Chapter

3-1

Adjusting the
Accounts
Chapter
3-2

Accounting Principles, Ninth Edition

Study
Study Objectives
Objectives
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.

Chapter
3-3

Adjusting
Adjusting the
the Accounts
Accounts

Timing Issues

Fiscal and
calendar years
Accrual- vs. cashbasis accounting
Recognizing
revenues and
expenses

Chapter
3-4

The Basics of
Adjusting Entries

Types of adjusting
entries
Adjusting entries
for deferrals
Adjusting entries
for accruals
Summary of
journalizing and
posting

The Adjusted Trial

Balance and
Financial
Statements
Preparing the
adjusted trial
balance
Preparing
financial
statements

Timing
Timing Issues
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.

Fiscal year vs. calendar year
Also known as the Periodicity Assumption
Chapter
3-5

SO 1 Explain the time period assumption.

Timing
Timing Issues
Issues

Review
The time period assumption states that:
a. revenue should be recognized in the accounting
period in which it is earned.
b. expenses should be matched with revenues.
c.

the economic life of a business can be divided

into artificial time periods.

d. the fiscal year should correspond with the

calendar year.

Chapter
3-6

SO 1 Explain the time period assumption.

Timing
Timing Issues
Issues

Accrual- vs. Cash-Basis Accounting

Accrual-Basis Accounting
Transactions recorded in the periods in which
the events occur
Revenues are recognized when earned, rather
than when cash is received.
Expenses are recognized when incurred, rather
than when paid.

Chapter
3-7

SO 2 Explain the accrual basis of accounting.

Timing
Timing Issues
Issues

Accrual- vs. Cash-Basis Accounting

Cash-Basis Accounting
Revenues are recognized when cash is received.
Expenses are recognized when cash is paid.
Cash-basis accounting is not in accordance with
generally accepted accounting principles (GAAP).

Chapter
3-8

SO 2 Explain the accrual basis of accounting.

Timing
Timing Issues
Issues

Recognizing Revenues and Expenses

Revenue Recognition Principle
Companies recognize
revenue in the accounting
period in which it is
earned.
In a service enterprise,
revenue is considered to
be earned at the time the
service is performed.
Chapter
3-9

SO 2 Explain the accrual basis of accounting.

Timing
Timing Issues
Issues

Recognizing Revenues and Expenses

Matching Principle
Match expenses with
revenues in the period
when the company makes
efforts to generate
those revenues.
Let the expenses follow
the revenues.
Chapter
3-10

SO 2 Explain the accrual basis of accounting.

Timing
Timing Issues
Issues
GAAP relationships
in revenue and
expense recognition

Chapter
3-11

Illustration 3-1

SO 2 Explain the accrual basis of accounting.

Chapter
3-12

SO 2 Explain the accrual basis of accounting.

Timing
Timing Issues
Issues

Review

One of the following statements about the accrual basis

of accounting is false. That statement is:
a. Events that change a companys financial
statements are recorded in the periods in which
the events occur.
b. Revenue is recognized in the period in which it is
earned.
c. The accrual basis of accounting is in accord with
generally accepted accounting principles.
d. Revenue is recorded only when cash is received, and
expenses are recorded only when cash is paid.

Chapter
3-13

SO 2 Explain the accrual basis of accounting.

The
The Basics
Basics of
of Adjusting
Adjusting Entries
Entries
Adjusting entries make it possible to report
correct amounts on the balance sheet and
on the income statement.
A company must make adjusting entries
every time it prepares financial statements.

Chapter
3-14

SO 3 Explain the reasons for adjusting entries.

The
The Basics
Basics of
of Adjusting
Adjusting Entries
Entries
Revenues - recorded in the period in which
they are earned.
earned
Expenses - recognized in the period in which
they are incurred.
incurred
Adjusting entries - needed to ensure that
the revenue recognition and matching
principles are followed.

Chapter
3-15

SO 3 Explain the reasons for adjusting entries.

Timing
Timing Issues
Issues

Review
Adjusting entries are made to ensure that:
a. expenses are recognized in the period in which
they are incurred.
b. revenues are recorded in the period in which
they are earned.
c. balance sheet and income statement accounts
have correct balances at the end of an
accounting period.
d. all of the above.
Chapter
3-16

SO 3 Explain the reasons for adjusting entries.

Types
Types of
of Adjusting
Adjusting Entries
Entries
Illustration 4-2
Categories of adjusting entries

Deferrals

Accruals

1. Prepaid Expenses.
Expenses paid in cash and
recorded as assets before
they are used or consumed.

3. Accrued Revenues.
Revenues earned but not
yet received in cash or
recorded.

2. Unearned Revenues.
Revenues received in cash
and recorded as liabilities
before they are earned.

4. Accrued Expenses.
Expenses incurred but not
yet paid in cash or
recorded.

Chapter
3-17

SO 4 Identify the major types of adjusting entries.

Trial
Trial Balance
Balance
Trial Balance Each account is analyzed to determine whether
it is complete and up-to-date.
Illustration 3-3

Chapter
3-18

SO 4 Identify the major types of adjusting entries.

Adjusting
Adjusting Entries
Entries for
for Deferrals
Deferrals
Deferrals are either:
Prepaid expenses

OR
Unearned revenues.

Chapter
3-19

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Prepaid
Prepaid Expenses
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
supplies
advertising

Chapter
3-20

rent
maintenance on equipment
fixed assets (depreciation)

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Prepaid
Prepaid Expenses
Expenses

Prepaid Expenses
Costs that expire either with the passage of time
or through use.
Adjusting entries (1) to record the expenses that
apply to the current accounting period, and (2) to
show the unexpired costs in the asset accounts.

Chapter
3-21

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Prepaid
Prepaid Expenses
Expenses
Adjusting entries for prepaid expenses
Illustration 3-4

Increases (debits) an expense account and

Decreases (credits) an asset account.

Chapter
3-22

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Prepaid
Prepaid Expenses
Expenses
Illustration: Pioneer Advertising Agency purchased advertising
supplies costing $2,500 on October 5. Sierra recorded the
payment by increasing (debiting) the asset Advertising 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

Advertising supplies expense

Advertising supplies

1,500
1,500
Illustration 3-5

Chapter
3-23

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Prepaid
Prepaid Expenses
Expenses
Illustration: On October 4, Pioneer Advertising Agency 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
Prepaid insurance

50
50
Illustration 3-6

Chapter
3-24

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Prepaid
Prepaid Expenses
Expenses
Depreciation
Buildings, equipment, and vehicles (long-lived
assets) are recorded as assets, rather than an
expense, in the year acquired.
Companies report a portion of the cost of a longlived asset as an expense (depreciation) during
each period of the assets useful life (Matching
Principle).

Chapter
3-25

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Prepaid
Prepaid Expenses
Expenses
Illustration: Pioneer Advertising estimates depreciation on the
office equipment to be $480 a year, or $40 per month.
Oct. 31

Depreciation expense
Accumulated depreciation

40
40
Illustration 3-7

Chapter
3-26

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Prepaid
Prepaid Expenses
Expenses
Depreciation (Statement Presentation)
Accumulated Depreciation is a contra asset account.
Appears just after the account it offsets
(Equipment) on the balance sheet.
Illustration 3-8

Chapter
3-27

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Prepaid
Prepaid Expenses
Expenses
Summary

Chapter
3-28

Illustration 3-9

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Unearned
Unearned Revenues
Revenues
Receipt of cash that is recorded as a liability because
the revenue has not been earned.
Cash Receipt

BEFORE

Revenue Recorded

Unearned revenues often occur in regard to:

rent
airline tickets
school tuition

Chapter
3-29

magazine subscriptions
customer deposits

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Unearned
Unearned Revenues
Revenues
Unearned Revenues
Company makes an adjusting entry to record the
revenue that has been earned and to show the
liability that remains.
The adjusting entry for unearned revenues results
in a decrease (a debit) to a liability account and an
increase (a credit) to a revenue account.

Chapter
3-30

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Unearned
Unearned Revenues
Revenues
Adjusting entries for unearned revenues
Illustration 3-10

Decrease (a debit) to a liability account and

Increase (a credit) to a revenue account.
Chapter
3-31

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Unearned
Unearned Revenues
Revenues
Illustration: Pioneer Advertising Agency 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

Service revenue

400
400
Illustration 3-11

Chapter
3-32

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Unearned
Unearned Revenues
Revenues
Summary
Illustration 3-12

Chapter
3-33

SO 5 Prepare adjusting entries for deferrals.

Chapter
3-34

SO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for Accruals
Accruals
Made to record:
Revenues earned and

OR
Expenses incurred
in the current accounting period that have not
been recognized through daily entries.

Chapter
3-35

SO 6 Prepare adjusting entries for accruals.

Adjusting
Adjusting Entries
Entries for
for Accrued
Accrued Revenues
Revenues
Revenues earned but not yet received in cash or
recorded.

Adjusting entry results in:

Revenue Recorded

BEFORE

Cash Receipt

Accrued revenues often occur in regard to:

rent
interest
services performed
Chapter
3-36

SO 6 Prepare adjusting entries for accruals.

Adjusting
Adjusting Entries
Entries for
for Accrued
Accrued Revenues
Revenues
Accrued Revenues
An adjusting entry serves two purposes:
(1) It shows the receivable that exists, and
(2) It records the revenues earned.

Chapter
3-37

SO 6 Prepare adjusting entries for accruals.

Adjusting
Adjusting Entries
Entries for
for Accrued
Accrued Revenues
Revenues
Adjusting entries for accrued revenues
Illustration 3-13

Increases (debits) an asset account and

Increases (credits) a revenue account.
Chapter
3-38

SO 6 Prepare adjusting entries for accruals.

Adjusting
Adjusting Entries
Entries for
for Accrued
Accrued Revenues
Revenues
Illustration: In October Pioneer Advertising Agency earned
$200 for advertising services that had not been recorded.
Oct. 31

Accounts Receivable
Service Revenue

200
200
Illustration 3-14

Chapter
3-39

SO 6 Prepare adjusting entries for accruals.

Adjusting
Adjusting Entries
Entries for
for Accrued
Accrued Revenues
Revenues
Summary
Illustration 3-15

Chapter
3-40

SO 6 Prepare adjusting entries for accruals.

Adjusting
Adjusting Entries
Entries for
for Accrued
Accrued Expenses
Expenses
Expenses incurred but not yet paid in cash or recorded.

Adjusting entry results in:

Expense Recorded

BEFORE

Cash Payment

Accrued expenses often occur in regard to:

rent
interest

Chapter
3-41

taxes
salaries

SO 6 Prepare adjusting entries for accruals.

Adjusting
Adjusting Entries
Entries for
for Accrued
Accrued Expenses
Expenses
Accrued Expenses
An adjusting entry serves two purposes:
(1) It records the obligations, and
(2) It recognizes the expenses.

Chapter
3-42

SO 6 Prepare adjusting entries for accruals.

Adjusting
Adjusting Entries
Entries for
for Accrued
Accrued Expenses
Expenses
Adjusting entries for accrued expenses
Illustration 3-16

Increases (debits) an expense account and

Increases (credits) a liability account.
Chapter
3-43

SO 6 Prepare adjusting entries for accruals.

Adjusting
Adjusting Entries
Entries for
for Accrued
Accrued Expenses
Expenses
Illustration: Pioneer Advertising Agency 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
Interest payable

50
50
Illustration 3-18

Chapter
3-44

SO 6 Prepare adjusting entries for accruals.

Adjusting
Adjusting Entries
Entries for
for Accrued
Accrued Expenses
Expenses
Illustration: Pioneer Advertising Agency 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).
Oct. 31

Salaries expense

1,200

Salaries payable

1,200
Illustration 3-20

Chapter
3-45

SO 6 Prepare adjusting entries for accruals.

Adjusting
Adjusting Entries
Entries for
for Accrued
Accrued Expenses
Expenses
Summary
Illustration 3-21

Chapter
3-46

SO 6 Prepare adjusting entries for accruals.

The
The Adjusted
Adjusted Trial
Trial Balance
Balance
After all adjusting entries are journalized and posted
the company prepares another trial balance from the
ledger accounts (Adjusted Trial Balance).
Its purpose is to prove the equality of debit balances
and credit balances in the ledger.

Chapter
3-47

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

The
The Adjusted
Adjusted Trial
Trial Balance
Balance

Chapter
3-48

The
The Adjusted
Adjusted Trial
Trial Balance
Balance

Review Question
Which of the following statements is incorrect concerning
the adjusted trial balance?
a. An adjusted trial balance proves the equality of the
total debit balances and the total credit balances in
the ledger after all adjustments are made.
b. The adjusted trial balance provides the primary basis
for the preparation of financial statements.
c. The adjusted trial balance lists the account balances
segregated by assets and liabilities.
d. The adjusted trial balance is prepared after the
adjusting entries have been journalized and posted.
Chapter
3-49

SO 7

Describe the nature and purpose of an adjusted trial balance.

Preparing
Preparing Financial
Financial Statements
Statements
Financial
Financial Statements
Statements are
are prepared
prepared directly
directly from
from the
the
Adjusted
Adjusted Trial
Trial Balance.
Balance.

Balance
Sheet

Chapter
3-50

Income
Statement

Owners
Equity
Statement

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

Preparing
Preparing Financial
Financial Statements
Statements
Illustration 3-25
Preparation of
the income
statement and
owners
equity statement
from the
adjusted trial
balance

Chapter
3-51

Preparing
Preparing Financial
Financial Statements
Statements
Illustration 3-26

Chapter
3-52

Alternative
Alternative Treatment
Treatment of
of Prepaid
Prepaid Expenses
Expenses
and
and Unearned
Unearned Revenues
Revenues
Some companies use an alternative treatment
for prepaid expenses and unearned revenues.
When a company prepays an expense, it debits
that amount to an expense account.
When a company receives payment for future
services, it credits the amount to a revenue
account.

Chapter
3-53

SO 8 Prepare adjusting entries for the alternative treatment of deferrals.

Alternative
Alternative Treatment
Treatment for
for Prepaid
Prepaid Expenses
Expenses
Illustration: Pioneer Advertising purchased supplies on
October 5 for $2,500 and debited Advertising
Supplies Expense for the full amount. What if an inventory
of $1,000 of advertising supplies remains on October 31?
Oct. 31

Advertising supplies

1,000

Advertising supplies expense

1,000
Illustration 3A-1

Chapter
3-54

SO 8 Prepare adjusting entries for the alternative treatment of deferrals.

Alternative
Alternative Treatment
Treatment for
for Prepaid
Prepaid Expenses
Expenses
Adjustment approachesa comparison
Illustration 3A-2

Chapter
3-55

SO 8 Prepare adjusting entries for the alternative treatment of deferrals.

Alternative
Alternative Treatment
Treatment for
for Unearned
Unearned Revenues
Revenues
Illustration: Assume that Pioneer Advertising received
$1,200 for future services on October 2 and credited the
entire amount to Service Revenue. If at the statement
date Pioneer has not performed $800 of the services, it
would make an adjusting entry.
Oct. 31

Service revenue
Unearned service revenue

800
800
Illustration 3A-4

Chapter
3-56

SO 8 Prepare adjusting entries for the alternative treatment of deferrals.

Alternative
Alternative Treatment
Treatment for
for Unearned
Unearned Revenues
Revenues
Adjustment approachesa comparison
Illustration 3A-5

Chapter
3-57

SO 8 Prepare adjusting entries for the alternative treatment of deferrals.

Summary
Summary of
of Additional
Additional Adjustment
Adjustment Relationships
Relationships
Illustration 3A-7

Chapter
3-58

SO 8 Prepare adjusting entries for the alternative treatment of deferrals.

Copyright
Copyright
Copyright 2009 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted
in Section 117 of the 1976 United States Copyright Act
without the express written permission of the copyright owner
is unlawful. Request for further information should be
addressed to the Permissions Department, John Wiley & Sons,
Inc. The purchaser may make back-up copies for his/her own
use only and not for distribution or resale. The Publisher
assumes no responsibility for errors, omissions, or damages,
caused by the use of these programs or from the use of the
information contained herein.

Chapter
3-59