The Adjusting

Process

Chapter 3

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Learning Objectives
1. Differentiate between cash basis
accounting and accrual basis
accounting
2. Define and apply the time period
concept, revenue recognition, and
matching principles
3. Explain the purpose of and
journalize and post adjusting entries
4. Explain the purpose of and prepare
an adjusted trial balance
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Learning Objectives
5. Identify the impact of adjusting
entries on the financial statements
6. Explain the purpose of a worksheet
and use it to prepare adjusting
entries and the adjusted trial
balance
7. Understand the alternative
treatments of recording prepaid
expenses and unearned revenues

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Learning Objective 1

Differentiate between
cash basis accounting
and accrual basis
accounting

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 What is the Difference between Cash
Basis Accounting & Accrual Basis
Accounting?
CASH BASIS ACCRUAL BASIS
• Revenue is recorded • Revenue is recorded
when Cash is when it is earned
received • Expenses are
• Expenses are recorded when
recorded when Cash incurred
is paid • Generally used by
• Not allowed under larger businesses
GAAP

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Learning Objective 2

Define and apply the

time period concept,
revenue recognition,
and matching
principles

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 The Time Period Concept
• Assumes that a business’s activities can
be sliced into small OCTOBER 2012
segments and that Su Mo Tu We Th Fr Sa

financial statements 1 2 3 4 5 6
7 8 9 10 11 12 13
can be prepared for 14 15 16 17 18 19 20
specific time periods, 21 22 23 24 25 26 27

such as a month, 28 29 30 31

quarter, or year.
• Any twelve month period is referred to as
a fiscal year.
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 The Revenue Recognition Principle
Revenue should be
The amount of
recorded when it is
revenues must
EARNED.
represent the
actually selling
price.
A good has
The If a $200 item is
been delivered
earnings discounted to
or a service
process is $100, then the
has been
complete. revenue is $100.
performed.
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 The Matching Principle

Expenses are matched at

Expenses are the end of the period
recorded when against the revenues for
they are that period.
incurred during
the period.
For example, rent expense
for January should be
matched against January
revenues, even if was
actually paid in December.
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Learning Objective 3

Explain the purpose of

and journalize and post
adjusting entries

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 Smart Touch Learning
Trial Balance
The initial trial balance
December 31, 2014 that comes from the
Debit Credit General Ledger is
Cash $ 12,200
Accounts Receivable 1,000 referred to as an
Office Supplies 500
Prepaid Rent 3,000
Unadjusted Trial
Furniture 18,000 Balance.
Building 60,000
Land 20,000
Accounts Payable
Utilities Payable
200
100
Because of the Time
Unearned Revenue 600 Period Concept,
Notes Payable 60,000
Bright, Capital 48,000 Revenue Recognition
Bright, Withdrawals
Service Revenue
5,000 -
16,500
Principle, and
Rent Expense 2,000 Matching Principle
Salaries Expense 3,600
Utilities Expense 100 some adjustments are
$ 125,400 $ 125,400
needed.
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 Smart Touch Learning
Trial Balance
December 31, 2014

Debit Credit
For example, the Office
Cash $ 12,200 Supplies account
Accounts Receivable 1,000
Office Supplies 500 shows $500 at the end
Prepaid Rent
Furniture
3,000
18,000
of December.
Building 60,000
Land 20,000
Accounts Payable 200
If a count of the actual
Utilities Payable
Unearned Revenue
100
600
supplies on hand
Notes Payable 60,000 shows that some
Bright, Capital 48,000
Bright, Withdrawals 5,000 -
supplies have been
Service Revenue 16,500 used, we will need to
Rent Expense 2,000
Salaries Expense 3,600 adjust the account.
Utilities Expense 100
$ 125,400 $ 125,400

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 Adjusting Journal Entries
• Adjustments to the Trial Balance are made
by recording actual Adjusting Journal
Entries.

Date Accounts and Explanation Debit Credit

Dec. 31 Account $$$
Account $$$

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 Adjusting Journal Entries
• Each Adjusting Journal Entry will adjust
a balance sheet account and an income
statement account.

Date Accounts and Explanation Debit Credit

Dec. 31 Supplies Expense $$$
Office Supplies $$$
To record office supplies used.

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 Adjusting Journal Entries
Adjusting Journal Entries (AJE’s) can be
divided into two basic categories:

Prepaids Accruals
1. Prepaid Expenses 1. Accrued revenues
2. Unearned 2. Accrued expenses
Revenues

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 Prepaid Rent Example
In Transaction #10 (see Chapter 2), on December
1, Smart Touch Learning prepaid 3 months rent of
$3,000 ($1,000 x 3 months).

Date Accounts and Explanation Debit Credit

Dec. 1 Prepaid Rent 3,000
Cash 3,000
Paid rent in advance.

Prepaid Rent
Dec. 1 3,000
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 Prepaid Rent Example
Paying rent in advance gives us the right to use
the property for 3 months (in this case). By the end
of December, 1/3 of that right has been used.

Date Accounts and Explanation Debit Credit

Dec. 1 Prepaid Rent 3,000
Cash 3,000
Paid rent in advance.

Prepaid Rent
Dec. 1 3,000
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 Prepaid Rent Example
To adjust the Prepaid Rent account, we need to
reduce it by 1/3, and we need to show the rent
expense related to the December revenues.

Date Accounts and Explanation Debit Credit

Dec. 31 Rent Expense 1,000
Prepaid Rent 1,000
To record rent expense.

Prepaid Rent
Dec. 1 3,000 1,000 Dec. 31
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 Depreciation
• Long-lived, tangible assets used to
generate revenue are referred to as plant
assets.
• Plant assets act like Prepaid Expenses
Paid for Used to
when produce
acquired revenues
Used up
over time

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 Depreciation
• The process of
Land is never
systematically recording
depreciated.
the periodic usage of
plant assets to generate
Accumulated
revenues is called
Depreciation is a
Depreciation.
contra-asset.
• The accounts used are: - Has a credit balance
– Depreciation Expense - Appears in the Asset
– Accumulated section of the Balance
Depreciation Sheet

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 Depreciation Example
Assume that, on December 2, Smart Touch
Learning received a contribution of furniture with a
market value of $18,000 from Sheena Bright.

Date Accounts and Explanation Debit Credit

Dec. 2 Furniture 18,000
Bright, Capital 18,000
Owner contribution of furniture.

At the end of December, Smart Touch Learning will

need to record depreciation for the use of the
furniture, assuming it has a 5 year useful life.
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 Depreciation Example
Using the straight-line method of computing
depreciation, Smart Touch Learning will need to
record $300 of depreciation for December.

Straight-Line Depreciation = ( Cost - Residual Value ) ÷ Useful Life

= ( $18,000 - $0 ) ÷ 5 Years
= $3,600 per year

Monthly Amount = $3,600 ÷ 12 months

= $300

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 Depreciation Example
Recording the entry requires the use of two
accounts: Depreciation Expense and
Accumulated Depreciation.

Date Accounts and Explanation Debit Credit

Dec. 31 Depreciation Expense—Furniture 300
Accumulated Depreciation—Furniture 300
To record depreciation on furniture.

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 Unearned Revenue Example
On December 21, a law firm engages Smart Touch
Learning to provide e-learning services for the next
30 days, paying $600 in advance.

Date Accounts and Explanation Debit Credit

Dec. 21 Cash 600
Unearned Revenue 600
Collected cash for future services.

Unearned Revenue
600 Dec. 21
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 Unearned Revenue Example
Smart Touch Learning is obligated to perform the
services. During the last 10 days of the month, 1/3
of the services are performed.
Date Accounts and Explanation Debit Credit
Dec. 31 Unearned Revenue 200
Service Revenue 200
To record service revenue earned
that was collected in advance.

Unearned Revenue
Dec. 31 200 600 Dec. 21
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 Accrued Expenses Example
Smart Touch Learning pays its employee a
monthly salary of $2,400, half on the 15th and half
on the first day of the next month.

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 Accrued Expenses Example
On December 31, Smart Touch Learning still owes
the employee $1,200, which won’t be paid until
January 1.

Date Accounts and Explanation Debit Credit

Dec. 31 Salaries Expense 1,200
Salaries Payable 1,200
To accrue salaries expense.

Salaries Expense Salaries Payable

Dec. 31 1,200 1,200 Dec. 31

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 Accrued Revenue Example
Accrued revenues arise when the company
recognizes that it has performed a service, or
delivered a product, but has not yet recorded that
they have “earned” the revenue.

Date Accounts and Explanation Debit Credit

Dec. 31 Accounts Receivable xxxx
Service Revenue xxxx
To accrue service revenue.

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 Accrued Revenue Example
On December 15, Smart Touch Learning agrees to
perform e-learning services for $1,600 per month.
By the end of December, they have earned ½ of
the monthly fee for December.

Date Accounts and Explanation Debit Credit

Dec. 31 Accounts Receivable 800
Service Revenue 800
To accrue service revenue.

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Learning Objective 4

Explain the purpose of

and prepare an
adjusted trial balance

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 The Adjusted Trial Balance
• After journalizing and posting all the
adjusting journal entries at the end of the
fiscal period, a new adjusted trial balance
is prepared.
– List all accounts
– List debit balances in the debit column
– List credit balance in the credit column
• If it balances, financial statements can be
prepared.
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 • The adjusted trial
balance includes
accounts that did not
appear on the original
unadjusted trial
balance.
• The financial
statements are
prepared directly from
the adjusted trial
balance.

© 2k015 Pearson Education, Limited. 3-32

Learning Objective 5

Identify the impact of

adjusting entries on
the financial
statements

© 2k015 Pearson Education, Limited. 3-33

© 2k015 Pearson Education, Limited. 3-34
Learning Objective 6

Explain the purpose of

a worksheet and use it
to prepare adjusting
entries and the
adjusted trial balance

© 2k015 Pearson Education, Limited. 3-35

 Unadjusted Trial Adjusted Trial
Balance Adjustments Balance
Account Names Debit Credit Debit Credit Debit Credit
Cash 6,500
Accounts Receivable 800
Office Supplies 250
Prepaid Rent 1,000
Delivery Van 23,000
Accumulated Depreciation - Delivery Van
Equipment 15,000 First, enter the
Accumulated Depreciation - Equipment
Accounts Payable 800 information from
Utilities Payable 230
Salaries Payable the unadjusted
Unearned Revenue
Sam, Capital
400
37,800
trial balance into
Sam, Withdrawals 8,000 the first two
Delivery Revenue 23,000
Rent Expense 3,000 columns of the
Salaries Expense 4,500
Supplies Expense
worksheet.
Utilities Expense 180
Depreciation Expense - Delivery Van
Depreciation Expense - Equipment
Total 62,230 62,230
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 Unadjusted Trial Adjusted Trial
Balance Adjustments Balance
Account Names Debit Credit Debit Credit Debit Credit
Cash 6,500
Accounts Receivable 800 225
Office Supplies 250 80
Prepaid Rent 1,000 800
Delivery Van 23,000
Accumulated Depreciation - Delivery Van 750
Equipment Second, enter
15,000
Accumulated Depreciation - Equipment 300
Accounts Payable the information 800
Utilities Payable
Salaries Payable for the adjusting 230 875
Unearned Revenue
Sam, Capital
journal entries 37,800
400 130

Sam, Withdrawals into the8,000

Delivery Revenue 23,000 355
Rent Expense Adjustments3,000 800
Salaries Expense 4,500 875
Supplies Expense
columns. 80
Utilities Expense 180
Depreciation Expense - Delivery Van 750
Depreciation Expense - Equipment 300
Total 62,230 62,230 3,160 3,160
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 Unadjusted Trial Adjusted Trial
Balance Adjustments Balance
Account Names Debit Credit Debit Credit Debit Credit
Cash 6,500 6,500
Accounts Receivable 800 225 1,025
Office Supplies 250 80 170
Prepaid Rent 1,000 800 200
Delviery Van 23,000 23,000
Accumulated Depreciation - Delivery Van 750 750
Third, cross-foot
Equipment 15,000 15,000
Accumulated Depreciation - Equipment 300 300
the numbers
Accounts Payable 800 800
Utilities Payable 230 230
across the
Salaries Payable 875 875
spreadsheet to
Unearned Revenue
Sam, Capital
400
37,800
130 270
37,800
the Adjusted
Sam, Withdrawals 8,000 8,000
Delivery Revenue 23,000 355 23,355
Trial Balance
Rent Expense 3,000 800 3,800
Salaries Expense 4,500 875 5,375
columns.
Supplies Expense 80 80
Utilities Expense 180 180
Depreciation Expense - Delivery Van 750 750
Depreciation Expense - Equipment 300 300
Total 62,230 62,230 3,160 3,160 64,380 64,380
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Learning Objective 7

Understand the
alternative treatments
of recording prepaid
expenses and
unearned revenues

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 Alternative Treatment of
Prepaid Expenses
Rather than record the prepayment of an expense
as a current asset, record the prepayment as an
expense on the date of payment.

Date Accounts and Explanation Debit Credit

Dec. 1 Rent Expense 3,000
Cash 3,000
Paid rent in advance.

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 Alternative Treatment of
Prepaid Expenses
At the end of the period, if any of the expense
remains “unused,” then adjust some of it INTO the
prepaid asset account.

Date Accounts and Explanation Debit Credit

Dec. 31 Prepaid Rent 2,000
Rent Expense 2,000
To record prepaid rent.
The results are the same as the
traditional approach.

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 Alternative Treatment of
Unearned Revenues
Rather than record the early cash receipt from a
customer as a current liability, record the cash
receipt as a revenue on the date of receipt.

Date Accounts and Explanation Debit Credit

Dec. 1 Cash 600
Service Revenue 600
Collected cash for future services.

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 Alternative Treatment of
Unearned Revenues
At the end of the period, if any of the revenue
remains “unearned,” then adjust some of it INTO
the unearned revenue account.

Date Accounts and Explanation Debit Credit

Dec. 31 Service Revenue 400
Unearned Revenue 400
To record unearned revenue.
The results are the same as the
traditional approach.

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End of Chapter 3

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