s t i n g

A d j u
Th e o c e ss
P r
t er 3
C h ap
c. 2014 Cengage Learning.   All Rights Reserved.  May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objectives

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.
5. Describe and illustrate the use of vertical analysis in
evaluating a company’s performance and financial
condition.
 Learn
i ng O
bj e ct i v e 1
Desc
ribe t
he na
tu ure of
the ad
justin
proce g
ss.

c. 2014 Cengage Learning.   All Rights Reserved.  May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Nature of the Adjusting Process

o The accounting period concept requires that revenues

and expenses be reported in the proper period.
Nature of the Adjusting Process

o Under the accrual basis of accounting, revenues are

reported on the income statement in the period in
which they are earned.
Nature of the Adjusting Process

o The accounting concept supporting the reporting of

revenues when they are earned regardless of when
cash is received is called the revenue recognition
concept.
Nature of the Adjusting Process

o The accounting concept supporting reporting

revenues and related expenses in the same period is
called the matching concept, or matching principle.
Nature of the Adjusting Process

o 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.
The Adjusting Process

o 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.
The Adjusting Process

o The analysis and updating of accounts at the end of

the period before the financial statements are
prepared is called the adjusting process.
The Adjusting Process

o The analysis and updating of accounts at the end of

the period before the financial statements are
prepared is called the adjusting process.
o The journal entries that bring the accounts up to date
at the end of the accounting period are called
adjusting entries.
Types of Accounts Requiring Adjustment

o Prepaid expenses are the advance payment of future

expenses and are recorded as assets when cash is
paid.
 PREPAID
EXPENSES

(continued)
 PREPAID
EXPENSES

(concluded)
Types of Accounts Requiring Adjustment

o Unearned revenues are the advance receipt of future

revenues and are recorded as liabilities when cash is
received.
UNEARNED
REVENUES

(continued)
UNEARNED
REVENUES

(concluded)
Types of Accounts Requiring Adjustment

o Accrued revenues are unrecorded revenues that have

been earned and for which cash has yet to be
received.
ACCRUED
REVENUES

(continued)
ACCRUED
REVENUES

(concluded)
Types of Accounts Requiring Adjustment

o Accrued expenses are unrecorded expenses that have

been incurred and for which cash has yet to be paid.
ACCRUED
EXPENSES

(continued)
ACCRUED
EXPENSES

(concluded)
 Learn
i ng O
Journ bj ectiv
alize
entrie
s for
e 2
accou
nts re
quirin
adjus g
t m en
t.

c. 2014 Cengage Learning.   All Rights Reserved.  May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
ADJUSTING
ENTRIES
ADJUSTING
ENTRIES
Prepaid Expenses

o NetSolutions’ supplies account 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
 PREPAID
EXPENSES

Accounting Equation Impact

Assets = Liabilities + Owner’s Equity (Expense)
increase

decrease
Prepaid Insurance

o The debit balance of $2,400 in NetSolutions’ prepaid

insurance account represents the December 1
prepayment of insurance for 12 months.
 PREPAID
INSURANCE

Accounting Equation Impact

Assets = Liabilities + Owner’s Equity (Expense)
increase

decrease
Impact of Omitting Adjusting Entries
Unearned Revenues

o The credit balance of $360 in NetSolutions’ unearned

rent account 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.
UNEARNED
REVENUES

Accounting Equation Impact

Assets = Liabilities + Owner’s Equity (Revenue)

increase
decrease
Impact of Omitting Adjusting Entry
Accrued Revenues

o 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.
UNEARNED
REVENUES

Accounting Equation Impact

Assets = Liabilities + Owner’s Equity (Revenue)

increase increase
Impact of Omitting Adjusting Entry
Accrued Expenses: Accrued Wages
Accrued Wages

o 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.
ACCRUED WAGES

Accounting Equation Impact

Assets = Liabilities + Owner’s Equity (Expense)

increase increase
Accrued Wages

o NetSolutions paid wages of $1,275 on January 10.

This payment includes the $250 of accrued wages
recorded on December 31.
IMPACT OF
OMITTING
ADJUSTING
ENTRY
Depreciation Expense

o Fixed assets, or plant assets, are physical resources

that are owned and used by a business and are
permanent or have a long life.
o As time passes, a fixed asset loses its ability to
provide useful services. This decrease in usefulness is
called depreciation.
Depreciation Expense

o All fixed assets, except land, lose their usefulness and

, thus, are said to depreciate.
o As a fixed asset depreciates, a portion of its cost
should be recorded as an expense. This periodic
expense is called depreciation expense.
Depreciation Expense

o 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).
o Accumulated depreciation accounts are called contra
accounts, or contra asset accounts.
Depreciation Expense

o Normal titles for fixed asset accounts and their

related contra asset accounts are as follows:
Depreciation Expense

o NetSolutions estimates the depreciation on its office

equipment to be $50 for the month of December.
DEPRECIATION
EXPENSE

Accounting Equation Impact

Assets = Liabilities + Owner’s Equity (Expense)

increase

increase
 Depreciation Expense

o 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 shown below.

Book Value of Asset = Cost of the Asset – Accumulated Depreciation of Asset

Book Value of Off. Equip. = Cost of Off. Equip. – Acc. Deprec. of Office Equip.
Book Value of Off. Equip.= $1,800 – $50
Book Value of Off. Equip.= $1,750
IMPACT OF
OMITTING
ADJUSTING
ENTRY
 Learn
i ng O
bj ectiv
Summ
arize
the a
e 3
djust
ment
proce
ss.

c. 2014 Cengage Learning.   All Rights Reserved.  May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
SUMMARY OF
ADJUSTMENT
PROCESS

(continued)
SUMMARY OF
ADJUSTMENT
PROCESS

(continued)
SUMMARY OF
ADJUSTMENT
PROCESS

(continued)
SUMMARY OF
ADJUSTMENT
PROCESS

(continued)
SUMMARY OF
ADJUSTMENT
PROCESS

(concluded)
ADJUSTING
ENTRIES
ADJUSTING
ENTRIES
LEDGER WITH
ADJUSTING
ENTRIES

(continued)
 LEDGER
WITH
ADJUSTING
ENTRIES
LEDGER WITH
ADJUSTING
ENTRIES
 Learn
i ng O
bject
i ve
Prepa
r e an
adj usted
t r i al b
alanc
4
e.

c. 2014 Cengage Learning.   All Rights Reserved.  May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Adjusted Trial Balance

o 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.
ADJUSTED TRIAL
BALANCE
 Learn
i ng O
Desc bject
i ve
5
ribe a
nd ill
analy ustra
sis
perfo te t
s i n ev the us
rman aluat e of v
ce an in e
d fina g a comp rtical
ncial any’s
condi
t i on

c. 2014 Cengage Learning.   All Rights Reserved.  May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Vertical Analysis

o Comparing each item in a financial statement with a

total amount from the same statement is referred to as
vertical analysis.
Vertical Analysis

$12,500
= .067 or 6.7%
$187,500
Vertical Analysis

$3,000
= .02 or 2%
$150,000
 s t i n g
A d j u
Th e o c e ss
P r
E n d
Th ee
c. 2014 Cengage Learning.   All Rights Reserved.  May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.