ACTG 2110

Chapter 3 – The Adjusting Process

Nature of the Adjusting Process

• Accounting Period – we measure income and expense for distinct periods of time (month, quarter, year)

• Accrual accounting versus cash accounting

Accrual Accounting

• Used for GAAP• Revenues are recorded when earned

REGARDLESS of when cash is received.• Expenses are recorded when they occur

REGARDLESS of when cash is paid.• Basically, revenues and expenses are recorded

when they happen• Cash is disregarded• Cannot manipulate accrual accounting as easily

Cash Accounting

• Revenues are recorded when the cash is received

• Expenses are recorded when the cash is paid

• Most individual taxpayers are on the accrual basis

• Can be manipulated easily

Principles

• Revenue recognition – revenue is recorded when earned; essentially all services have been performed or goods have been delivered.

• Matching Principle – Expenses are recorded in the same period as the revenue that they are associated with is earned– Examples: bad debts, warranties

• Time period Concept – information is reported often in the same time increments.

Adjusting Entries

• Performed at the end of the accounting period• Some items are not known during the regular

transactions• Performed to update the balance sheet accounts

to the correct amounts• Performed to record revenues and expenses

that were previously not on the books• NO CASH IS EVER INVOLVED!!!!!!• All entries involve a balance sheet account and

an income statement account.

Types of Adjusting Entries

• Prepaid expenses

• Depreciation expense

• Unearned revenues

• Accrued revenues

• Accrued expenses

Prepaid Expenses

• Asset has previously been recorded when cash was paid

• Adjusting entry is to expense the USE of the asset

• ASSET >>>>>>>>>EXPENSE• 12/31 Expense XXX• Asset XXX• Examples: Prepaid insurance, prepaid

rent, supplies

Depreciation Expense

• Special type of prepaid expense• Depreciation represents the use or wear and tear

of plant and equipment of the business• Adjusting entry is to expense the USE of the

building, automobile, equipment, machinery, etc.• ASSET >>>>>>>>>>>>>>>>>>EXPENSE• 12/31Depreciation expense XXX• Accumulated Depr.

XXX• Accumulated Depreciation is a CONTRA-ASSET

(with a normal credit balance)

Unearned Revenues

• Liability has previously been recorded when cash was received (deposits, retainers.)

• The services have not been performed or the goods have not been delivered

• We have a liability to perform services or deliver goods

• Adjusting entry will occur when the services have been earned.

Unearned Revenues

• Adjusting entry:• 12/31Unearned revenues XXX• Revenues XXX• Unearned revenues (liability) is decreased

because we have done what we were supposed to do to earn the cash we received.

• Examples: magazine subscriptions, season ticket sales for baseball games, plays, music recitals

Accrued Revenues

• Nothing previously recorded

• A revenue has been earned but no cash has been received yet

• Adjusting Entry records the revenue.

• 12/31 Receivable XXX

• Revenue XXX

• Examples: Dividend revenue, interest revenue, sales revenue

Accrued Expenses

• Nothing previously recorded

• An expense has occurred but no payment has been made yet

• Adjusting entry records the expense.

• 12/31 Expense XXX

• Payable XXX

• Examples: Wages, interest, advertising, property taxes, income taxes, etc.

Adjusted Trial Balance

• After adjusting journal entries have been prepared, they are posted to the general ledger.

• Another trial balance is performed to equate $debits to $credits.