Chapter 4Adjusting the Accounts

4-1 Guidelines to Report Revenue and Expenses

Time Period AssumptionTime Period Assumption

Economic life of businessEconomic life of businesscan be divided intocan be divided into

artificial time periodsartificial time periods

Revenue RecognitionRevenue RecognitionPrinciplePrinciple

Revenue recognized inRevenue recognized inthe accounting period inthe accounting period in

which it is earnedwhich it is earned

Matching PrincipleMatching Principle

Expenses matched withExpenses matched withrevenues in the periodrevenues in the period

when efforts are expendedwhen efforts are expendedto generate revenuesto generate revenues

4-2 DepreciationPREPAYMENTPREPAYMENT ASSETASSET EXPENSEEXPENSE

Cost ofCost ofTruckTruck

$15,000$15,000

1/1/081/1/08

20082008 20092009 20102010

Entry:Entry:TruckTruck 15,000 15,000 CashCash 15,000 15,000 DepreciationDepreciation

ExpenseExpense 5,0005,000

AccumulatedAccumulatedDepreciationDepreciation

5,0005,000DepreciationDepreciation

ExpenseExpense5,0005,000

AccumulatedAccumulatedDepreciationDepreciation

5,0005,000CONTRA ASSETCONTRA ASSET

EXPENSEEXPENSE

ASSETASSET

12/31/0812/31/08 12/31/0912/31/09 12/31/1012/31/10

DepreciationDepreciationExpenseExpense

5,0005,000

Statement Presentation:

Balance Sheet

Asset Truck $15,000 $15,000 $15,000

Contra Asset Less: Accum. Depr. 5,000 10,000 15,000

Book Value $10,000 $ 5,000 $ -0-

AccumulatedAccumulatedDepreciationDepreciation

5,0005,000

4-3 Prepayment Relationships

PREPAYMENTSPREPAYMENTSBenefits More Than OneBenefits More Than One

Accounting PeriodAccounting Period

RECORD AS ASSETRECORD AS ASSET RECORD AS LIABILITYRECORD AS LIABILITY

InitialInitialEntryEntry

AdjustingAdjustingEntryEntry

Prepaid Insurance 1,200

Cash 1,200

(Acquired one year policy)

Insurance Expense 100

Prepaid Insurance 100

(One month expired)

Cash 6,000

Unearned Rent 6,000

(Received one year’s rent)

Unearned Rent 500

Rent Revenue 500

(One month earned)

Benefits Consumed orBenefits Consumed orEarned in Current PeriodEarned in Current Period

4-3 Prepayment Relationships(continued)

Account Effects:Account Effects:

Balance Sheet

Prepaid Insurance Unearned Rent

1,200 100 500 6,000

Bal. 1,100 Bal. 5,500

Income Statement

Insurance Expense Rent Revenue

100 500

4-4 Accrual Relationships

ACCRUALSACCRUALSExpense or RevenueExpense or Revenue

Not Yet RecordedNot Yet Recorded

RECORD EXPENSERECORD EXPENSE RECORD REVENUERECORD REVENUE

AdjustingAdjustingEntryEntry

Salaries Expense 500

Salaries Payable 500

(Accrued salary owed)

Salaries Payable 500

Cash 500

(Paid salaries)

Accounts Receivable 1,000

Service Revenue 1,000

(Accrued revenue for services

provided)

Cash 1,000

Accounts Receivable 1,000

(Collected account receivable)

SubsequentSubsequentEntryEntry

4-5 Types of Adjusting Entries

Type of Adjustment Reason for Adjustment Account Balances Before Adjustment

Adjusting Entry

1. Prepaid Expenses (a) Prepaid expenses originally recorded in asset accounts have been used

Assets Overstated

Expenses Understated

Dr. Expenses

Cr. Assets

2. Unearned Revenues (b) Unearned revenues initially recorded in liability accounts have been earned

Liabilities Overstated

Revenues Understated

Dr. Liabilities

Cr. Revenues

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

Assets Understated

Revenues Understated

Dr. Assets

Cr. Revenues

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

Expenses Understated

Liabilities Understated

Dr. Expenses

Cr. Liabilities

Each adjusting entry affects a balance sheetEach adjusting entry affects a balance sheetaccount and an income statement account.account and an income statement account.

4-6 Examples of Adjusting Entries

Instructions:Instructions: For each entry indicate the name of the accountFor each entry indicate the name of the accountdebited debited and the account and the account creditedcredited..

Adjusting Entry

Account Debited Account Credited

1. To record expired rent which had been prepaid

2. To record supplies used during the period

3. To record depreciation on furniture

4. To record unearned revenue that has been earned

5. To record salary owed but not paid

6. To record rent earned but not recorded.

4-6 Examples of Adjusting Entries(continued)

Account

Debited

Account

Credited

1. Rent Expense Prepaid Rent

2. Supplies Expense Supplies

3. Depreciation Expense Accumulated Depreciation

4. Unearned Revenue Revenue

5. Salary Expense Salary Payable

6. Rent Receivable Rent Revenue

Answer:Answer:

4-7 Posting of Adjusting Entries

The following unadjusted accounts and related balances are provided at The following unadjusted accounts and related balances are provided at September 30:September 30:Accounts Receivable………………………………. $ 2,400

Supplies…………………………………………….. 1,200

Salary Payable…………………………………….. -0-

Unearned Revenue……………………………….. 500

Revenue…………………………………………….. 15,000

Salary Expense…………………………………….. 2,100

Depreciation Expense…………………………….. -0-

Accumulated Depreciation……………………….. 3,000

Instructions: Open T-accounts and post the adjusting entries indicated from the following data:

a) Supplies on hand, $200.

b) Revenue earned but not accrued, $900.

c) Unearned revenue earned by not recorded, $400.

d) Salary owed to employees, $700.

e) Depreciation of $200 is recognized.

4-7 Posting of Adjusting Entries (continued)

Accounts Receivable Supplies Salary Payable

2,400 1,000 (a) 1,000 -0-

(b) 900 (d) 700

3,300 200 700

Unearned Revenue Supplies Expense Salary Expense

(c) 400 500 -0- 2,100

(a) 1,000 (d) 700

100 1,000 2,800

Revenue Depreciation Expense Accumulated Depreciation

15,000 -0- 3,000

(b) 900 (e) 200 (e) 200

(c) 400 200 3,200

16,300

4-8 Review Chapter Concepts

Topic Applied Results Justification

1. Time Period Assumption Economic life of business is divided into time periods.

To provide information to prepare financial statements and tax return

2. Revenue Recognition Revenue is recorded in period earned. Requires adjusting entries.

To record assets or decreases in liabilities and proper reporting of revenue earned.

3. Matching Principle Record expenses in the period they occur. Requires adjusting entries.

To record liabilities or use of assets and expenses incurred in earning revenues.

4. Accrual Basis Accounting Applies revenue recognition principle, matching principle, and time period assumption.

To record revenue when earned and expenses when incurred.

4-9 Prepayment—Alternative Treatment

PREPAYMENTSPREPAYMENTSBenefits More Than OneBenefits More Than One

Accounting PeriodAccounting Period

RECORD AS EXPENSERECORD AS EXPENSE RECORD AS REVENUERECORD AS REVENUE

InitialInitialEntryEntry

Insurance Expense 1,200

Cash 1,200

(Acquired one year policy)

Prepaid Insurance 1,100

Insurance Expense 1,100

(Eleven months unexpired)

Cash 6,000

Rent Revenue 6,000

(Received one year’s rent)

Rent Revenue 5,500

Unearned Rent 5,500

(Eleven months unearned)

AdjustingAdjustingEntryEntry

4-9 Prepayment—Alternative Treatment (continued)

Account Effects:Account Effects:

Balance Sheet

Prepaid Insurance Unearned Rent

1,100 5,500

Income Statement

Insurance Expense Rent Revenue

1,200 1,100 5,500 6,000

Bal. 100 Bal. 500