1. 3 The Adjusting Process Accounting 26e C H A P T E R Warren Reeve
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2. Nature of the Adjusting Process (slide 1 of 2)
The accounting period concept requires that revenues and expenses be reported in the proper period.
Under the accrual basis of accounting, revenues are reported on the income statement in the period in which they are earned.
For example, revenue is reported when the services are provided to customers.
Cash may or may not be received from customers during this period.
The accounting concept supporting this reporting of revenues is called the revenue recognition concept.
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3. Nature of the Adjusting Process (slide 2 of 2)
Under accrual accounting, revenues are recognized when services have been performed or products have been delivered to customers. Revenue is measured as assets received, such as cash or accounts receivable, in exchange for a service or product. This process of recording revenues is called revenue recognition.
The accounting concept supporting reporting revenues and related expenses in the same period is called the matching concept.
Under the cash basis of accounting, revenues and expenses are reported on the income statement in the period in which cash is received or paid.
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4. The Adjusting Process (slide 1 of 2)
Under the accrual basis, some of the accounts need updating at the end of the accounting period for the following reasons:
Some expenses are not recorded daily.
Some revenues and expenses are incurred as time passes rather than as separate transactions.
Some revenues and expenses may be unrecorded.
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5. The Adjusting Process (slide 2 of 2)
The analysis and updating of accounts at the end of the period before the financial statements are prepared is called the adjusting process.
The journal entries that bring the accounts up to date at the end of the accounting period are called adjusting entries.
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6. Types of Accounts Requiring Adjustment
The following basic types of accounts require adjusting entries:
Prepaid expenses are the advance payment of future expenses and are recorded as assets when cash is paid.
Unearned revenues are the advance receipt of future revenues and are recorded as liabilities when cash is received.
Accrued revenues are unrecorded revenues that have been earned and for which cash has yet to be received.
Accrued expenses are unrecorded expenses that have been incurred and for which cash has yet to be paid.
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7. Depreciation Expense (slide 1 of 4)
Fixed assets, or plant assets, are physical resources that are owned and used by a business and are permanent or have a long life.
As time passes, a fixed asset loses its ability to provide useful services. This decrease in usefulness is called depreciation.
All fixed assets, except land, lose their usefulness and, thus, are said to depreciate.
As a fixed asset depreciates, a portion of its cost should be recorded as an expense. This periodic expense is called depreciation expense.
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8. Depreciation Expense (slide 2 of 4)
The fixed asset account is not decreased (credited) when making the related adjusting entry. This is because both the original cost of a fixed asset and the depreciation recorded since its purchase are reported on the balance sheet. Instead, an account entitled Accumulated Depreciation is increased (credited).
Accumulated depreciation accounts are called contra accounts, or contra asset accounts.
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9. Depreciation Expense (slide 3 of 4)
Normal titles for fixed asset accounts and their related contra asset accounts are as follows:
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10. Depreciation Expense (slide 4 of 4)
The difference between the original cost of the office equipment and the balance in the accumulated depreciation—office equipment account is called the book value of the asset (or net book value).
It is computed as follows:
Book Value of Asset = Cost of the Asset – Accumulated Depreciation of Asset
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11. Adjusted Trial Balance
The purpose of the adjusted trial balance is to verify the equality of the total debit and credit balances before the financial statements are prepared.
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12. Financial Analysis and Interpretation: Vertical Analysis
Comparing each item in a financial statement with a total amount from the same statement is referred to as vertical analysis.
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