AAccounting Principlesccounting Principles

Adjusting Adjusting Entries: Entries:

Accruals

REVENUE RECOGNITION PRINCIPLE

The revenue recognition principle dictates that revenue be recognized in the accounting period in which it is earned.

In a service business, revenue is considered to be earned at the time the service is performed.

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 earned

this monthare offset against....

expensesincurred inearning the

revenue

STUDY OBJECTIVE STUDY OBJECTIVE

Identify the major types of adjusting entries.

Adjusting entries are required each time financial statements are prepared.

Adjusting entries can be classified as1 prepayments (prepaid expenses or unearned revenues) OR2 accruals (accrued revenues or accrued expenses)

ADJUSTING ENTRIES

TYPES OF ADJUSTING ENTRIES

Prepayments1 Prepaid Expenses — Expenses paid in cash

and recorded as assets before they are used or consumed

2 Unearned Revenues — cash received and recorded as liabilities before revenue is earned

TYPES OF ADJUSTING ENTRIES

Accruals1 Accrued Revenues — Revenues earned but

not yet received in cash or recorded2 Accrued Expenses — Expenses incurred but

not yet paid in cash or recorded

ILLUSTRATION 3-3 TRIAL BALANCE

The Trial Balance is the starting

place for adjusting entries.

STUDY OBJECTIVE STUDY OBJECTIVE

Prepare adjusting entries for accruals.

ACCRUALS

The second category of adjusting entries 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.

Adjusting Entries

Asset

Debit Adjusting Entry (+)

Accrued RevenuesRevenue

Credit Adjusting Entry (+)

Accrued ExpensesExpense

Debit Adjusting Entry (+)

Liability

Credit Adjusting Entry (+)

ILLUSTRATION 3-10 ADJUSTING ENTRIES FOR ACCRUALS

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.

ACCRUED REVENUES

ADJUSTING ENTRIES FOR ACCRUALS

ACCRUED REVENUESOctober 31, the agency earned $200 for advertising services that were not billed to clients before October 31.

JOURNAL ENTRY

POSTING

ADJUSTMENT

Accrued expenses are expenses incurred but not paid yet.

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

ACCRUED EXPENSES

ADJUSTING ENTRIES FOR ACCRUALS

ACCRUED INTEREST

JOURNAL ENTRY

POSTING

ADJUSTMENT October 31, the portion of the interest to be accrued on a 3-month note payable is calculated to be $50.

ADJUSTING ENTRIES FOR ACCRUALS

ACCRUED SALARIES

JOURNAL ENTRY

POSTING

ADJUSTMENT October 31, accrued salaries are calculated to be $1,200.

ILLUSTRATION 3-16 SUMMARY OF ADJUSTING ENTRIES

1 Prepaid Assets and Assets overstated Dr. Expenses expenses expenses Expenses understated Cr. Assets2 Unearned Liabilities and Liabilities overstated Dr. Liabilities revenues revenues Revenues understated Cr. Revenues3 Accrued Assets and Assets understated Dr. Assets revenues revenues Revenues understated Cr. Revenues4 Accrued Expenses and Expenses understated Dr. Expenses expenses liabilities Liabilities understated Cr. Liabilities

Journalize transactions. Post entries to

the ledger accounts.

Prepare trial balance.

Make end-of-year

adjustments.

Prepare adjusted trial balance.

Let’s look at JJ’s Lawn Care Services’ adjusted trial balance.

Effects of the Adjusting Entries