Chapter Two Part Two Adjusting Entries and Completing The Accounting

Adjusting the Accounts and completing
the accounting cycle
Learning Objectives
After studying this chapter, you should be able to:
1. Explain the time period assumption.
2. Explain the accrual basis of accounting.
3. Explain the reasons for adjusting entries.
4. Identify the major types of adjusting entries.
5. Prepare adjusting entries for deferrals.
6. Prepare adjusting entries for accruals.
7. Describe the nature and purpose of an adjusted trial balance.
3-1
Completing the
Learning Objectives
Accounting Cycle
After studying this chapter, you should be able to:
8. Prepare a worksheet.
9. Explain the process of closing the books.
10. Describe the content and purpose of a post-closing trial

balance.
3-2
Timing Issues
Accountants divide the economic life of a business into

artificial time periods (Time Period Assumption).
.....
Jan. Feb. Mar. Apr. Dec.
 Generally a month, a quarter, or a year.

 Also known as the “Periodicity Assumption”
3-3 LO 1 Explain the time period assumption.

Timing Issues
Fiscal and Calendar Years

 Monthly and quarterly time periods are called interim
periods.
 Most large companies must prepare both quarterly and

annual financial statements.
 Fiscal Year = Accounting time period that is one year in

length.
 Calendar Year = January 1 to December 31.
3-4 LO 1 Explain the time period assumption.

Timing Issues
Accrual- vs. Cash-Basis Accounting

Accrual-Basis Accounting
 Transactions recorded in the periods in which the
events occur.
 Revenues are recognized when the services are

performed, rather than when cash is received.
 Expenses are recognized when incurred, rather than

when paid.
3-5 LO 2 Explain the accrual basis of accounting.

Timing Issues
Accrual- vs. Cash-Basis Accounting

Cash-Basis Accounting
 Revenues recognized when cash is received.
 Expenses recognized when cash is paid.
 Cash-basis accounting is not in accordance with

International Financial Reporting Standards (IFRS).

Timing Issues
Recognizing Revenues and Expenses

Revenue Recognition Principle
Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.
In a service enterprise,
revenue is considered to be
earned at the time the service
is performed.

Timing Issues
Recognizing Revenues and Expenses

Expense Recognition Principle
Match expenses with
revenues in the period when
the company makes efforts to
generate those revenues.
“Let the expenses follow

the revenues.”

Timing Issues
Illustration 3-1
IFRS relationships in revenue
and expense recognition

The Basics of Adjusting Entries
Adjusting Entries
 Ensure that the revenue recognition and expense
recognition principles are followed.
 Necessary because the trial balance may not contain
up-to-date and complete data.
 Required every time a company prepares financial
statements.
 Will include one income statement account and one
statement of financial position account.
3-10 LO 3 Explain the reasons for adjusting entries.

Types of Adjusting Entries

Illustration 3-2
Categories of adjusting entries
Deferrals Accruals
1. Prepaid Expenses. 3. Accrued Revenues.

Expenses paid in cash before Revenues for services
they are used or consumed. performed but not yet received
in cash or recorded.
2. Unearned Revenues. 4. Accrued Expenses.

Cash received before services Expenses incurred but not yet
are performed. paid in cash or recorded.
3-11 LO 4 Identify the major types of adjusting entries.

Types of Adjusting Entries
Trial Balance –
Each account is
analyzed to
determine whether
it is complete and
up-to-date.
Illustration 3-3
3-12 LO 4 Identify the major types of adjusting entries.

Adjusting Entries for Deferrals

Deferrals are either:
 Prepaid expenses
OR
 Unearned revenues.
3-13 LO 5 Prepare adjusting entries for deferrals.

Prepaid Expenses
Payment of cash, that is recorded as an asset because
service or benefit will be received in the future.
Cash Payment BEFORE Expense Recorded
Prepayments often occur in regard to:

 insurance  rent
 supplies  equipment
 advertising  buildings

Prepaid Expenses
 Expire either with the passage of time or through use.
 Adjusting entry:
► Increase (debit) to an expense account and
► Decrease (credit) to an asset account.
Illustration 3-4

Illustration: Pioneer Advertising Agency

purchased supplies costing $2,500 on
October 5. Pioneer recorded the payment
by increasing (debiting) the asset
Supplies. This account shows a balance
of $2,500 in the October 31 trial balance.
An inventory count at the close of
business on October 31 reveals that
$1,000 of supplies are still on hand.
Oct. 31 Supplies expense 1,500

Supplies 1,500

Illustration 3-5
3-17 LO 5
Illustration: On October 4, Pioneer

Advertising paid $600 for a one-year fire
insurance policy. Coverage began on
October 1. Pioneer recorded the payment
by increasing (debiting) Prepaid
Insurance. This account shows a balance
of $600 in the October 31 trial balance.
Insurance of $50 ($600 ÷ 12) expires
each month.
Oct. 31 Insurance expense 50

Prepaid insurance 50

Illustration 3-6
3-19 LO 5
Depreciation
 Buildings, equipment, and vehicles (assets with long
lives) are recorded as assets, rather than an expense,
in the year acquired.
 Depreciation allocates a portion of the asset’s cost as

an expense during each period of the asset’s useful life.
 Depreciation does not attempt to report the actual

change in the value of the asset.

Illustration: For Pioneer Advertising, assume

that depreciation on the equipment is $480 a
year, or $40 per month.
Oct. 31
Depreciation expense 40
Accumulated depreciation 40
Accumulated Depreciation is called a contra

asset account.

Illustration 3-7
3-22 LO 5
Statement Presentation
 Accumulated Depreciation is a contra asset account
(credit).
 Appears just after the account it offsets (Equipment) on
the statement of financial position.
 Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.
Illustration 3-8

Illustration 3-9

Unearned Revenues
Receipt of cash that is recorded as a liability because service
has not be performed.
Cash Receipt BEFORE Revenue Recorded
Unearned revenues often occur in regard to:

 Rent  Magazine subscriptions
 Airline tickets  Customer deposits

Unearned Revenues
 Adjusting entry is made to record the revenue for
services performed and to show the liability that remains.
 Results in a decrease (debit) to a liability account and an
increase (credit) to a revenue account.
Illustration 3-10

Illustration: Pioneer Advertising received $1,200 on October 2

from R. Knox for advertising services expected to be completed by
December 31. Unearned Service Revenue shows a balance of
$1,200 in the October 31 trial balance. Analysis reveals that the
company earned $ 400 of those fees in October.
Oct. 31 Unearned service revenue 400

Service revenue 400

Illustration 3-11
3-28 LO 5
Illustration 3-12

Adjusting Entries for Accruals

Accruals are made to record
 Revenues for services performed
OR
 Expenses incurred
in the current accounting period that have not been

recognized through daily entries.
3-30 LO 6 Prepare adjusting entries for accruals.

Accrued Revenues
Revenues for services performed but not yet received in cash
or recorded.
Revenue Recorded BEFORE Cash Receipt
Accrued revenues often occur in regard to:

 Interest  Rent
 Services performed

Accrued Revenues
 Adjusting entry shows the receivable that exists and
records the revenues for services performed.
► Increases (debits) an asset account and
► Increases (credits) a revenue account.
Illustration 3-13
3-32 LO 6
Illustration: In October Pioneer Advertising

Agency recognized $200 for advertising
services performed but not recorded.
Oct. 31
Accounts receivable 200
Service revenue 200
On November 10, Pioneer receives cash of $

200 for the services performed.
Nov. 10 Cash 200

Accounts receivable 200
Illustration 3-14
3-34 LO 6
Illustration 3-15

Accrued Expenses
Expenses incurred but not yet paid in cash or recorded.
Expense Recorded BEFORE Cash Payment
Accrued expenses often occur in regard to:

 Rent  Taxes
 Interest  Salaries

Accrued Expenses
 Adjusting entry records the obligation and recognizes
the expense.
► Increase (debit) an expense account and
► Increase (credit) a liability account.
Illustration 3-16
3-37 LO 6
Illustration: Pioneer Advertising signed a three-month note

payable in the amount of $5,000 on October 1. The note requires
Pioneer to pay interest at an annual rate of 12%.
Illustration 3-17
Oct. 31 Interest expense 50

Interest payable 50

Illustration 3-18
3-39 LO 6
Illustration: Pioneer Advertising last paid salaries on October 26;

the next payment of salaries will not occur until November 9. The
employees receive total salaries of $2,000 for a five-day work
week, or $400 per day. Thus, accrued salaries at October 31 are
$1,200 ($ 400 x 3 days).
Illustration 3-19

Illustration 3-20
3-41 LO 6
Illustration 3-21

Summary of Basic Relationships

Illustration 3-22

The Adjusted Trial Balance
Adjusted Trial Balance

 Prepared after all adjusting entries are journalized and
posted.
 Purpose is to prove the equality of debit balances and

credit balances in the ledger.
 Is the primary basis for the preparation of financial

statements.
3-44 LO 7 Describe the nature and purpose of an adjusted trial balance.

Illustration 3-25
3-45
Adjustment Class exercise
September 1. Paid office rent of 6,000 for three months.
12. Received Br.3,200 advance on a management
consulting engagement.
15. Hired a secretary-receptionist at a Br. 5000 a monthly.
Information for Adjustment
(A) Salaries and wages accrued but unpaid Br. 2,500.
(B). Services performed for clients that were not recorded
by September 30, Br.3,000.
(C). Unearned management consulting service of Br. 1,200
was earned prior to September 30.

(D). Office rent expired during the September Br.2,000.
(E) Office supplies on hand Br. 800
3-46
Preparing Financial Statements
Financial Statements are prepared directly from the

Adjusted Trial Balance.
Retained Statement
Income
Earnings of Financial
Statement
Statement Position
3-47 LO 7 Describe the nature and purpose of an adjusted trial balance.

Illustration 3-26
3-48 LO 7
Illustration 3-27
3-49 LO 7
Using a Worksheet
Preparing a Worksheet
 Multiple-column form used in preparing financial
statements.
 Not a permanent accounting record.
 Five step process.
 Use of worksheet is optional.
3-50 LO 8 Prepare a worksheet.

Steps in Preparing a Worksheet
Illustration 4-1

1. Prepare a Trial Balance on the Worksheet Illustration 4-2
Adjusted Income Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200
Supplies 2,500
Prepaid Insurance 600
Equipment 5,000
Notes Payable 5,000
Accounts Payable 2,500
Unearned Revenue 1,200
Share Capital-Ordinary 10,000
Dividends 500
Service Revenue 10,000
Salaries and Wages Exp. 4,000

Rent Expense 900
Totals 28,700 28,700
Trial balance amounts come

directly from ledger accounts.
Include all accounts
with balances.

Illustration 3-23
General journal
showing adjusting
entries
Adjusting
Journal
Entries
(Chapter 3)

2. Enter the Adjustments in the Adjustments Columns
Cash 15,200
Supplies 2,500 (a) 1,500
Prepaid Insurance 600 (b) 50
Equipment 5,000 Adjustments Key:
Notes Payable 5,000
Accounts Payable 2,500
(a) Supplies Used.
Unearned Revenue 1,200 (d) 400 (b) Insurance Expired.
Share Capital-Ordinary 10,000
Dividends 500 (c) Depreciation Expensed.
Service Revenue 10,000 (d) 400 (d) Service Revenue Earned.
(e) 200
Salaries and Wages Exp. 4,000 (g)1,200 (e) Service Revenue Accrued.
Rent Expense 900 (f) Interest Accrued.
Totals 28,700 28,700
Supplies Expense (a) 1,500 (g) Salaries Accrued.
Insurance Expense (b) 50
Accumulated Depreciation (c) 40
Depreciation Expense (c) 40
Accounts Receivable (e) 200
Interest Expense (f)
50
Enter adjustment amounts, total
Interest Payable (f) 50 adjustments columns,
(g) 1,200
Salaries and Wages Payable and check for equality.
Totals 3,440 3,440
Add additional accounts as needed.

3. Complete the Adjusted Trial Balance Columns
Cash 15,200 15,200
Supplies 2,500 (a) 1,500 1,000
Prepaid Insurance 600 (b) 50 550
Equipment 5,000 5,000
Notes Payable 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 (d) 400 800
Share Capital-Ordinary 10,000 10,000
Dividends 500 500
Service Revenue 10,000 (d) 400 10,600
(e) 200
Salaries and Wages Exp. 4,000 (g)1,200 5,200
Rent Expense 900 900
Totals 28,700 28,700
Supplies Expense (a) 1,500 1,500
Insurance Expense (b) 50 50
Accumulated Depreciation (c) 40 40
Depreciation Expense (c) 40 40
Accounts Receivable (e) 200 200
(f)
Interest Expense 50 50
Interest Payable (f) 50 50
Salaries and Wages Payable (g) 1,200 1,200
Totals 3,440 3,440 30,190 30,190
Total the adjusted trial balance

columns and check for equality.
4. Extend Amounts to Financial Statement Columns
Cash 15,200 15,200
Supplies 2,500 (a) 1,500 1,000
Prepaid Insurance 600 (b) 50 550
Equipment 5,000 5,000
Notes Payable 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 (d) 400 800
Share Capital-Ordinary 10,000 10,000
Dividends 500 500
Service Revenue 10,000 (d) 400 10,600 10,600
(e) 200
Salaries and Wages Exp. 4,000 (g)1,200 5,200 5,200
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense (a) 1,500 1,500 1,500
Insurance Expense (b) 50 50 50
Accumulated Depreciation (c) 40 40
Depreciation Expense (c) 40 40 40
Accounts Receivable (e) 200 200
(f)
Interest Expense 50 50 50
Interest Payable (f) 50 50
Salaries and Wages Payable (g) 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600
Extend all revenue and expense account

balances to the income statement columns.
5. Total Columns, Compute Net Income (Loss)
Cash 15,200 15,200 15,200
Supplies 2,500 (a) 1,500 1,000 1,000
Prepaid Insurance 600 (b) 50 550 550
Equipment 5,000 5,000 5,000
Notes Payable 5,000 5,000 5,000
Accounts Payable 2,500 2,500 2,500
Unearned Revenue 1,200 (d) 400 800 800
Share Capital-Ordinary 10,000 10,000 10,000
Dividends 500 500 500
Service Revenue 10,000 (d) 400 10,600 10,600
(e) 200
Salaries and Wages Exp. 4,000 (g)1,200 5,200 5,200
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense (a) 1,500 1,500 1,500
Insurance Expense (b) 50 50 50
Accumulated Depreciation (c) 40 40 40
Depreciation Expense (c) 40 40 40
Accounts Receivable (e) 200 200 200
Interest Expense (f) 50 50 50
Interest Payable (f) 50 50 50
Salaries and Wages Payable (g) 1,200 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590
Net Income 2,860 2,860
Totals 10,600 10,600 22,450 22,450
Compute Net Income or Net Loss.
Using a Worksheet
Preparing Statements from a Worksheet

 Income statement is prepared from the income
statement columns.
 Statement of financial position and retained earnings

statement are prepared from the statement of financial
position columns.
 Companies journalize and post adjusting entries.

Illustration 4-4

Illustration 4-4

Illustration
4-4
3-61 LO 8
Using a Worksheet
Preparing Adjusting Entries from a Worksheet

 Adjusting entries are prepared from the adjustments
columns of the worksheet.
 Journalizing and posting of adjusting entries follows the

preparation of financial statements when a worksheet is
used.

Closing the Books
At the end of the accounting period, the company makes

the accounts ready for the next period.
Illustration 4-5
3-63 LO 9 Explain the process of closing the books.

Closing the Books
Preparing Closing Entries

Closing entries formally recognize, in the general ledger, the
transfer of
 net income (or net loss) and
 dividends
to retained earnings.
Closing entries are only made at the end of the annual

accounting period.
3-64 LO 9 Explain the process of closing the books.

Closing the Books
Note:
Dividends are closed directly Illustration 4-6
to retained earnings and not

to Income Summary because
Retained earnings is a
dividends are not an permanent account; all
other accounts are
expense. temporary accounts.
3-65 LO 9
Closing the Books
Closing
Entries
Illustrated
Illustration 4-7
Closing entries
journalized
3-66
Closing the Books
Posting
Closing
Entries
Illustration 4-8
3-67 LO 9
Preparing a Post-Closing Trial Balance
Purpose is to prove the equality of the permanent account

balances after journalizing and posting of closing entries.
Illustration 4-9
3-68 LO 10
Summary of the Accounting Cycle
Illustration 4-12
1. Analyze business transactions
9. Prepare a post-closing 2. Journalize the

trial balance transactions
8. Journalize and post

3. Post to ledger accounts
closing entries
7. Prepare financial
4. Prepare a trial balance
statements
6. Prepare an adjusted trial 5. Journalize and post

balance adjusting entries
3-69 LO 11 State the required steps in the accounting cycle.

End of chapter two
3-70

Chapter Two Part Two Adjusting Entries and Completing The Accounting

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Chapter Two Part Two Adjusting Entries and Completing The Accounting

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Adjusting the Accounts and completing

the accounting cycle

1. Explain the time period assumption.

2. Explain the accrual basis of accounting.

3. Explain the reasons for adjusting entries.

4. Identify the major types of adjusting entries.

5. Prepare adjusting entries for deferrals.

6. Prepare adjusting entries for accruals.

7. Describe the nature and purpose of an adjusted trial balance.

9. Explain the process of closing the books.

10. Describe the content and purpose of a post-closing trial

Accountants divide the economic life of a business into

 Generally a month, a quarter, or a year.

3-3 LO 1 Explain the time period assumption.

Fiscal and Calendar Years

 Most large companies must prepare both quarterly and

 Fiscal Year = Accounting time period that is one year in

 Calendar Year = January 1 to December 31.

3-4 LO 1 Explain the time period assumption.

Accrual- vs. Cash-Basis Accounting

 Revenues are recognized when the services are

 Expenses are recognized when incurred, rather than

3-5 LO 2 Explain the accrual basis of accounting.

Accrual- vs. Cash-Basis Accounting

 Expenses recognized when cash is paid.

 Cash-basis accounting is not in accordance with

3-6 LO 2 Explain the accrual basis of accounting.

Recognizing Revenues and Expenses

3-7 LO 2 Explain the accrual basis of accounting.

Recognizing Revenues and Expenses

“Let the expenses follow

3-8 LO 2 Explain the accrual basis of accounting.

3-9 LO 2 Explain the accrual basis of accounting.

3-10 LO 3 Explain the reasons for adjusting entries.

Types of Adjusting Entries

1. Prepaid Expenses. 3. Accrued Revenues.

2. Unearned Revenues. 4. Accrued Expenses.

3-11 LO 4 Identify the major types of adjusting entries.

Types of Adjusting Entries

3-12 LO 4 Identify the major types of adjusting entries.

Adjusting Entries for Deferrals

3-13 LO 5 Prepare adjusting entries for deferrals.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

3-14 LO 5 Prepare adjusting entries for deferrals.

3-15 LO 5 Prepare adjusting entries for deferrals.

Illustration: Pioneer Advertising Agency

Oct. 31 Supplies expense 1,500

3-16 LO 5 Prepare adjusting entries for deferrals.

Illustration: On October 4, Pioneer

Oct. 31 Insurance expense 50

3-18 LO 5 Prepare adjusting entries for deferrals.

 Depreciation allocates a portion of the asset’s cost as

 Depreciation does not attempt to report the actual

3-20 LO 5 Prepare adjusting entries for deferrals.

Illustration: For Pioneer Advertising, assume

Accumulated Depreciation is called a contra

3-21 LO 5 Prepare adjusting entries for deferrals.

3-23 LO 5 Prepare adjusting entries for deferrals.

3-24 LO 5 Prepare adjusting entries for deferrals.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

3-25 LO 5 Prepare adjusting entries for deferrals.