Accounting Principles

Thirteenth Edition
Weygandt Kimmel Kieso

Chapter 3

Adjusting the Accounts

Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College
 Chapter 3

Adjusting the Accounts

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 ©2019 John Wiley & Son, Inc. 3

 Accrual-Basis and Adjusting Entries
Accountants divide the economic life of a business into
artificial time periods (Time Period Assumption).
.....
Jan. Feb. Mar. Apr. Dec.

Generally a
ALTERNATIVE TERMINOLOGY
• month, The time period assumption
is also called the
• quarter, or periodicity assumption.
• year.
LO 1 Copyright ©2019 John Wiley & Son, Inc. 4
 Fiscal and Calendar Years
• 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

LO 1 Copyright ©2019 John Wiley & Son, Inc. 5

 Fiscal and Calendar Years
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.

LO 1 Copyright ©2019 John Wiley & Son, Inc. 6

 Accrual- versus Cash-Basis Accounting
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)
phat sinh
• Expenses are recognized when incurred (rather than
when paid)
• In accordance with International Financial Reporting
Standards (IFRS)
LO 1 Copyright ©2019 John Wiley & Son, Inc. 7
 Accrual- versus Cash-Basis Accounting
Cash-Basis Accounting
• Revenues recognized when cash is received
• Expenses recognized when cash is paid
• Cash-basis accounting is not in accordance with
International Financial Reporting Standards (IFRS)

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 Recognizing Revenues and Expenses
Revenue Recognition Principle
Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.

LO 1 Copyright ©2019 John Wiley & Son, Inc. 9

 Recognizing Revenues and Expenses
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.”

LO 1 Copyright ©2019 John Wiley & Son, Inc. 10

 ILLUSTRATION 3.1
IFRS relationships in
Time Period Assumption revenue and expense
recognition

Economic life of business can be

divided into artificial time periods.

Revenue Recognition Expense Recognition

Principle Principle
Recognize revenue in the Recognize expense in the period
accounting period in which the that efforts are made to generate
performance obligation is satisfied. revenue.

Revenue and Expense

Recognition
In accordance with
International Financial
Reporting Standards (IFRS).

LO 1 Copyright ©2019 John Wiley & Son, Inc. 11

 Fiscal and Calendar Years
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 International Financial
Reporting Standards.
d. Revenue is recorded only when cash is received, and
expense is recorded only when cash is paid.

LO 1 Copyright ©2019 John Wiley & Son, Inc. 12

 The Need for Adjusting Entries
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.
revenue aand expense

• Will include one income statement account and one

statement of financial position account.
asset, liabilites, owner's equity

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 The Need for Adjusting Entries
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. statement of financial position and income
statement accounts have correct balances at the
end of an accounting period.
d. All the responses above are correct.

LO 1 Copyright ©2019 John Wiley & Son, Inc. 14

 Types of Adjusting Entries
Deferrals cash and transactional Accruals
1. Prepaid Expenses. Expenses 1. Accrued Revenues.
paid in cash before they are Revenues for services
used or consumed. performed but not yet
prepayment: pay before enjoying,using the services
received in cash or recorded.
2. Unearned Revenues. 2. Accrued Expenses.
Cash received before Expenses incurred but not
services are performed. yet paid in cash or recorded.

ILLUSTRATION 3.2
Categories of adjusting entries

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

LO 1 Copyright ©2019 John Wiley & Son, Inc. 16

 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
Journalize and post
Trial
Analyze Journalize Post adjusting entries:
Balance
deferrals/accruals

Adjusted
Financial Closing Post-Closing
Trial
Balance Statements Entries Trial Balance

LO 2 Copyright ©2019 John Wiley & Son, Inc. 17

 Prepaid Expenses
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

LO 2 Copyright ©2019 John Wiley & Son, Inc. 18

 Prepaid Expenses
• Expire either with the passage of time or through use
• Adjusting entry:
 Increase (debit) to an expense account and
 Decrease (credit) to an asset account
ILLUSTRATION 3.4

Asset Expense
Unadjusted Credit Debit
Balance Adjusting Adjusting
Entry (-) Entry (+)

LO 2 Copyright ©2019 John Wiley & Son, Inc. 19

 Yazici Advertising
Trial Balance
October 31, 2020
Debit Credit
Cash ₺15,200
Supplies 2,500
Prepaid Insurance Subsequent 600
Equipment examples are 5,000
Notes Payable based on the ₺ 5,000
Accounts Payable October 31 trial 2,500
Unearned Revenue balance from 1,200
Owner’s Capital Chapter 2. 10,000
Owner’s Drawings 500
Service Revenue 10,000
Salaries and Wages Expense 4,000
Rent Expense 900
ILLUSTRATION 2.31 ₺28,700 ₺28,700
LO 2 Copyright ©2019 John Wiley & Son, Inc. 20
 Supplies
Illustration: Yazici Advertising purchased
supplies costing ₺2,500 on October 5.
Yazici 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
LO 2 Copyright ©2019 John Wiley & Son, Inc. 21
 Supplies ILLUSTRATION 3.5
Adjustment for supplies

unadjusted
balance
adjusment /
adjusted balance adjusting entry

LO 2 Copyright ©2019 John Wiley & Son, Inc. 22

 Insurance
Illustration: On October 4, Yazici
Advertising paid ₺600 for a one-year fire
insurance policy. Coverage began on
October 1. Yazici 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
after done st. DR. unearned service revenue 50
CR. service revenue 50
LO 2 Copyright ©2019 John Wiley & Son, Inc. 23
 Insurance ILLUSTRATION 3.6
Adjustment for insurance

LO 2 Copyright ©2019 John Wiley & Son, Inc. 24

 Depreciation khau hao long term fix asset

• 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
 Allocation concept, not a valuation concept

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 Depreciation
Illustration: For Yazici 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.

LO 2 Copyright ©2019 John Wiley & Son, Inc. 26

 ILLUSTRATION 3.7
Adjustment for depreciation

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 Depreciation
Statement Presentation
• Accumulated Depreciation is a contra asset account
(credit)
• Offsets related asset account on the statement of
financial position
giá tri so sach con lai
• Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation
Equipment ₺5,000
Less: Accumulated depreciation—equipment 40
ILLUSTRATION 3.8 ₺4,960
Statement of financial position presentation of accumulated depreciation

LO 2 Copyright ©2019 John Wiley & Son, Inc. 28

 Prepaid Expenses
Accounting for Prepaid Expenses
Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Insurance, Prepaid expense Assets Dr. Expenses
supplies, originally recorded overstated. Cr. Assets
advertising, rent, in asset accounts Expenses or Contra
depreciation have been used. understated. Assets
ILLUSTRATION 3.9
Accounting for prepaid expenses

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 Unearned Revenues
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

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 Unearned Revenues
• 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 3.10

Liability Revenue
Debit Unadjusted Credit
Adjusting Balance Adjusting
Entry (-) Entry (+)

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 Unearned Revenues
Illustration: Yazici 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 costumer otc2 400
costumer : otc 31 DR. prepaid advert 1200
DR. adver expense 400 CR.. cash 1200
LO 2 Copyright ©2019 John Wiley & Son, Inc. 32
CR. prepaid adver 400
 Unearned Revenues ILLUSTRATION 3.11
Service revenue accounts
after adjustment

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 Unearned Revenues ILLUSTRATION 3.12
Accounting for unearned revenues

Accounting for Unearned Revenues

Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Rent, Unearned revenues Liabilities Dr. Liabilities
magazine recorded in liability overstated. Cr. Revenues
subscriptions, accounts are now Revenues
customer recognized as understated.
deposits for revenue for services
future service performed.

LO 2 Copyright ©2019 John Wiley & Son, Inc. 34

 DO IT! 2 Adjusting Entries for Deferrals
The ledger of Hammond Deliveries, 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.
LO 2 Copyright ©2019 John Wiley & Son, Inc. 35
 DO IT! 2 Adjusting Entries for Deferrals
The ledger of Hammond Deliveries, 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
Prepare the adjusting entries for the month of March.
1. Insurance expires at the rate of €100 per month.
Insurance Expense 100
Prepaid Insurance 100

LO 2 Copyright ©2019 John Wiley & Son, Inc. 36

 DO IT! 2 Adjusting Entries for Deferrals
The ledger of Hammond Deliveries, 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
Prepare the adjusting entries for the month of March.
2. Supplies on hand total € 800.
Supplies Expense 2,000
Supplies 2,000

LO 2 Copyright ©2019 John Wiley & Son, Inc. 37

 DO IT! 2 Adjusting Entries for Deferrals
The ledger of Hammond Deliveries, 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
Prepare the adjusting entries for the month of March.
3. The equipment depreciates €200 a month.
Depreciation Expense 200
Accumulated Depreciation—Equipment 200

LO 2 Copyright ©2019 John Wiley & Son, Inc. 38

 DO IT! 2 Adjusting Entries for Deferrals
The ledger of Hammond Deliveries, 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
Prepare the adjusting entries for the month of March.
4. During March, services were performed for €4,000 of the unearned service
revenue reported.
Unearned Service Revenue 4,000
Service Revenue 4,000

LO 2 Copyright ©2019 John Wiley & Son, Inc. 39

 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
Journalize and post
Trial
Analyze Journalize Post adjusting entries:
Balance
deferrals/accruals

Adjusted
Financial Closing Post-Closing
Trial
Balance Statements Entries Trial Balance

LO 3 Copyright ©2019 John Wiley & Son, Inc. 40

 Accrued Revenues
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

LO 3 Copyright ©2019 John Wiley & Son, Inc. 41

 Accrued Revenues
• Adjusting entry records the receivable that exists and
records the revenues for services performed.
• Adjusting entry:
 Increases (debits) an asset account and
 Increases (credits) a revenue account
ILLUSTRATION 3.13

Asset Revenue
Debit Credit
Adjusting Adjusting
Entry (+) Entry (+)

LO 3 Copyright ©2019 John Wiley & Son, Inc. 42

 Accrued Revenues
Illustration: In October Yazici Advertising
performed services worth ₺200 that were
not billed to clients on or before October 31.
Oct. 31
Accounts Receivable 200
Service Revenue 200
On November 10, Pioneer receives cash of ₺200 for the
services performed. The journal entry on the 10th is:
Cash 200 still not adjusting entry

Accounts Receivable 200

LO 3 Copyright ©2019 John Wiley & Son, Inc. 43
 Accrued Revenues ILLUSTRATION 3.14
Adjustments for accrued revenue

LO 3 Copyright ©2019 John Wiley & Son, Inc. 44

 Accrued Revenues ILLUSTRATION 3.15
Accounting for accrued revenues

Accounting for Accrued Revenues

Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Interest, Services performed Assets Dr. Assets
rent, services but not yet received understated. Cr. Revenues
in cash or recorded. Revenues
understated.

LO 3 Copyright ©2019 John Wiley & Son, Inc. 45

 Accrued Expenses
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

LO 3 Copyright ©2019 John Wiley & Son, Inc. 46

 Accrued Expenses
• Adjusting entry records the obligation and recognizes
the expense.
• Adjusting entry:
 Increase (debit) an expense account and
 Increase (credit) a liability account
ILLUSTRATION 3.16

Expense Liability
Debit Credit
Adjusting Adjusting
Entry (+) Entry (+)

LO 3 Copyright ©2019 John Wiley & Son, Inc. 47

 Accrued Expenses
Accrued Interest
Illustration: Yazici Advertising signed a three-month note
payable in the amount of ₺5,000 on October 1. The note
requires Yazici to pay interest at an annual rate of 12%.

Face Value Annual Time in Terms

of Note x Interest Rate x of One Year = Interest
₺5,000 x 12% x 1/12 = ₺50
ILLUSTRATION 3.17
Oct. 31 Interest Expense 50
Interest Payable 50
LO 3 Copyright ©2019 John Wiley & Son, Inc. 48
 Accrued Expenses ILLUSTRATION 3.18
Adjustment for accrued interest

LO 3 Copyright ©2019 John Wiley & Son, Inc. 49

 Accrued Expenses
Accrued Salaries and Wages
Illustration: Yazici 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. ILLUSTRATION 3.19

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 Accrued Expenses ILLUSTRATION 3.20
Adjustment for accrued salaries
and wages

November 9:
DR. S&W Expense 2800
LO 3 DR. S&W Payable 1200 Copyright ©2019 John Wiley & Son, Inc. 51
CR. cash 4000
 Accrued Expenses ILLUSTRATION 3.21
Accounting for accrued expenses

Accounting for Accrued Revenues

Accounts
Reason for Before Adjusting
Examples Adjustment Adjustment Entry
Interest, Expenses have Expenses Dr. Expenses
rent, salaries been incurred but understated. Cr. Liabilities
not yet paid in Liabilities
cash or recorded. understated.

LO 3 Copyright ©2019 John Wiley & Son, Inc. 52

 Summary of Basic Relationships ILLUSTRATION 3.22
Summary of
adjusting entries

Type of Adjustment Accounts Before 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

LO 3 Copyright ©2019 John Wiley & Son, Inc. 53

 DO IT! 3 Adjusting Entries Accruals
Mahindra 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 (amounts
in thousands).
1. At August 31, the company owed its employees INR800 in
salaries and wages that will be paid on September 1.
2. On August 1, the company borrowed INR30,000 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 INR1,100.
Prepare the adjusting entries needed at August 31, 2020.
LO 3 Copyright ©2019 John Wiley & Son, Inc. 54
 DO IT! 3 Adjusting Entries Accruals
Prepare the adjusting entries needed at August 31, 2020.
1. At August 31, the company owed its employees INR800 in
salaries and wages that will be paid on September 1.
Salaries and Wages Expense 800
Salaries and Wages Payable 800
2. On August 1, the company borrowed INR30,000 from a local
bank on a 15-year mortgage. The annual interest rate is 10%.
Interest Expense 250
Interest Payable 250

LO 3 Copyright ©2019 John Wiley & Son, Inc. 55

 DO IT! 3 Adjusting Entries Accruals
Prepare the adjusting entries needed at August 31, 2020.
3. Revenue for services performed but unrecorded for August
totaled INR1,100.
Accounts Receivable 1,100
Service Revenue 1,100

LO 3 Copyright ©2019 John Wiley & Son, Inc. 56

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

Trial Adjusting
Analyze Journalize Post
Balance Entries

Adjusted Prepare Journalize and

Post-Closing
Trial Financial Post Closing
Trial Balance
Balance Statements Entries

LO 4 Copyright ©2019 John Wiley & Son, Inc. 57

 Yazici Advertising
Adjusted Trial Balance
October 31, 2020
Debit Credit
Cash ₺15,200
Accounts Receivable 200
Supplies 1,000
Prepaid Insurance 550
Equipment 5,000
Accumulated Depreciation ₺ 40
Notes Payable 5,000
Accounts Payable 2,500
Unearned Service Revenue 800
Salaries and Wages Payable 1,200
Interest Payable 50
Owner’s Capital 10,000
Owner’s Drawings 500
Service Revenue 10,600
Salaries and Wages Expense 5,200
Supplies Expense 1,500
Rent Expense 900
Insurance Expense 50
Interest Expense 50
Depreciation Expense 40
₺30,190 ₺30,190
ILLUSTRATION 3.25
LO 4 Copyright ©2019 John Wiley & Son, Inc. 58
 Adjusted Trial Balance
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.
LO 4 Copyright ©2019 John Wiley & Son, Inc. 59
 Preparing Financial Statements
Financial Statements are prepared directly from the Adjusted Trial Balance.

Statement of
Income Owner’s Equity
Financial
Statement Statement
Position

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 ILLUSTRATION 3.26
Preparation of the income statement and owner’s equity
statement from the adjusted trial balance
LO 4 Copyright ©2019 John Wiley & Son, Inc. 61
 ILLUSTRATION 3.27
Preparation of the statement of financial position
from the adjusted trial balance

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 DO IT! 4 Trial Balance
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
Utilities Expense 510
Interest Expense 50
$37,310 $37,310

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 DO IT! 4 Trial Balance
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
Net income $ 2,490

LO 4 Copyright ©2019 John Wiley & Son, Inc. 64

 DO IT! 4 Trial Balance
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)
Total assets $23,350 Total liabilities $7,460

LO 4 Copyright ©2019 John Wiley & Son, Inc. 65

 DO IT! 4 Trial Balance
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

LO 4 Copyright ©2019 John Wiley & Son, Inc. 66

 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

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 Prepaid Expenses
Company may choose to debit (increase) an expense account
rather than an asset account. This alternative treatment is
simply more convenient. ILLUSTRATION 3A.2
Adjustment approaches— a comparison

Prepayment Initially Oct. 5 Supplies 2,500

Debited to Asset Accounts payable 2,500
Account
Oct. 31 Supplies Expense 1,500
(per chapter)
Supplies 1,500
Prepayment Initially Oct. 5 Supplies Expense 2,500
Debited to Expense Accounts payable 2,500
Account
Oct. 31 Supplies 1,000
(per appendix)
Supplies Expense 1,000
LO 5 Copyright ©2019 John Wiley & Son, Inc. 68
 Unearned Revenues
Company may credit (increase) a revenue account when they
receive cash for future services.
ILLUSTRATION 3A.5
Adjustment approaches— a comparison

Unearned Revenue Oct. 2 Cash 1,200

Initially Credited to Unearned Revenue 1,200
Liability Account
Oct. 31 Unearned Revenue 400
(per chapter)
Service Revenue 400

Unearned Revenue Oct. 2 Cash 1,200

Initially Credited to Service Revenue 1,200
Revenue Account
Oct. 31 Service Revenue 800
(per appendix)
Unearned Revenue 800
LO 5 Copyright ©2019 John Wiley & Son, Inc. 69
 Summary of Additional Adjustments
ILLUSTRATION 3A.7
Prepaid Expenses
Reason for Account Balances Adjusting
Adjustment Before Adjustment 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.

LO 5 Copyright ©2019 John Wiley & Son, Inc. 70

 Summary of Additional Adjustments
ILLUSTRATION 3A.7
Unearned Revenues
Reason for Account Balances Adjusting
Adjustment Before Adjustment Entry
(a) Unearned revenues Liabilities Dr. Liabilities
initially recorded in overstated. Cr. Revenues
liability accounts are now Revenues
recognized as revenue. understated.
(b) Unearned revenues Liabilities Dr. Revenues
initially recorded in understated. Cr. Liabilities
revenue accounts are still Revenues
unearned. overstated.

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 Appendix 3B Financial Reporting Concepts
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
 An item is material when its size makes it likely to
influence the decision of an investor or creditor
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 Appendix 3B Financial Reporting Concepts
Two fundamental qualities
2. Faithful Representation
• Information accurately depicts what really happened.
• Information must be
 complete (nothing important has been omitted)
 neutral (is not biased toward one position or
another)
 free from error

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 Qualities of Useful Information
Enhancing Qualities
Comparability Information is Information has the
results when verifiable if quality of
different companies independent understandability
use the same observers, using the if it is presented in a
accounting same methods, clear and concise
principles. obtain similar results. fashion.

Consistency means that a For accounting

company uses the same information to have
accounting relevance, it must be
principles and methods timely.
from year to year.

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 Assumptions in Financial Reporting

Monetary Unit Economic Entity

Requires that only those States that every economic
things that can be expressed entity can be separately
in money are included in the identified and accounted for.
accounting records.
ILLUSTRATION 3B.2

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 Assumptions in Financial Reporting

Time Period Going Concern

States that the life of a The business will remain in
business can be divided into operation for the
artificial time periods. foreseeable future.

ILLUSTRATION 3B.2

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

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 Principles of Financial Reporting
Revenue Expense Full
Recognition Recognition Disclosure
Principle Principle Principle
Requires that Dictates that efforts Requires that
companies recognize (expenses) be companies disclose
revenue in the matched with results all circumstances
accounting period in (revenues). Thus, and events that
which the expenses follow would make a
performance revenues. difference to
obligation is financial statement
satisfied. users.

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 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.

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 A Look at U.S. GAAP
Key Points
Similarities
• Like IFRS, companies applying GAAP 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 IFRS, cash-basis accounting is not in accordance with GAAP.
• GAAP 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.

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 A Look at U.S. GAAP
Key Points
Similarities
• The form and content of financial statements are very similar under
GAAP and IFRS.
• Revenue recognition fraud is a major issue in U.S. financial reporting.
The same situation exists for most other countries as well.

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 A Look at U.S. GAAP
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,
under IFRS, income 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.

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 A Look at U.S. GAAP
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.

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 A Look at U.S. GAAP
Looking to the Future
The IASB and FASB completed a joint project on revenue recognition. The
purpose of this project was to develop comprehensive guidance on when
to recognize revenue. It is hoped that this approach will lead to more
consistent accounting in this area.

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Copyright
Copyright © 2019 John Wiley & Sons, Inc.
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or from the use of the information contained herein.

Copyright ©2019 John Wiley & Son, Inc. 85