Week4.ClosingTheAccounts.TheAdjustingProcess

Week 4:Closing The Accounts – The Adjusting Process

Learning Objective 1

1. Describe the nature of the adjusting process.

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.

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Nature of the Adjusting Process

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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.

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.

LO 1LO 1Nature of the Adjusting

Process

The Adjusting ProcessLO 1LO 1

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.

Types of Accounts Requiring Adjustment

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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.

Types of Accounts Requiring Adjustment

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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.

Learning Objective 2

1. Describe the nature of the adjusting process.

2. Journalize entries for accounts requiring adjustment.

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) $2,000Supplies on hand, December 31 –

760Supplies used

$1,240

Prepaid ExpensesLO 2LO 2

Prepaid ExpensesLO 2LO 2

Assets = Liabilities + Owner’s Equity (Expense)

Accounting Equation Impact

decrease

increase

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Prepaid Insurance



decrease

increase

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

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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 month’s rent has been earned.

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Unearned Revenues

Assets = Liabilities + Owner’s Equity (Revenue)


decreaseincrease

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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.

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Accrued Revenues

Assets = Liabilities + Owner’s Equity (Revenue)


increase increase

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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.

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Accrued Wages



increaseincrease

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Accrued Wages

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

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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.

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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.

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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).

Accumulated depreciation accounts are called contra accounts, or contra asset accounts.

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

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increaseincrease

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

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The difference between the original cost of the office equipment and the balance in the accumulated depreciation—office 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 – Accum. Depre. 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

Summarizing the Adjustment Process:Adjusting Entries

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Adjusting EntriesLO 3LO 3

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Ledger with Adjusting Entries

(continued)

LO 3LO 3Ledger with Adjusting Entries

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Ledger with Adjusting Entries

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.

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Adjusted Trial BalanceLO 4LO 4

Exercises

Blum Services, Inc. has the following unadjusted balances at year-end.

Cash $12,900

Prepaid insurance 2,000

Office supplies 1,300

Office equipment 10,500

Accumulated depreciation–office equipment 3,500

Accounts payable 2,900

Salaries payable -0-

Unearned service revenue 4,500

Common stock 10,000

Retained earnings 1,750

Dividends paid 5,600

Service revenue 13,350

Salary expense 3,700

Depreciation expense -0-

Supplies expense -0-

Insurance expense -0-

The following information is available to use in making adjusting entries.

1. Office supplies on hand at year-end: $2502. Prepaid insurance expired during the year:

$3253. Unearned revenue remaining at year-end

$2,5004. Depreciation expense for the year $1,8005. Accrued salaries at year-end $900

Journalise the adjusting entries.

1. Office supplies on hand at year-end: $250

Office supplies per unadjusted TB: $1,300Actual balance at year end: $250Therefore, the balance needs to be adjusted

by: $1,300 - $250 = $1,050.

Journal entry:Cr Office Supplies $1,050Dr Supplies Expense $1,050


2.Prepaid insurance expired during the year: $325

Journal entry:Cr Prepaid insurance $325Dr Insurance Expense $325


3. Unearned revenue remaining at year-end $2,500

Unearned service revenue per unadjusted TB: $4,500

Actual balance at year end: $2,500Therefore, the balance needs to be adjusted

by: $4,500 - $2,500 = $2,000.

Journal entry:Dr Unearned service revenue $2,000Cr Service revenue $2,000


4. Depreciation expense for the year $1,800

Journal entry:Cr Accumulated depreciation$1,800Dr Depreciation Expense

$1,800


5. Accrued salaries at year-end $900

Journal entry:Cr Salaries payable $900Dr Salaries expense $900

Using a work sheet, prepare the trial balance, the adjustments and the adjusted trial balance for Blum Services, Inc.

Accounts Trial balance Adjustments Adj’d TB

Debit Credit Debit Credit Debit Credit

Cash$12,90

0


Office supplies 1,300




Salaries payable 0


Common shares 10,000




Salaries expense 3,700

Depreciation expense 0

Supplies expense 0

Insurance expense 0

Totals 36,000 36,000



Cash$12,90

0


Office supplies 1,300 1,050




Salaries payable 0








Supplies expense 0 1,050

Insurance expense 0

Totals 36,000 36,000



Cash$12,90

0

Prepaid insurance 2,000 325





Salaries payable 0









Insurance expense 0 325

Totals 36,000 36,000



Cash$12,90

0






Salaries payable 0

Unearned service revenue 4,500 2,000




Service revenue 13,350 2,000





Totals 36,000 36,000



Cash$12,90

0




Accumulated depreciation–office equipment 3,500 1,800


Salaries payable 0







Depreciation expense 0 1,800



Totals 36,000 36,000



Cash$12,90

0




Accumulated depreciation–office equipment 3,500 1,800


Salaries payable 0 900






Salaries expense 3,700 900

Depreciation expense 0 1,800



Totals 36,000 36,000



Cash$12,90

012,90

0

Prepaid insurance 2,000 325 1,675

Office supplies 1,300 1,050 250

Office equipment 10,50010,50

0

Accumulated depreciation–office equipment 3,500 1,800 5,300

Accounts payable 2,900 2,900

Salaries payable 0 900 900

Unearned service revenue 4,500 2,000 2,500

Common shares 10,00010,00

0

Retained earnings 1,750 1,750

Dividends paid 5,600 5,600

Service revenue 13,350 2,00015,35

0

Salaries expense 3,700 900 4,600

Depreciation expense 0 1,800 1,800

Supplies expense 0 1,050 1,050

Insurance expense 0 325 325

Totals 36,000 36,000 6,075 6,07538,70

038,70

0

Week4.ClosingTheAccounts.TheAdjustingProcess

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