The Adjusting Process

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The Adjusting Process
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After studying this chapter, you should be able
to

• Describe the nature of the adjusting process.

• Journalize entries for accounts requiring
  adjustment.
• Summarize the adjustment process.
• Prepare an adjusted trial balance.

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3-1
Objective 1
Describe the nature of the adjusting process.
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Under the accrual basis of accounting, revenues
are reported in the income statement in the
period in which they are earned.
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The accounting concept that supports this
approach to reporting of revenues is called the
revenue recognition concept.
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The accounting concept that supports reporting
revenues and related expenses in the same period
is called the matching concept, or matching
principle.
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Under the cash basis of accounting, revenues and
expenses are reported in the income statement in
the period in which cash is received or paid.
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The Adjusting Process
The analysis and updating of accounts at the end
of the period before the financial statements are
prepared is called the adjusting process.
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Adjusting Entries
The journal entries that bring the accounts up to
date at the end of the accounting period are
called adjusting entries.
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Adjusting entries--

• allow revenues and expenses to be recorded in the
  correct time period.
• are dated the last day of the period.
• always involved at one least balance sheet and at
  least one income statement account.
• never involves the Cash account.

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Indicate with a Yes or No whether or not each of
the following accounts normally requires an
adjusting entry.

• Cash c. Wages Expense e. Accounts Receivable
• Prepaid Rent d. Office Equipment f. Unearned Rent

• No c. Yes e. Yes
• Yes d. No f. Yes

For Practice PE 3-1A, PE 3-1B
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Accounts Requiring Adjustment
Prepaid expenses, sometimes referred to as
deferred expenses, are items that have been
initially recorded as assets but are expected to
become expenses over time or through the normal
operations of the business.
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Accounts Requiring Adjustment
Unearned revenues, sometimes referred to as
deferred revenues, are items that have been
initially recorded as liabilities but are
expected to become revenues over time or through
the normal operations of the business.
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Type of Adjustment Prepaid Expense and Unearned
Revenue
Insert Exhibit 1
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Accounts Requiring Adjusting
Accrued revenues, sometimes referred to as
accrued assets (accrued means unpaid), are
revenues that have been earned but have not been
recorded in the accounts.
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Accrued expenses, sometimes referred to as
accrued liabilities, are expenses that have been
incurred but have not been recorded in the
accounts.
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Type of Adjustment Accrued Revenue and Expense
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3-1
Classify the following items as (1) prepaid
expense, (2) unearned revenue, (3) accrued
expense, or (4) accrued revenue.

• Wages owed but not c. Fees received but not yet
  yet paid. earned.
• Supplies on hand. d. Fees earned but not yet
  received.

• Accrued expense c. Unearned revenue
• Prepaid expense d. Accrued revenue

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For Practice PE 3-2A, PE 3-2B
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3-2
Objective 2
Journalize entries for accounts requiring
adjustment.
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Unadjusted Trial Balance for NetSolutions
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Adjusting Process for Prepaid Expenses
NetSolutions Supplies account has a balance of
2,000 in the unadjusted trial balance. Some of
these supplies have been used. On December 31, a
count reveals that 760 of supplies are on hand.
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Supplies (balance on trial balance) 2,000 Suppl
ies on hand, December 31 760 Supplies
used 1,240
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Supplies 1 240 00
Supplies used (2,000 760)
Supplies Expense
Supplies
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Dec. 31 1,240
Bal. 2,000
Bal. 800
Dec. 31 1,240
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The debit balance of 2,400 in NetSolutions
Prepaid Insurance account represents the December
1 prepayment of insurance for 12 months.
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31 Insurance Expense 200 00
Prepaid Insurance 200 00
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Insurance expired (2,400/12).
Prepaid Insurance
Insurance Expense
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Dec. 31 200
Dec. 31 200
Bal. 2,400
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The prepaid insurance account had a beginning
balance of 6,400 and was debited for 3,600 of
premiums paid during the year. Journalize the
adjusting entry required at the end of the year
assuming the amount of unexpired insurance
related to future periods is 3,250.
Insurance Expense 6,750 Prepaid
Insurance 6,750 Insurance expired (6,400
3,600 3,250).
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For Practice PE 3-3A, PE 3-3B
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On December 1, the tenant prepaid three months
rent for use of an office building owned by
NetSolutions. As of December 31, only 120 has
been earned.
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31 Unearned Rent 120 00
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Rent Revenue 120 00
Rent earned (360/3 months)
Unearned Rent
Rent Revenue
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Dec. 31 120
Dec. 31 120
Bal. 360
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The balance in the unearned fees account, before
adjustment at the end of the year, is 44,900.
Journalize the adjusting entry required if the
amount of unearned fees at the end of the year is
22,300.
Unearned Fees 22,600 Fees Earned 22,600 Fees
earned (44,900 22,300).
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For Practice PE 3-4A, PE 3-4B
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NetSolutions provided 500 in services during
December for which the customer has not been
billed.
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31 Accounts Receivable 500 00
Fees Earned 500 00
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Accrued fees (25 hrs. x 20)
Fees Earned
Accounts Receivable
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Bal. 16,340
Bal. 2,220
Dec. 31 500
Dec. 31 500
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At the end of the current year, 13,680 of fees
have been earned but have not been billed to
clients. Journalize the adjusting entry to
record the accrued fees.
Accounts Receivable 13,680 Fees
Earned 13,680 Accrued fees.
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For Practice PE 3-5A, PE 3-5B
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At the end of December, accrued wages amounted to
250. Without this adjusting entry, Wages
Expense is understated.
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31 Wages Expense 250 00
Wages Payable 250 00
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Accrued wages.
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Wages Payable
Wages Expense
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Dec. 31 250
Bal. 4,275
Dec. 31 250
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Wages Payable
Wages Expense
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Dec. 31 250
Bal. 4,275
Dec. 31 250
Closing entries will be discussed in a later
chapter. For now, just be aware that Wages
Expense is closed after financial statements are
prepared and its balance rolled back to zero.
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The payment of January 10 wages totaling 1,275
is shown below.
Jan. 10 Wages Expense 1 025 00
Wages Payable 250 00 Cash 1 275 00
Paid wages.
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The liability is cancelled.
An expense for wages of 1,025 is recorded in the
new fiscal year.
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Sanregret Realty Co. pays weekly salaries of
12,500 on Friday for a five-day week ending on
that day. Journalize the necessary adjusting
entry at the end of the accounting period,
assuming that the period ends on Thursday.
Salaries Expense 10,000 Salaries
Payable 10,000 Accrued salaries (12,500/5 x
4 days).
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For Practice PE 3-6A, PE 3-6B
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Physical resources that are owned and used by a
business and are permanent or have a long life
are called fixed assets or plant assets.
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As time passes, a fixed asset loses its ability
to provide useful services. This decrease in
usefulness is called depreciation.
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Normal Titles and Related Contra Asset Accounts
Normal titles for fixed asset accounts and their
related contra asset accounts are as follows
Fixed Asset Contra Asset
Land NoneLand is not depreciated Buildings Accu
mulated Depreciation Buildings Store
Equipment Accumulate DepreciationStore
Equipment Office Equipment Accumulated
DepreciationOffice Equipment
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NetSolutions estimates the depreciation on its
office equipment to be 50 for the month of
December.
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31 Depreciation Expense 50 00
Accum. Depreciation Office
Equipment 50 00
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Depreciation of office equipment.
Depreciation Expense
Accum. Depr.Office Equip.
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Dec. 31 50
Dec. 31 50
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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 value
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The estimated amount of depreciation on equipment
for the current year is 4,250. Journalize the
adjusting entry to record the depreciation.
Depreciation Expense 4,250 Accumulated
Depreciation Equipment 4,250 Depreciation
on equipment.
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For Practice PE 3-7A, PE 3-7B
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Objective 3
Summarize the adjustment process
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Adjusting EntriesNetSolutions
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(Continued)
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(Continued)
Capital Stock
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(Continued)
Dividends
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(Concluded)
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For the year ending December 31, 2008, Mann
Medical Co. mistakenly omitted adjusting entries
for (1) 8,600 of unearned revenue that was
earned, (2) earned revenue that was not billed of
12,500, and (3) accrued wages of 2,900.
Indicate the combined effect of the errors on (a)
revenues, (b) expenses, and (c) net income for
2008.

• Revenues were understated by 21,100 (8,600
  12,500).
• Expenses were understated by 2,900.
• Net income was understated by 18,200 (8,600
  12,500 2,900).

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For Practice PE 3-8A, PE 3-8B
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Objective 4
Prepare an adjusted trial balance.
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Adjusted Trial Balance
The purpose of the adjusted trial balance is to
verify the equality of the total debit balances
and total credit balances before the financial
statements are prepared.
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Adjusted Trial Balance
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For each of the following errors, considered
individually, indicate whether the error would
cause the adjusted trial balance totals to be
unequal. If the error would cause the adjusted
trial balance total to be unequal, indicate
whether the debit or credit total is higher and
by how much.

• The adjustment for accrued fees of 5,340 was
  journalized as a debit to Accounts Payable for
  5,340 and a credit to Fees Earned of 5,340.
• The adjustment for depreciation of 3,260 was
  journalized as a debit to Depreciation Expense
  for 3,620 and a credit to Accumulated
  Depreciation for 3,260.

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• The totals are equal even though the debit should
  have been to Accounts Receivable instead of
  Accounts Payable.
• The totals are unequal. The debit total is
  higher by 360 (3,620 3,260).

For Practice PE 3-9A, PE 3-9B
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