(2) adjusting the accounts & completing the accounting cycle 2012 (1)

ADJUSTING THE ACCOUNTS

Mahfuzul Hoque Ph.D

Monday, May 1, 2023 1DMH - DU

After studying this chapter, you should be able to:

ADJUSTING THE ACCOUNTS

1 Explain the time period assumption.2 Explain the accrual basis of accounting.3 Explain why adjusting entries are needed.4 Identify the major types of adjusting entries.5 Prepare adjusting entries for prepayments.6 Prepare adjusting entries for accruals.7 Describe the nature and purpose of an adjusted

trial balance.


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.


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.


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


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.


• 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 consumed2. Unearned Revenues — cash received and recorded as

liabilities before revenue is earnedAccruals1. Accrued Revenues — Revenues earned but not yet

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

in cash or recorded


TRIAL BALANCE PIONEER ADVERTISING AGENCY Trial Balance October 31, 2002 Debit Credit Cash $ 15,200 Advertising Supplies 2,500 Prepaid Insurance 600 Office Equipment 5,000 Notes Payable $ 5,000 Accounts Payable 2,500 Unearned Revenue 1,200 C. R. Byrd, Capital 10,000 C. R. Byrd, Drawing 500 Service Revenue 10,000 Salaries Expense 4,000 Rent Expense 900 $ 28,700 $ 28,700

The Trial Balance is the starting place for adjusting

entries.


Advertising Supplies ExpenseOct. 31 1,500

Advertising Supplies Oct. 5 2,500 Oct. 31 1,500 31 1,000

Date Account Titles and Explanation Debit Credit Oct. 31 Advertising Supplies Expense 1,500

Advertising Supplies 1,500 (To record supplies used)

JOURNAL ENTRY

POSTING

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

ADJUSTING ENTRIES FOR PREPAYMENTS SUPPLIES


ADJUSTING ENTRIES FOR PREPAYMENTS INSURANCE

Insurance Expense 63Oct. 31 50

Prepaid Insurance 10 Oct. 4 600 Oct. 31 50 31 550

Date Account Titles and Explanation Debit Credit Oct. 31 Insurance Expense 50

Prepaid Insurance 50 (To record insurance expired)

JOURNAL ENTRY

POSTING

ADJUSTMENT October 31, an analysis of the policy reveals that $50 of insurance expires each month.


• Depreciation is the allocation of the cost of an asset to expense over its useful life in a rational and systematic manner.

• The purchase of equipment or a building is viewed as a long-term prepayment of services and, therefore, is allocated in the same manner as other prepaid expenses.

DEPRECIATION


DEPRECIATION

• Depreciation is an estimate rather than a factual measurement of the cost that has expired.

• In recording depreciation, Depreciation Expense is debited and a contra asset account, Accumulated Depreciation, is credited

Depreciation Expense

XXX

Accumulated Depreciation

XXX


• In the balance sheet, Accumulated Depreciation is offset against the asset account.

• The difference between the cost of any depreciable asset and its related accumulated depreciation is referred to as the book value of the asset.

DEPRECIATION


ADJUSTING ENTRIES FOR PREPAYMENTS - DEPRECIATION

Accumulated Depreciation -Office Equipment

Oct. 31 40

Date Account Titles and Explanation Debit Credit Oct. 31 Depreciation Expense 40

Accumulated Depreciation - Office Equipment 40 (To record monthly depreciation)

JOURNAL ENTRY

POSTING

ADJUSTMENT October 31, depreciation on the office equipment is estimated to be $480 a year, or $40 per month.

Depreciation ExpenseOct. 31 40


ADJUSTING ENTRIES FOR PREPAYMENTS - UNEARNED REVENUES

Service RevenueOct. 31 10,000 31 400

Unearned RevenueOct. 31 400 Oct. 2 1,200

31 800

JOURNAL ENTRY

POSTING

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

Date Account Titles and Explanation Debit Credit Oct. 31 Unearned Revenue 400

Service Revenue 400 (To record revenue for services provided)


ADJUSTING ENTRIES FOR ACCRUALS - ACCRUED REVENUES

Service RevenueOct. 31 10,000 31 400 31 200 31 10,600

Accounts ReceivableOct. 31 200

Date Account Titles and Explanation Debit Credit Oct. 31 Accounts Receivable 200

Service Revenue 200 (To accrue revenue for services provided)

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

JOURNAL ENTRY

POSTING

ADJUSTMENT


ADJUSTING ENTRIES FOR ACCRUALS - ACCRUED INTEREST

Interest PayableOct. 31 50

Interest ExpenseOct. 31 50

Date Account Titles and Explanation Debit Credit Oct. 31 Interest Expense 50

Interest Payable 50 (To accrue interest on notes payable)

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

Salaries PayableOct. 31 1,200

Date Account Titles and Explanation Debit Credit Oct. 31 Salaries Expense 1,200

Salaries Payable 1,200 (To record accrued salaries)

JOURNAL ENTRY

POSTING

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

Salaries ExpenseOct. 26 4,000 31 1,200 31 5,200


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.


PIONEER ADVERTISING AGENCYAdjusted Trial Balance

October 31, 2002Before After

Adjustment AdjustmentDebit Credit Debit Credit

Cash $ 15,200 $ 15,200Accounts Receivable 200Advertising Supplies 2,500 1,000Prepaid Insurance 600 550Office Equipment 5,000 5,000Accumulated Depreciation - Office Equipment $ 40Notes Payable $ 5,000 5,000Accounts Payable 2,500 2,500Interest Payable 50Unearned Revenue 1,200 800Salaries Payable 1,200C. R. Byrd, Capital 10,000 10,000C. R. Byrd, Drawing 500 500Service Revenue 10,000 10,600Salaries Expense 4,000 5,200Advertising Supplies Expense 1,500Rent Expense 900 900Insurance Expense 50Interest Expense 50Depreciation Expense 40

$ 28,700 $ 28,700 $ 30,190 $ 30,190

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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 owner’s equity statement is derived from the

owner’s 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 owner’s capital balance as reported in the owner’s equity statement.



October 31, 2002

Debit CreditCash $ 15,200Accounts Receivable 200Advertising Supplies 1,000Prepaid Insurance 550Office Equipment 5,000Accumulated Depreciation - Office Equipment $ 40Notes Payable 5,000Accounts Payable 2,500Interest Payable 50Unearned Revenue 800Salaries Payable 1,200C. R. Byrd, Capital 10,000C. R. Byrd, Drawing 500Service Revenue 10,600Salaries Expense 5,200Advertising Supplies Expense 1,500Rent Expense 900Insurance Expense 50Interest Expense 50Depreciation Expense 40

$ 30,190 $ 30,190

PREPARATION OF THE INCOME STATEMENT AND THE OWNER’S EQUITY STATEMENT FROM THE ADJUSTED TRIAL BALANCE



PIONEER ADVERTISING AGENCYIncome Statement

For the Month Ended October 31, 2002

Revenues Fees earned $ 10,600

Expenses Salaries expense $ 5,200 Advertising supplies expense 1,500 Rent expense 900 Insurance expense 50 Interest expense 50 Depreciation expense 40 Total expenses 7,740Net income $ 2,860

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



October 31, 2002


$ 30,190 $ 30,190




PIONEER ADVERTISING AGENCYOwner’s Equity Statement

For the Month Ended October 31, 2002

C.R. Byrd, Capital, October 1 $ -0-Add: Investments $ 10,000 Net income 2,860 12,860

12,860Less: Drawings 500C.R. Byrd, Capital, October 31 $ 12,360

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



October 31, 2002


$ 30,190 $ 30,190

PREPARATION OF THE BALANCE SHEET FROM THE ADJUSTED TRIAL BALANCE


PREPARATION OF THE BALANCE SHEET FROM THE ADJUSTED TRIAL BALANCE

PIONEER ADVERTISING AGENCYBalance Sheet

October 31, 2002

Assets Liabilities and Owner’s Equity

Cash $ 15,200 LiabilitiesAccounts receivable 200 Notes payable $ 5,000Advertising supplies 1,000 Accounts payable 2,500Prepaid insurance 550 Interest payable 50Office equipment $ 5,000 Unearned fees 800Less: Accumulated Salaries payable 1,200

depreciation 40 4,960 Total liabilities 9,550Owner’s equity C.R. Byrd, Capital 12,360

Total liabilities and owner’sTotal assets $ 21,910 equity $ 21,910

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


Completing the Accounting Cycle


Study Objectives1. Prepare a worksheet.2. Explain the process of closing the books.3. Describe the content and purpose of a post-closing trial balance.4. State the required steps in the accounting cycle.5. Explain the approaches to preparing correcting entries.6. Identify the sections of a classified balance sheet.


Using a Worksheet

Steps in preparationPreparing financial statementsPreparing adjusting entries

Current assetsLong-term investmentsProperty, plant, and equipmentIntangible assetsCurrent liabilitiesLong-term liabilitiesOwner’s equity

Reversing entries—An optional stepCorrecting entries—An avoidable step

Preparing closing entriesPosting closing entriesPreparing a post-closing trial balance

Closing the Books Summary of Accounting Cycle

Classified Balance Sheet

Completing the Accounting Cycle


A multiple-column form used in preparing financial statements.

Not a permanent accounting record.

Five step process.

Use of worksheet is optional.

Using A Worksheet

Worksheet


Steps in Preparing a WorksheetIllustration 1


Illustration:

Steps in Preparing a WorksheetIllustration -2Preparing a trial balance


Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.Cash 15,200 Advertising Supplies 2,500 Prepaid Insurance 600 Office Equipment 5,000 Notes Payable 5,000 Accounts Payable 2,500 Unearned Revenue 1,200 C. R. Byrd, Capital 10,000 C. R. Byrd, Drawing 500 Service Revenue 10,000

Salaries Expense 4,000 Rent 900

Totals 28,700 28,700

Balance SheetAdjusted Income

Trial Balance Adjustments Trial Balance Statement

Steps in Preparing a Worksheet1. Prepare a Trial Balance on the Worksheet

Trial balance amounts come directly from ledger accounts.

Include all accounts with balances.


Steps in Preparing a WorksheetGeneral journal showing adjusting entries

Adjusting Journal Entries


Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.Cash 15,200 Advertising Supplies 2,500 1,500 Prepaid Insurance 600 50 Office Equipment 5,000 Notes Payable 5,000 Accounts Payable 2,500 Unearned Revenue 1,200 400 C. R. Byrd, Capital 10,000 C. R. Byrd, Drawing 500 Service Revenue 10,000 400

200 Salaries Expense 4,000 1,200 Rent 900

Totals 28,700 28,700 Advertising Supplies Expense 1,500 Insurance Expense 50 Accumulated Depreciation 40 Depreciation Expense 40 Accounts Receivable 200 Interest Expense 50 Interest Payable 50 Salaries Payable 1,200

Totals 3,440 3,440



Steps in Preparing a Worksheet2. Enter the Adjustments in the Adjustments Columns

(a)(b)

(a)

(g)

(c)

(d)

(d)

(e)

(b)

(e)(f)

(f)(g)

(c)

Enter adjustment amounts, total adjustments columns,and check for equality.

Add additional accounts as needed.

Adjustments Key:(a) Supplies Used.(b) Insurance Expired.(c) Depreciation Expensed.(d) Service Revenue Earned.(e) Service Revenue Accrued.(f) Interest Accrued.(g) Salaries Accrued.


Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.Cash 15,200 15,200 Advertising Supplies 2,500 1,500 1,000 Prepaid Insurance 600 50 550 Office Equipment 5,000 5,000 Notes Payable 5,000 5,000 Accounts Payable 2,500 2,500 Unearned Revenue 1,200 400 800 C. R. Byrd, Capital 10,000 10,000 C. R. Byrd, Drawing 500 500 Service Revenue 10,000 400 10,600

200 Salaries Expense 4,000 1,200 5,200 Rent 900 900

Totals 28,700 28,700 Advertising Supplies Expense 1,500 1,500 Insurance Expense 50 50 Accumulated Depreciation 40 40 Depreciation Expense 40 40 Accounts Receivable 200 200 Interest Expense 50 50 Interest Payable 50 50 Salaries Payable 1,200 1,200

Totals 3,440 3,440 30,190 30,190



Steps in Preparing a Worksheet3. Complete the Adjusted Trial Balance Columns

(a)(b)

(a)

(g)

(c)

(d)

(d)

(e)

(b)

(e)(f)

(f)(g)

(c)

Total the adjusted trial balance columns and check for equality.Monday, May 1, 2023 39DMH - DU

Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.Cash 15,200 15,200 Advertising Supplies 2,500 1,500 1,000 Prepaid Insurance 600 50 550 Office Equipment 5,000 5,000 Notes Payable 5,000 5,000 Accounts Payable 2,500 2,500 Unearned Revenue 1,200 400 800 C. R. Byrd, Capital 10,000 10,000 C. R. Byrd, Drawing 500 500 Service Revenue 10,000 400 10,600 10,600

200 Salaries Expense 4,000 1,200 5,200 5,200 Rent 900 900 900

Totals 28,700 28,700 Advertising Supplies Expense 1,500 1,500 1,500 Insurance Expense 50 50 50 Accumulated Depreciation 40 40 Depreciation Expense 40 40 40 Accounts Receivable 200 200 Interest Expense 50 50 50 Interest Payable 50 50 Salaries Payable 1,200 1,200

Totals 3,440 3,440 30,190 30,190 7,740 10,600



Steps in Preparing a Worksheet4. Extend Amounts to Financial Statement Columns

(a)(b)

(a)

(g)

(c)

(d)

(d)

(e)

(b)

(e)(f)

(f)(g)

(c)

Extend all revenue and expense account balances to the income statement columns.Monday, May 1, 2023 40DMH - DU

Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.Cash 15,200 15,200 15,200 Advertising Supplies 2,500 1,500 1,000 1,000 Prepaid Insurance 600 50 550 550 Office Equipment 5,000 5,000 5,000 Notes Payable 5,000 5,000 5,000 Accounts Payable 2,500 2,500 2,500 Unearned Revenue 1,200 400 800 800 C. R. Byrd, Capital 10,000 10,000 10,000 C. R. Byrd, Drawing 500 500 500 Service Revenue 10,000 400 10,600 10,600


Totals 28,700 28,700 Advertising Supplies Expense 1,500 1,500 1,500 Insurance Expense 50 50 50 Accumulated Depreciation 40 40 40 Depreciation Expense 40 40 40 Accounts Receivable 200 200 200 Interest Expense 50 50 50 Interest Payable 50 50 50 Salaries Payable 1,200 1,200 1,200

Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590



Steps in Preparing a Worksheet4. Extend Amounts to Financial Statement Columns

Extend all asset, liability, and equity account balances to the balance sheet columns.

(a)(b)

(a)

(g)

(c)

(d)

(d)

(e)

(b)

(e)(f)

(f)(g)

(c)


Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.Cash 15,200 15,200 15,200 Advertising Supplies 2,500 1,500 1,000 1,000 Prepaid Insurance 600 50 550 550 Office Equipment 5,000 5,000 5,000 Notes Payable 5,000 5,000 5,000 Accounts Payable 2,500 2,500 2,500 Unearned Revenue 1,200 400 800 800 C. R. Byrd, Capital 10,000 10,000 10,000 C. R. Byrd, Drawing 500 500 500 Service Revenue 10,000 400 10,600 10,600


Totals 28,700 28,700 Advertising Supplies Expense 1,500 1,500 1,500 Insurance Expense 50 50 50 Accumulated Depreciation 40 40 40 Depreciation Expense 40 40 40 Accounts Receivable 200 200 200 Interest Expense 50 50 50 Interest Payable 50 50 50 Salaries Payable 1,200 1,200 1,200

Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590 Net income 2,860 2,860

Totals 10,600 10,600 22,450 22,450



Steps in Preparing a Worksheet5. Total Columns, Compute Net Income (Loss)

(a)(b)

(a)

(g)

(c)

(d)

(d)

(e)

(b)

(e)(f)

(f)(g)

(c)

Compute Net Income or Net Loss.Monday, May 1, 2023 42DMH - DU

Net income is shown on a worksheet in the:a. income statement debit column only.b. balance sheet debit column only.c. income statement credit column and balance sheet debit

column.d. income statement debit column and balance sheet credit

column.

Review Question

Steps in Preparing a Worksheet


Income statement is prepared from the income statement columns.

Balance sheet and owner’s equity statement are prepared from the balance sheet columns.

Companies journalize and post adjusting entries.

Preparing Financial Statements from a Worksheet

Worksheet


The adjusting entries are prepared from the adjustments columns of the worksheet.

Journalizing and posting of adjusting entries follows the preparation of financial statements when a worksheet is used.

Preparing Adjusting Entries from a Worksheet

Adjusting Entries



General journal showing adjusting entries

Adjusting Journal Entries


Q4-2. Explain the purpose of the worksheet.

Discussion Question

See notes page for discussion



At the end of the accounting period, the company makes the accounts ready for the next period.

Closing the Books


Closing entries formally recognize, in the general ledger, the transfer of net income (or net loss) and owner’s drawing to owner’s capital.

Closing the Books

Closing entries are only at the end of the annual accounting period.


Closing the Books

Illustration 4-6

Owner’s Capital is a permanent account; all other

accounts are temporary accounts.

Owner’s Drawing is closed directly to Capital and not to

Income Summary because Owner’s Drawing is not an

expense.

Note:


Closing the Books

Closing Entries need to

be Posted

Closing entries journalized


Purpose is to prove the equality of the permanent account balances after journalizing and posting of closing entries.

Preparing a Post-Closing Trial Balance

Temporary accounts will have zero balances.

Illustration 4-9


Summary of the Accounting Cycle

1. Analyze business transactions

2. Journalize the transactions

6. Prepare an adjusted trial balance

7. Prepare financial statements

8. Journalize and post closing entries

9. Prepare a post-closing trial balance

4. Prepare a trial balance

3. Post to ledger accounts

5. Journalize and post adjusting entries

Illustration 4-12


Correcting entries

are unnecessary if the records are error-free.

are made whenever an error is discovered.

must be posted before closing entries.

Instead of preparing a correcting entry, it is possible to reverse the incorrect entry and then prepare the correct entry.

Correcting Entries—An Avoidable Step


Illustration (Case 1): On May 10, Mercato Co. journalized and posted a $50 cash collection on account from a customer as a debit to Cash $50 and a credit to Service Revenue $50. The company discovered the error on May 20, when the customer paid the remaining balance in full.


Cash 50Incorrect entry Service revenue 50

Cash 50Correct entry

Accounts receivable 50

Service revenue 50Correcting entry Accounts receivable 50


Illustration (Case 2): On May 18, Mercato purchased on account office equipment costing $450. The transaction was journalized and posted as a debit to Delivery Equipment $45 and a credit to Accounts Payable $45. The error was discovered on June 3.


Delivery equipment 45Incorrect entry

Accounts payable 45

Office equipment 450Correct entryAccounts payable 450

Office equipment 450Correcting entry Delivery equipment 45

Accounts receivable 405


The Classified Balance Sheet

Presents a snapshot at a point in time.

To improve understanding, companies group similar assets and similar liabilities together.

Assets Liabilities and Owner’s EquityCurrent assets Current liabilitiesLong-term investments Long-term liabilitiesProperty, plant, and equipment Owner’s (Stockholders’) equityIntangible assets

Standard Classifications



Assets that a company expects to convert to cash or use up within one year or the operating cycle, whichever is longer.

Operating cycle is the average time it takes from the purchase of inventory to the collection of cash from customers.

Current Assets



Companies usually list current asset accounts in the order they expect to convert them into cash.

Current Assets


Cash, and other resources that are reasonably expected to be realized in cash or sold or consumed in the business within one year or the operating cycle, are called:

a. Current assets.b. Intangible assets.c. Long-term investments.d. Property, plant, and equipment.

Review Question




Investments in stocks and bonds of other companies.

Investments in long-term assets such as land or buildings that a company is not currently using in its operating activities.

Long-Term Investments



Long useful lives.

Currently used in operations.

Depreciation - allocating the cost of assets to a number of years.

Accumulated depreciation - total amount of depreciation expensed thus far in the asset’s life.

Property, Plant, and Equipment



Property, Plant, and Equipment



Assets that do not have physical substance.

Intangible Assets


Patents and copyrights area. Current assets.b. Intangible assets.c. Long-term investments.d. Property, plant, and equipment.

Review Question




Obligations the company is to pay within the coming year.

Usually list notes payable first, followed by accounts payable. Other items follow in order of magnitude.

Liquidity - ability to pay obligations expected to be due within the next year.

Current Liabilities



Current Liabilities



Obligations a company expects to pay after one year.

Long-Term Liabilities


Which of the following is not a long-term liability?a. Bonds payableb. Current maturities of long-term obligationsc. Long-term notes payabled. Mortgages payable

Review Question




Proprietorship - one capital account.

Partnership - capital account for each partner.

Corporation - Capital Stock and Retained Earnings.

Owner’s Equity


(a) What is the term used to describe the owner’s equity section of a corporation?

(b) Identify the two owner’s equity accounts in a corporation and indicate the purpose of each.


Discussion Question


(2) adjusting the accounts & completing the accounting cycle 2012 (1)

Business