Accounting Principles, 5e

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Accounting Principles
Adjusting Entries Accruals
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TIME-PERIOD ASSUMPTION

• The time period (or periodicity) assumption
  assumes that the economic life of a business can
  be divided into artificial time periods.
• Accounting time periods are generally
  a month, a quarter, or a year.
• The accounting time period of one
  year in length is referred to as a
  fiscal year.

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ACCRUAL BASIS OF ACCOUNTING

• The revenue recognition and matching principles
  are used under the accrual basis of accounting.
• Under cash basis accounting, revenue is recorded
  when cash is received, and expenses are recorded
  when cash is paid.
• Generally accepted accounting principles require
  accrual basis accounting because the cash basis
  often causes misleading financial statements.

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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.

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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 month
expenses incurred in earning the revenue
are offset against....
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ILLUSTRATION 3-1 GAAP
RELATIONSHIPS IN REVENUE AND EXPENSE RECOGNITION
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STUDY OBJECTIVE 3

• Explain why adjusting entries are needed.

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ADJUSTING ENTRIES

• Adjusting entries are made in order for
• 1 Revenues to be recorded in the period in which
  they are earned, and for......
• 2 Expenses to be recognized in the period in
  which they are incurred.

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STUDY OBJECTIVE 4

• Identify the major types of adjusting entries.

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ADJUSTING ENTRIES

• Adjusting entries are required each time
  financial statements are prepared.
• Adjusting entries can be classified as
• 1 prepayments (prepaid expenses or unearned
  revenues) OR
• 2 accruals (accrued revenues or accrued
  expenses)

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TYPES OF ADJUSTING ENTRIES

• Prepayments
• 1 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

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TYPES OF ADJUSTING ENTRIES

• Accruals
• 1 Accrued Revenues Revenues earned but not yet
  received in cash or recorded
• 2 Accrued Expenses Expenses incurred but not
  yet paid in cash or recorded

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ILLUSTRATION 3-3 TRIAL
BALANCE

• The Trial Balance is the starting place for
  adjusting entries.

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STUDY OBJECTIVE 6

• Prepare adjusting entries for accruals.

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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.

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ILLUSTRATION 3-10
ADJUSTING ENTRIES FOR ACCRUALS
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ACCRUED REVENUES

• 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.

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ADJUSTING ENTRIES FOR ACCRUALS ACCRUED REVENUES
ADJUSTMENT

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

JOURNAL ENTRY
POSTING
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ACCRUED EXPENSES

• 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

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ADJUSTING ENTRIES FOR ACCRUALS ACCRUED INTEREST
ADJUSTMENT

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

JOURNAL ENTRY
POSTING
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ADJUSTING ENTRIES FOR ACCRUALS ACCRUED SALARIES
ADJUSTMENT

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

JOURNAL ENTRY
POSTING
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ILLUSTRATION 3-16
SUMMARY OF ADJUSTING ENTRIES

• 
  
  
  
  
  
  
  1 Prepaid
  Assets and Assets overstated
  Dr. Expenses expenses expenses
  Expenses understated Cr. Assets
• 2 Unearned Liabilities and
  Liabilities overstated Dr. Liabilities
  revenues revenues
  Revenues understated Cr. Revenues
• 3 Accrued Assets and
  Assets understated Dr. Assets revenues
  revenues Revenues understated
  Cr. Revenues
• 4 Accrued Expenses and
  Expenses understated Dr. Expenses expenses
  liabilities Liabilities
  understated Cr. Liabilities

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STUDY OBJECTIVE 7

• Describe the nature and purpose of an adjusted
  trial balance.

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ADJUSTED TRIAL BALANCE

• An Adjusted Trial Balance is prepared after all
  adjusting entries have been journalized and
  posted.
• Its purpose is to prove the equality of the total
  debit and credit balances in the ledger after all
  adjustments have been made.
• Financial statements can be prepared directly
  from the adjusted trial balance.

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ILLUSTRATION 3-19
TRIAL BALANCE AND ADJUSTED TRIAL BALANCE COMPARED
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PREPARING FINANCIAL STATEMENTS

• Financial statements can be prepared directly
  from the adjusted trial balance.
• 1 The income statement is prepared from the
  revenue and expense accounts.
• 2 The owners equity statement is derived from
  the owners capital and drawing accounts and the
  net income (or net loss) from the income
  statement.
• 3 The balance sheet is then prepared from the
  asset and liability accounts and the ending
  owners capital balance as reported in the
  owners equity statement.

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ILLUSTRATION 3-20
PREPARATION OF THE INCOME STATEMENT AND THE
OWNERS EQUITY STATEMENT FROM THE ADJUSTED TRIAL
BALANCE
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ILLUSTRATION 3-20
PREPARATION OF THE INCOME STATEMENT AND THE
OWNERS EQUITY STATEMENT FROM THE ADJUSTED TRIAL
BALANCE

• The income statement is prepared from the revenue
  and expense accounts.

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ILLUSTRATION 3-20
PREPARATION OF THE INCOME STATEMENT AND THE
OWNERS EQUITY STATEMENT FROM THE ADJUSTED TRIAL
BALANCE
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ILLUSTRATION 3-20
PREPARATION OF THE INCOME STATEMENT AND THE
OWNERS EQUITY STATEMENT FROM THE ADJUSTED TRIAL
BALANCE

• The owners equity statement is prepared from the
  owners capital and drawing accounts and the net
  income (or net loss) shown in the income
  statement.

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ILLUSTRATION 3-21
PREPARATION OF THE BALANCE SHEET FROM THE
ADJUSTED TRIAL BALANCE
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ILLUSTRATION 3-21
PREPARATION OF THE BALANCE SHEET FROM THE
ADJUSTED TRIAL BALANCE

• The balance sheet is then prepared from the asset
  and liability accounts and the ending owners
  capital balance as reported in the owners equity
  statement.

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STUDY OBJECTIVE 8

• Prepare adjusting entries for the alternative
  treatment of prepayments.

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ALTERNATIVE TREATMENTOF PREPAID EXPENSES AND
UNEARNED REVENUES

• Some businesses use an alternative treatment for
  prepaids and unearned revenues.
• Instead of debiting an asset at the time an
  expense is prepaid, the amount is charged to an
  expense account.
• Instead of crediting a liability at the time cash
  is received in advance of earning it, the amount
  is credited to a revenue account.
• This treatment of prepaid expenses and unearned
  revenues will ultimately result in the same
  effect on the financial statements as initial
  entries to balance sheet accounts and then
  adjusting entries.

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ALTERNATIVE ADJUSTMENTS FOR PREPAYMENTS SUPPLIES
ADJUSTMENT

• October 31, an inventory count reveals that
  1,000 of 2,500 of supplies are still on hand.

JOURNAL ENTRY
POSTING
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ALTERNATIVE ADJUSTMENTS FOR PREPAYMENTS UNEARNED
REVENUES
ADJUSTMENT

• October 31, analysis reveals that, of 1,200 in
  fees, 400 has been earned in October.

JOURNAL ENTRY
POSTING
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ILLUSTRATION 3A-7
SUMMARY OF BASIC RELATIONSHIPS FOR PREPAYMENTS

• 
  
  
  
  
  
  
  1
  Prepaid Assets and a Prepaid expenses
  Assets overstated Dr Expenses Expenses
  Expenses initially recorded in Expenses
  understated Cr Assets
  asset accounts have
  
  been used.
• b Prepaid expenses Assets
  understated Dr Assets
  initially recorded in Expenses overstated Cr
  Expenses expense accounts
  
  have not been
  used.
• 2 Unearned Liabilities and a Unearned
  revenues Liabilities overstated Dr Liabilities
  Revenues Revenues initially recorded
  in Revenues understated Cr Revenues
  liability
  accounts
  have been earned.
• b Unearned revenues
  Liabilities understated Dr Revenues
  initially recorded in Revenues
  overstated Cr Liabilities
  revenue accounts
  have not been earned.

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The Concept of Materiality
An item is material if knowledge of the item
might reasonably influence the decisions of users
of financial statements.
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Effects of the Adjusting Entries
Make end-of-year adjustments.
Journalize transactions.
Post entries to the ledger accounts.
Prepare trial balance.
Lets look at JJs Lawn Care Services adjusted
trial balance.
Prepare adjusted trial balance.