1. Chapter
3-1

2. Adjusting the
Accounts
Chapter
3-2 Accounting Principles, Ninth Edition

3. Study Objectives
Study Objectives
1. Explain the time period assumption.
2. Explain the accrual basis of accounting.
3. Explain the reasons for adjusting entries.
4. Identify the major types of adjusting entries.
5. Prepare adjusting entries for deferrals.
6. Prepare adjusting entries for accruals.
7. Describe the nature and purpose of an adjusted
trial balance.
Chapter
3-3

4. Adjusting the Accounts
Adjusting the Accounts
The Adjusted
The Adjusted
The Basics of
The Basics of Trial Balance and
Trial Balance and
Timing Issues
Timing Issues
Adjusting Entries
Adjusting Entries Financial
Financial
Statements
Statements
Fiscal and Types of adjusting Preparing the
calendar years entries adjusted trial
Accrual- vs. cash- Adjusting entries balance
basis accounting for deferrals Preparing
Recognizing Adjusting entries financial
revenues and for accruals statements
expenses Summary of
journalizing and
posting
Chapter
3-4

5. Timing Issues
Timing 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 1 Explain the time period assumption.

6. Timing Issues
Timing 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 1 Explain the time period assumption.

7. Timing Issues
Timing 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 2 Explain the accrual basis of accounting.

8. Timing Issues
Timing 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 2 Explain the accrual basis of accounting.

9. Timing Issues
Timing 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 2 Explain the accrual basis of accounting.

10. Timing Issues
Timing 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 2 Explain the accrual basis of accounting.

11. Timing Issues
Timing Issues
GAAP relationships Illustration 3-1
in revenue and
expense recognition
Chapter
3-11 SO 2 Explain the accrual basis of accounting.

12. Chapter
3-12 SO 2 Explain the accrual basis of accounting.

13. Timing Issues
Timing Issues
Review
One of the following statements about the accrual basis
of accounting is false. That statement is:
a. Events that change a company’s financial
statements are recorded in the periods in which
the events occur.
b. Revenue is recognized in the period in which it is
earned.
c. The accrual basis of accounting is in accord with
generally accepted accounting principles.
d. Revenue is recorded only when cash is received, and
expenses are recorded only when cash is paid.
Chapter
3-13 SO 2 Explain the accrual basis of accounting.

14. The Basics of Adjusting Entries
The Basics of Adjusting Entries
Adjusting entries make it possible to report
correct amounts on the balance sheet and
on the income statement.
A company must make adjusting entries
every time it prepares financial statements.
Chapter
3-14 SO 3 Explain the reasons for adjusting entries.

15. The Basics of Adjusting Entries
The Basics of Adjusting Entries
Revenues - recorded in the period in which
they are earned.
earned
Expenses - recognized in the period in which
they are incurred.
incurred
Adjusting entries - needed to ensure that
the revenue recognition and matching
principles are followed.
Chapter
3-15 SO 3 Explain the reasons for adjusting entries.

16. Timing Issues
Timing Issues
Review
Adjusting entries are made to ensure that:
a. expenses are recognized in the period in which
they are incurred.
b. revenues are recorded in the period in which
they are earned.
c. balance sheet and income statement accounts
have correct balances at the end of an
accounting period.
d. all of the above.
Chapter
3-16 SO 3 Explain the reasons for adjusting entries.

17. Types of Adjusting Entries
Types of Adjusting Entries
Illustration 4-2
Categories of adjusting entries
Deferrals Accruals
1. Prepaid Expenses. 3. Accrued Revenues.
Expenses paid in cash and Revenues earned but not
recorded as assets before yet received in cash or
they are used or consumed. recorded.
2. Unearned Revenues. 4. Accrued Expenses.
Revenues received in cash Expenses incurred but not
and recorded as liabilities yet paid in cash or
before they are earned. recorded.
Chapter
3-17 SO 4 Identify the major types of adjusting entries.

18. Trial Balance
Trial Balance
Trial Balance – Each account is analyzed to determine whether
it is complete and up-to-date.
Illustration 3-3
Chapter
3-18 SO 4 Identify the major types of adjusting entries.

19. Adjusting Entries for Deferrals
Adjusting Entries for Deferrals
Deferrals are either:
Prepaid expenses
OR
Unearned revenues.
Chapter
3-19 SO 5 Prepare adjusting entries for deferrals.

20. Adjusting Entries for “Prepaid Expenses”
Adjusting Entries for “Prepaid Expenses”
Payment of cash that is recorded as an asset because
service or benefit will be received in the future.
Cash Payment BEFORE Expense Recorded
Prepayments often occur in regard to:
insurance rent
supplies maintenance on equipment
advertising fixed assets (depreciation)
Chapter
3-20 SO 5 Prepare adjusting entries for deferrals.

21. Adjusting Entries for “Prepaid Expenses”
Adjusting Entries for “Prepaid Expenses”
Prepaid Expenses
Costs that expire either with the passage of time
or through use.
Adjusting entries (1) to record the expenses that
apply to the current accounting period, and (2) to
show the unexpired costs in the asset accounts.
Chapter
3-21 SO 5 Prepare adjusting entries for deferrals.

22. Adjusting Entries for “Prepaid Expenses”
Adjusting Entries for “Prepaid Expenses”
Adjusting entries for prepaid expenses
Illustration 3-4
Increases (debits) an expense account and
Decreases (credits) an asset account.
Chapter
3-22 SO 5 Prepare adjusting entries for deferrals.

23. Adjusting Entries for “Prepaid Expenses”
Adjusting Entries for “Prepaid Expenses”
Illustration: Pioneer Advertising Agency purchased advertising
supplies costing $2,500 on October 5. Sierra recorded the
payment by increasing (debiting) the asset Advertising Supplies.
This account shows a balance of $2,500 in the October 31 trial
balance. An inventory count at the close of business on October
31 reveals that $1,000 of supplies are still on hand.
Oct. 31 Advertising supplies expense 1,500
Advertising supplies 1,500
Illustration 3-5
Chapter
3-23 SO 5 Prepare adjusting entries for deferrals.

24. Adjusting Entries for “Prepaid Expenses”
Adjusting Entries for “Prepaid Expenses”
Illustration: On October 4, Pioneer Advertising Agency paid
$600 for a one-year fire insurance policy. Coverage began on
October 1. Pioneer recorded the payment by increasing (debiting)
Prepaid Insurance. This account shows a balance of $600 in the
October 31 trial balance. Insurance of $50 ($600 / 12) expires
each month.
Oct. 31 Insurance expense 50
Prepaid insurance 50
Illustration 3-6
Chapter
3-24 SO 5 Prepare adjusting entries for deferrals.

25. Adjusting Entries for “Prepaid Expenses”
Adjusting Entries for “Prepaid Expenses”
Depreciation
Buildings, equipment, and vehicles (long-lived
assets) are recorded as assets, rather than an
expense, in the year acquired.
Companies report a portion of the cost of a long-
lived asset as an expense (depreciation) during
each period of the asset’s useful life (Matching
Principle).
Chapter
3-25 SO 5 Prepare adjusting entries for deferrals.

26. Adjusting Entries for “Prepaid Expenses”
Adjusting Entries for “Prepaid Expenses”
Illustration: Pioneer Advertising estimates depreciation on the
office equipment to be $480 a year, or $40 per month.
Oct. 31 Depreciation expense 40
Accumulated depreciation 40
Illustration 3-7
Chapter
3-26 SO 5 Prepare adjusting entries for deferrals.

27. Adjusting Entries for “Prepaid Expenses”
Adjusting Entries for “Prepaid Expenses”
Depreciation (Statement Presentation)
Accumulated Depreciation is a contra asset account.
Appears just after the account it offsets
(Equipment) on the balance sheet.
Illustration 3-8
Chapter
3-27 SO 5 Prepare adjusting entries for deferrals.

28. Adjusting Entries for “Prepaid Expenses”
Adjusting Entries for “Prepaid Expenses”
Summary Illustration 3-9
Chapter
3-28 SO 5 Prepare adjusting entries for deferrals.

29. Adjusting Entries for “Unearned Revenues”
Adjusting Entries for “Unearned Revenues”
Receipt of cash that is recorded as a liability because
the revenue has not been earned.
Cash Receipt BEFORE Revenue Recorded
Unearned revenues often occur in regard to:
rent magazine subscriptions
airline tickets customer deposits
school tuition
Chapter
3-29 SO 5 Prepare adjusting entries for deferrals.

30. Adjusting Entries for “Unearned Revenues”
Adjusting Entries for “Unearned Revenues”
Unearned Revenues
Company makes an adjusting entry to record the
revenue that has been earned and to show the
liability that remains.
The adjusting entry for unearned revenues results
in a decrease (a debit) to a liability account and an
increase (a credit) to a revenue account.
Chapter
3-30 SO 5 Prepare adjusting entries for deferrals.

31. Adjusting Entries for “Unearned Revenues”
Adjusting Entries for “Unearned Revenues”
Adjusting entries for unearned revenues
Illustration 3-10
Decrease (a debit) to a liability account and
Increase (a credit) to a revenue account.
Chapter
3-31 SO 5 Prepare adjusting entries for deferrals.

32. Adjusting Entries for “Unearned Revenues”
Adjusting Entries for “Unearned Revenues”
Illustration: Pioneer Advertising Agency received $1,200 on
October 2 from R. Knox for advertising services expected to be
completed by December 31. Unearned Service Revenue shows a
balance of $1,200 in the October 31 trial balance. Analysis reveals
that the company earned $400 of those fees in October.
Oct. 31 Unearned service revenue 400
Service revenue 400
Illustration 3-11
Chapter
3-32 SO 5 Prepare adjusting entries for deferrals.

33. Adjusting Entries for “Unearned Revenues”
Adjusting Entries for “Unearned Revenues”
Summary
Illustration 3-12
Chapter
3-33 SO 5 Prepare adjusting entries for deferrals.

34. Chapter
3-34 SO 5 Prepare adjusting entries for deferrals.

35. Adjusting Entries for Accruals
Adjusting Entries for Accruals
Made to record:
Revenues earned and
OR
Expenses incurred
in the current accounting period that have not
been recognized through daily entries.
Chapter
3-35 SO 6 Prepare adjusting entries for accruals.

36. Adjusting Entries for “Accrued Revenues”
Adjusting Entries for “Accrued Revenues”
Revenues earned but not yet received in cash or
recorded.
Adjusting entry results in:
Revenue Recorded BEFORE Cash Receipt
Accrued revenues often occur in regard to:
rent
interest
services performed
Chapter
3-36 SO 6 Prepare adjusting entries for accruals.

37. Adjusting Entries for “Accrued Revenues”
Adjusting Entries for “Accrued Revenues”
Accrued Revenues
An adjusting entry serves two purposes:
(1) It shows the receivable that exists, and
(2) It records the revenues earned.
Chapter
3-37 SO 6 Prepare adjusting entries for accruals.

38. Adjusting Entries for “Accrued Revenues”
Adjusting Entries for “Accrued Revenues”
Adjusting entries for accrued revenues
Illustration 3-13
Increases (debits) an asset account and
Increases (credits) a revenue account.
Chapter
3-38 SO 6 Prepare adjusting entries for accruals.

39. Adjusting Entries for “Accrued Revenues”
Adjusting Entries for “Accrued Revenues”
Illustration: In October Pioneer Advertising Agency earned
$200 for advertising services that had not been recorded.
Oct. 31 Accounts Receivable 200
Service Revenue 200
Illustration 3-14
Chapter
3-39 SO 6 Prepare adjusting entries for accruals.

40. Adjusting Entries for “Accrued Revenues”
Adjusting Entries for “Accrued Revenues”
Summary
Illustration 3-15
Chapter
3-40 SO 6 Prepare adjusting entries for accruals.

41. Adjusting Entries for “Accrued Expenses”
Adjusting Entries for “Accrued Expenses”
Expenses incurred but not yet paid in cash or
recorded.
Adjusting entry results in:
Expense Recorded BEFORE Cash Payment
Accrued expenses often occur in regard to:
rent taxes
interest salaries
Chapter
3-41 SO 6 Prepare adjusting entries for accruals.

42. Adjusting Entries for “Accrued Expenses”
Adjusting Entries for “Accrued Expenses”
Accrued Expenses
An adjusting entry serves two purposes:
(1) It records the obligations, and
(2) It recognizes the expenses.
Chapter
3-42 SO 6 Prepare adjusting entries for accruals.

43. Adjusting Entries for “Accrued Expenses”
Adjusting Entries for “Accrued Expenses”
Adjusting entries for accrued expenses
Illustration 3-16
Increases (debits) an expense account and
Increases (credits) a liability account.
Chapter
3-43 SO 6 Prepare adjusting entries for accruals.

44. Adjusting Entries for “Accrued Expenses”
Adjusting Entries for “Accrued Expenses”
Illustration: Pioneer Advertising Agency signed a three-month
note payable in the amount of $5,000 on October 1. The note
requires Pioneer to pay interest at an annual rate of 12%.
Illustration 3-17
Oct. 31 Interest expense 50
Interest payable 50
Illustration 3-18
Chapter
3-44 SO 6 Prepare adjusting entries for accruals.

45. Adjusting Entries for “Accrued Expenses”
Adjusting Entries for “Accrued Expenses”
Illustration: Pioneer Advertising Agency last paid salaries on
October 26; the next payment of salaries will not occur until
November 9. 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 3 days).
Oct. 31 Salaries expense 1,200
Salaries payable 1,200
Illustration 3-20
Chapter
3-45 SO 6 Prepare adjusting entries for accruals.

46. Adjusting Entries for “Accrued Expenses”
Adjusting Entries for “Accrued Expenses”
Summary
Illustration 3-21
Chapter
3-46 SO 6 Prepare adjusting entries for accruals.

47. The Adjusted Trial Balance
The Adjusted Trial 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 7 Describe the nature and purpose of an adjusted trial balance.

48. The Adjusted Trial Balance
The Adjusted Trial Balance
Chapter
3-48

49. The Adjusted Trial Balance
The Adjusted Trial 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 7 Describe the nature and purpose of an adjusted trial balance.

50. Preparing Financial Statements
Preparing Financial Statements
Financial Statements are prepared directly from the
Financial Statements are prepared directly from the
Adjusted Trial Balance.
Adjusted Trial Balance.
Owner’s
Balance Income
Equity
Sheet Statement
Statement
Chapter
3-50 SO 7 Describe the nature and purpose of an adjusted trial balance.

51. Preparing Financial Statements
Preparing Financial Statements
Illustration 3-25
Preparation of
the income
statement and
owner’s
equity statement
from the
adjusted trial
balance
Chapter
3-51

52. Preparing Financial Statements
Preparing Financial Statements
Illustration 3-26
Chapter
3-52

53. Alternative Treatment of Prepaid Expenses
Alternative Treatment of Prepaid Expenses
and Unearned Revenues
and Unearned 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 8 Prepare adjusting entries for the alternative treatment of deferrals.

54. Alternative Treatment for “Prepaid Expenses”
Alternative Treatment for “Prepaid Expenses”
Illustration: Pioneer Advertising purchased supplies on
October 5 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 8 Prepare adjusting entries for the alternative treatment of deferrals.

55. Alternative Treatment for “Prepaid Expenses”
Alternative Treatment for “Prepaid Expenses”
Adjustment approaches—a comparison
Illustration 3A-2
Chapter
3-55 SO 8 Prepare adjusting entries for the alternative treatment of deferrals.

56. Alternative Treatment for “Unearned Revenues”
Alternative Treatment for “Unearned Revenues”
Illustration: Assume that Pioneer Advertising received
$1,200 for future services on October 2 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 800
Unearned service revenue 800
Illustration 3A-4
Chapter
3-56 SO 8 Prepare adjusting entries for the alternative treatment of deferrals.

57. Alternative Treatment for “Unearned Revenues”
Alternative Treatment for “Unearned Revenues”
Adjustment approaches—a comparison
Illustration 3A-5
Chapter
3-57 SO 8 Prepare adjusting entries for the alternative treatment of deferrals.

58. Summary of Additional Adjustment Relationships
Summary of Additional Adjustment Relationships
Illustration 3A-7
Chapter
3-58 SO 8 Prepare adjusting entries for the alternative treatment of deferrals.

59. Copyright
Copyright
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Chapter
3-59