1 1. Describe the nature of the adjusting process. 2. Journalize entries for accounts requiring adjustment. 3. Summarize the adjustment process. 4. Prepare an adjusted trial balance. After studying this chapter, you should be able to: 3 - The Adjusting Process

2 3-1 Under the cash basis of accounting, revenues and expenses are reported in the income statement in the period in which cash is received or paid. E.g. Some Government Accounting Under the accrual basis of accounting, revenues are reported in the income statement in the period in which they are earned. Objective 1 - Describe the nature of the adjusting process.

3 3-1 The accounting concept that supports this approach to reporting of revenues is called the revenue recognition concept. Expenses are reported in the same period as the revenue to which they relate. The accounting concept that supports reporting revenues and related expenses in the same period is called the matching concept, or matching principle. Our focus in the course will be on the accrual basis of accounting i..e. revenues are reported in the income statement in the period in which they are earned.

4 The analysis and updating of accounts at the end of the period before the financial statements are prepared is called the adjusting process. 3-1 Some accounts may need to updated at the end of an accounting period e.g. Supplies vs Supplies Expense The journal entries that bring the accounts up to date at the end of the accounting period are called adjusting entries.

5 Prepaid expenses, sometimes referred to as deferred expenses, are items that have been initially recorded as assets but are expected to become expenses over time or through the normal operations of the business. 3-1 Items That Need Adjusting - 1 “Cash is paid for the service/expense before the service/expense is used”

6 Unearned revenues, sometimes referred to as deferred revenues, are items that have been initially recorded as liabilities but are expected to become revenues over time or through the normal operations of the business. 3-1 Items That Need Adjusting - 2 “Cash is collected before service is rendered”

7 Accrued revenues, sometimes referred to as accrued assets (accrued means unpaid), are revenues that have been earned but have not been recorded in the accounts. 3-1 Items That Need Adjusting - 3 “Services rendered for which cash has not yet been collected”

8 Accrued expenses, sometimes referred to as accrued liabilities, are expenses that have been incurred but have not been recorded in the accounts. 3-1 Items That Need Adjusting - 4 “The service has been used or the expense incurred, but the cash has not been paid”

9 Example Exercise 3-2 Classify the following items as (1) prepaid expense, (2) unearned revenue, (3) accrued expense, or (4) accrued revenue. a.Wages owed but notc.Fees received but not yet yet paid.earned. b.Supplies on hand.d.Fees earned but not yet received. 3-1

10 Journalize entries for accounts requiring adjustment. Objective 2 3-2

11 3-2

12 NetSolutions’ Supplies account has a balance of $2,000 in the unadjusted trial balance. Some of these supplies have been used. On December 31, a count reveals that $760 of supplies are on hand. 3-2 Adjusting Process for Prepaid Expenses (1) Supplies (balance on trial balance)$2,000 Supplies on hand, December 31 – 760 Supplies used$1,240

13 Supplies Supplies used ($2,000 – $760) Dec. 311,240 Supplies Bal.2,000 Supplies Expense Bal , Dec. 31Supplies Expense

14 The debit balance of $2,400 in NetSolutions’ Prepaid Insurance account represents the December 1 prepayment of insurance for 12 months. 3-2 Adjusting Process for Prepaid Expenses (2)

15 Dec Prepaid Insurance Bal.2,400 Insurance Expense , Insurance Expense Prepaid Insurance Insurance expired ($2,400/12). 3-2

16 On December 1, the tenant prepaid three months’ rent for use of an office building owned by NetSolutions. As of December 31, only $120 has been earned. 3-2 Adjusting Process for Unearned Revenue

17 Dec Unearned Rent Bal.360 Rent Revenue Unearned Rent Rent Revenue Rent earned ($360/3 months) Bal.

18 NetSolutions provided $500 in services during December for which the customer has not been billed. 3-2 Adjusting Process for Accrued Revenues 31Accounts Receivable Fees Earned Accrued fees 12 41

19 Assuming that wages were last paid on Friday, December 27 th, and at the end of December, outstanding/accrued wages amounted to $250. (e.g. This is for Monday & Tuesday, Dec 30 th & 31 st.) Without this adjusting entry, Wages Expense is understated. 3-2 Adjusting Process for Accrued Expenses 31Wages Expense Wages Payable Accrued wages

20 Dec Wages Payable Bal.4,275 Wages Expense Bal.4,

21 Physical resources that are owned and used by a business and are permanent or have a long life are called fixed assets, or plant assets. 3-2 Adjusting Process for Depreciation Expenses As time passes, a fixed asset loses its ability to provide useful services (by being used in the business i.e. an expenses) This decrease (or expense) in usefulness is called depreciation.

22 Normal titles for fixed asset accounts and their related contra asset accounts are as follows: Fixed Asset Contra Asset LandNone—Land is not depreciated BuildingsAccumulated Depreciation— Buildings Store EquipmentAccumulate Depreciation—Store Equipment Office EquipmentAccumulated Depreciation—Office Equipment 3-2 Instead of the assets account being credited, a contra account is established that normally carries a credit balance and appears as a deduction on the balance sheet

23 Dec Depreciation Expense Dec Accum. Depr.—Office Equip Depreciation Expense50 00 Accum. Depreciation— Office Equipment50 00 Depreciation of office equipment NetSolutions estimates the depreciation on its office equipment to be $50 for the month of December.

24 NetSolutions’ balance sheet would show the office equipment at cost, less the accumulated depreciation. Office equipment$1,800 Less accumulated depreciation 50$1,750 Book Value or Net Book Value 3-2

25 Summarize the adjustment process Objective See pages 116 – 120 and exhibit 8 for Ledger with adjusting entries

26 3-3

Prepare an adjusted trial balance. Objective 4

28 The purpose of the adjusted trial balance is to verify the equality of the total debit balances and total credit balances before the financial statements are prepared. 3-4

29 3-4