CHAPTER 3 ADJUSTING THE ACCOUNTS Accounting Principles Eighth

CHAPTER 3 ADJUSTING THE ACCOUNTS Accounting Principles, Eighth Edition Chapter 3 -1

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. Prepare adjusting entries for alternative treatment for deferral 8. Describe the nature and purpose of an adjusted trial balance. Chapter 3 -2

Adjusting the Accounts Timing Issues Time period assumption Fiscal and calendar years Accrual- vs. cashbasis accounting Recognizing revenues and expenses Chapter 3 -3 LO 1 - 2 The Basics of Adjusting Entries Types of adjusting entries Adjusting entries for deferrals and accruals Alternative treatment for deferrals Summary of journalizing and posting LO 2 - 7 The Adjusted Trial Balance and Financial Statements Preparing the adjusted trial balance Preparing financial statements LO 8

Timing Issues Time Period or Periodicity Assumption Divide the economic life of a business into artificial time periods Jan. Feb. Mar. Apr. . . Dec. Generally a month, a quarter, or a year. Fiscal year vs. calendar year Chapter 3 -4 LO 1 Explain the time period assumption.

Timing Issues Time Period or Periodicity Assumption Exercise - 1 Classify following periods as Calendar year, fiscal year, and interim periods Chapter 3 -5 Accounting Period January 1 – 31, 2013 Interim October 1, 2013 – September 30, 2014 Fiscal January 1 – December 31, 2013 Calendar & Fiscal January 1 – March 2013 Interim April 1 2013 – March 31, 2014 Fiscal January 1 – June 30, 2013 Interim December 29, 2012 – December 27, 2013 Fiscal July 1, 2013 – June 30, 2014 Fiscal LO 1 Explain the time period assumption.

Timing Issues Accrual- vs. Cash-Basis Accounting Accrual-Basis Accounting Transactions are 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 -6 LO 2 Explain the accrual basis of accounting.

Timing Issues Accrual- vs. 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 -7 LO 2 Explain the accrual basis of accounting.

Timing Issues Recognizing Revenues and Expenses Revenue Recognition Principle Question # 3 - Rick Marsh, a lawyer, accepts a legal engagement in March, performs the work in April, and is paid in May. If Marsh’s law firm prepares monthly financial statements, when should it recognize revenue from this engagement? It should recognize the revenue in April, the accounting period in which it is earned. Chapter 3 -8 LO 2 Explain the accrual basis of accounting.

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 LO 2 Explain the accrual basis of accounting.

Timing Issues Recognizing Revenues and Expenses Matching Principle In completing the engagement, Marsh pays no costs in March, $2, 000 in April and $2, 500 in May (incurred in April). How much expenses should the firm deduct from revenue in the month when it recognizes revenue? Expenses of $4, 500 should be deducted from the revenues in April when the revenue is recognized. Chapter 3 -10 LO 2 Explain the accrual basis of accounting.

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 -11 LO 2 Explain the accrual basis of accounting.

Timing Issues GAAP relationships in revenue and expense recognition Illustration 3 -1 Chapter 3 -12 LO 2 Explain the accrual basis of accounting.

Timing Issues Review Question – SSQ 3 - 1 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 -13 LO 1 Explain the time period assumption.

Timing Issues Review Question – SSQ 3 - 3 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 -14 LO 2 Explain the accrual basis of accounting.

Adjusting the Accounts Timing Issues Time period assumption Fiscal and calendar years Accrual- vs. cashbasis accounting Recognizing revenues and expenses Chapter 3 -15 LO 1 - 2 The Basics of Adjusting Entries Types of adjusting entries Adjusting entries for deferrals and accruals Alternative treatment for deferrals Summary of journalizing and posting LO 2 - 7 The Adjusted Trial Balance and Financial Statements Preparing the adjusted trial balance Preparing financial statements LO 8

The Basics of Adjusting Entries Revenue and Expense Recognition q Revenues are recorded in the period in which they are earned q Expenses are recognized in the period in which they are incurred There are situations when the trial balance – the first summarization of transaction data, is not up-to-date and complete. Chapter 3 -16 LO 3 Explain the reasons for adjusting entries.

The Basics of Adjusting Entries Situations when the trial balance is not up-to-date Some transactions are recorded at month end only. q Payment of salaries q Consumption of supplies Some costs are paid in advance q Chapter 3 -17 Rent, insurance, subscriptions, maintenance charges, property and related taxes, etc. LO 3 Explain the reasons for adjusting entries.

The Basics of Adjusting Entries Situations when trial balance is not up-to-date Some transactions are unrecorded Chapter 3 -18 q Utilities and other bills received after the month end. q Payment of contractual commitments after the month end like rent, service charges, lawyers’ fees, interest, etc. q Services rendered but unbilled, interest income, commission revenue etc. LO 3 Explain the reasons for adjusting entries.

The Basics of Adjusting Entries Adjusting entries are needed to ensure that the revenue recognition and matching principles are followed. 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 -19 LO 3 Explain the reasons for adjusting entries.

Types of Adjusting Entries Deferrals Accruals 1. Prepaid Expenses paid in cash and recorded as assets before they are used or consumed. 3. Accrued Revenues earned but not yet received in cash or recorded. 2. Unearned Revenues received in cash and recorded as liabilities before they are earned. 4. Accrued Expenses incurred but not yet paid in cash or recorded. Chapter 3 -20 LO 4 Identify the major types of adjusting entries.

Adjusting Entries for Deferrals Exercise 2 - On Jan. 1 st, Xpress Consulting paid $24, 000 to Mars Real Estate Management for 3 months rent in advance. What are the effects of this transaction on Xpress Consulting and Mars Real Estate Management? Jan Feb Mar 8, 000 For Xpress Consulting, it is a prepayment and will be recorded as an asset (Prepaid expense). For Mars Real Estate Management, Management it is revenue received in advance and will be recorded as liability (Unearned revenue). Chapter 3 -21 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for Deferrals Exercise 2 - On Jan. 1 st, Xpress Consulting paid $24, 000 to Mars Real Estate Management for 3 months rent in advance. What are the effects of this transaction on Xpress Consulting and Mars Real Estate Management? Debit Xpress Consulting Prepaid rent 24, 000 Cash 24, 000 Mars Real Estate Debit Cash Credit 24, 000 Unearned rent revenue Chapter 3 -22 Credit 24, 000 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for Deferrals Exercise 3 - On Jan. 1 st, Xpress Consulting signed a rental agreement with Mars Real Estate Management for an office space at a monthly rent of $8, 000 payable on the first day of the following month. What are the effects of this transaction on Xpress Consulting and Mars Real Estate Management? As at Jan 31, Xpress Consulting has incurred rent expenses, but not yet paid it. It is a liability and will be recorded as Accrued expense. As at Jan 31, Mars Real Estate Management has earned rent revenue, but not yet received it. It is an asset and will be recorded as Accrued revenue. Chapter 3 -23 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for Deferrals Exercise 3 - On Jan. 1 st, Xpress Consulting signed a rental agreement with Mars Real Estate Management for an office space at a monthly rent of $8, 000 payable on the first day of the following month. Debit Xpress Consulting Rent expense Credit 8, 000 Accrued rent expense 8, 000 Mars Real Estate Debit Accrued Rent Revenue 8, 000 Rent revenue Chapter 3 -24 Credit 8, 000 LO 5 Prepare adjusting entries for deferrals.

Analyzing Accounts in Trial Balance Each account in the Trial Balance is analyzed to determine whether it is complete and up-to-date. (Exercise 4) Chapter 3 -25 LO 4 Identify the major types of adjusting entries.

Adjusting Entries for Deferrals are either: Prepaid expenses and OR Unearned revenues. Chapter 3 -26 LO 5 Prepare adjusting entries for deferrals.

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: rent maintenance on equipment fixed assets (depreciation) insurance supplies advertising Chapter 3 -27 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Prepaid Expenses” Prepaid Expenses Costs that expire either with the passage of time or through use. Adjusting entries Chapter 3 -28 1) to record the expenses that apply to the current accounting period, and 2) to show the unexpired costs in the asset accounts. LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Prepaid Expenses” Illustration 3 -4 Adjusting entries for prepaid expenses Increases (debits) an expense account and Decreases (credits) an asset account. Chapter 3 -29 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Prepaid Expenses” Exercise 4 (Insurance): On Jan. 1 st, Phoenix Consulting paid $12, 000 for 12 months of insurance coverage. Show the journal entry to record the payment on Jan. 1 st. Jan. 1 Prepaid Insurance 12, 000 Cash 12, 000 Prepaid Insurance Debit Cash Credit Debit 12, 000 Chapter 3 -30 Credit 12, 000 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Prepaid Expenses” Exercise 4 (Insurance): On Jan. 1 st, Phoenix Consulting paid $12, 000 for 12 months of insurance coverage. Show the adjusting journal entry required at Jan. 31 st. Insurance Expense for Jan: ? 1, 000 Jan. 31 Insurance Expense 1, 000 Prepaid Insurance Debit 12, 000 1, 000 Insurance Expense Credit Debit 1, 000 Credit 1, 000 11, 000 Chapter 3 -31 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Prepaid Expenses” Exercise 5 (Supplies): On Jan. 25 th, RK Enterprises Consulting purchased supplies of $2, 500 on cash. Show the journal entry to record the payment on Jun. 25 th. Jun. 25 Supplies 2, 500 Cash 2, 500 Supplies Debit Cash Credit Debit 2, 500 Chapter 3 -32 Credit 2, 500 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Prepaid Expenses” Exercise 5 (Supplies): On Jan. 31 st, an inventory count reveals that $1, 000 of supplies are still on hand. Show the adjusting journal entry required at Jan. 31 st. Supplies Expense for Jan: ? 1, 500 Jan. 31 Supplies Expense 1, 500 Supplies Debit 2, 500 Supplies Expense Credit Debit 1, 500 Credit 1, 500 1, 000 Chapter 3 -33 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Prepaid Expenses” Depreciation Buildings, equipment, and vehicles (long-lived assets) are recorded as assets, rather than an expense, in the year these are acquired. Companies report a portion of the cost of a longlived asset as an expense (depreciation) during each period of the asset’s useful life (Matching Principle). Chapter 3 -34 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Prepaid Expenses” Exercise 4 (Depreciation): On Jan. 1 st, Phoenix Consulting paid $24, 000 for equipment that has an estimated useful life of 20 years. Show the journal entry to record the purchase of the equipment on Jan. 1 st. Jan. 1 Equipment 24, 000 Cash 24, 000 Equipment Debit Cash Credit Debit 24, 000 Chapter 3 -35 Credit 24, 000 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Prepaid Expenses” Exercise 4 (Depreciation): On Jan. 1 st, Phoenix Consulting paid $24, 000 for equipment that has an estimated useful life of 20 years. Show the adjusting journal entry required at Jan. 31 st. Allocation of cost over useful life of 20 years Y 1 Y 2 Y 3 Y 4 Y 18 Y 19 Y 20 1, 200 1, 200 Allocation of cost for a year over 12 months JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC 100 100 100 Chapter 3 -36 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Prepaid Expenses” Exercise 4 (Depreciation): On Jan. 1 st, Phoenix Consulting paid $24, 000 for equipment that has an estimated useful life of 20 years. Show the adjusting journal entry required at Jan. 31 st. Depreciation for Jan: ? ($24, 000 / 20 yrs. / 12 months = $100) Jan. 31 Depreciation Expense Accumulated Depreciation Expense Debit Credit Chapter 3 -37 100 Accumulated Depreciation Debit 100 Credit 100 LO 5 Prepare adjusting entries for deferrals.

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. Chapter 3 -38 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Prepaid Expenses” Depreciation (Financial Statement Presentation over the useful life) Equipment costing $ 24, 000 with useful life of 20 years Balance sheet presentation over useful life of 10 years Y 1 Y 2 Y 3 Y 19 Y 20 Cost 24, 000 24, 000 Accumulated Depreciation 1, 200 2, 400 3, 600 22, 800 24, 000 Net Book Value 22, 800 21, 600 20, 400 1, 200 - Chapter 3 -39 LO 5 Prepare adjusting entries for deferrals.

Prepaid Expenses - Summary Accounting for Prepaid Expenses Type of adjustment Initial recording in Account overstated Account understated Adjusting entry Prepaid expenses Asset accounts Asset Expense Dr. Expense Cr. Asset Chapter 3 -40 LO 7 Prepare adjusting entries for the alternative treatment of deferrals.

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: magazine subscriptions customer deposits rent airline tickets school tuition Chapter 3 -41 LO 5 Prepare adjusting entries for deferrals.

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 -42 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Unearned Revenues” Illustration 3 -10 Adjusting entries for unearned revenues Decrease (a debit) to a liability account and Increase (a credit) to a revenue account. Chapter 3 -43 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Unearned Revenues” Exercise 4 - On Jan. 1 st, Phoenix Consulting received $24, 000 from Arcadia High School for 3 months rent in advance. Show the journal entry to record the receipt on Jan. 1 st. Jan. 1 Cash 24, 000 Unearned Rent Revenue Cash Debit Unearned Rent Revenue Credit Debit 24, 000 Chapter 3 -44 24, 000 Credit 24, 000 LO 5 Prepare adjusting entries for deferrals.

Adjusting Entries for “Unearned Revenues” Exercise 4 - On Jan. 1 st, Phoenix Consulting received $24, 000 from Arcadia High School for 3 months rent in advance. Show the adjusting journal entry required on Jan. 31 st. Rent for Jan : ? Jan. 31 8, 000 Unearned Rent Revenue 8, 000 Rent Revenue Debit 8, 000 Unearned Rent Revenue Credit Debit 8, 000 Credit 24, 000 16, 000 Chapter 3 -45 LO 5 Prepare adjusting entries for deferrals.

Unearned Revenue - Summary Accounting for Unearned Revenue Type of Initial Account adjustment recording in overstated understated Unearned revenue Chapter 3 -46 Liability accounts Liability Revenue Adjusting entry Dr. Liability Cr. Revenue LO 7 Prepare adjusting entries for the alternative treatment of deferrals.

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 -47 LO 6 Prepare adjusting entries for accruals.

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 for: rent interest services performed Chapter 3 -48 LO 6 Prepare adjusting entries for accruals.

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 -49 LO 6 Prepare adjusting entries for accruals.

Adjusting Entries for “Accrued Revenues” Illustration 3 -13 Adjusting entries for accrued revenues Increases (debits) an asset account and Increases (credits) a revenue account. Chapter 3 -50 LO 6 Prepare adjusting entries for accruals.

Adjusting Entries for “Accrued Revenues” Exercise – 4 On Jan. 1 st, Phoenix Consulting invested $300, 000 in securities that return 5% interest per year. Show the journal entry to record the investment on Jan. 1 st. Jan. 1 Investments 300, 000 Cash 300, 000 Investments Debit Cash Credit Debit 300, 000 Chapter 3 -51 Credit 300, 000 LO 6 Prepare adjusting entries for accruals.

Adjusting Entries for “Accrued Revenues” Exercise – 4 On Jan. 1 st, Phoenix Consulting invested $300, 000 in securities that return 5% interest per year. Show the adjusting journal entry required on Jan. 31 st. Interest for Jan: ? Jan. 31 ($300, 000 x 5% x 1/ 12 months = $1, 250) Interest Receivable 1, 250 Interest Revenue Interest Receivable Debit Interest Revenue Credit Debit 1, 250 Chapter 3 -52 1, 250 Credit 1, 250 LO 6 Prepare adjusting entries for accruals.

Accrued Revenues - Summary Accounting for Accrued Revenue Type of adjustment Reason for adjustment Revenue (interest, rent, services) earned but not collected Revenue earned but not yet received in cash or recorded. Chapter 3 -53 Account understated Asset Revenue Adjusting entry Dr. Asset Cr. Revenue LO 7 Prepare adjusting entries for the alternative treatment of deferrals.

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 interest Chapter 3 -54 taxes salaries LO 6 Prepare adjusting entries for accruals.

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 -55 LO 6 Prepare adjusting entries for accruals.

Adjusting Entries for “Accrued Expenses” Illustration 3 -16 Adjusting entries for accrued expenses Increases (debits) an expense account and Increases (credits) a liability account. Chapter 3 -56 LO 6 Prepare adjusting entries for accruals.

Adjusting Entries for “Accrued Expenses” Exercise - 4 On Jan. 2 nd, Phoenix Consulting signed a one year note of $200, 000 at a rate of 9% per year. Interest is due on first of each month. Show the journal entry to record the borrowing on Jan. 2 nd. Jan. 2 Cash 200, 000 Notes Payable Cash Debit Notes Payable Credit Debit 200, 000 Chapter 3 -57 200, 000 Credit 200, 000 LO 6 Prepare adjusting entries for accruals.

Adjusting Entries for “Accrued Expenses” Exercise – 4 On Jan. 2 nd, Phoenix Consulting signed a one year note of $200, 000 at a rate of 9% per year. Interest is due on first of each month. Show the adjusting journal entry required on Jan. 31 st. Interest for Jan: ? Jan. 31 ($200, 000 x 9% x 1/ 12 months = $1, 500) Interest Expense Interest Payable Interest Expense Debit 1, 500 Interest Payable Credit Debit 1, 500 Chapter 3 -58 1, 500 Credit 1, 500 LO 6 Prepare adjusting entries for accruals.

Adjusting Entries for “Accrued Expenses” Exercise 6 - Micro computer Services started operations in September 20 XX. The Company will pay salaries amounting to $1, 500 to employees on October 1 st. Show the adjusting journal entry required on Sep. 30 th. Sep. 30 Salaries Expense 1, 500 Salaries Payable Salaries Expense Debit Salaries Payable Credit Debit 1, 500 Chapter 3 -59 1, 500 Credit 1, 500 LO 6 Prepare adjusting entries for accruals.

Adjusting Entries for “Accrued Expenses” Exercise 7 - Jay Kay Printing started operation from June 14 th and paid fortnightly salaries on Friday June 25 th. The next pay day is Friday July 9 th. Total salaries for a five-days week are $2, 000. Employees do not work on week-end. Show the journal entry payment of salaries on Jun. 25 th. Salaries for two weeks = 2000 x 2 = $4, 000 Jun. 25 Salaries Expense 4, 000 Cash 4, 000 Salaries Expense Debit 6/25 Chapter 3 -60 Credit 4, 000 LO 6 Prepare adjusting entries for accruals.

Adjusting Entries for “Accrued Expenses” Exercise 7 Jay Kay Printing started operation from June 14 th and paid fortnightly salaries on Friday June 25 th. The next pay day is Friday July 9 th. Total salaries for a five-days week are $2, 000. Employees do not work on week-end. Show the adjusting journal entry required on Jun. 30 th. Salaries for three days Jun 28 -30 = 2000 / 5 * 3 = $1200 Jun. 30 Salaries Expense 1, 200 Salaries Payable 1, 200 Salaries Expense Debit 6/25 Chapter 3 -61 6/30 4, 000 1, 200 6/30 5, 200 Salaries Payable Credit Debit Credit 6/30 LO 6 1, 200 Prepare adjusting entries for accruals.

Adjusting Entries for “Accrued Expenses” Exercise 7 - Jay Kay Printing pays salaries on fortnightly basis and the next pay day is July 9 th. Total salaries for two week are $4, 000. Show the adjusting journal entry required on Jul. 9 th. Jul. 9 Salaries Payable 1, 200 Salaries Expense 2, 800 Cash 4, 000 July 1 -2 = 2 days + July 5 -9 = 5 days Total work-days = 7 Total salaries relating to July = 2, 000 / 5 * 7 = 2, 800 Chapter 3 -62 LO 6 Prepare adjusting entries for accruals.

Accrued Expenses - Summary Accounting for Accrued Expenses Type of adjustment Reason for adjustment Expenses (interest, rent, salaries) incurred but not paid Expenses have been incurred but not yet paid in cash or recorded Chapter 3 -63 Account understated Expenses Liabilities Adjusting entry Dr. Expenses Cr. Liabilities LO 7 Prepare adjusting entries for the alternative treatment of deferrals.

Alternative Treatment of Prepaid Expenses 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 -64 LO 7 Prepare adjusting entries for the alternative treatment of deferrals.

Alternative Treatment for “Prepaid Expenses” Exercise 4 - (Insurance): On Dec. 1 st, Phoenix Consulting paid $12, 000 for 12 months of insurance coverage. The accounting year ends on December 31 st. Show the journal entry to record the payment on Dec. 1 st. Dec. 1 Insurance Expense 12, 000 Cash 12, 000 Insurance Expense Debit 12, 000 Chapter 3 -65 Credit Cash Debit Credit 12, 000 LO 7 Prepare adjusting entries for the alternative treatment of deferrals.

Alternative Treatment for “Prepaid Expenses” Exercise 4 - (Insurance): On Dec 1 st, Phoenix Consulting paid $12, 000 for 12 months of insurance coverage. The accounting year ends on December 31 st. Show the adjusting journal entry required at Dec. 31 st. Insurance Expense for Dec: ? Dec. 31 1, 000 Prepaid Insurance Expense Debit 12, 000 Credit 11, 000 Prepaid Insurance Debit Credit 11, 000 Chapter 3 -66 LO 7 Prepare adjusting entries for the alternative treatment of deferrals.

Alternative Treatment for “Prepaid Expenses” Exercise 4 - (Insurance): On Dec 1 st, Phoenix Consulting paid $12, 000 for 12 months of insurance coverage. Next year, the company will record insurance expense by transferring the amount appearing as opening balance in prepaid insurance account. Jan. 1 Insurance Expense Prepaid Insurance Expense Debit 11, 000 Chapter 3 -67 Credit 11, 000 Prepaid Insurance Debit 11, 000 Credit 11, 000 LO 7 Prepare adjusting entries for the alternative treatment of deferrals.

Alternative Treatment for “Unearned Revenues” Exercise 4 - On Dec. 1 st, Phoenix Consulting received $24, 000 from Arcadia High School for 3 months rent in advance. The accounting year ends on December 31 st. Show the journal entry to record the receipt on Dec. 1 st. Dec. 1 Cash 24, 000 Rent Revenue Cash Debit 24, 000 Chapter 3 -68 24, 000 Rent Revenue Credit Debit Credit 24, 000 LO 7 Prepare adjusting entries for the alternative treatment of deferrals.

Alternative Treatment for “Unearned Revenues” Exercise 4 - On Dec. 1 st, Phoenix Consulting received $24, 000 from Arcadia High School for 3 months rent in advance. The accounting year ends on December 31 st. Show the adjusting journal entry required on Dec. 31 st. Rent for Dec: ? 8, 000 Dec. 31 Rent Revenue 16, 000 Unearned Rent Revenue Debit Credit 16, 000 Rent Revenue Debit 16, 000 Credit 24, 000 8, 000 Chapter 3 -69 LO 7 Prepare adjusting entries for the alternative treatment of deferrals.

Alternative Treatment for “Unearned Revenues” Exercise 4 - On Dec. 1 st, Phoenix Consulting received $24, 000 from Arcadia High School for 3 months rent in advance. The accounting year ends on December 31 st. Next year, the company will record rent revenue by transferring the amount appearing as opening balance in unearned revenue account. Jan 1 Unearned Rent Revenue Debit 16, 000 Chapter 3 -70 Credit 16, 000 Rent Revenue Debit Credit 16, 000 LO 7 Prepare adjusting entries for the alternative treatment of deferrals.

Summary of Basic Relationships for Deferrals Type of adjustment Prepaid expenses Unearned revenue Chapter 3 -71 Method Initial recording in Account overstated Account understated Adjusting entry Normal Asset accounts Asset Expense Dr. Expense Cr. Asset Alternate Expense accounts Expense Asset Dr. Asset Cr. Expense Normal Liability accounts Liability Revenue Dr. Liability Cr. Revenue Alternate Revenue accounts Revenue Liability Dr. Revenue Cr. Liability LO 7 Prepare adjusting entries for the alternative treatment of deferrals.

Adjusting the Accounts Timing Issues Time period assumption Fiscal and calendar years Accrual- vs. cashbasis accounting Recognizing revenues and expenses Chapter 3 -72 LO 1 - 2 The Basics of Adjusting Entries Types of adjusting entries Adjusting entries for deferrals and accruals Alternative treatment for deferrals Summary of journalizing and posting LO 2 - 7 The Adjusted Trial Balance and Financial Statements Preparing the adjusted trial balance Preparing financial statements LO 8

The Adjusted Trial Balance When 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 after all adjustments. Chapter 3 -73 LO 8 Describe the nature and purpose of an adjusted trial balance.

The Adjusted Trial Balance Chapter 3 -74 LO 8 Describe the nature and purpose of an adjusted trial balance.

Timing Issues Review Question - 3 - 5 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 -75 LO 3 Explain the reasons for adjusting entries.

Timing Issues Review Question - 3 - 14 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. Chapter 3 -76 d. The adjusted trial balance is prepared after the adjusting entries have been journalized and posted. LO 8 Describe the nature and purpose of an adjusted trial balance.

Preparing Financial Statements are prepared directly from the Adjusted Trial Balance Sheet Chapter 3 -77 LO 8 Income Statement Owner’s Equity Statement of Cash Flows Describe the nature and purpose of an adjusted trial balance.

Preparing Financial Statements Income Statement Chapter 3 -78 LO 8 Describe the nature and purpose of an adjusted trial balance.

Preparing Financial Statements Statement of Owner’s Equity Chapter 3 -79 LO 8 Describe the nature and purpose of an adjusted trial balance.

Preparing Financial Statements Chapter 3 -80 LO 8 Describe the nature and purpose of an adjusted trial balance.

Adjusting the Accounts QUESTIONS Accounting Principles, Eighth Edition Chapter 3 -81

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