue received before it is earned and 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. An asset account (to decrease) Dr. An asset account (to decrease) Cr. A revenue account (to increase) Examples: subscriptions, customer deposits Examples: subscriptions, customer deposits

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 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 Unadjusted Balance Revenue CreditAdjusting Entry (-)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 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, Third Canadian Edition © 2009 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, Third Canadian Edition © 2009 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, Third Canadian Edition © 2009 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, Third Canadian Edition © 2009 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 Net income from the Income statement From Income statement

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 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, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. COPYRIGHT Copyright © 2009 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.