The Adjusting Process

1. 3 The Adjusting Process Principles of Financial Accounting, 11e Reeve • Warren • Duchac

2. Describe the nature of the adjusting process. 1 Journalize entries for accounts requiring adjustment. 2 Summarize the adjustment process. 3 4 Prepare an adjusted trial balance. The Adjusting Process After studying this chapter, you should be able to: 3-2

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

4. 1 Under the accrual basis of accounting, revenues are reported in the income statement in the period in which they are earned.

5. 1 Revenue Recognition Concept The accounting concept supporting the reporting of revenues when they are earned regardless of when cash is received is called therevenue recognition concept.

6. 1 Matching Principle The accounting concept supporting reporting revenues and related expenses in the same period is called the matching concept, or matching principle.

7. 1 Under the cash basis of accounting, revenues and expenses are reported in the income statement in the period in which cash is received or paid.

8. 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.

9. 1 The Adjusting Process The analysis and updating of accounts at the end of the period before the financial statements are prepared is called theadjusting process.

10. Follow My Example 3-1 Left click the mouse for the answers. Follow My Example 6-1 For Practice: PE 3-1A, PE 3-1B 1 Example Exercise 3-1 Accounts Requiring Adjustment Indicate with a Yes or No whether or not each of the following accounts normally requires an adjusting entry. • Cash d. Office Equipment • Prepaid Rent e. Accounts Receivable • Wages Expense f. Unearned Rent No No Yes Yes Yes Yes 3-10

11. 1 Types of Accounts Requiring Adjustment Prepaid expenses are the advance payment of future expenses and are recorded as assets when cash is paid.

12. 1 Types of Accounts Requiring Adjustment Unearned revenues are the advance receipt of future revenues and are recorded as liabilities when cash is received.

13. 1 Type of Adjustments: Prepaid Expenses and Unearned Revenues Exhibit 1

14. 1 Types of Accounts Requiring Adjustment Accrued revenues are unrecorded revenues that have been earned and for which cash has yet to be received.

15. 1 Types of Accounts Requiring Adjustment Accrued expenses are unrecorded expenses that have been incurred and for which cash has not been paid.

16. 1 Type of Adjustments: Accrued Revenues and Expenses Exhibit 2

17. Follow My Example 3-2 For Practice: PE 3-2A, PE 3-2B 1 Example Exercise 3-2 Type of Adjustment 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 paid. earned. • Supplies on hand. d. Fees earned but not yet received. Follow My Example 6-1 a. Accrued expense c. Unearned revenue b. Prepaid expense d. Accrued revenue 3-17

18. 2 Journalize entries for accounts requiring adjustment. 3-18

19. 2 Exhibit 3 Unadjusted Trial Balance for NetSolutions

20. 2 Exhibit 4 Expanded Chart of Accounts for NetSolutions

21. 2 Prepaid Expenses NetSolutions’ Supplies account 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. Supplies (balance on trial balance) $2,000 Supplies on hand, December 31 – 760 Supplies used $1,240

22. 760 2,040 2 Supplies Expense Supplies 14 55 Bal. 2,000 Bal. 800 Dec. 31 1,240 Dec. 31 1,240

23. 2 Prepaid Expenses The debit balance of $2,400 in NetSolutions’ Prepaid Insurance account represents the December 1 prepayment of insurance for 12 months.

24. 2,200 2 Prepaid Insurance Insurance Expense 15 56 Dec. 31 200 Bal. 2,400 Dec. 31 200

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

26. 2 Unearned Revenues The December 31 unadjusted trial balance of NetSolutions indicates a balance in the unearned rent account of $360.

27. 2 Unearned Rent Rent Revenue 23 42 Dec. 31 120 Bal. 360

28. Unearned Rent 23 240 Dec. 31 120 Bal. 360 Bal. 2 Rent Revenue 42 Dec. 31 120

29. Follow My Example 3-4 Unearned Fees……………………………. 22,600 Fees Earned………………………….. 22,600 Fees earned ($44,900 – $22,300). For Practice: PE 3-4A, PE 3-4B 2 Example Exercise 3-4 Adjustment for Unearned Revenue 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. 3-29

30. 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.

31. Bal. 2,720 2 Fees Earned Accounts Receivable 12 41 Bal. 2,220 Bal. 16,340 Dec. 31 500

32. Bal. Bal. 2,720 16,840 2 Fees Earned Accounts Receivable 12 41 Bal. 2,220 Bal. 16,340 Dec. 31 500 Dec. 31 500

33. Follow My Example 3-5 Accounts Receivable……………………. 13,680 Fees Earned………………………….. 13,680 Accrued fees. For Practice: PE 3-5A, PE 3-5B 2 Example Exercise 3-5 Adjustment for Accrued Fees 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. 3-33

34. 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.

35. Bal. 4,525 2 22 Wages Payable Wages Expense 51 Bal. 4,275 Dec. 31 250

36. Bal. 4,525 2 22 Wages Payable Wages Expense 51 Dec. 31 250 Bal. 4,275 Dec. 31 250

37. Follow My Example 3-6 Salaries Expense……………………….. 10,000 Salaries Payable…………………….. 10,000 Accrued salaries [($12,500 ÷ 5 days) × 4 days]. For Practice: PE 3-6A, PE 3-6B 2 Example Exercise 3-6 Adjustment for Accrued Expenses 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. 3-39

38. 2 Fixed Assets Fixed assets, or plant assets, are physical resources that are owned and used by a business and are permanent or have a long life.

39. 2 Depreciation As time passes, a fixed asset loses its ability to provide useful services. This decrease in usefulness is called depreciation.

40. 2 Normal titles for fixed asset accounts andtheir relatedcontra assetaccounts are asfollows: Fixed AssetContra Asset Land None—Land is not depreciated Buildings Accumulated Depreciation— Buildings Store Equipment Accumulated Depreciation—Store Equipment Office Equipment Accumulated Depreciation—Office Equipment

41. 2 NetSolutions estimates the depreciation on its office equipment to be $50 for the month of December.

42. 2 Depreciation Expense Accum. Depr.—Office Equip. 19 53 Dec. 31 50

43. 2 Depreciation Expense Accum. Depr.—Office Equip. 19 53 Dec. 31 50 Dec. 31 50

44. 2 NetSolutions’ balance sheet would show office equipment at cost, less accumulated depreciation. Office equipment $1,800 Less accumulated depreciation 50 $1,750 Book value

45. Follow My Example 3-7 Depreciation Expense………...……….. 4,250 Accumulated Depreciation— Equipment………………………….. 4,250 Depreciation on equipment. For Practice: PE 3-7A, PE 3-7B 2 Example Exercise 3-7 Adjustment for Depreciation The estimated amount of depreciation on equipment for the current year is $4,250. Journalize the adjusting entry to record the depreciation. 3-47

46. 3 Summarize the adjustment process. 3-48

47. 3 Exhibit 7 Adjusting Entries—NetSolutions (continued)

48. 3 Exhibit 7 Adjusting Entries—NetSolutions (continued) .

49. 3 Example Exercise 3-8 Effect of Omitting Adjustments For the year ending December 31, 2010, Mann Medical Co. mistakenly omitted adjusting entries for (1) $8,600 of unearned revenue that was earned, (2) earned revenue of $12,500 that was not billed, and (3) accrued wages of $2,900. Indicate the combined effect of the errors on (a) revenues, (b) expenses, and (c) net income for 2010. 3-55

50. For Practice: PE 3-8A, PE 3-8B Follow My Example 3-8 3 Example Exercise 3-8 (continued) • Revenues were understated by $21,100 ($8,600 + $12,500). • Expenses were understated by $2,900. • Net income was understated by $18,200 ($8,600 +12,500 – $2,900). 3-56