Adjusting

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The Adjusting The Adjusting ProcessProcess

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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

Describe the nature of the adjusting process.

Objective 1Objective 1Objective 1Objective 1

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Under the accrual basis of accounting, revenues are

reported in the income statement in the period in

which they are earned.

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The accounting concept that supports this approach to reporting of

revenues is called the revenue recognition concept.

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The accounting concept that supports reporting revenues and

related expenses in the same period is called the matching

concept, or matching principle.

3-1

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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.

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The analysis and updating of accounts at the end of the period before the financial statements

are prepared is called the adjusting process.

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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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Example Exercise 3-1

Indicate with a Yes or No whether or not each of the following accounts normally requires an adjusting entry.

For Practice: PE 3-1A, PE 3-1B 10

Follow My Example 3-1

a. No c. Yes e. Yesb. Yes d. No f. Yes

a. Cash c. Wages Expense e. Accounts Receivable

b. Prepaid Rent d. Office Equipment f. Unearned Rent

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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.

3-1Items That Need Adjusting

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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.


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Insert Exhibit 1

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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.


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Accrued expenses, sometimes referred to as accrued

liabilities, are expenses that have been incurred but have

not been recorded in the accounts.


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Classify the following items as (1) prepaid expense, (2) unearned revenue, (3) accrued expense, or (4) accrued revenue.



a. Accrued expense c. Unearned revenueb. Prepaid expense d. Accrued revenue

a. Wages owed but not c. Fees received but not yet yet paid. earned.

b. Supplies on hand. d. Fees earned but not yet received.

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Journalize entries for accounts requiring

adjustment.


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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.

3-2Adjusting Process for Prepaid Expenses

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Supplies (balance on trial balance) $2,000Supplies on hand, December 31 – 760Supplies used $1,240

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Supplies 1 240 00

Supplies used ($2,000 –

$760)

Dec. 31 1,240Dec. 31 1,240

SuppliesBal. 2,000

Supplies ExpenseBal. 800

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2,040760

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Dec. 31 Supplies Expense 1 240 002007

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The debit balance of $2,400 in NetSolutions’ Prepaid

Insurance account represents the December 1 prepayment of

insurance for 12 months.

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Dec. 31 200 Dec. 31 200Prepaid InsuranceBal.

2,400

Insurance Expense15 56

2,200

31 Insurance Expense 200 00

Prepaid Insurance 200 00

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15Insurance expired

($2,400/12).

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The prepaid insurance account had a beginning balance of $6,400 and was debited for $3,600 of premiums paid during the year. Journalize the adjusting entry required at the end of the year assuming the amount of unexpired insurance related to future periods is $3,250.


Insurance Expense 6,750Prepaid Insurance 6,750

Insurance expired ($6,400 +$3,600 – $3,250).

For Practice: PE 3-3A, PE 3-3B25

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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.

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Dec. 31

120

Dec. 31

120

Unearned RentBal. 360

Rent Revenue23 42

31 Unearned Rent 120 00

Rent Revenue 120 00

Rent earned ($360/3

months)

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3-2

240Bal.

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The balance in the unearned fees account, before adjustment at the end of the year, is $44,900. Journalize the adjusting entry required if the amount of unearned fees at the end of the year is $22,300.


Unearned Fees 22,600Fees Earned 22,600

Fees earned ($44,900 – $22,300).


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NetSolutions provided $500 in services during December for which the customer has not

been billed.

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Dec. 31 500Dec. 31 500

Accounts ReceivableBal. 16,340

Fees Earned12 41Bal. 2,220

31 Accounts Receivable 500 00

Fees Earned 500 00

Accrued fees (25 hrs.

x $20)

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3-2

2,720Bal. 16,840Bal.

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At the end of the current year, $13,680 of fees have been earned but have not been billed to clients. Journalize the adjusting entry to record the accrued fees.


Accounts Receivable 13,680Fees Earned 13,680

Accrued fees.


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At the end of December, accrued wages amounted to

$250. Without this adjusting entry, Wages Expense is understated.

3-2

3333

Dec. 31 250Dec. 31 250

Wages Payable Bal.

4,275

Wages Expense22 51

31 Wages Expense 250 00

Wages Payable 250 00

Accrued wages.

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Bal. 4,525

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Dec. 31 250Dec. 31 250

Wages Payable Bal.

4,275

Wages Expense22 51

Bal. 4,525

3-2

Closing entries will be discussed in a later chapter. For now, just be aware that Wages Expense is

closed after financial statements are prepare and its balance rolled back to zero.

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The payment of January 10 wages totaling $1,275 is shown below.

Jan. 10 Wages Expense 1 025 00

Wages Payable 250 00

Cash 1 275 00

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Dec. 31 250Dec. 31 250

Wages Payable Bal.

4,275

Wages Expense22 51

Bal. 4,525

Jan. 10 1,025

Jan. 10 250

An expense for wages of $1,025 is

recorded in the new fiscal year.

An expense for wages of $1,025 is

recorded in the new fiscal year.

The liability is cancelled.

The liability is cancelled.

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Sanregret Realty Co. pays weekly salaries of $12,500 on Friday for a five-day week ending on that day. Journalize the necessary adjusting entry at the end of the accounting period, assuming that the period ends on Thursday.


Salaries Expense 10,000Salaries Payable 10,000

Accrued salaries ($12,500/5x 4 days).


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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.

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As time passes, a fixed asset loses its ability to provide useful services.

This decrease in usefulness is called

depreciation.

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Normal titles for fixed asset accounts and their related contra asset accounts are as follows:

Fixed Asset Contra Asset

Land None—Land is not depreciatedBuildings Accumulated Depreciation—

BuildingsStore Equipment Accumulate Depreciation—Store

EquipmentOffice Equipment Accumulated Depreciation—Office

Equipment

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NetSolutions estimates the depreciation on its office

equipment to be $50 for the month of December.

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Dec. 31 50Depreciation Expense

Dec. 31 50Accum. Depr.—Office Equip. 1953

31 Depreciation Expense 50 00

Accum. Depreciation—

Office Equipment 50 00

Depreciation of

office equipment.

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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 Book valuevalue

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The estimated amount of depreciation on equipment for the current year is $4,250. Journalize the adjusting entry to record the depreciation.


Depreciation Expense 4,250Accumulated Depreciation— Equipment 4,250

Depreciation on equipment.


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Summarize the adjustment process


3-3

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3-3

(Continued)

Ledger with Adjusting Entries

—NetSolutions47

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(Continued) 3-3Ledger with

Adjusting Entries—NetSolutions

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(Continued) 3-3Ledger with


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(Concluded) 3-3Ledger with


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For the year ending December 31, 2008, Mann Medical Co. mistakenly omitted adjusting entries for (1) $8,600 of unearned revenue that was earned, (2) earned revenue that was not billed of $12,500, and (3) accrued wages of $2,900. Indicate the combined effect of the errors on (a) revenues, (b) expenses, and (c) net income for 2008.


a. Revenues were understated by $21,100 ($8,600 + $12,500).

b. Expenses were understated by $2,900.c. Net income was understated by $18,200 ($8,600

+12,500 – $2,900).


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3-4

Prepare an adjusted trial balance.


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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.

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5454

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For each of the following errors, considered individually, indicate whether the error would cause the adjusted trial balance totals to be unequal. If the error would cause the adjusted trial balance total to be unequal, indicate whether the debit or credit total is higher and by how much.a. The adjustment for accrued fees of $5,340 was

journalized as a debit to Accounts Payable for $5,340 and a credit to Fees Earned of $5,340.

b. The adjustment for depreciation of $3,260 was journalized as a debit to Depreciation Expense for $3,620 and a credit to Accumulated Depreciation for $3,260. 55

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a. The totals are equal even though the debit should have been to Accounts Receivable instead of Accounts Payable.

b. The totals are unequal. The debit total is higher by $360 ($3,620 – $3,260).

For Practice: PE 3-9A, PE 3-9B

3-4

Adjusting

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