Chapter 3 The adjusting process

Deferred Expenses

an asset created when a business makes advance payment of future expenses. (prepaid expense such as prepaid rent, prepaid insurance). -Expense increased (debit) -Asset decreased (credit) - because the business is PAYING for that prepaid expense, decreasing cash.

Contra Account

an account that is paired with, and is listed imediately after, its relatable account in the chart of accounts and associated financial statement and whose normal balance is opposite of the normal balance of the related account.

what is the purpose of the adjusted trail balance, and how do we prepare it?

an adjusted trial balance is a list of all the accounts with their adjusted balances. -it ensures that total debits equal total credits.

On the worksheet, Accounts Receivable has a debit balance of $15,000 on the Unadjusted Trial Balance. In the Adjustments there is a debit of $3,000. What is the amount for Accounts Receivable in the Adjusted Trial Balance?

$18,000

On the worksheet, the Service Revenue account has a credit balance of $20,000 on the Unadjusted Trial Balance. In the Adjustments there is a credit of $2,000. What is the amount for Service Revenue in the Adjusted Trial Balance?

$22,000

On the worksheet, the Office Supplies account has a debit balance of $9,000 on the Unadjusted Trial Balance. In the Adjustments there is a credit of $2,000. What is the amount for Office Supplies in the Adjusted Trial Balance?

$7,000

Thompson Company had $1,000 in office supplies at the beginning of the fiscal year. At the end of the fiscal year, Thompson Company did an inventory of the office supplies and determined that $300 of supplies remained in the supply room unused. What is the amount of Supplies Expense at the end of the fiscal year?

$700

Jones Company purchased a piece of equipment for $12,000. It has accumulated depreciation at the end of three years of $4,000. What is the book value of the equipment at the end of year 3?

$8,000

Deferred Revenues

(unearned revenue) advance receipts of future revenues adjusted for amount earned -Liability decreases (debit) -Revenue increases (credit) - because cash is received but has not yet been earned.

What is an alternative treatment of recording deferred expenses and deferred revenues?

-Deferred expenses can be recorded to an expense account at the time of payment. The adjusting entry would transfer any remaining prepayment to the asset account, Prepaid expenses. -Deferred revenues can be recorded to a revenue account at the time of cash receipt. The adjusting entry would transfer any remaining liability to the liability account, unearned revenue.

first four sections of worksheet:

1. account names 2. adjusted trial balance (copied directly from ledger before any adjustments.) 3. Adjustments (enter the adjusted journal entries that were made at the end of the period) 4. Adjusted trial balance. gives the account balances after adjustments.

Two rules to remember about adjusting entries:

1. adjusting entries never involve the cash account. 2. adjusting entries either: -increase a revenue account (credit revenue) -increases an expense account (debit)

Accrual Basis Accounting

Accounting method that records revenues when earned and expenses when incurred (suffered/experiences). - -records the effect of each transaction as it occurs -this method provides a better picture of a business's revenues and expenses. -records only when it is earned or distributed (exp. paid).

When accounts have normal balances, which of the following accounts does not have a debit balance on the Adjusted Trial balance? Accounts Receivable Accounts Payable Office Supplies Cash I don't know yet

Accounts Payable

What are adjusted entries and how do we record them?

Adjusting entries are completed at the end of the accounting period and record revenues to the period in which they are earned and expenses to the period in which they occur. -they also update the asset and liability accounts.

Fiscal year

An accounting year of any 12 consecutive months that may or may not coincide with the calendar year. ex: Jan 1 to Dec 31 or April 1 to March 31.

what is a worksheet?

An internal document that helps summarize data for the preparation of financial statements. Helps identify accounts that need to be adjusted.

When accounts have normal balances, which of the following accounts does not have a credit balance on the Adjusted Trial balance?

Cash

A piece of equipment purchased cost $10,000 and has depreciation expense of $2,000 for this year. What is the journal entry to record the depreciation expense for the year?

Debit $2,000 Depreciation expense- equipment Credit $2,000 Accumulated depreciation- equipment

If a journal entry and posting for the use of one month of rent from the prepaid rent account during the year is accidently omitted, what would be the impact on the financial statements?

Net Income would be overstated (Expenses understated) and Balance Sheet assets would be overstated.

If a journal entry and posting for Salaries Expense that incurred during this year but will be paid until next year is accidentally omitted, what would be the impact on the financial statements?

Net Income would be overstated (Expenses understated) and Balance Sheet liabilities would be understated.

Which of the following is an example of an accrued expense adjusting entry? Recording the revenue that has been earned but not received yet Recording the amount of Salaries Expense for employees that is not paid yet Recording the amount of supplies used during the period Recording the amount of depreciation on a piece of equipment I don't know yet

Recording the amount of Salaries Expense for employees that is not paid yet

Uptown Theatre has customers who prepay a total of $1,000 for season tickets to attend five upcoming shows. Uptown Dinner Theatre collects the $1,000 in advance before the shows are performed. After three shows are performed, what should Uptown Theatre report on its income statement assuming it used the accrual basis accounting method?

Service Revenue of $600 - Each show earns $200 of Service Revenue ($1,000 / 5 shows = $200 per show). Three shows have been performed so $600 has been earned as Service Revenue ($200 * 3 shows = $600). Therefore, $600 is earned and Service Revenue is on the income statement. Cash is not on the Income Statement, but rather the Balance Sheet. The $1,000 of cash that is received is recorded on the balance sheet as Unearned Service Revenue when received. As the revenue is earned, this account is debited and Service Revenue is credited.

The Revenue Recognition Principle requires a company to follow a five step process:

Step 1. Identify the contract with the customer 2. Identify the performance obligations in the contract 3. Determine the transaction price 4. Allocate (distribute) the transaction price to the performance obligations in the contract. 5. Recognize when or as the entity satisfies each performance obligation.

Strait-line Method

a depreciation method that allocates an equal amount of depreciation each year. (cost-residual value)/useful life

Adjusted Trail Balance

a trail balance taken after adjusting entries have been recorded

Cash basis accounting

accounting method that records revenues only when cash is received and expenses only when cash is paid. - this method is not allowed under Generally Accepted Accounting Principles (GAAP). -small businesses often use this method.

Time Period Concept

assumes that a business's activities can be sliced into small time segments and that financial statements can be prepared for specific periods, such as month, quarter or year.

there are two ways for recording a transaction. what are they?

cash basis accounting or accrual basis accounting.

Interest of $100 is accumulated on a notes payable, although the company will not pay the interest until next year. What is the adjusting journal entry at the end of the year for the accrued interest?

debit $100 interest expense credit $100 interest payable

Jones Company received $2,200 in cash during March for Service Revenue for a job that will be completed in May. This job would be completed before the end of the year when the finance's are prepared. Since it is short lived and will be earned during this accounting period, Jones Company decided to record it as revenue instead of a liability at the time the cash was received in March. The journal entry to record this transaction when we received the cash in March would be:

debit $2,200 cash credit $2,200 service revenue

Assume the weekly payroll of the Abbott Company is $5,000. December 31, the end of the year, falls on a Wednesday and Abbott will pay its employee on Friday for the full week. What adjusting entry will Abbott make on Wednesday, December 31 (Use five days as a full work week)?

debit $3,000 salaries expense (bc what is incurred) credit $3,000 salaries payable (bc what WILL be distributed/paid to employees)

Smith Company had $1,200 in office supplies at the beginning of the fiscal year. At the end of the fiscal year, Smith Company did an inventory of the office supplies and determined that $400 of supplies remained in the supply room unused. What is the journal entry to adjust for the use of supplies at the end of the fiscal year?

debit $800 supplies expense credit $800 office supplies (this is what was used up.)

Jones Company purchased $800 in office supplies with cash this year but it will be used up before the end of the year when the financials are prepared. Since it is short lived and will be used up during this accounting period, Jones Company decided to record it as an expense instead of an asset at the time of purchase. The journal entry to record this transaction when Jones Company buys the office supplies would be:

debit $800 supplies expense (because it is directly going in the expense account since it will be used up soon. And not office supplies, because this is an EXPENSE since it will be used up) credit $800 cash.

Software Solutions was hired by Jones Company on December 1 to install and updated software. The total entire amount of $1,800 in revenues is to be paid to us by Jones Company when the job is completed the following January 31. As of December 31, we have completed one half of the software installation and updates. On December 31, Software Solutions makes the following entry to adjust for the revenues earned during December:

debit $900 accounts receivable credit $900 service revenue - Only half of the revenue has actually been earned but we do not get any cash payment until it is completed on January 31. To make sure that revenues that have been earned are reflected on the company's current financial statements, we record half of the total ($900) as a debit to Accounts Receivable and a credit to Service Revenue.

Four types of adjusting entries:

deferred expenses (or prepaid expenses advance payment of future expenses adjusted for amount used), deferred revenues (or unearned revenues advance receipts of future revenues adjusted for amount earned), accrued expenses (expenses that have been incurred but not yet paid), and accrued revenues (revenues that have been earned but not yet collected).

Book value

depreciable asset's cost - accumulated depreciation

Accrued Expenses

expenses that have been incurred, but not yet paid -expense increases (debit) -Liability increases (credit) -because expense incurred, but NOT YET paid.

The Matching Principle

guides accounting for expenses, ensures that all expenses are recorded when they are incurred during the period, and matches these expenses against the revenue of the period. -to match expenses against revenue means to subtract expenses incurred during one month from revenues earned during that same month. Goal is to complete an accurate net income or net loss for the time period.

Property, plant, and equipment

long-lived tangible assets, such as land, buildings, and equipment used in the operation of a business. As a business uses these assets, their value and usefulness decline. The decline in usefulness of a plant asset is an expense, and accountants systematically spread the asset's cost over its useful life.

The Revenue Recognition Principle

requires companies to record revenue when (or as) the entity satisfies each performance obligation.

Accrued Revenues

revenue that have been earned but not yet collected. -Asset increases (debit) -Revenue increases (credit)

Adjusting entries:

special entries (updating the books)

What is the impact of adjusting entries on the financial statements?

the balance sheet and income statement accounts will either be overstated or understated. -overstating or understating accounts causes the financial statements to be incorrect.

Residual value

the expected value of a depreciable asset at the end of its useful life.

Depreciation

the process by which businesses spread the allocation of a plant asset's total cost over its useful life: all plant assets are depreciated, but not land because it doesn't have a definitive or clearly estimable useful life.

Accumulated Depreciation

the sum of all depreciation expense recorded to date for a depreciable asset. will increases (accumulate) over time. -this is a contra asset meaning that it is an asset account with a normal credit balance (opposite because it is not debit).

What concepts and principles apply to accrual basis accounting?

time period concept, the revenue recognition principle, and the matching principle.

The purpose of adjusting entries is to __________.

update the account balances at the end of each period to match revenues and expenses to the appropriate period