The Adjusting Process

1. The Adjusting Process Chapter 3

2. Learning Objectives • Describe the nature of the adjusting process. • Journalize entries for accounts requiring adjustment. • Summarize the adjustment process. • Prepare an adjusted trial balance. • Describe and illustrate the use of vertical analysis in evaluating a company’s performance and financial condition.

3. Learning Objective 1 • Describe the nature of the adjusting process.

4. Nature of the Adjusting Process • The accounting period concept requires that revenues and expenses be reported in the proper period.

5. Nature of the Adjusting Process • Under the accrual basis of accounting, revenues are reported on the income statement in the period in which they are earned.

6. Nature of the Adjusting Process • The accounting concept supporting the reporting of revenues when they are earned regardless of when cash is received is called the revenue recognition concept.

7. LO 1 Nature of the Adjusting Process • The accounting concept supporting reporting revenues and related expenses in the same period is called the matchingconcept, or matching principle.

8. LO 1 Nature of the Adjusting Process • 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.

9. LO 1 The Adjusting Process • 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.

10. LO 1 The Adjusting Process • The analysis and updating of accounts at the end of the period before the financial statements are prepared is called the adjusting process.

11. LO 1 The Adjusting Process • 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.

12. EE 3-1

13. LO 1 Types of Accounts Requiring Adjustment • Prepaid expenses are the advance payment of future expenses and are recorded as assets when cash is paid.

14. LO 1 Prepaid Expenses (continued)

15. LO 1 Prepaid Expenses (concluded)

16. LO 1 Types of Accounts Requiring Adjustment • Unearned revenues are the advance receipt of futurerevenues and are recorded as liabilities when cash is received.

17. LO 1 Unearned Revenues (continued)

18. LO 1 Unearned Revenues (concluded)

19. LO 1 Types of Accounts Requiring Adjustment • Accrued revenues are unrecorded revenues that have been earned and for which cash has yet to be received.

20. LO 1 Accrued Revenues (continued)

21. LO 1 Accrued Revenues (concluded)

22. LO 1 Types of Accounts Requiring Adjustment • Accrued expensesare unrecorded expenses that have been incurred and for which cash has not yet been paid.

23. LO 1 Accrued Expenses (continued)

24. LO 1 Accrued Expenses (concluded)

25. EE 3-2

26. Learning Objective 2 • Describe the nature of the adjusting process. • Journalize entries for accounts requiring adjustment.

27. LO 2 Adjusting Entries Unadjusted Trial Balance for NetSolutions NetSolutions Unadjusted Trial Balance December 31, 2011

28. LO 2 Adjusting Entries

29. LO 2 Prepaid Expenses NetSolutions’ suppliesaccount has a balance of $2,000 on the unadjusted trial balance. Some of these supplies have been used. On December 31, a count reveals that the amount of supplies on hand is $760. Supplies (balance on trial balance) $2,000 Supplies on hand, December 31 – 760 Supplies used $1,240

30. Accounting Equation Impact Assets = Liabilities + Owner’s Equity (Expense) LO 2 Prepaid Expenses increase decrease

31. LO 2 Prepaid Insurance The debit balance of $2,400 in NetSolutions’ prepaid insurance account represents the December 1 prepayment of insurance for 12 months.

32. Accounting Equation Impact Assets = Liabilities + Owner’s Equity (Expense) LO 2 Prepaid Insurance increase decrease

33. LO 2 Impact of Omitting Adjusting Entries

34. EE 3-3

35. LO 2 Unearned Revenues The credit balance of $360 in NetSolutions’ unearned rentaccount represents the receipt of three months’ rent on December 1 for December, January, and February. At the end of December, one month’s rent has been earned.

36. Accounting Equation Impact Assets = Liabilities + Owner’s Equity (Revenue) LO 2 Unearned Revenues increase decrease

37. LO 2 Impact of Omitting Adjusting Entry

38. EE 3-4

39. LO 2 Accrued Revenues NetSolutions signed an agreement with Danker Co. on December 15 to provide services at a rate of $20 per hour. As of December 31, NetSolutions had provided 25 hours of services. The revenue will be billed on January 15.

40. Accounting Equation Impact Assets = Liabilities + Owner’s Equity (Revenue) LO 2 Unearned Revenues increase increase

41. LO 2 Impact of Omitting Adjusting Entry

42. EE 3-5

43. LO 2 Accrued Wages

44. LO 2 Accrued Wages • 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, December 30 and 31.

45. Accounting Equation Impact Assets = Liabilities + Owner’s Equity (Expense) LO 2 Accrued Wages increase increase

46. LO 2 Accrued Wages NetSolutions paid wages of $1,275 on January 10. This payment includes the $250 of accrued wages recorded on December 31.

47. LO 2 Impact of Omitting Adjusting Entry

48. EE 3-6

49. LO 2 Depreciation Expense • Fixed assets, orplant 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.

50. LO 2 Depreciation Expense • 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.