Chapter Chapter 33The Matching Concept The Matching Concept

and the Adjusting Processand the Adjusting ProcessFinancial and Managerial Accounting

8th Edition

Warren Reeve Fess

1. Explain how the matching concept relates to the accrual basis of accounting.

2. Explain why adjustments are necessary and list the characteristics of adjusting entries.

3. Journalize entries for accounts requiring adjustment.

4. Summarize the adjustment process and prepare an adjusted trial balance.

5. Use vertical analysis to compare financial statement items with each other and with industry averages.

ObjectivesObjectivesObjectivesObjectives

The Matching Concept

TWO METHODS

ReportingReporting Revenue and Expenses Revenue and Expenses

Cash Basis of Accounting

Accrual Basis of Accounting

Under the cash basis for the accounting period concept, revenues

and expenses are reported in the income statement in the period in which cash is received or paid.

Under the accrual basis for the accounting period concept, revenues

are reported in the income statement in the period in which they are earned.

Accrual Basis of AccountingAccrual Basis of Accounting

Revenue reported when earned

Expense reported when incurred

Properly matches revenues and expenses in determining net income

Requires adjusting entries at end of period

Revenue reported when earned

Expense reported when incurred

Properly matches revenues and expenses in determining net income

Requires adjusting entries at end of period

The The matching conceptmatching concept supports supports reporting revenues and related reporting revenues and related expenses in the same period.expenses in the same period.

The The matching conceptmatching concept supports supports reporting revenues and related reporting revenues and related expenses in the same period.expenses in the same period.

2004 2005

Paid $10,000 for an advertising campaign for a

product that will be introduced in

2003.

Sold the advertised product.$10,000 $10,000

expensed in expensed in 2005 to match 2005 to match

revenuesrevenues

Paid $10,000 for an advertising campaign for a

product that will be introduced in

2005.

$10,000 $10,000 recorded as an recorded as an

assetasset

NetSolutionsTrial Balance

December 31, 2005

Cash 2 065 00Accounts Receivable 2 220 00Supplies 2 000 00Prepaid Insurance 2 400 00Land 20 000 00Office Equipment 1 800 00Accounts Payable 900 00Unearned Rent 360 00Capital Stock 25 000 00Dividends 4 000 00Fees Earned 16 340 00Wages Expense 4 275 00Rent Expense 1 600 00Utilities Expense 985 00Supplies Expense 800 00Miscellaneous Expense 455 00

42 600 00 42 600 00

Unadjusted trial

balance

Unadjusted trial

balance

Cash 2 065 00Accounts Receivable 2 220 00Supplies 2 000 00Prepaid Insurance 2 400 00Land 20 000 00Office Equipment 1 800 00Accounts Payable 900 00Unearned Rent 360 00Capital Stock 25 000 00Dividends 4 000 00Fees Earned 16 340 00Wages Expense 4 275 00Rent Expense 1 600 00Utilities Expense 985 00Supplies Expense 800 00Miscellaneous Expense 455 00

42 600 00 42 600 00

NetSolutionsTrial Balance

December 31, 2005

AssetsAssets

Cash 2 065 00Accounts Receivable 2 220 00Supplies 2 000 00Prepaid Insurance 2 400 00Land 20 000 00Office Equipment 1 800 00Accounts Payable 900 00Unearned Rent 360 00Capital Stock 25 000 00Dividends 4 000 00Fees Earned 16 340 00Wages Expense 4 275 00Rent Expense 1 600 00Utilities Expense 985 00Supplies Expense 800 00Miscellaneous Expense 455 00

42 600 00 42 600 00

NetSolutionsTrial Balance

December 31, 2005

LiabilitiesLiabilities

Cash 2 065 00Accounts Receivable 2 220 00Supplies 2 000 00Prepaid Insurance 2 400 00Land 20 000 00Office Equipment 1 800 00Accounts Payable 900 00Unearned Rent 360 00Capital Stock 25 000 00Dividends 4 000 00Fees Earned 16 340 00Wages Expense 4 275 00Rent Expense 1 600 00Utilities Expense 985 00Supplies Expense 800 00Miscellaneous Expense 455 00

42 600 00 42 600 00

NetSolutionsTrial Balance

December 31, 2005

Owners’ (Stockholders’

Equity

Owners’ (Stockholders’

Equity

Cash 2 065 00Accounts Receivable 2 220 00Supplies 2 000 00Prepaid Insurance 2 400 00Land 20 000 00Office Equipment 1 800 00Accounts Payable 900 00Unearned Rent 360 00Capital Stock 25 000 00Dividends 4 000 00Fees Earned 16 340 00Wages Expense 4 275 00Rent Expense 1 600 00Utilities Expense 985 00Supplies Expense 800 00Miscellaneous Expense 455 00

42 600 00 42 600 00

NetSolutionsTrial Balance

December 31, 2005

RevenueRevenue

Cash 2 065 00Accounts Receivable 2 220 00Supplies 2 000 00Prepaid Insurance 2 400 00Land 20 000 00Office Equipment 1 800 00Accounts Payable 900 00Unearned Rent 360 00Capital Stock 25 000 00Dividends 4 000 00Fees Earned 16 340 00Wages Expense 4 275 00Rent Expense 1 600 00Utilities Expense 985 00Supplies Expense 800 00Miscellaneous Expense 455 00

42 600 00 42 600 00

NetSolutionsTrial Balance

December 31, 2005

ExpensesExpenses

NetSolutionsChart of Accounts

1. Assets11 Cash12 Accounts Receivable14 Supplies15 Prepaid Insurance17 Land18 Office Equipment19 Accumulated

Depreciation19Accumulated Depreciation

2. Liabilities21 Accounts Payable22 Wages Payable23 Unearned Rent

3. Owners’ (Stockholders’ Equity31 Capital Stock32 Retained Earnings33 Dividends

4. Revenue41 Fees Earned42 Rent Revenue

5. Expenses51 Wages Expense52 Rent Expense53 Depreciation Expense54 Utilities Expense55 Supplies Expense56 Insurance Expense59 Miscellaneous Expense

Deferred Deferred Expenses Expenses (Prepaid (Prepaid

Expenses)Expenses)

NetSolutionsTrial Balance

December 31, 2005

Cash 2 065 00Accounts Receivable 2 220 00Supplies 2 000 00Prepaid Insurance 2 400 00Land 20 000 00Office Equipment 1 800 00Accounts Payable 900 00Unearned Rent 360 00Capital Stock 25 000 00Dividends 4 000 00Fees Earned 16 340 00Wages Expense 4 275 00Rent Expense 1 600 00Utilities Expense 985 00Supplies Expense 800 00Miscellaneous Expense 455 00

42 600 00 42 600 00

Some of these supplies have been used. On December 31, a count reveals that $760 of

supplies are on hand.

Some of these supplies have been used. On December 31, a count reveals that $760 of

supplies are on hand.

1

2

3

4

Supplies Expense 1 240 00

Supplies 1 240 00

Supplies (balance on trial balance) $2,000Supplies on hand, December 31 – 760Supplies used $1,240

Dec. 312005

Dec. 31 1,240Dec. 31 1,240

55

14

SuppliesBal. 2,000

Supplies ExpenseBal. 800

14 55

2,040760

Cash 2 065 00Accounts Receivable 2 220 00Supplies 2 000 00Prepaid Insurance 2 400 00Land 20 000 00Office Equipment 1 800 00Accounts Payable 900 00Unearned Rent 360 00Capital Stock 25 000 00Dividends 4 000 00Fees Earned 16 340 00Wages Expense 4 275 00Rent Expense 1 600 00Utilities Expense 985 00Supplies Expense 800 00Miscellaneous Expense 455 00

42 600 00 42 600 00

NetSolutionsTrial Balance

December 31, 2005

The prepayment for 24 months of insurance does not reflect that

December’s insurance has theoretically expired.

The prepayment for 24 months of insurance does not reflect that

December’s insurance has theoretically expired.

4

5

6

7

31 Insurance Expense 100 00

Prepaid Insurance 100 00

Dec. 31 100 Dec. 31 100

56

15

Prepaid InsuranceBal. 2,400

Insurance Expense15 56

2,300

Note: You probably have the idea of how posting flows, so the rest of the slides will omit the arrows.

Note: You probably have the idea of how posting flows, so the rest of the slides will omit the arrows.

Effect of Omitting AdjustmentEffect of Omitting AdjustmentEffect of Omitting AdjustmentEffect of Omitting Adjustment

Deferred Revenue Deferred Revenue (Unearned (Unearned Revenue)Revenue)

NetSolutionsTrial Balance

December 31, 2005

Cash 2 065 00Accounts Receivable 2 220 00Supplies 2 000 00Prepaid Insurance 2 400 00Land 20 000 00Office Equipment 1 800 00Accounts Payable 900 00Unearned Rent 360 00Capital Stock 25 000 00Retained Earnings 4 000 00Fees Earned 16 340 00Wages Expense 4 275 00Rent Expense 1 600 00Utilities Expense 985 00Supplies Expense 800 00Miscellaneous Expense 455 00

42 600 00 42 600 00

Three months’ rent, $360, was received on December 1. As of

December 31, only $120 has been earned.

Three months’ rent, $360, was received on December 1. As of

December 31, only $120 has been earned.

7

8

9

10

31 Unearned Rent 120 00

Rent Revenue 120 00

Dec. 31 120 Dec. 31 120

23

42

Unearned RentBal. 360

Rent Revenue23 42

240

Effect of Omitting AdjustmentEffect of Omitting AdjustmentEffect of Omitting AdjustmentEffect of Omitting Adjustment

Accrued Accrued Expenses Expenses (Accrued (Accrued

Liabilities)Liabilities)

NetSolutionsTrial Balance

December 31, 2005

Cash 2 065 00Accounts Receivable 2 220 00Supplies 2 000 00Prepaid Insurance 2 400 00Land 20 000 00Office Equipment 1 800 00Accounts Payable 900 00Unearned Rent 360 00Capital Stock 25 000 00Dividends 4 000 00Fees Earned 16 340 00Wages Expense 4 275 00Rent Expense 1 600 00Utilities Expense 985 00Supplies Expense 800 00Miscellaneous Expense 455 00

42 600 00 42 600 00

At the end of December, accrued wages amounted to $250.

Currently, Wages Expense is understated and there is no

liability shown for these wages.

At the end of December, accrued wages amounted to $250.

Currently, Wages Expense is understated and there is no

liability shown for these wages.

10

11

12

13

31 Wages Expense 250 00

Wages Payable 250 00

Dec. 31 250Dec. 31 250

51

22

Wages PayableBal. 4,275

Wages Expense22 51

Effect of Omitting AdjustmentEffect of Omitting AdjustmentEffect of Omitting AdjustmentEffect of Omitting Adjustment

Accrued Accrued Revenues Revenues

(Accrued Assets)(Accrued Assets)

NetSolutionsTrial Balance

December 31, 2005

Cash 2 065 00Accounts Receivable 2 220 00Supplies 2 000 00Prepaid Insurance 2 400 00Land 20 000 00Office Equipment 1 800 00Accounts Payable 900 00Unearned Rent 360 00Capital Stock 25 000 00Dividends 4 000 00Fees Earned 16 340 00Wages Expense 4 275 00Rent Expense 1 600 00Utilities Expense 985 00Supplies Expense 800 00Miscellaneous Expense 455 00

42 600 00 42 600 00

NetSolutions provided $500 in services during December for which the customer has

not been billed.

NetSolutions provided $500 in services during December for which the customer has

not been billed.

13

14

15

16

31 Accounts Receivable 500 00Fees Earned 500 00

Dec. 31 500Dec. 31 500

12

41

Accounts ReceivableBal. 16,340

Fees Earned12 41Bal. 2,220

2,720 16,840

Effect of Omitting AdjustmentEffect of Omitting AdjustmentEffect of Omitting AdjustmentEffect of Omitting Adjustment

Fixed Fixed AssetsAssets

LandLandLandLand

Land has an infinite life; therefore, it does not depreciate.

BuildingBuildingBuildingBuilding

A building has a limited life, so it must be depreciated. A building has a limited life, so it must be depreciated. The contra account used in the adjusting entry is The contra account used in the adjusting entry is

Accumulated DepreciationAccumulated Depreciation——BuildingBuilding

EquipmentEquipmentEquipmentEquipment

Because equipment has a limited life, it depreciates. The contra account used is Accumulated Depreciation—Equipment

NetSolutions estimates the NetSolutions estimates the depreciation on its office equipment depreciation on its office equipment

to be $50 for the month of December.to be $50 for the month of December.

NetSolutions estimates the NetSolutions estimates the depreciation on its office equipment depreciation on its office equipment

to be $50 for the month of December.to be $50 for the month of December.

16

17

18

19

Accumulated Depreciation—

Office Equipment 50 00

Dec. 31 50

19

Depreciation ExpenseDec. 31 50

Accumulated Depreciation—Office Equipment

19 53

53Depreciation Expense 50 0031

NetSolutions’ balance sheet would show the office

equipment at cost, less the accumulated depreciation.

NetSolutions’ balance sheet would show the office

equipment at cost, less the accumulated depreciation.

Office equipment $1,800 Less accumulated depreciation 50 $1,750

Book Book valuevalue

Effect of Omitting AdjustmentEffect of Omitting AdjustmentEffect of Omitting AdjustmentEffect of Omitting Adjustment

Summary of Basic AdjustmentsSummary of Basic AdjustmentsSummary of Basic AdjustmentsSummary of Basic Adjustments

NetSolutions’ Adjusted Trial Balance for

December 31, 2005

Cash 2 065 00Accounts Receivable 2 720 00Supplies 760 00Prepaid Insurance 2 300 00Land 20 000 00Office Equipment 1 800 00Accumulated Depreciation 50 00Accounts Payable 900 00Wages Payable 250 00Unearned Rent 240 00Capital Stock 25 000 00Dividends 4 000 00Fees Earned 16 840 00Rent Revenue 120 00Wages Expense 4 525 00Rent Expense 1 600 00Depreciation expense 50 00Utilities Expense 985 00 Supplies Expense 2 040 00 Insurance Expense 100 00 Miscellaneous Expense 455 00

43 400 00 43 400 00

Vertical Vertical Analysis and Analysis and InterpretationInterpretation

Fees earned $187,500 $150,000

Operating expenses:Wages expense $60,000 $45,000Rent expense 15,000 12,000Utilities expense 12,500 9,000Supplies expense 2,700 3,000Miscellaneous exp. 2,300 1,800 Total operating expenses $92,500 $70,800

Net income $95,000 $79,200

Amount Percent Amount Percent

2006 2005

J. Holmes, Attorney-at-Law, P.C.Income Statements

For the Years Ended December 31, 2005 and 2006

Fees earned $187,500 100.0% $150,000100.0%

Operating expenses:Wages expense $60,000 $45,000Rent expense 15,000 12,000Utilities expense 12,500 9,000Supplies expense 2,700 3,000Miscellaneous exp. 2,300 1,800 Total operating expenses $92,500 $70,800

Net income $95,000 $79,200

Amount Percent Amount Percent

2006 2005

Fees earned $187,500 100.0% $150,000100.0%

Operating expenses:Wages expense $60,000 $45,000Rent expense 15,000 12,000Utilities expense 12,500 9,000Supplies expense 2,700 3,000Miscellaneous exp. 2,300 1,800 Total operating expenses $92,500 $70,800

Net income $95,000 $79,200

2006 2005 Amount Percent Amount Percent

$60,000$60,000$187,500$187,500

$60,000$60,000$187,500$187,500

32.0%$15,000$15,000

$187,500$187,500

$15,000$15,000$187,500$187,500

38.0%

Fees earned $187,500 100.0% $150,000100.0%

Operating expenses:Wages expense $60,000 $45,000

30.0%Rent expense 15,000 12,000

8.0%Utilities expense 12,500 9,000

6.0%Supplies expense 2,700 3,000

2.0%Miscellaneous exp. 2,300 1,800

1.2% Total operating expenses $92,500 $70,800

47.2%Net income $95,000 $79,200

52.8%

6.7%1.4%

1.2%

49.3%50.7%

2006 2005 Amount Percent Amount Percent

32.0%8.0%

The EndThe End

Chapter 3Chapter 3