P1105 FUNDAMENTALS OF ACCOUNTING

Chapter
3
The Adjusting Process
 CH 3: THE ADJUSTING PROCESS

LEARNING OBJECTIVES
AFTER COMPLETING THIS LESSON, THE STUDENT
SHOULD BE ABLE TO:

1. Accrual-basis vs Cash-basis accounting.

2. Apply revenue & expense matching principles.

3. Make adjusting entries @ end of accting period

4. Prepare an adjusted trial balance

5. Prepare fin statements from adjusted trial balance

 ACCOUNTING CONCEPTS
Business Transactions Chapter One
Journal Entries Chapter Two
Posting to Ledgers
Trial Balance
Adjustments Chapter Three

Adjusted Trial Balance

Financial Statements
 1 ACCRUAL VS CASH ACCOUNTING

Accrual-basis:
Accrual-basis: Cash-basis:
Cash-basis:
Transactions
Transactions are
are recorded
recorded Transactions
Transactions areare
when
when revenues
revenues areare recorded
recorded when
when
earned
earned oror expenses
expenses cash
cash is
is paid
paid or
or
are
are incurred.
incurred. cash
cash is
is received.
received.

REVENUE EXPENSES
ACCURAL RECORDED WHEN RECORDED WHEN
BASIS EARNED INCURRED
CASH RECORDED WHEN RECORDED WHEN
BASIS CASH IS RECEIVED CASH IS PAID
92
OBJ 1 ACCRUAL VS CASH ACCOUNTING

Cash-Basis Accounting
Only records cash receipts and cash payments
Ignores receivables, payables, and depreciation
Faulty accounting

Accrual-Basis Accounting
Records the effects of transactions as they occur
Correct way to do accounting
92
OBJ 1 ACCRUAL VS CASH ACCOUNTING
EXAMPLE
Your business collects $3,000 from a customer
on January 1 for services to be provided in Jan.,
Feb., & March. How much service revenue
would you record?
Jan. Feb. March
Cash-Basis Accounting $3,000
Accrual-Basis Accounting $1,000 $1,000 $1,000
92
OBJ 1 ACCRUAL VS CASH ACCOUNTING
EXAMPLE
Your business prepays $6,000 for advertising that
will run during Oct., Nov., and Dec. How much
advertising expense would you record?
Oct. Nov. Dec.
Cash-Basis Accounting $6,000
Accrual-Basis Accounting $2,000 $2,000 $2,000
 THE ACCOUNTING PERIOD

Accounting Period
Managers
Managers adopt
adopt anan
artificial
artificial period
period of
of time
time
to
to evaluate
evaluate performance.
performance.

Interim Period Statements

Monthly
Monthly Quarterly
Quarterly Semi-annually
Semi-annually
 Now

Lets discuss adjusting entries which

are key to accrual accounting!
102 Make adjusting entries at the
OBJ 3
end of the accounting period.

Accruals Basis

What is an accrual?
It is the recognition of an expense or
revenue that has arisen but has not yet
been recorded.
Expenses or revenues are recorded
before the cash settlement.
97 Make Adjusting Entries At The
OBJ 3 End Of The Accounting Period.

Adjusting Entries
Assign revenue to the period
earned.
Assign expenses to the period
incurred.
Bring related asset and liability
accounts into correct balance.
Study this material carefully, because it is
the most challenging topic in all of
introductory accounting.
 At the end of the
period, we need to
make adjusting entries
to get the accounts up
to date for the financial
statements.
 Adjusting Entries

Adjusting Every
entries are adjusting
needed whenever entry involves a
revenue or expenses change in either a
affect more than one revenue or expense
accounting and an asset
period. or liability.
 Types of Adjusting Entries

Converting
Converting Converting
Converting
assets
assets to
to liabilities
liabilities to
to
expenses
expenses revenue
revenue

Accruing
Accruing Accruing
Accruing
unpaid
unpaid uncollected
uncollected
expenses
expenses revenues
revenues
97 Make adjusting entries at the
OBJ 3
2
end of the accounting period.
Two Types Of Adjusting Entries
Prepaids
Prepaids or
or Deferrals
Deferrals

The Cash transaction occurs before related expense

Accruals
Accruals
Record expense or revenue before related
cash settlement
97 Make Adjusting Entries At The
OBJ 3 End Of The Accounting Period.
Five Categories Of Adjusting Entries
Prepaids
Prepaids or
or Deferrals
Deferrals
1.
1. Prepaid
Prepaid expenses
expenses 3.
3. Unearned
Unearned revenues
revenues
2.
2. Depreciation
Depreciation
Cash paid first expense/revenue later
Accruals
Accruals
4.
4. Accrued
Accrued expenses
expenses 5.
5. Accrued
Accrued revenues
revenues
Expense/Revenue first - Cash paid later
97 Make Adjusting Entries At The
OBJ 3 End Of The Accounting Period.
Five Categories Of Adjusting Entries
Prepaids
Prepaids or
or Deferrals
Deferrals
1.
1. Prepaid
Prepaid expenses
expenses 2.
2. Unearned
Unearned revenues/
revenues/
Current
Current Assets
Assets Revenue
Revenue Received
Received
in
in Advance
Advance
Current
Current Liabilities
Liabilities
Accruals
Accruals
3.
3. Accrued
Accrued expenses
expenses 4.
4. Accrued
Accrued revenues
revenues
Current
Current Liabilities
Liabilities Current
Current Assets
Assets
101 Make adjusting entries at the
OBJ 3
end of the accounting period.
Contra Accounts
Accumulated
Accumulated depreciation
depreciation
is
is aa contra
contra account
account to
to plant
plant assets.
assets.
AA contra
contra
AA contra accounts
accounts normal
normal
contra account
account balance
has
has aa balance isis
companion opposite
opposite that
that of
of
companion the
account.
account. the companion
companion
account.
account.
All
All contra
contra assets
assets have
have credit
credit balances.
balances.
101 Make adjusting entries at the
OBJ 3
end of the accounting period.
Wood Co Example
Partial Balance Sheet
December 31, 2002
Plant assets:
Machinery $30,000
Less: Accumulated depreciation (10,000)
Total $20,000

Contra
Contra account
account
Book value
96 Make adjusting entries at the
OBJ 3
end of the accounting period.

ADJUSTING RULES
Adjusting entries always have...
one income statement account
and...
one balance sheet account.
Adjusting entries never involve cash.
96 Make adjusting entries at the
OBJ 3
end of the accounting period.
ADJUSTMENT
REVENUE UNEARNED REV
REVENUE
FIRST LATER
INSUR EXPENSE
EXPENSE PREPAID INSUR
DEPREC EXPENSE
CASH ACUM DEPREC
TRANSACTION
REVENUE ACCTS REC
REVENUE
LATER FIRST

EXPENSE WAGE EXPENSE

WAGE PAYBLE
96 Make adjusting entries at the
OBJ 3
end of the accounting period.
ADJUSTMENT
USING UP INSUR EXPENSE
CASH FIRST PREPAID INSUR
SOMETHING
DEPREC EXPENSE
EXPENSE ACUM DEPREC
WAGE EXPENSE
ACCUMULATING WAGE PAYBLE
SUBJECT OF
TRANSACTION
COLLECT ACCTS REC
AFTER REVENUE
REVENUE
COLLECT IN UNEARNED REV
CASH FIRST ADVANCE REVENUE
96 Make adjusting entries at the
OBJ 3
end of the accounting period.
CATEGORIES OF DEBIT CREDIT
ADJUSTING ENTRY Exp Acct Asset/Liab
PRE PAID ASSET Acct
1. CURRENT
SUPPLIES SUPPLIES EXP SUPPLIES
INSURANCE INSURANCE EXP PRE PD INS
RENT RENT EXP PRE PD RENT
2. PLANT (DEPRECIATION)
FURN, EQUIP DEPREC EXP ACCUM DEPREC
ACCURED EXPENSE
WAGES WAGES EXP WAGES PAYABLE
SALARIES SALARIES EXP SALARIES PAYABLE
UTILITIES UTILITIES EXP UTILITIES PAYABLE
96
OBJ 4 Prepare an adjusted trial balance.

Adjusted Trial Balance

The adjusting process starts with the
unadjusted trial balance.
Adjusting entries are made at the end of
the accounting period and then an
adjusted trial balance is prepared.
The adjusted trial balance serves as the
basis for the preparation of the financial
statements.
 Adjusted Trial Balance to
Financial Statements

Once we have the Adjusted Trial

Balance completed, we can take those
numbers to create the financial
statements.
100 Prepare Financial
OBJ 5
Statements From Adj Trial Bal

Financial Statements
Financial statements have two parts:
1 The first part is the heading and
includes the following:
name of the entity
title of the statement
date or period covered
2 The second part is the body of the
statement.
09 Prepare Financial
OBJ 5
Statements From Adj Trial Bal
Financial Statements Example
Prensa Insurance
Income Statement
Year Ended December 31, 2002
Revenue
Revenues from insurance services $50,000
Expenses
Less: Salaries expense 14,275
Supplies expense 250
Rent expense 3,600
Utilities expense 625
Interest expense 600
Depreciation 650
Total Expenses 20,000
Net income $30,000
100 Prepare Financial
OBJ 5
Statements From Adj Trial Bal
Financial Statements Example
Prensa Insurance
Balance Sheet
As of December 31, 2002
Assets:
Cash $189,150
Accounts receivable 5,000
Supplies inventory 100
Prepaid rent 1,000
Office equipment 5,000
Less: Accumulated depreciation (250)
Total assets $200,000
100 Prepare Financial
OBJ 5
Statements From Adj Trial Bal
Financial Statements Example
Liabilities and Equities:
Utilities payable $ 150
Interest payable 600
Accounts payable (supplies) 250
Salaries payable 4,100
Bank loan 64,900
Total liabilities $ 70,000

Owners equity 130,000

Total liabilities and owners equity $200,000
 CH 3: THE ADJUSTING PROCESS
SUMMARY
2. New Procedures
1. New Terms a. Adjusting Entries
a. Accrual Basis b. Adjusted
b. Cash Basis Trial Balance
c. Revenue Principle
d. Matching Principle
e. Prepaid Expense
f. Depreciation
g. Contra-Account
h. Accrued Expenses