Chapter 3-1 Adjusting the Accounts Chapter 3-2 Accounting Principles, Ninth Edition Study Study Objectives Objectives Explain the time period assumption Explain the accrual basis of accounting Explain the reasons for adjusting entries Identify the major types of adjusting entries Prepare adjusting entries for deferrals Prepare adjusting entries for accruals Describe the nature and purpose of an adjusted trial balance Chapter 3-3 Adjusting Adjusting the the Accounts Accounts Timing Issues Fiscal and calendar years Accrual- vs cashbasis accounting Recognizing revenues and expenses Chapter 3-4 The Basics of Adjusting Entries Types of adjusting entries Adjusting entries for deferrals Adjusting entries for accruals Summary of journalizing and posting The Adjusted Trial Balance and Financial Statements Preparing the adjusted trial balance Preparing financial statements Timing Timing Issues Issues Accountants divide the economic life of a business into artificial time periods (Time Period Assumption) Jan Feb Mar Apr Dec Generally a month, a quarter, or a year Fiscal year vs calendar year Also known as the “Periodicity Assumption” Chapter 3-5 SO Explain the time period assumption Timing Timing Issues Issues Review The time period assumption states that: a revenue should be recognized in the accounting period in which it is earned b expenses should be matched with revenues c the economic life of a business can be divided into artificial time periods d the fiscal year should correspond with the calendar year Chapter 3-6 SO Explain the time period assumption Timing Timing Issues Issues Accrual- vs Cash-Basis Accounting Accrual-Basis Accounting Transactions recorded in the periods in which the events occur Revenues are recognized when earned, rather than when cash is received Expenses are recognized when incurred, rather than when paid Chapter 3-7 SO Explain the accrual basis of accounting Timing Timing Issues Issues Accrual- vs Cash-Basis Accounting Cash-Basis Accounting Revenues are recognized when cash is received Expenses are recognized when cash is paid Cash-basis accounting is not in accordance with generally accepted accounting principles (GAAP) Chapter 3-8 SO Explain the accrual basis of accounting Timing Timing Issues Issues Recognizing Revenues and Expenses Revenue Recognition Principle Companies recognize revenue in the accounting period in which it is earned In a service enterprise, revenue is considered to be earned at the time the service is performed Chapter 3-9 SO Explain the accrual basis of accounting Timing Timing Issues Issues Recognizing Revenues and Expenses Matching Principle Match expenses with revenues in the period when the company makes efforts to generate those revenues “Let the expenses follow the revenues.” Chapter 3-10 SO Explain the accrual basis of accounting Adjusting Adjusting Entries Entries for for “Accrued “Accrued Expenses” Expenses” Illustration: Pioneer Advertising Agency last paid salaries on October 26; the next payment of salaries will not occur until November The employees receive total salaries of $2,000 for a five-day work week, or $400 per day Thus, accrued salaries at October 31 are $1,200 ($400 x days) Oct 31 Salaries expense 1,200 Salaries payable 1,200 Illustration 3-20 Chapter 3-45 SO Prepare adjusting entries for accruals Adjusting Adjusting Entries Entries for for “Accrued “Accrued Expenses” Expenses” Summary Chapter 3-46 Illustration 3-21 SO Prepare adjusting entries for accruals The The Adjusted Adjusted Trial Trial Balance Balance After all adjusting entries are journalized and posted the company prepares another trial balance from the ledger accounts (Adjusted Trial Balance) Its purpose is to prove the equality of debit balances and credit balances in the ledger Chapter 3-47 SO Describe the nature and purpose of an adjusted trial balance The The Adjusted Adjusted Trial Trial Balance Balance Chapter 3-48 The The Adjusted Adjusted Trial Trial Balance Balance Review Question Which of the following statements is incorrect concerning the adjusted trial balance? a An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger after all adjustments are made b The adjusted trial balance provides the primary basis for the preparation of financial statements c The adjusted trial balance lists the account balances segregated by assets and liabilities d The adjusted trial balance is prepared after the adjusting entries have been journalized and posted Chapter 3-49 SO Describe the nature and purpose of an adjusted trial balance Preparing Preparing Financial Financial Statements Statements Financial Financial Statements Statements are are prepared prepared directly directly from from the the Adjusted Adjusted Trial Trial Balance Balance Balance Sheet Chapter 3-50 Income Statement Owner’s Equity Statement SO Describe the nature and purpose of an adjusted trial balance Preparing Preparing Financial Financial Statements Statements Illustration 3-25 Preparation of the income statement and owner’s equity statement from the adjusted trial balance Chapter 3-51 Preparing Preparing Financial Financial Statements Statements Illustration 3-26 Chapter 3-52 Alternative Alternative Treatment Treatment of of Prepaid Prepaid Expenses Expenses and and Unearned Unearned Revenues Revenues Some companies use an alternative treatment for prepaid expenses and unearned revenues When a company prepays an expense, it debits that amount to an expense account When a company receives payment for future services, it credits the amount to a revenue account Chapter 3-53 SO Prepare adjusting entries for the alternative treatment of deferrals Alternative Alternative Treatment Treatment for for “Prepaid “Prepaid Expenses” Expenses” Illustration: Pioneer Advertising purchased supplies on October for $2,500 and debited Advertising Supplies Expense for the full amount What if an inventory of $1,000 of advertising supplies remains on October 31? Oct 31 Advertising supplies 1,000 Advertising supplies expense 1,000 Illustration 3A-1 Chapter 3-54 SO Prepare adjusting entries for the alternative treatment of deferrals Alternative Alternative Treatment Treatment for for “Prepaid “Prepaid Expenses” Expenses” Adjustment approaches—a comparison Illustration 3A-2 Chapter 3-55 SO Prepare adjusting entries for the alternative treatment of deferrals Alternative Alternative Treatment Treatment for for “Unearned “Unearned Revenues” Revenues” Illustration: Assume that Pioneer Advertising received $1,200 for future services on October and credited the entire amount to Service Revenue If at the statement date Pioneer has not performed $800 of the services, it would make an adjusting entry Oct 31 Service revenue Unearned service revenue 800 800 Illustration 3A-4 Chapter 3-56 SO Prepare adjusting entries for the alternative treatment of deferrals Alternative Alternative Treatment Treatment for for “Unearned “Unearned Revenues” Revenues” Adjustment approaches—a comparison Illustration 3A-5 Chapter 3-57 SO Prepare adjusting entries for the alternative treatment of deferrals Summary Summary of of Additional Additional Adjustment Adjustment Relationships Relationships Illustration 3A-7 Chapter 3-58 SO Prepare adjusting entries for the alternative treatment of deferrals Copyright Copyright “Copyright © 2009 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” Chapter 3-59 ... recognized when cash is paid Cash-basis accounting is not in accordance with generally accepted accounting principles (GAAP) Chapter 3-8 SO Explain the accrual basis of accounting Timing Timing Issues... incurred, rather than when paid Chapter 3-7 SO Explain the accrual basis of accounting Timing Timing Issues Issues Accrual- vs Cash-Basis Accounting Cash-Basis Accounting Revenues are recognized...Adjusting the Accounts Chapter 3-2 Accounting Principles, Ninth Edition Study Study Objectives Objectives Explain the time period assumption Explain the accrual basis of accounting Explain the