Accounting

Principles
Second Canadian Edition
Weygandt Kieso Kimmel
Trenholm

Prepared by:
Carole Bowman, Sheridan College
ADJUSTING THE ACCOUNTS
 Accounting Principles

In adopting the accrual basis,

Accountant adheres to

revenuerecognition principle
matching principle
 REVENUE RECOGNITION
PRINCIPLE
The revenue recognition principle states that
revenue should be recognized in the accounting
period in which it is earned.
In a service business, revenue is usually considered
to be earned at the time the service is performed.
In a merchandising business, revenue is usually
earned at the time the goods are delivered.
 THE MATCHING PRINCIPLE

The practice of expense recognition is

referred to as the matching principle.
The matching principle dictates that efforts
(expenses) be matched with
accomplishments (revenues).

Revenues expenses
earned are offset incurred in
this month against.... earning the
revenue
 ACCRUAL BASIS OF
ACCOUNTING

Adheres to the

GAAP
Revenue recognition principle
Matching principle

Revenue recorded when earned, not only

when cash received.
Expense recorded when services or goods
are used or consumed in the generation
of revenue, not only when cash paid.
 CASH BASIS OF
ACCOUNTING

Revenue recorded
only when cash

NO
received.

T
Expense recorded

GA
only when cash
paid.

AP
 ADJUSTING ENTRIES

Adjustingentries make the revenue

recognition and matching principles

HAPPEN!
 ILLUSTRATION 3-3
TRIAL BALANCE
Pioneer Advertising Agency
Trial Balance
October 31, 2002
Debit Credit
Cash $ 15,200
Advertising Supplies 2,500
Prepaid Insurance The Trial Balance 600
Office Equipment 5,000
Notes Payable
is analysed to $ 5,000
Accounts Payable determine the 2,500
Unearned Revenue 1,200
C.R. Byrd, Capital
need for adjusting 10,000
C.R. Byrd, Drawings entries. 500
Service Revenue 10,000
Salaries Expense 4,000
Rent Expense 900
$ 28,700 $ 28,700
 ADJUSTING ENTRIES

Adjusting entries are required each time financial

statements are prepared.

Adjusting entries can be classified as

1. prepayments (prepaid expenses or unearned
revenues),
2. accruals (accrued revenues or accrued
expenses), or
3. estimates (Depreciation).
 TYPES OF ADJUSTING ENTRIES

Prepayments
1. Prepaid Expenses Expenses paid in cash
and recorded as assets before they are used or
consumed.
2. Unearned Revenues Revenues received in
cash and recorded as liabilities before they are
earned.
 TYPES OF ADJUSTING ENTRIES

Accruals
1. Accrued Revenues Revenues earned but not
yet received in cash or recorded.
2. Accrued Expenses Expenses incurred but
not yet paid in cash or recorded.
 TYPES OF ADJUSTING ENTRIES

Estimates
1. Depreciation Allocation of the cost of
capital assets to expense over their useful
lives.
 PREPAYMENTS

Prepayments are either prepaid expenses or

unearned revenues.
Adjusting entries for prepayments are
required to record the portion of the
prepayment that represents
1. the expense incurred or,
2. the revenue earned in the current
accounting period.
 PREPAID EXPENSES

Prepaid expenses are expenses paid in cash

and recorded as assets before they are used
or consumed.
Prepaid expenses expire with the passage of
time or through use and consumption.
An asset-expense account relationship exists
with prepaid expenses.
 PREPAID EXPENSES

Prior to adjustment, assets are overstated and

expenses are understated.
The adjusting entry results in a debit to an
expense account and a credit to an asset
account.
Examples of prepaid expenses include
supplies, rent, insurance, and property tax.
 UNEARNED REVENUES

Unearned revenues are revenues received

and recorded as liabilities before they are
earned.
Unearned revenues are subsequently
earned by performing a service or
providing a good to a customer.
A liability-revenue account relationship
exists with unearned revenues.
 UNEARNED REVENUES

Prior to adjustment, liabilities are

overstated and revenues are understated.
The adjusting entry results in a debit to a
liability account and a credit to a revenue
account.
Examples of unearned revenues include
rent, magazine subscriptions, airplane
tickets, and tuition.
 ILLUSTRATION 3-4
ADJUSTING ENTRIES FOR PREPAYMENTS

Adjusting Entries
Prepaid Expenses
Asset Expense
Unadjusted Credit Debit
Balance Adjusting Adjusting
Entry (-) Entry (+)
Unearned Revenues
Liability Revenue
Debit Unadjusted Credit
Adjusting Balance Adjusting
Entry (-) Entry (+)
Example
 Analyzing an Adjusting Entry:
An Example
You have the following data about an adjustment:
Prepaid $15,000 for 12 months of insurance
on Sept 1 of the current year. Make the
appropriate adjustment as of the end of the
fiscal period.
 Analyzing an Adjusting Entry:
An Example
Original Entry: On Sept 1 the following entry
would be recorded when the insurance was
prepaid:
Prepaid Insurance 15,000
Cash 15,000

Prepaid Insurance is an asset account it is an

amount owned by the company that has economic
value.
 Analyzing an Adjusting Entry:
An Example

Each month, a portion of the prepaid insurance

expires. At the end of the fiscal period, the
Prepaid Insurance and Insurance Expense
accounts must be updated for the insurance that
has expired (been used).
 Analyzing an Adjusting Entry:
An Example
Lets divide the analysis of this transaction into two parts:
1.What accounts are involved?
When something is used up it indicates an expense
account. In this case, we need to debit Insurance
Expense for the expired insurance. Furthermore, the
asset, Prepaid Insurance, has decreased so we will credit
this asset.
2.What is the amount of the adjustment?
See the next slide for the calculation of the amount of
expired insurance.
Analyzing an Adjusting Entry:
An Example

$15,000 for 12 months =

$1,250/month (15,000/12)

Policy purchased on Sept 1. Months

that
have expired between purchase and
fiscal year-end = 4 (Sept, Oct, Nov,
Dec)
Amount of adjustment = $5,000
($1,250/month X 4 months)
 Record the Adjustment
Adjusting entries are always recorded on
the last day of the fiscal period. For our
example, the fiscal period closes on Dec
31. The adjustment is journalized as
follows:

POST
DATE ACCOUNT DEBIT CREDIT
REF
0
Dec 31 Insurance Expense 5000
0
Prepaid Insurance 5000 00
 Analyzing an Adjusting Entry:
Another Example
Lets try another example. You have the following data about an adjustment:

You received $12,000 advance cash on

November 1 for a painting job you are to
complete over the next three months.
 Analyzing an Adjusting Entry:
Another Example
Original Entry: On November 1, Cash would be
debited and a liability account called Unearned
Painting Revenue would be credited. The liability
account is credited because you owe the customer.
You owe the customer painting services.)
Cash 12,000
Unearned Painting Rev 12,000
 Analyzing an Adjusting Entry:
Another Example

Each month as you perform painting services, you are

earning a portion of the unearned revenue. At the end
of the fiscal period, the Unearned Painting Revenue
and Painting Revenue accounts must be updated for
the revenue that has now been earned.
 Completing the Adjustment
We have performed step 1 of the analysis: the
accounts involved are Unearned Painting Revenue
(a liability) and Painting Revenue (a revenue). So
far, the adjusting entry looks as follows:
POST
DATE ACCOUNT DEBIT CREDIT
REF

Dec 31 Unearned Painting Revenue

Painting Revenue

Note that as we perform the services owed, the

liability decreases (this is accomplished by
debiting Unearned Painting Revenue) and the
revenue earned increases (this is accomplished by
crediting Painting Revenue).
Step 2: What amount is
Used in the Adjustment?

$12,000 for 3 months=

$4,000/month (12,000/3)

Cash advance received on

November 1. Two months of work
have been completed by the fiscal
year-end (Nov and Dec)
Amount of adjustment = $8,000
($4,000/month X 2 months)
 Complete the Adjusting Entry
Now fill in the amount of the adjustment:

POST
DATE ACCOUNT DEBIT CREDIT
REF
0
Dec 31 Unearned Painting Revenue 8,000
0
Painting Revenue 8,000 00
 ACCRUALS

A different type of adjusting entry is

accruals.
Adjusting entries for accruals are required
to record revenues earned and expenses
incurred in the current period.
The adjusting entry for accruals will
increase both a balance sheet and an
income statement account.
 ACCRUED REVENUES

Accrued revenues may accumulate with the

passing of time or through services performed but
not billed or collected.
An asset-revenue account relationship exists with
accrued revenues.
Prior to adjustment, assets and revenues are
understated.
The adjusting entry requires a debit to an asset
account and a credit to a revenue account.
Examples of accrued revenues include accounts
receivable, rent receivable, and interest
receivable.
 ACCRUED EXPENSES
Accrued expenses are expenses incurred but not
yet paid.
A liability-expense account relationship exists.
Prior to adjustment, liabilities and expenses are
understated.
The adjusting entry results in a debit to an
expense account and a credit to a liability
account.
Examples of accrued expenses include accounts
payable, rent payable, salaries payable, and
interest payable.
 ILLUSTRATION 3-6
FORMULA TO CALCULATE
INTEREST

Face Annual Time

Value of x Interest x (in Terms of = Interest
Note Rate One Year)

$5,000 x 6% x 1/12 = $25

 ILLUSTRATION 3-5
ADJUSTING ENTRIES FOR ACCRUALS
Adjusting Entries

Accrued Revenues
Asset Revenue
Debit Credit
Adjusting Adjusting
Entry (+) Entry (+)
Accrued Expenses
Expense Liability
Debit Credit
Adjusting Adjusting
Entry (+) Entry (+)
 Accrued Revenues
Earned $200 for advertising services to clients
in October, but they were not billed until after
October 31st.
Accounts Service
Receivable Revenue
Oct 31 200 Oct 31 200

GENERAL JOURNAL Debit Credit

Oct 31 Accounts Receivable 200
Service Revenue 200
Interest expense is the cost a
company incurs to use money:
Information needed to compute interest expense:
face value of note
interest rate (always expressed in annual rate)
the length of time note is outstanding

Formula for Calculating Interest

Face Value Annual Time

of Note Interest in Terms of Interest
Rate One Year

$ 5,000 X 12% 1/12 = $50

Accrued Interest Expense
Interest Expense Interest Payable
Oct 31 50 Oct 31 50

GENERAL JOURNAL Debit Credit

Oct 31 Interest Expense 50
Interest Payable 50
Accrue interest expense for the month
 Accrued Salaries Expense
(Salaries Paid for after the Service Has Been Performed)
Accrued Salaries Expense
Salaries Expense Salaries Payable
Oct 31 1,200 Oct 31 1,200

GENERAL JOURNAL Debit Credit

Oct 31 Salaries Expense 1,200
Salaries Payable 1,200
Accrue salary expense for the month
 Depreciation

Depreciation is the process of allocating the

cost of certain capital assets to expense over
their useful life in a rational and systematic
manner.
Depreciation attempts to match the cost of
a long-term, capital asset to the revenue it
generates each period.
 Depreciation

Depreciationis an estimate rather than

a factual measurement of the cost that
has expired.

Were not attempting to reflect the

actual change in value of an asset!
 Depreciation
In recording Depreciation, Depreciation
Expense is debited and a contra asset account,
Accumulated Depreciation, is credited.
The difference between the cost of the asset and
its related accumulated Depreciation is referred
to as the net book value of the asset.

Depreciation Expense Accumulated Depreciation

xxx xxx
 Depreciation

Balance Sheet Presentation

Office equipment $5,000 Estimate

Less: Accumulated
Depreciation 83
Net book value $4,917
 ILLUSTRATION 3-8
SUMMARY OF ADJUSTING ENTRIES
Type of Account Accounts before Adjusting
Adjustment Relationship Adjustment Entry

1.Prepaid Assets and Assets overstated Dr. Expenses

Dr.
expenses expenses Expenses understated Cr. Cr. Assets
2.Unearned Liabilities and Liabilities overstated Dr. Liabilities
Dr.
revenues revenues Revenues understated Cr. Cr. Revenues
3.Accrued Assets and Assets understated Dr. Dr. Assets revenues
revenues Revenues understated Cr. Cr. Revenues
4.Accrued Expenses and Expenses understated Dr. Dr. Expenses
expenses liabilities Liabilities understated Cr.
Cr. Liabilities
5.Depreciation Expense and Expenses understated Dr. Dr. Amort. Exp
contra asset Assets overstated Cr. Cr. Accum. Depreciation
 ADJUSTED TRIAL BALANCE
An Adjusted Trial Balance is prepared after all
adjusting entries have been journalized and posted.
It shows the balances of all accounts at the end of
the accounting period and the effects of all financial
events that have occurred during the period.
It proves the equality of the total debit and credit
balances in the ledger after all adjustments have
been made.
Financial statements can be prepared directly from
the adjusted trial balance.
 ILLUSTRATION 3-11
TRIAL BALANCE AND ADJUSTED TRIAL BALANCE COMPARED
Pioneer Advertising Agency
Trial Balance
October 31, 2002
Before Adjustment After Adjustment
Debit Credit Debit Credit
Cash $ 15,200 $ 15,200
Accounts Receivable 200
Advertising Supplies 2,500 1,000
Prepaid Insurance 600 550
Office Equipment 5,000 5,000
Accumulated Amort'n. $ 83
Notes Payable $ 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 800
Salaries Payable 1,200
Interest Payable 25
C.R. Byrd, Capital 10,000 10,000
C.R. Byrd, Drawings 500 500
Service Revenue 10,000 10,600
Adv. Supplies Expense 1,500
Amortization Expense 83
Insurance Expense 50
Salaries Expense 4,000 5,200
Rent Expense 900 900
Interest Expense 25
$ 28,700 $ 28,700 $ 30,208 $ 30,208
 PREPARING FINANCIAL STATEMENTS
Financial statements can be prepared directly from
an adjusted trial balance.
1. The income statement is prepared from the revenue
and expense accounts.
2. The statement of owners equity is derived from the
owners capital and drawings accounts and the net
income (or net loss) shown in the income statement.
3. The balance sheet is then prepared from the asset
and liability accounts and the ending owners capital
balance as reported in the statement of owners equity.
 ILLUSTRATION 3-12
PREPARATION OF THE INCOME STATEMENT AND THE
STATEMENT OF OWNERS EQUITY FROM THE
ADJUSTED TRIAL BALANCE
Pioneer Advertising Agency Pioneer Advertising Agency
Adjusted Trial Balance Income Statement
October 31, 2002 For the Month Ended October 31, 2002
Debit Credit Revenues
Cash $ 15,200 Service Revenue $ 10,600
Accounts Receivable 200
Expenses
Advertising Supplies 1,000
Adv. Supplies Expense $ 1,500
Prepaid Insurance 550
Office Equipment 5,000
Amortization Expense 83
Accumulated Amort'n. $ 83 Insurance Expense 50
Notes Payable 5,000 Salaries Expense 5,200
Accounts Payable 2,500 Rent Expense 900
Unearned Revenue 800 Interest Expense 25
Salaries Payable 1,200 Total Expenses 7,758
Interest Payable 25 Net Income $ 2,842
C.R. Byrd, Capital 10,000
C.R. Byrd, Drawings 500 Pioneer Advertising Agency
Service Revenue 10,600 Statement of Owner's Equity
Adv. Supplies Expense 1,500 For the Month Ended October 31, 2002
Amortization Expense 83 C.R. Byrd, Capital, October 1 $ -
Insurance Expense 50
Add: Investments 10,000
Salaries Expense 5,200
Net income 2,842
Rent Expense 900
Interest Expense 25 12,842
$ 30,208 $ 30,208 Less: Drawings 500
C.R. Byrd, Capital, October 31 $ 12,342
 ILLUSTRATION 3-13
PREPARATION OF THE BALANCE SHEET FROM
THE ADJUSTED TRIAL BALANCE
Pioneer Advertising Agency Pioneer Advertising Agency
Adjusted Trial Balance Balance Sheet
October 31, 2002 October 31, 2002
Debit Credit Assets
Cash $ 15,200
Cash $ 15,200
Accounts Receivable 200
Accounts Receivable 200
Advertising Supplies 1,000
Advertising Supplies 1,000
Prepaid Insurance 550
Office Equipment 5,000 Prepaid Insurance 550
Accumulated Amort'n. $ 83 Office Equipment $ 5,000
Notes Payable 5,000 Less: Accumulated Amortization 83 4,917
Accounts Payable 2,500 Total Assets $ 21,867
Unearned Revenue 800
Salaries Payable 1,200 Liabilities and Owner's Equity
Interest Payable 25 Liabilities
C.R. Byrd, Capital 10,000 Notes Payable $ 5,000
C.R. Byrd, Drawings 500 Accounts Payable 2,500
Service Revenue 10,600
Unearned Revenue 800
Adv. Supplies Expense 1,500
Salaries Payable From 1,200
Amortization Expense 83
Insurance Expense 50
Interest Payable Statement 25
Salaries Expense 5,200 Total Liabilities of Owners $ 9,525
Rent Expense 900 Owner's Equity Equity
Interest Expense 25 C.R. Byrd, Capital 12,342
$ 30,208 $ 30,208 Total Liabilities and Owner's Equity $ 21,867
STEPS IN THE ACCOUNTING CYCLE
1. Analyse
transactions 2. Journalize the
9. Coming transactions
next chapter
3. Post to ledger
accounts
8. Coming
4. Prepare a
next chapter
trial balance

7. Prepare 5. Journalize
financial and post
statements adjusting
6. Prepare
adjusted trial entries
balance
Thank you