The Adjusting Process

Chapter 3

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2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Prepared by: C. Douglas

Cloud
Professor Emeritus of
Accounting
Pepperdine University

Learning Objective 1

Describe the nature

of the adjusting
process.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 1

Nature of the Adjusting

Process

The accounting period concept

requires that revenues and expenses
be reported in the proper period.
Under the accrual basis of
accounting, revenues are reported
on the income statement in the
period in which they are earned.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 1

Nature of the Adjusting

Process

The accounting concept supporting

the reporting of revenues when they
are earned regardless of when cash
is received is called the revenue
recognition
concept.
The
accounting
concept supporting
reporting revenues and related
expenses in the same period is called
the matching concept, or matching
principle.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 1

Nature of the Adjusting

Process

Under the cash basis of

accounting, revenues and
expenses are reported on the
income statement in the period in
which cash is received or paid.
Under the accrual basis of
accounting, some of the accounts
need updating at the end of the
accounting period.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 1

The Adjusting Process

The analysis and updating of
accounts at the end of the period
before the financial statements are
prepared is called the adjusting
process.
The journal entries that bring the
accounts up to date at the end of the
accounting period are called
adjusting entries.
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 1

Types of Accounts Requiring

Adjustment
Prepaid expenses are the advance
payment of future expenses and are
recorded as assets when cash is
paid.
Unearned
revenues are the advance
receipt of future revenues and are
recorded as liabilities when cash is
received.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 1

Types of Accounts Requiring

Adjustment
Accrued revenues are unrecorded
revenues that have been earned and
for which cash has yet to be
received.
Accrued expenses are unrecorded
expenses that have been incurred
and for which cash has not yet been
paid.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objective 2

Journalize entries for

accounts requiring
adjustment.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Prepaid Expenses
NetSolutions Supplies account has a balance of
$2,000 on the unadjusted trial balance. Some of
these supplies have been used. On December
31, a count reveals that the amount of supplies
on hand is $760.
Supplies (balance on trial balance) $2,000
Supplies on hand, December 31
760
Supplies used
$1,240

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Prepaid Expenses

Accounting Equation Impact

Assets

Liabilities

+
Stockholders Equity (Expense)
increase

decrease

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Prepaid Insurance
The debit balance of $2,400 in NetSolutions
Prepaid Insurance account represents the
December 1 prepayment for 12 months.

Accounting Equation Impact

Assets

Liabilities

Stockholders Equity (Expense)

increase

decrease
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Unearned Revenues
The credit balance of $360 in NetSolutions
Unearned Rent account represents the
receipt of three months rent on December 1
for December, January, and February. At the
end of December, one months rent has been
earned.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Unearned Revenues

Accounting Equation Impact

Assets

Liabilities

+ Stockholders Equity (Revenue)

increase
decrease
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Accrued Revenues
NetSolutions signed an agreement with
Danker Co. on December 15 to provide
services at a rate of $20 per hour. As of
December 31, NetSolutions had provided 25
hours of services. The revenue will be billed
on January 15.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Unearned Revenues

Accounting Equation Impact

Assets

Liabilities

Stockholders Equity (Revenue)

increase
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

increase

LO 2

Accrued Wages
NetSolutions pays it employees biweekly. During
December, NetSolutions paid wages of $950 on
December 13 and $1,200 on December 27. As of
December 31, NetSolutions owes $250 of wages
to employees for Monday and Tuesday,
December 30 and 31.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Accrued Wages

Accounting Equation Impact

Assets

Liabilities

increase

Stockholders Equity (Expense)

increase

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Accrued Wages
NetSolutions paid wages of $1,275 on January
10. This payment includes the $250 of accrued
wages recorded on December 31.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Depreciation Expense
Fixed assets, or plant assets, are
physical resources that are owned
and used by a business and are
permanent or have a long life.
As time passes, a fixed asset loses its
ability to provide useful services. This
decrease in usefulness is called
depreciation.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Depreciation Expense
All fixed assets, except land, lose
their usefulness and , thus, are said
to depreciate.
As a fixed asset depreciates, a
portion of its cost should be recorded
as an expense. This periodic expense
is called depreciation expense.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Depreciation Expense
The fixed asset account is not
decreased (credited) when making
the related adjusting entry. This is
because both the original cost of a
fixed asset and the depreciation
recorded since its purchase are
reported on the balance sheet.
Instead, an account entitled
Accumulated Depreciation is
increased (credited).
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Depreciation Expense
Normal titles for fixed asset accounts
and their related contra asset
accounts are as follows:

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Depreciation Expense
NetSolutions estimates the depreciation on
its office equipment to be $50 for the month
of December.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Depreciation Expense

Accounting Equation Impact

Assets

Liabilities

Stockholders Equity (Expense)

increase
increase
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 2

Depreciation Expense
The difference between the original
cost of the office equipment and the
balance in the Accumulated
DepreciationOffice Equipment
account is called the book value of
the asset (or net book value). It is
computed as shown below.
Book Value of Asset = Cost of the Asset Accumulated Depreciation of Asset
Book Value of Off. Equip. = Cost of Off. Equip. Accum. Depre. of Office Equip.
Book Value of Off. Equip. = $1,800 $50
Book Value of Off. Equip. = $1,750
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objective 3

Summarize the
adjustment process.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 3

Adjusting Entries
Adjusting EntriesNetSolutions

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

(continued)

LO 3

Adjusting Entries
Adjusting EntriesNetSolutions

(concluded)
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 3

Ledger with Adjusting Entries

(continued)
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 3

Ledger with Adjusting Entries

Ledger with
Adjusting
Entries
NetSolutions

(continued)
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 3

Ledger with Adjusting Entries

Ledger with
Adjusting
Entries
NetSolutions

(continued)
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 3

Ledger with Adjusting Entries

Ledger with
Adjusting
Entries
NetSolutions

(concluded)
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objective 4

Prepare an
adjusted trial
balance.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 4

Adjusted Trial Balance

The purpose of the adjusted trial
balance is to verify the equality of
the total debit and credit balances
before the financial statements are
prepared.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 4

Adjusted Trial Balance

Adjusted Trial
Balance

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Learning Objective 5

Describe and illustrate

the use of vertical
analysis in evaluating a
companys
performance and
financial condition.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Vertical Analysis
Comparing each item in a financial
statement with a total amount from
the same statement is referred to as
vertical analysis.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Vertical Analysis

$12,500
$187,500

= .067 or 6.7%

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Vertical Analysis

$3,000
$150,000

= .02 or 2%

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

The Adjusting Process

The End
Prepared by: C. Douglas
Cloud
Professor Emeritus of
Accounting
Pepperdine University
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

41