1. Chapter 3
The Adjusting Process

2. Accrual Accounting Versus Cash-Basis Accounting
Accrual Basis
Revenues recognized when earned
Expenses recognized when incurred
Cash Basis
Revenues recognized when cash received
Expenses recorded when cash paid
Not GAAP 9 9

3. Accrual vs. Cash-Basis: Revenue

4. Accrual vs. Cash-Basis: Revenue
Accrual basis revenue transactions
Cash-basis revenue transactions

5. Accrual vs. Cash-Basis: Expenses

6. Accrual vs. Cash-Basis Accounting
Accrual basis
Cash-basis 9 9

7. S3-2: COMPARING ACCRUAL AND CASH-BASIS ACCOUNTING
The Johnny Flowers Law Firm uses a client database. Suppose Johnny Flowers paid $2,900 for a computer.
Requirements:
1. Describe how the business should account for the $2,900 expenditure under
the cash basis.
b. the accrual basis.

8. 2. State why the accrual basis is more realistic for this situation.
S3-2: COMPARING ACCRUAL AND CASH-BASIS ACCOUNTING
2. State why the accrual basis is more realistic for this situation.

9. Accounting Period Concept
Businesses prepare financial statements for specific periods to evaluate performance
Basic accounting period = one year
Interim periods

10. Revenue Recognition Principle
When to record revenue?
When it is earned
The amount of revenue to recorded?
Value of item or service transferred to customer

11. Recording Revenue: The Revenue Recognition Principle

12. The Matching Principle
Measure all expenses incurred during the period
Match the expenses against the revenues earned during the same period

13. The Time-Period Concept
Requires that accounting information be reported at regular intervals
Accounts are updated at the end of each accounting period

14. Time-Period Concept
On May 31, Smart Touch recorded salary expense of $900 that is owed to an employee at the end of the month.

15. Adjusting Entries 12 12

16. Adjusting Entries Prepared at end of an accounting period Assigns:
Revenues to the period when earned
Expenses to the period when incurred
Update asset and liability accounts
Need to properly match revenues and expenses to measure:
Net Income
Assets and Liabilities 12 12

17. Adjusting Entry Rules Never involve the cash account
Either increase revenue or increase an expense
When worded as “accrued”, journalize the stated amount

18. Types of Adjusting Entries
Prepaid expenses
Depreciation
Accrued expenses
Accrued revenues
Unearned revenues

19. Prepaid Expenses Advance payments of expenses Recorded as an asset
Adjusting entry records amount used as an expense

20. Prepaid Expense: Rent

21. Depreciation Plant assets Depreciation
Long-lived tangible assets used in business operations
Depreciation
Allocation of a plant asset’s cost to expense over its useful life

22. Depreciation Entry

23. Accumulated Depreciation
Contra asset
Holds sum of all depreciation recorded on a plant asset
Book value

24. Depreciation Posting

25. Accrued Expenses Expenses incurred before payment is made
Opposite of a prepaid expense 31 31

26. Accrued Expense Entries16 16

27. Accrued Revenues Revenue earned before cash is received
Results in a receivable 36 36

28. Unearned Revenue Cash is collected before revenue is earned
Also called deferred revenue
BEFORE 25 25

29. Unearned Revenue Entries16 16

30. Summary of Adjusting Entries
To properly measure net income for the period
To update the balance sheet

31. Summary of Adjusting Entries
Category of Adjusting Entry
Debit
Credit
Prepaid expense
Expense
Asset
Depreciation
Contra asset
Accrued expense
Liability
Accrued revenue
Revenue
Unearned revenue

32. S3-5: IDENTIFYING TYPES OF ADJUSTING ENTRIES
A select list of transactions for Anuradha’s Goals follows:
Apr 1 Paid six months of rent, $4,800.
10 Received $1,200 from customer for six-month service contract that began April 1.
15 Purchased computer for $1,000.
Requirement:
1. For each transaction, identify what type of adjusting entry would be needed.

33. S3-5: IDENTIFYING TYPES OF ADJUSTING ENTRIES
A select list of transactions for Anuradha’s Goals follows:
Apr 18 Purchased $300 of office supplies on account.
30 Work performed but not yet billed to customer, $500.
30 Employees earned $600 in salary that will be paid May 2.

34. The following data at January 31, 2012 is given for EBM, Inc.
E3-22: JOURNALIZING ADJUSTING ENTRIES AND ANALYZING THEIR EFFECT ON THE INCOME STATEMENT
The following data at January 31, 2012 is given for EBM, Inc.
a. Depreciation, $500
b. Prepaid rent expired, $600
c. Interest expense accrued, $300
d. Employee salaries owed for Monday through Thursday of a five-day workweek; weekly payroll, $13,000
e. Unearned service revenue earned, $1,300
Requirement:
1. Journalize the adjusting entries needed on January 31, 2012.

35. ACCOUNTS AND EXPLANATIONS
E3-22: JOURNALIZING ADJUSTING ENTRIES AND ANALYZING THEIR EFFECT ON THE INCOME STATEMENT
Journal
DATE
ACCOUNTS AND EXPLANATIONS
POST.
REF.
DEBIT
CREDIT
2013
Adjusting Entries
Jan 31
Depreciation expense
Accumulated depreciation
Rent expense
Prepaid rent
Interest expense
Interest payable
Salary expense
Salary payable
Unearned service revenue
Service revenue

36. E3-22: JOURNALIZING ADJUSTING ENTRIES AND ANALYZING THEIR EFFECT ON THE INCOME STATEMENT
2. Suppose the adjustments made in Requirement 1 were not made. Compute the overall overstatement or understatement of net income as a result of the omission of these adjustments.

37. Adjusted Trial Balance
Prepared after adjusting entries are posted
Useful step in preparing financial statements
Often appears on a work sheet

38. 43

39. S3-10: PREPARING AN ADJUSTED TRIAL BALANCE

40. 43

41. Income Statement

42. Statement of Retained Earnings

43. Balance Sheet

44. E3-25: PREPARING THE FINANCIAL STATEMENTS
Refer to the adjusted trial balance in Exercise 3-21 for the month ended April 30, 2012.
Requirements:
Prepare the income statement.
2. Prepare the statement of retained earnings.
3. Prepare the balance sheet.

45. E3-21: ADJUSTED TRIAL BALANCE

46. E3-25: PREPARING THE FINANCIAL STATEMENTS
Jobs-4-U Employment Service, Inc.
Income Statement
Month Ended April 30, 2012
Revenue:
Service revenue
$ ,600
Expenses:
Salary expense
$ 3,700
Rent expense
1,000
Depreciation expense
Supplies expense
500
Total expenses
6,200
Net income
$ ,400

47. E3-25: PREPARING THE FINANCIAL STATEMENTS
Jobs-4-U Employment Service, Inc.
Statement of Retained Earnings
Month Ended April 30, 2012
Retained earnings, March 31, 2012
$ 10,300
Net income
4,400
17,900
Dividends
4,800
Retained earnings, April 30, 2012
$ 9,900

48. E3-25: PREPARING THE FINANCIAL STATEMENTS
Jobs-4-U Employment Service, Inc.
Balance Sheet
April 30, 2012
Assets
Liabilities
Cash $
Salary payable
$ 1,200
Accounts receivable
5,600
Supplies
500
Stockholders’ Equity
Equipment
$32,500
Common stock
13,000
Accu. Depr (15,400)
17,100
Retained earnings
9,900
Total stockholders’ equity
22,900
Total assets
$24,100
Total liabilities and stockholders’ equity

49. Alternative Treatment of Prepaid Expenses
Prepaid Expenses (normally)
Advance payments of expenses
Debit an asset account
Adjust at end of period
Alternative
Debit an expense account

50. Prepaid Expense Initially debit and expense account
Adjust at end of period for unused amount

51. Unearned (Deferred) Revenues
Unearned Revenues (normally)
Advance receipt of revenues–creates liability
Credit a liability account
Adjust at end of period
Alternative
Credit a revenue account

52. Unearned (Deferred) Revenues
Initially credit a revenue account
Adjust at end of period for unearned amount