The Adjusting Process

1. 0 3 The Adjusting Process

2. 0 After studying this chapter, you should be able to: Describe the nature of the adjusting process. Journalize entries for accounts requiring adjustment. Summarize the adjustment process. Prepare an adjusted trial balance.

3. 0 3-1 Objective 1 Describe the nature of the adjusting process. 3

4. Reporting Revenue and Expense TWO METHODS Cash Basis of Accounting Accrual Basis of Accounting

5. Cash Basis of Accounting • Revenue reported when cash is received • Expense reported when cash is paid • Does not properly match revenues and expenses

6. Accrual Basis of Accounting • Revenue reported when earned • Expense reported when incurred • Properly matches revenues and expenses in determining net income • Requires adjusting entries at end of period • It just sounds mean – it really isn’t

7. Not GAAP Accounting Accrual Basis Vs. Cash Basis Accrual Basis Revenues are recognized when earned and expenses are recognized when incurred. Cash Basis Revenues are recognized when cash is received and expenses recorded when cash is paid.

8. 0 3-1 Under the accrual basis ofaccounting, revenues are reported in the income statement in the period in which they are earned.

9. 0 3-1 The accounting concept that supports this approachtoreporting of revenues is called therevenue recognition concept.

10. 0 3-1 The accounting concept that supports reporting revenues and related expenses in the same period is called the matching concept, or matching principle.

11. 0 3-1 Under the cash basis ofaccounting, revenues and expenses are reported in the income statement in the period in which cash is received or paid.

12. 0 3-1 The analysis and updating of accounts at the end of the period before the financial statements are prepared is called the adjusting process.

13. 1 The Adjusting Process Under the accrual basis, at the end of the accounting period some of the accounts need updating 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.

14. 0 3-1 The journal entries that bring the accounts up to date at the end of the accounting period are called adjusting entries.

15. Example Exercise 3-1 Follow My Example 3-1 0 3-1 Indicate with a Yes or No whether or not each of the following accounts normally requires an adjusting entry. • Cash c. Wages Expense e. Accounts Receivable • Prepaid Rent d. Office Equipment f. Unearned Rent • No c. Yes e. Yes • Yes d. No?/Yes f. Yes For Practice: PE 3-1A, PE 3-1B 10

16. 0 3-1 Items That Need Adjusting 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.

17. 0 3-1 Items That Need Adjusting 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.

18. 0 3-1 Insert Exhibit 1 13

19. 0 3-1 Items That Need Adjusting 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.

20. 0 3-1 Items That Need Adjusting Accrued expenses, sometimes referred to as accrued liabilities, are expenses that have been incurred but have not been recorded in the accounts.

21. 0 3-1 16

22. Example Exercise 3-2 Follow My Example 3-2 0 3-1 Classify the following items as (1) prepaid expense, (2) unearned revenue, (3) accrued expense, or (4) accrued revenue. • Wages owed but not c. Fees received but not yet yet paid. earned. • Supplies on hand. d. Fees earned but not yet received. • Accrued expense c. Unearned revenue • Prepaid expense d. Accrued revenue 17 For Practice: PE 3-2A, PE 3-2B

23. 0 3-2 Objective 2 Journalize entries for accounts requiring adjustment.

24. 0 3-2 19

25. 0 3-2 Adjusting Process for Prepaid Expenses NetSolutions’ Suppliesaccount 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.

26. 0 3-2 Supplies (balance on trial balance) $2,000 Supplies on hand, December 31 – 760 Supplies used $1,240

27. 2007 Dec. 31 Supplies Expense 1 240 00 760 2,040 0 3-2 55 14 Supplies 1 240 00 Supplies used ($2,000 – $760) Supplies Expense Supplies 14 55 Bal. 2,000 Dec. 31 Adj 1,240 Bal. 800 Dec. 31 1,240 22

28. 0 3-2 The debit balance of $2,400 in NetSolutions’ PrepaidInsuranceaccount represents the December 1 prepayment of insurance for 12 months.

29. 2,200 0 3-2 56 31 Insurance Expense 200 00 Prepaid Insurance 200 00 15 Insurance expired ($2,400/12). Prepaid Insurance Insurance Expense 15 56 Dec. 31 Adj 200 Bal. 2,400 Dec. 31Adj 200 24

30. Example Exercise 3-3 Follow My Example 3-3 0 3-2 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 6,750 Prepaid Insurance 6,750 Insurance expired ($6,400 + $3,600 – $3,250). 25 For Practice: PE 3-3A, PE 3-3B

31. 0 3-2 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.

32. 240 Bal. 0 3-2 23 31 Unearned Rent 120 00 42 Rent Revenue 120 00 Rent earned ($360/3 months) Unearned Rent Rent Revenue 23 42 Dec. 31Adj 120 Bal. 360 Dec. 31 Adj. 120 27

33. Example Exercise 3-4 Follow My Example 3-4 0 3-2 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 22,600 Fees Earned 22,600 Fees earned ($44,900 – $22,300). 28 For Practice: PE 3-4A, PE 3-4B

34. 2 Accrued Revenues NetSolutions signed an agreement with Danker Co. on December 15 to provide services at $20 per hour. As of December 31, NetSolutions had provided 25 hours of assistance.

35. 0 3-2 NetSolutions provided (25 hrs * $20) $500 in services during December for which the customer has not been billed.

36. Bal. Bal. 2,720 16,840 0 3-2 12 31 Accounts Receivable 500 00 Fees Earned 500 00 41 Accrued fees (25 hrs. x $20) Fees Earned Accounts Receivable 12 41 Bal. 2,220 Bal. 16,340 Dec. 31Adj 500 Dec. 31Adj 500 30

37. Example Exercise 3-5 Follow My Example 3-5 0 3-2 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 13,680 Fees Earned 13,680 Accrued fees. 31 For Practice: PE 3-5A, PE 3-5B

38. 2 Accrued Expenses NetSolutions pays it employees biweekly. During December, NetSolutions paid wages of $950 on December 13 and $1,200 on December 27. As of December 31, NetSolutions owes $250 of wages to employees for Monday and Tuesday.

39. 0 3-2 Without this adjusting entry, Wages Expenseis understated.

40. Bal. 4,525 0 3-2 51 31 Wages Expense 250 00 Wages Payable 250 00 22 Accrued wages. 51 Wages Payable Wages Expense 22 Dec. 31Adj 250 Bal. 4,275 Dec. 31Adj 250 33

41. Bal. 4,525 0 3-2 51 Wages Payable 22 Wages Expense Dec. 31 250 Bal. 4,275 Dec. 31 250 Closing entries will be discussed in a later chapter. For now, just be aware that Wages Expense is closed after financial statements are prepared and its balance rolled back to zero. 34

42. 0 3-2 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 35

43. Wages Payable 22 Wages Expense 51 Dec. 31 250 Jan. 10 250 Bal. 4,275 Dec. 31 250 Jan. 10 1,025 Bal. 4,525 0 3-2 The liability is cancelled. An expense for wages of $1,025 is recorded in the new fiscal year. 36

44. Example Exercise 3-6 Follow My Example 3-6 0 3-2 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 10,000 Salaries Payable 10,000 Accrued salaries ($12,500/5 x 4 days). 37 For Practice: PE 3-6A, PE 3-6B

45. 0 3-2 Physical resources that are owned and used by a business and are permanent or have a long life are called fixed assets, orplant assets.

46. 0 3-2 As time passes, a fixed asset loses its ability to provide useful services. This decrease in usefulness is called depreciation.

47. 0 3-2 Normal titles for fixed asset accounts andtheir relatedcontra assetaccounts are asfollows: Fixed Asset Contra Asset Land None—Land is not depreciated Buildings Accumulated Depreciation— Buildings Store Equipment Accumulate Depreciation—Store Equipment Office Equipment Accumulated Depreciation—Office Equipment

48. 0 3-2 NetSolutions estimates the depreciation on its office equipment to be $50 for the month of December.

49. 0 3-2 53 31 Depreciation Expense 50 00 Accum. Depreciation— Office Equipment 50 00 19 Depreciation of office equipment. Depreciation Expense Accum. Depr.—Office Equip. 19 53 Dec. 31Adj 50 Dec. 31Adj 50 42

50. 0 3-2 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