AKD cpt03

Accounting Principles
Thirteenth Edition
Weygandt ● Kimmel ● Kieso
Chapter 3
Adjusting the Accounts

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Chapter Outline
Learning Objectives
LO 1 Explain the accrual basis of accounting and the reasons
for adjusting entries.
LO 2 Prepare adjusting entries for deferrals.
LO 3 Prepare adjusting entries for accruals.
LO 4 Describe the nature and purpose of an adjusted trial
balance.
Copyright ©2018 John Wiley & Sons, Inc. 2

Accrual-Basis and Adjusting Entries
Accountants divide the economic life of a business into
artificial time periods (Time Period Assumption).
Generally a
Alternative terminology
• month, The time period assumption is also
• quarter, or called the periodicity assumption.
• year.
Fiscal and Calendar Years (1 of 5)
• Monthly and quarterly time periods are called interim
periods
• Most large companies must prepare both quarterly
and annual financial statements
• Fiscal Year = Accounting time period that is one year
in length
• Calendar Year = January 1 to December 31

The time period assumption states that:
a. companies must wait until the calendar year is
completed to prepare financial statements.
b. companies use the fiscal year to report financial
information.
c. the economic life of a business can be divided into
artificial time periods.
d. companies record information in the time period in
which the events occur.

The time period assumption states that:
a. companies must wait until the calendar year is
completed to prepare financial statements.
b. companies use the fiscal year to report financial
information.
c. Answer: the economic life of a business can be divided
into artificial time periods.
d. companies record information in the time period in

Accrual- versus Cash-Basis Accounting (1 of 2)
Accrual-Basis Accounting
• Transactions recorded in the periods in which the events
occur
• Companies recognize revenues when they perform
services (rather than when they receive cash)
• Expenses are recognized when incurred (rather than when
paid)
• In accordance with generally accepted accounting
principles (GAAP)

Accrual- versus Cash-Basis Accounting (2 of 2)
Cash-Basis Accounting
• Revenues recognized when cash is received
• Expenses recognized when cash is paid
• Cash-basis accounting is not in accordance with generally
accepted accounting principles (GAAP)

Recognizing Revenues and Expenses (1 of 3)
Revenue Recognition Principle

Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.

Expense Recognition Principle

Companies recognize expenses
in the period in which they
make efforts (consume assets
or incur liabilities) to generate
revenue.
“Let the expenses follow
the revenues.”


Which of the following statements about the accrual basis
of accounting is false?
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 services are
performed.
c. This basis is in accordance with generally accepted
accounting principles.
d. Revenue is recorded only when cash is received, and
expense is recorded only when cash is paid.

Which of the following statements about the accrual basis
of accounting is false?
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 services are
performed.
c. This basis is in accordance with generally accepted
accounting principles.
d. Answer: Revenue is recorded only when cash is received,
and expense is recorded only when cash is paid.

The Need for Adjusting Entries (1 of 3)
Adjusting Entries
• Ensure that the revenue recognition and expense
recognition principles are followed.
• Necessary because the trial balance may not contain
up-to-date and complete data.
• Required every time a company prepares financial
statements.
• Will include one income statement account and one
balance sheet account.

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 services are
performed.
c. balance sheet and income statement accounts have correct
balances at the end of an accounting period.
d. All the responses above are correct.

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 services are
performed.
c. balance sheet and income statement accounts have correct
balances at the end of an accounting period.
d. Answer: All the responses above are correct.

Types of Adjusting Entries
Deferrals Accruals
1. Prepaid Expenses. Expenses 1. Accrued Revenues. Revenues
paid in cash before they are for services performed but not
used or consumed. yet received in cash or
2. Unearned Revenues. Cash recorded.
received before services are 2. Accrued Expenses. Expenses
performed. incurred but not yet paid in cash
or recorded.

Do It! 1: Timing Concepts (1 of 2)
Below is a list of timing concepts in the (a) Monthly and quarterly time periods.
left column, with a description of the
(b) Efforts (expenses) should be recognized in the
concept in the right column. There are
more descriptions provided than period in which a company uses assets or
concepts. Match the description to the incurs liabilities to generate results
concept (revenues).
(c) Accountants divide the economic life of a
1. [blank] Accrual-basis accounting. business into artificial time periods.
2. [blank] Calendar year. (d) Companies record revenues when they
3. [blank] Time period assumption. receive cash and record expenses when they
pay out cash.
4. [blank] Expense recognition principle.
(e) An accounting time period that starts on
January 1 and ends on December 31.
(f) Companies record transactions in the period in

Do It! 1: Timing Concepts (2 of 2)
Below is a list of timing concepts in the (a) Monthly and quarterly time periods.
left column, with a description of the
(b) Efforts (expenses) should be recognized in the
concept in the right column. There are
more descriptions provided than period in which a company uses assets or
concepts. Match the description to the incurs liabilities to generate results
concept (revenues).
(c) Accountants divide the economic life of a
1. f Accrual-basis accounting. business into artificial time periods.
2. e Calendar year. (d) Companies record revenues when they
3. c Time period assumption. receive cash and record expenses when they
pay out cash.
4. b Expense recognition principle.
(e) An accounting time period that starts on
January 1 and ends on December 31.
(f) Companies record transactions in the period in

Adjusting Entries for Deferrals
Deferrals are expenses or revenues that are recognized
at a date later than the point when cash was originally
exchanged. There are two types:
• Prepaid expenses
• Unearned revenues

Prepaid Expenses (1 of 5)
Payments of expenses that are recorded as an asset to show
the service or benefit the company will receive in the future.
Cash Payment BEFORE Expense Recorded
Prepayments often occur in regard to:

• insurance • rent
• supplies • equipment
• advertising • buildings

• Expire either with the passage of time or through use
• Adjusting entry:
o Increase (debit) to an expense account and
o Decrease (credit) to an asset account


Adjustment for Supplies (1 of 2)
Illustration: Pioneer Advertising purchased
supplies costing $2,500 on October 5.
Pioneer recorded the payment by increasing
(debiting) the asset 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 Supplies Expense 1,500

Supplies 1,500

Adjustment for Supplies (2 of 2)

Adjustment for Insurance (1 of 2)
Illustration: On October 4, Pioneer Advertising
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

Adjustment for Insurance (2 of 2)

Depreciation (1 of 4)
• Buildings, equipment, and motor vehicles (assets that
provide service for many years) are recorded as assets,
rather than an expense, on the date acquired
• Depreciation is the process of allocating the cost of an
asset to expense over its useful life
• Depreciation does not attempt to report the actual
change in the value of the asset
o Allocation concept, not a valuation concept

Adjustment for Depreciation (2 of 4)
Illustration: For Pioneer Advertising, assume
that depreciation on the equipment is $480 a
year, or $40 per month.
Oct. 31
Depreciation Expense 40
Accumulated Depreciation 40
Accumulated Depreciation is called a

contra asset account.

Adjustment for Depreciation (3 of 4)

Depreciation (4 of 4)
Statement Presentation
• Accumulated Depreciation is a contra asset account (credit)
• Offsets related asset account on the balance sheet
• Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation
Equipment $5,000
Less: Accumulated depreciation—equipment 40
$4,960

Accounting for Prepaid Expenses
Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Insurance, Prepaid expense Assets Dr. Expenses
supplies, originally overstated. Cr. Assets or
advertising, rent, recorded Expenses Contra Assets
Depreciation in asset accounts understated.
have been used.

Unearned Revenues (1 of 5)
Receipt of cash that is recorded as a liability because the
service has not been performed.
Cash receipt BEFORE revenue recorded
Unearned revenues often occur in regard to:

• Rent • Magazine subscriptions
• Airline tickets • Customer deposits

• Adjusting entry is made to record the revenue for services
performed during the period and to show the liability that
remains at the end of the period
• Results in a decrease (debit) to a liability account and an
increase (credit) to a revenue account

Illustration: Pioneer Advertising 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
performed $400 of services in October.
Oct. 31 Unearned Service Revenue 400

Service Revenue 400


Accounting for Unearned Revenue
Accounts
Rent, magazine Unearned revenues Liabilities Dr. Liabilities
subscriptions, recorded in liability overstated. Cr. Revenues
customer deposits accounts are now Revenues
for future service recognized as understated.
revenue for services
performed.

Do It! 2: Adjusting Entries for Deferrals (1 of 5)
The ledger of Hammond Company, on March 31, 2020, includes these selected accounts before
adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
An analysis of the accounts shows the following.

1. Insurance expires at the rate of $100 per month.
2. Supplies on hand total $800.
3. The equipment depreciates $200 a month.
4. During March, services were performed for $4,000 of the unearned service revenue reported.
Prepare the adjusting entries for the month of March.
Debit Credit
Supplies 2,800
Equipment 25,000

1. Insurance expires at the rate of $100 per month.
Insurance Expense 100

Prepaid Insurance 100
(To record insurance expired)

Debit Credit
Supplies 2,800
Equipment 25,000

2. Supplies on hand total $800.
Supplies Expense 2,000

Supplies 2,000
(To record supplies used)

Debit Credit
Supplies 2,800
Equipment 25,000

3. The equipment depreciates $200 a month.
Depreciation Expense 200

Accumulated Depreciation—Equipment 200
(To record monthly depreciation)

Debit Credit
Supplies 2,800
Equipment 25,000

4. During March, services were performed for $4,000 of the unearned service revenue reported.

Service Revenue 4,000
(To record revenue for services performed)

Adjusting Entries for Accruals
Accruals are made to record,
• Revenues for services performed but not yet recorded at
the statement date
• Expenses incurred but not yet paid or recorded at the
statement date

Accrued Revenues (1 of 5)
Revenues for services performed but not yet received in cash
or recorded.
Revenue recorded BEFORE cash receipt
Accrued revenues often occur in regard to:

• Rent
• Interest
• Services

• Adjusting entry records the receivable that exists and
records the revenues for services performed.
o Increases (debits) an asset account and
o Increases (credits) a revenue account

Illustration: In October Pioneer Advertising
performed services worth $200 that were
not billed to clients on or before October 31.
Oct. 31
Accounts 200
Receivable
Service Revenue 200
On November 10, Pioneer receives cash of $200 for the services
performed. The journal entry on the 10th is:
Cash 200
Accounts Receivable 200
(To record cash collected on account)

Accounting for Accrued Revenues
Accounts
Interest, Services performed Assets Dr. Assets
rent, services but not yet received understated. Cr. Revenues
In cash or recorded. Revenues
understated.

Accrued Expenses (1 of 7)
Expenses incurred but not yet paid in cash or recorded.
Expense recorded BEFORE cash payment
Accrued expenses often occur in regard to:

• Rent • Taxes
• Interest • Salaries

Adjusting Accrued Expenses (2 of 7)
• Adjusting entry records the obligation and recognizes
the expense.
o Increase (debit) an expense account and
o Increase (credit) a liability account

Accrued Interest
Illustration: Pioneer Advertising 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%.
Face Value Annual Time in Terms

of Note × Interest Rate × of One Year = Interest
$5,000 × 12% × = $50
Oct. 31 Interest Expense 50

Interest Payable 50


Accrued Salaries and Wages
Illustration: Pioneer Advertising paid salaries and wages 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.
On October 31, the salaries and wages for three remaining working days
(October 29 to 31) represent an accrued expense and a related liability.

Accounting for Accrued Expenses
Accounts
Interest, Expenses have Expenses Dr. Expenses
rent, salaries been incurred but understated. Cr. Liabilities
not yet paid in Liabilities
cash or recorded. understated.

Summary of Basic Relationships
Accounts Before
Type of Adjustment Adjustment Adjusting Entry
Prepaid expenses Assets overstated. Dr. Expense
Expenses understated. Cr. Assets or Contra
Assets
Unearned revenues Liabilities overstated. Dr. Liabilities
Revenues understated. Cr. Revenues
Accrued revenues Assets understated. Dr. Assets
Revenues understated. Cr. Revenues
Accrued expenses Expenses understated. Dr. Expenses
Liabilities understated. Cr. Liabilities

Do It! 3: Adjusting Entries for Accruals (1 of 3)
Micro Computer Services began operations on August 1, 2020. At

the end of August 2020, management prepares monthly financial
statements. The following information relates to August.
1. At August 31, the company owed its employees $800 in salaries
and wages that will be paid on September 1.
2. On August 1, the company borrowed $30,000 from a local bank
on a 15-year mortgage. The annual interest rate is 10%.
3. Revenue for services performed but unrecorded for August
totaled $1,100.
Prepare the adjusting entries needed at August 31, 2020.

1. At August 31, the company owed its employees $800 in salaries
and wages that will be paid on September 1.
Salaries and Wages Expense 800
Salaries and Wages Payable 800
(To record accrued salaries)
2. On August 1, the company borrowed $30,000 from a local bank

on a 15-year mortgage. The annual interest rate is 10%.
Interest Expense 250
Interest Payable 250
(To record accrued interest)

3. Revenue for services performed but unrecorded for August
totaled $1,100.
Accounts Receivable 1,100

Adjusted Trial Balance (1 of 4)
• Prepared after adjusting entries are journalized and posted
• Proves equality of debit and credit balances
• Basis for the preparation of financial statements


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.

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. Answer: 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.

Preparing Financial Statements (1 of 3)



Do It! 4: Trial Balance (1 of 4)
Skolnick Co. was organized on April 1, 2020. The company prepares quarterly
financial statements. The adjusted trial balance at June 30 are shown below.
Debit Credit
Cash $ 6,700 Accumulated Depreciation $ 850
Accounts Receivable 600 Notes Payable 5,000
Prepaid Rent 900 Accounts Payable 1,510
Supplies 1,000 Salaries and Wages Payable 400
Equipment 15,000 Interest Payable 50
Owner’s Drawings 600 Unearned Rent Revenue 500
Salaries and Wages Expense 9,400 Owner’s Capital 14,000
Rent Expense 1,500 Service Revenue 14,200
Depreciation Expense 850 Rent Revenue 800
Supplies Expense 200 $37,310 double border
Utilities Expense 510

Interest Expense 50
$37,310 double border

a. Determine the net income for the quarter April 1 to June 30.
Revenues
Service revenue $14,200
Rent revenue 800
Total revenues $15,000
Expenses
Salaries and wages expense 9,400
Rent expense 1,500
Depreciation expense 850
Utilities expense 510
Supplies expense 200
Interest expense 50
Total expenses 12,510
$2,490 double border
Net income

b. Determine the total assets and total liabilities at June 30, 2020.
Assets Liabilities
Cash $ 6,700 Notes Payable 5,000
Accounts Receivable 600 Accounts Payable 1,510
Prepaid Rent 900 Salaries and Wages Payable 400
Supplies 1,000 Interest Payable 50
Equipment 15,000 Unearned Rent Revenue 500
Accumulated Depreciation (850) blank
Total assets $23,350 double border
Total liabilities $37,310 double border

c. Determine the amount of owner’s capital at June 30, 2020.
Owner’s capital, April 1 $0

Add: Investments 14,000
Net income 2,490
Less: Owner’s drawings 600
Total assets $15,890

Appendix 3A: Alternative Treatment of
Deferrals
• When a company prepays an expense, it debits that
amount to an expense account
• When it receives payment for future services, it credits
the amount to a revenue account

Company may choose to debit (increase) an expense account
rather than an asset account. This alternative treatment is simply
more convenient.
Prepayment Initially Debited to Asset Account (per chapter)
Oct. 5 Supplies 2,500

Accounts payable 2,500
(Purchased supplies on account)
Supplies 1,500
(To record supplies used)

Company may choose to debit (increase) an expense account
rather than an asset account. This alternative treatment is simply
more convenient.
Prepayment Initially Debited to Expense Account (per appendix)

Accounts payable 2,500
(Purchased supplies on account)
Oct. 31 Supplies 1,000
Supplies Expense 1,000
(To record supplies inventory)

Company may credit (increase) a revenue account when they
receive cash for future services.
Unearned Revenue Initially Credited to Liability Account (per chapter)
Oct. 2 Cash 1,200

Unearned Revenue 1,200
(Record cash received for future service)
Oct. 31 Unearned Revenue 400
Service Revenue 400
(Record revenue for services performed)

Company may credit (increase) a revenue account when they
receive cash for future services.
Unearned Revenue Initially Credited to Revenue Account (per appendix)
Oct. 2 Cash 1,200

(Record cash received for future service)
Oct. 31 Service Revenue 800
Unearned Revenue 800
(To record unearned service revenue)

Summary of Additional Adjustments (1 of 2)
Prepaid Expenses
Accounts Balances
Reason for Adjustment Before Adjustment Adjusting Entry
(a) Prepaid expenses Assets overstated. Dr. 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.

Summary of Additional Adjustments (2 of 2)
Unearned Revenues
Accounts Balances
Reason for Adjustment Before Adjustment Adjusting Entry
(a) Unearned revenues Liabilities overstated. Dr. Liabilities
initially recorded in Revenues understated. Cr. Revenues
liability accounts are
now recognized as
revenue.
(b) Unearned revenues Liabilities understated. Dr. Revenues
initially recorded in Revenues overstated. Cr. Liabilities
revenue accounts are
still unearned.

Appendix 3B: Financial Reporting
Concepts (1 of 2)
Qualities of Useful Information
Two fundamental qualities
1. Relevance
• Make a difference in a business decision
• Provides information that has predictive value and
confirmatory value
• Materiality is a company-specific aspect of relevance
o An item is material when its size makes it likely to influence
the decision of an investor or creditor

Appendix 3B: Financial Reporting
Concepts (2 of 2)
Two fundamental qualities
2. Faithful Representation
• Information accurately depicts what really happened.
• Information must be
o complete (nothing important has been omitted)
o neutral (is not biased toward one position or another)
o free from error

Qualities of Useful Information
Enhancing Qualities
• Comparability results when different companies use the
same accounting principles.
• Consistency means that a company uses the same
accounting principles and methods from year to year.
• Information is verifiable if independent observers, using the
same methods, obtain similar results.
• For accounting information to have relevance, it must be
timely.
• Information has the quality of understandability if it is
presented in a clear and concise fashion.
Assumptions in Financial Reporting (1 of 3)


Measurement Principles
• Historical Cost
• Or cost principle, dictates that companies record assets at
their cost.
• Fair Value
• Indicates that assets and liabilities should be reported at fair
value (the price received to sell an asset or settle a liability).

Principles of Financial Reporting
• Revenue Recognition Principle
• Requires that companies recognize revenue in the
accounting period in which the performance obligation is
satisfied.
• Expense Recognition Principle
• Dictates that companies recognize expense in the period in
which they make efforts to generate revenue. Thus, expenses
follow revenues.
• Full Disclosure Principle
• Requires that companies disclose all circumstances and events
that would make a difference to financial statement users.
Cost Constraint
Cost Constraint
Accounting standard-setters
weigh the cost that
companies will incur to
provide the information
against the benefit that
financial statement users
will gain from having the
information available.

A Look at IFRS (1 of 5)
Key Points
Similarities
• Companies applying IFRS also use accrual-basis accounting to
ensure that they record transactions that change a company’s
financial statements in the period in which events occur.
• Similar to GAAP, cash-basis accounting is not in accordance
with IFRS.
• IFRS also divides the economic life of companies into artificial
time periods. Under both GAAP and IFRS, this is referred to as
the time period assumption.

Key Points
Similarities
• The general revenue recognition principle required by G AAP that
is used in this textbook is similar to that used under I FRS.
• Revenue recognition fraud is a major issue in U.S. financial
reporting. The same situation occurs in other countries, as
evidenced by revenue recognition breakdowns at Dutch
software company Baan NV, Japanese electronics giant NEC, and
Dutch grocer Ahold NV.

Key Points
Differences
• Under IFRS, revaluation (using fair value) of items such as land and
buildings is permitted. IFRS allows depreciation based on revaluation
of assets, which is not permitted under GAAP.
• The terminology used for revenues and gains, and expenses and
losses, differs somewhat between IFRS and GAAP. For example,
income under IFRS includes both revenues, which arise during the
normal course of operating activities, and gains, which arise from
activities outside of the normal sales of goods and services. The term
income is not used this way under GAAP. Instead, under GAAP income
refers to the net difference between revenues and expenses.

Key Points
Differences
• Under IFRS, expenses include both those costs incurred in the normal
course of operations as well as losses that are not part of normal
operations. This is in contrast to GAAP, which defines each separately.

Looking to the Future
The IASB and FASB are completing a joint project on revenue recognition.
The purpose of this project is to develop comprehensive guidance on
when to recognize revenue. It is hoped that this approach will lead to
more consistent accounting in this area.

Copyright
Copyright © 2018 John Wiley & Sons, Inc.
All rights reserved. Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States 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.

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Accounting Principles

Adjusting the Accounts

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Revenue Recognition Principle

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Expense Recognition Principle

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Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

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Oct. 31 Supplies Expense 1,500

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Accumulated Depreciation is called a

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Cash receipt BEFORE revenue recorded

Unearned revenues often occur in regard to:

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Oct. 31 Unearned Service Revenue 400

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An analysis of the accounts shows the following.

Prepare the adjusting entries for the month of March.

Insurance Expense 100

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Prepare the adjusting entries for the month of March.

Supplies Expense 2,000

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Prepare the adjusting entries for the month of March.

Depreciation Expense 200

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Prepare the adjusting entries for the month of March.

Unearned Service Revenue 4,000

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