Adjusting EntriesAdjusting Entries

Measuring Business IncomeMeasuring Business Income

Accounting period assumptionAccounting period assumption Cash accounting versus accrual Cash accounting versus accrual

accountingaccounting Matching principleMatching principle Materiality conceptMateriality concept

Adjusting EntriesAdjusting Entries

Journal entries that update the general Journal entries that update the general ledger accounts to state revenues, ledger accounts to state revenues, expenses, assets, and liabilities more expenses, assets, and liabilities more accuratelyaccurately

InvolveInvolve– One balance sheet accountOne balance sheet account

– One income statement accountOne income statement account

– Never cashNever cash

Adjusting ProcessAdjusting Process

Identify the accounts requiring Identify the accounts requiring adjustmentadjustment

Determine unadjusted balancesDetermine unadjusted balances Determine correct (adjusted) balances Determine correct (adjusted) balances

for each accountfor each account Prepare adjusting entry to bring Prepare adjusting entry to bring

accounts in agreement with adjusted accounts in agreement with adjusted balancesbalances

DeferralsDeferrals

A cash payment or receipt occurred A cash payment or receipt occurred in current periodin current period

Must defer a portion of expense or Must defer a portion of expense or revenue until a future periodrevenue until a future period

DeferralsDeferrals

Two situationsTwo situations– Pay a cost of benefit in advance and Pay a cost of benefit in advance and

allocate cost as expenses to periods allocate cost as expenses to periods that receive benefitthat receive benefit

DeferralsDeferrals

Two situationsTwo situations– Pay a cost of benefit in advance and Pay a cost of benefit in advance and

allocate cost as expenses to periods allocate cost as expenses to periods that receive benefitthat receive benefit

– Receive a cash revenue in advance Receive a cash revenue in advance and allocate amounts as revenues to and allocate amounts as revenues to periods in which revenues earnedperiods in which revenues earned

Prepaid InsurancePrepaid Insurance

Dec. 1, paid $600 for 12 month Dec. 1, paid $600 for 12 month insurance premium recording as insurance premium recording as asset, Prepaid Insuranceasset, Prepaid Insurance

At Dec. 31At Dec. 31– Prepaid Insurance balance $600Prepaid Insurance balance $600

– Insurance Expense balance $0Insurance Expense balance $0

Prepaid InsurancePrepaid Insurance

As of Dec. 31, one month’s As of Dec. 31, one month’s insurance has expired and become insurance has expired and become expenseexpense

Correct Dec. 31 balanceCorrect Dec. 31 balance– Prepaid Insurance $550Prepaid Insurance $550

– Insurance Expense $50Insurance Expense $50

Prepaid InsurancePrepaid Insurance

Adjusting entryAdjusting entry– Debit Insurance Expense $50Debit Insurance Expense $50

»Increases Insurance Expense to Increases Insurance Expense to correct balance $50correct balance $50

– Credit Prepaid Insurance $50Credit Prepaid Insurance $50

»Decreases Prepaid Insurance to Decreases Prepaid Insurance to correct balance $550correct balance $550

Depreciation ExpenseDepreciation Expense

Similar to prepaid insurance but for Similar to prepaid insurance but for long-term assetlong-term asset

Decrease in asset not recorded in Decrease in asset not recorded in asset accountasset account

Recorded as increase in contra Recorded as increase in contra asset - Accumulated Depreciationasset - Accumulated Depreciation

Depreciation ExpenseDepreciation Expense

Before After

Balance Sheet

TrucksAccum Deprec

$26,000400

$26,000800

Income Statement

Depreciation expense $0 $400

Unearned RevenuesUnearned Revenues

Dec. 1, received $600 for 6 month Dec. 1, received $600 for 6 month rent recording as liability, Unearned rent recording as liability, Unearned RentRent

At Dec. 31At Dec. 31– Unearned Rent balance $600Unearned Rent balance $600

– Rent Revenue balance $0Rent Revenue balance $0

Unearned RevenuesUnearned Revenues

As of Dec. 31, one month’s rent As of Dec. 31, one month’s rent has been earned and become has been earned and become revenuerevenue

Correct Dec. 31 balanceCorrect Dec. 31 balance– Unearned Revenue $500Unearned Revenue $500

– Rent Revenue $100Rent Revenue $100

Unearned RevenuesUnearned Revenues

Adjusting entryAdjusting entry– Debit Unearned Rent $100Debit Unearned Rent $100

»Decreases Unearned Rent to Decreases Unearned Rent to correct balance $500correct balance $500

– Credit Rent Revenue $100Credit Rent Revenue $100

»Increases Rent Revenue to correct Increases Rent Revenue to correct balance $100balance $100

AccrualsAccruals

Recognize revenues and expenses Recognize revenues and expenses that have accumulated (accrued) that have accumulated (accrued) during the accounting period but during the accounting period but have not been recordedhave not been recorded

Accrued RevenuesAccrued Revenues

Dec.11, received 30-day, 15% note Dec.11, received 30-day, 15% note from customer.from customer.

At Dec. 31At Dec. 31– Interest Revenue balance $0Interest Revenue balance $0

– Interest Receivable balance $0Interest Receivable balance $0

Accrued RevenuesAccrued Revenues

As of Dec. 31, 20 days interest has As of Dec. 31, 20 days interest has been earned and become revenuebeen earned and become revenue

$1,200 x 0.15 x 20/360 = $10$1,200 x 0.15 x 20/360 = $10 Correct Dec. 31 balanceCorrect Dec. 31 balance

– Interest Revenue $10Interest Revenue $10

– Interest Receivable $10Interest Receivable $10

Accrued RevenuesAccrued Revenues

Adjusting entryAdjusting entry– Debit Interest Receivable $10Debit Interest Receivable $10

»Increases Interest Receivable to Increases Interest Receivable to correct balance $10correct balance $10

– Credit Interest Revenue $10Credit Interest Revenue $10

»Increases Interest Revenue to Increases Interest Revenue to correct balance $10correct balance $10

Accrued ExpensesAccrued Expenses

Employees paid Friday for 5-day Employees paid Friday for 5-day work week at $1,000 per weekwork week at $1,000 per week

At Dec. 31, a TuesdayAt Dec. 31, a Tuesday– Wages Expense balance $50,000 - Wages Expense balance $50,000 -

represents past weeks wagesrepresents past weeks wages

– Wages Payable balance $0Wages Payable balance $0

Accrued ExpensesAccrued Expenses

As of Dec. 31, 2 days wages have As of Dec. 31, 2 days wages have been incurred and become been incurred and become expenseexpense

Correct Dec. 31 balanceCorrect Dec. 31 balance– Wages Expense $50,200Wages Expense $50,200

– Wages Payable $200Wages Payable $200

Accrued ExpensesAccrued Expenses

Adjusting entryAdjusting entry– Debit Wages Expense $200Debit Wages Expense $200

»Increases Wages Expense to Increases Wages Expense to correct balance $50,200correct balance $50,200

– Credit Wages Payable $200Credit Wages Payable $200

»Increases Wages Payable to Increases Wages Payable to correct balance $200correct balance $200

Summarize AdjustmentsSummarize Adjustments

Analyzing InformationAnalyzing Information

Use questions to compare Use questions to compare companiescompanies

Income StatementIncome Statement

Which company has the higher Which company has the higher revenues?revenues?

Which company has the higher Which company has the higher percentage change in revenues?percentage change in revenues?

Which company has the lower Which company has the lower percentage of expenses to percentage of expenses to revenues?revenues?

Balance SheetBalance Sheet

Which company has the higher assets?Which company has the higher assets? What is the percentage change in What is the percentage change in

assets for each company?assets for each company? Is the percent of total liabilities to total Is the percent of total liabilities to total

liabilities plus owners’ equity increasing liabilities plus owners’ equity increasing or decreasing? Which company is or decreasing? Which company is more risky?more risky?

Integrative AnalysisIntegrative Analysis

Are companies operating efficiently by Are companies operating efficiently by using least amount of assets to using least amount of assets to generate a given level of revenues?generate a given level of revenues?– Calculate total asset turnoverCalculate total asset turnover

Are companies operating efficiently by Are companies operating efficiently by using least amount of assets to using least amount of assets to generate a given net income?generate a given net income?– Calculate return on assetsCalculate return on assets