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The Adjusting Process

3. The Adjusting Process. 0. 3-1. Under the accrual basis of accounting , revenues are reported in the income statement in the period in which they are earned. 0. 3-1. The accounting concept that supports this approach to reporting of revenues is called the revenue recognition concept . 0.

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The Adjusting Process

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  1. 3 The Adjusting Process

  2. 0 3-1 Under the accrual basis ofaccounting, revenues are reported in the income statement in the period in which they are earned.

  3. 0 3-1 The accounting concept that supports this approachtoreporting of revenues is called therevenue recognition concept.

  4. 0 3-1 The accounting concept that supports reporting revenues and related expenses in the same period is called the matching concept, or matching principle.

  5. 0 3-1 Under the cash basis ofaccounting, revenues and expenses are reported in the income statement in the period in which cash is received or paid.

  6. 0 3-1 The analysis and updating of accounts at the end of the period before the financial statements are prepared is called the adjusting process.

  7. 0 3-1 The journal entries that bring the accounts up to date at the end of the accounting period are called adjusting entries.

  8. Example Exercise 3-1 Follow My Example 3-1 0 3-1 Indicate with a Yes or No whether or not each of the following accounts normally requires an adjusting entry. • Cash c. Wages Expense e. Accounts Receivable • Prepaid Rent d. Office Equipment f. Unearned Rent • No c. Yes e. Yes • Yes d. No f. Yes For Practice: PE 3-1A, PE 3-1B 10

  9. 0 3-1 Items That Need Adjusting Prepaid expenses, sometimes referred to as deferred expenses, are items that have been initially recorded as assets but are expected to become expenses over time or through the normal operations of the business.

  10. 0 3-1 Items That Need Adjusting Unearned revenues, sometimes referred to as deferred revenues, are items that have been initially recorded as liabilities but are expected to become revenues over time or through the normal operations of the business.

  11. 0 3-1 Items That Need Adjusting Accrued revenues, sometimes referred to as accrued assets (accrued means unpaid), are revenues that have been earned but have not been recorded in the accounts.

  12. 0 3-1 Items That Need Adjusting Accrued expenses, sometimes referred to as accrued liabilities, are expenses that have been incurred but have not been recorded in the accounts.

  13. Example Exercise 3-2 Follow My Example 3-2 0 3-1 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 yet paid. earned. • Supplies on hand. d. Fees earned but not yet received. • Accrued expense c. Unearned revenue • Prepaid expense d. Accrued revenue 17 For Practice: PE 3-2A, PE 3-2B

  14. 0 3-2 Adjusting Process for Prepaid Expenses NetSolutions’ Suppliesaccount 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.

  15. 2007 Dec. 31 Supplies Expense 1 240 00 760 2,040 0 3-2 55 14 Supplies 1 240 00 Supplies used ($2,000 – $760) Supplies Expense Supplies 14 55 Bal. 2,000 Dec. 31 1,240 Bal. 800 Dec. 31 1,240 22

  16. 0 3-2 The debit balance of $2,400 in NetSolutions’ PrepaidInsuranceaccount represents the December 1 prepayment of insurance for 12 months.

  17. 2,200 0 3-2 56 31 Insurance Expense 200 00 Prepaid Insurance 200 00 15 Insurance expired ($2,400/12). Prepaid Insurance Insurance Expense 15 56 Dec. 31 200 Bal. 2,400 Dec. 31 200 24

  18. Example Exercise 3-3 Follow My Example 3-3 0 3-2 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. Insurance Expense 6,750 Prepaid Insurance 6,750 Insurance expired ($6,400 + $3,600 – $3,250). 25 For Practice: PE 3-3A, PE 3-3B

  19. 0 3-2 On December 1, the tenant prepaid three months’ rent for use of an office building owned by NetSolutions. As of December 31, only $120 has been earned.

  20. 240 Bal. 0 3-2 23 31 Unearned Rent 120 00 42 Rent Revenue 120 00 Rent earned ($360/3 months) Unearned Rent Rent Revenue 23 42 Dec. 31 120 Bal. 360 Dec. 31 120 27

  21. Example Exercise 3-4 Follow My Example 3-4 0 3-2 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. Unearned Fees 22,600 Fees Earned 22,600 Fees earned ($44,900 – $22,300). 28 For Practice: PE 3-4A, PE 3-4B

  22. 0 3-2 NetSolutions provided $500 in services during December for which the customer has not been billed.

  23. Bal. Bal. 2,720 16,840 0 3-2 12 31 Accounts Receivable 500 00 Fees Earned 500 00 41 Accrued fees (25 hrs. x $20) Fees Earned Accounts Receivable 12 41 Bal. 2,220 Bal. 16,340 Dec. 31 500 Dec. 31 500 30

  24. Example Exercise 3-5 Follow My Example 3-5 0 3-2 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. Accounts Receivable 13,680 Fees Earned 13,680 Accrued fees. 31 For Practice: PE 3-5A, PE 3-5B

  25. 0 3-2 At the end of December, accrued wages amounted to $250. Without this adjusting entry, Wages Expenseis understated.

  26. Bal. 4,525 0 3-2 51 31 Wages Expense 250 00 Wages Payable 250 00 22 Accrued wages. 51 Wages Payable Wages Expense 22 Dec. 31 250 Bal. 4,275 Dec. 31 250 33

  27. Bal. 4,525 0 3-2 51 Wages Payable 22 Wages Expense Dec. 31 250 Bal. 4,275 Dec. 31 250 Closing entries will be discussed in a later chapter. For now, just be aware that this account is closed after financial statements are prepare and its balance rolled back to zero. 34

  28. 0 3-2 The payment of January 10 wages totaling $1,275 is shown below. Jan. 10 Wages Expense 1 025 00 Wages Payable 250 00 Cash 1 275 00 35

  29. Wages Payable 22 Wages Expense 51 Dec. 31 250 Jan. 10 250 Bal. 4,275 Dec. 31 250 Jan. 10 1,025 Bal. 4,525 0 3-2 The liability is cancelled. An expense for wages of $1,025 is recorded in the new fiscal year. 36

  30. Example Exercise 3-6 Follow My Example 3-6 0 3-2 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. Salaries Expense 10,000 Salaries Payable 10,000 Accrued salaries ($12,500/5 x 4 days). 37 For Practice: PE 3-6A, PE 3-6B

  31. 0 3-2 Physical resources that are owned and used by a business and are permanent or have a long life are called fixed assets, orplant assets.

  32. 0 3-2 As time passes, a fixed asset loses its ability to provide useful services. This decrease in usefulness is called depreciation.

  33. 0 3-2 Normal titles for fixed asset accounts andtheir relatedcontra assetaccounts are asfollows: Fixed Asset Contra Asset Land None—Land is not depreciated Buildings Accumulated Depreciation— Buildings Store Equipment Accumulate Depreciation—Store Equipment Office Equipment Accumulated Depreciation—Office Equipment

  34. 0 3-2 NetSolutions estimates the depreciation on its office equipment to be $50 for the month of December.

  35. 0 3-2 53 31 Depreciation Expense 50 00 Accum. Depreciation— Office Equipment 50 00 19 Depreciation of office equipment. Depreciation Expense Accum. Depr.—Office Equip. 19 53 Dec. 31 50 Dec. 31 50 42

  36. 0 3-2 NetSolutions’ balance sheet would show the office equipment at cost, less the accumulated depreciation. Office equipment $1,800 Less accumulated depreciation 50 $1,750 Book value

  37. Example Exercise 3-7 Follow My Example 3-7 0 3-2 The estimated amount of depreciation on equipment for the current year is $4,250. Journalize the adjusting entry to record the depreciation. Depreciation Expense 4,250 Accumulated Depreciation— Equipment 4,250 Depreciation on equipment. 44 For Practice: PE 3-7A, PE 3-7B

  38. 0 3-4 The purpose of the adjustedtrial balanceis to verify the equality of the total debit balances and total credit balances before the financial statements are prepared.

  39. Example Exercise 3-9 0 3-4 For each of the following errors, considered individually, indicate whether the error would cause the adjusted trial balance totals to be unequal. If the error would cause the adjusted trial balance total to be unequal, indicate whether the debit or credit total is higher and by how much. • The adjustment for accrued fees of $5,340 was journalized as a debit to Accounts Payable for $5,340 and a credit to Fees Earned of $5,340. • The adjustment for depreciation of $3,260 was journalized as a debit to Depreciation Expense for $3,620 and a credit to Accumulated Depreciation for $3,260. 55

  40. Follow My Example 3-9 0 3-4 • The totals are equal even though the debit should have been to Accounts Receivable instead of Accounts Payable. • The totals are unequal. The debit total is higher by $360 ($3,620 – $3,260). For Practice: PE 3-9A, PE 3-9B 56

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