Chapter THE ACCOUNTING

3 CYCLE:
Adjusting The Accounts
Facilitator: Maqsood Ali Jamali

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 3 Adjusting The Accounts

Learning Objectives
Explain the accrual basis of accounting and the
1
reasons for adjusting entries.

2 Prepare adjusting entries for deferrals.

3 Prepare adjusting entries for accruals.

Describe the nature and purpose of an adjusted

4
trial balance.
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 LEARNING Explain the accrual basis of accounting
1
OBJECTIVE and the reasons for 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
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 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
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 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).
 Expenses are recognized when incurred (rather than
when paid).
 In accordance with generally accepted accounting
principles (GAAP).

LO 1
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 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
generally accepted accounting principles (GAAP).

LO 1
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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
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 Recognizing Revenues and Expenses

EXPENSE RECOGNITION PRINCIPLE

Match expenses with revenues
in the period when the company
makes efforts that generate
those revenues.

“Let the expenses

follow the revenues.”

LO 1
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 Recognizing Revenues and Expenses
• REVENUE RECOGNITION PRINCIPLE: The
revenue recognition principle requires that
companies recognize revenue in the accounting
period in which it is earned.
• THE MATCHING PRINCIPLE: In recognizing
expenses, a simple rule is followed: “Let the expenses
follow the revenues.” Thus, expense recognition is
tied to revenue recognition. This practice of expense
recognition is referred to as the expense recognition
principle. It dictates that efforts (expenses) be
matched with results (revenues).
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Using a Worksheet
A worksheet is a multiple-column form used in the
adjustment process and in preparing financial
statements. As its name suggests, the worksheet is a
working tool. It is not a permanent accounting
record; it is neither a journal nor a part of the general
ledger. The use of a worksheet is optional.

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 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.
 Will include one income statement account and one
balance sheet account.

LO 1
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 The Basics of Adjusting Entries
• In order for revenues to be recorded in the period in
which they are earned, and for expenses to be
recognized in the period in which they are incurred,
companies make adjusting entries. Adjusting entries
ensure that the revenue recognition and matching
principles are followed.
• Adjusting entries are necessary because the trial
balance—the first pulling together of the transaction
data—may not contain up-to-date and complete data.

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 The Basics of Adjusting Entries
• Adjusting entries are required every time a company
prepares financial statements. The company analyzes
each account in the trial balance to determine whether
it is complete and up to date for financial statement
purposes. Every adjusting entry will include one
income statement account and one balance sheet
account.
• In theory, a business could make adjusting entries on a
daily basis. But as a practical matter, these entries are
made only at the end of each accounting period. For
most companies, adjusting entries are made on a
monthly basis.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Types of Adjusting Entries
Illustration 3-2
Categories of adjusting entries

Deferrals Accruals

1. Prepaid Expenses. Expenses 1. Accrued Revenues.

paid in cash before they are Revenues for services
used or consumed. performed but not yet received
in cash or recorded.

2. Unearned Revenues. 2. Accrued Expenses.

Cash received before services Expenses incurred but not yet
are performed. paid in cash or recorded.

LO 1
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 TYPES OF ADJUSTING ENTRIES
Adjusting entries are classified as either deferrals or accruals.
•Deferrals:
•1. Prepaid expenses: Expenses paid in cash and
recorded as assets before they are used or consumed.
•2. Unearned revenues: Cash received before services
are performed and recorded as liabilities before revenue
is earned.
•Accruals:
•1. Accrued revenues: Revenues earned but not yet
received in cash or recorded.
•2. Accrued expenses: Expenses incurred but not yet
paid in cash or recorded.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Adjusting Entries for Deferrals
• Deferrals are expenses or revenues that are
recognized at a date later than the point when cash
was originally exchanged. The two types of deferrals
are prepaid expenses and unearned revenues.

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 LEARNING
OBJECTIVE
2 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

LO 2
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 LEARNING
OBJECTIVE
3 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.

LO 3
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Adjusting Entries for Accruals
• The second category of adjusting entries is
accruals. Prior to an accrual adjustment, the
revenue account (and the related asset
account) or the expense account (and the
related liability account) are understated. Thus,
the adjusting entry for accruals will increase
both a balance sheet and an income statement
account.

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Adjusting Entries for Accruals

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 TYPES OF ADJUSTMENTS
• The number of adjustments needed at the end
of each accounting period depends entirely
upon the nature of the company’s business
activities. However, most adjusting entries fall
into one of four general categories:
• 1. Converting Assets to Expenses.
• 2. Converting liabilities to Revenue.
• 3. Accruing Unpaid Expenses.
• 4. Accruing Uncollected Revenue.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Converting Assets to Expenses
• A cash expenditure (or cost) that will benefit more
than one accounting period usually is recorded by
debiting an asset account (for example, Supplies,
Unexpired Insurance, and so on) and by crediting
Cash. The asset account created actually represents
the deferral (or the postponement) of an expense.
• In each future period that benefits from the use of this
asset, an adjusting entry is made to allocate a portion
of the asset’s cost from the balance sheet to the
income statement as an expense. This adjusting entry
is recorded by debiting the appropriate expense
account and crediting the related asset account.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Converting Liabilities to Revenue
• A business may collect cash in advance for services to be
rendered in future accounting periods. Transactions of this
nature are usually recorded by debiting Cash and by crediting
a liability account (typically called Unearned Revenue). Here,
the liability account created represents the deferral (or the
postponement) of a revenue. In the period that services are
actually rendered (or that goods are sold), an adjusting entry is
made to allocate a portion of the liability from the balance
sheet to the income statement to recognize the revenue earned
during the period. The adjusting entry is recorded by debiting
the liability (Unearned Revenue) and by crediting Revenue
Earned (or a similar account) for the value of the services.

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Accruing Unpaid Expenses
• An expense may be incurred in the current
accounting period even though no cash
payment will occur until a future period. These
accrued expenses are recorded by an adjusting
entry made at the end of each accounting
period. The adjusting entry is recorded by
debiting the appropriate expense account (for
example, Interest Expense or Salary Expense)
and by crediting the related liability (for
example, Interest Payable or Salaries Payable).

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Accruing Uncollected Revenue
• Revenue may be earned (or accrued ) during the
current period, even though the collection of cash will
not occur until a future period. Unrecorded earned
revenue, for which no cash has been received,
requires an adjusting entry at the end of the
accounting period. The adjusting entry is recorded by
debiting the appropriate asset (for example, Accounts
Receivable or Interest Receivable) and by crediting
the appropriate revenue account (for example,
Service Revenue Earned or Interest Earned).

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 ADJUSTING ENTRIES AND TIMING
DIFFERENCES
• Adjusting entries to convert assets to expenses result
from cash being paid prior to an expense being
incurred.
• Adjusting entries to convert liabilities to revenue
result from cash being received prior to revenue being
earned.
• • Adjusting entries to accrue unpaid expenses result
from expenses being incurred before cash is paid.
• Adjusting entries to accrue uncollected revenue result
from revenue being earned before cash is received.

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Types of Adjusting Entries

Converting
Converting  Converting
Converting
assets
assets to
to liabilities
liabilities to
to
expenses
expenses revenue
revenue

Accruing
Accruing Accruing
Accruing
unpaid
unpaid uncollected
uncollected
expenses
expenses revenues
revenues

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Converting Assets to Expenses
End of Current Period
Prior Periods Current Period Future Periods

Transaction
Transaction Adjusting
AdjustingEntry
Entry
Paid
Paidfuture
future Recognize
Recognizeportion
portion
expenses
expensesin in of
ofasset
assetconsumed
consumed
advance
advance as
asexpense,
expense,and
and
(creates
(createsanan Reduce
Reducebalance
balanceof
of
asset).
asset). asset
assetaccount.
account.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Converting Assets to Expenses

Examples Include:
Depreciation
Supplies
Expiring Insurance Policies

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Converting Assets to Expenses

$2,400 Insurance Policy

Coverage for 12 Months

$200 Monthly Insurance Expense

Jan. 1 Dec. 31
On
On January
January 1,
1, Webb
Webb Co.
Co. purchased
purchased aa one-year
one-year
insurance
insurance policy
policy for
for $2,400.
$2,400.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Converting Assets to Expenses

Initially,
Initially, costs
costs that
that benefit
benefit more
more than
than one
one
accounting
accounting period
period are
are recorded
recorded as
as assets.
assets.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Jan. 1 Unexpired Insurance 2,400
Cash 2,400
Purchase a one-year insurance policy.

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Converting Assets to Expenses

The
The costs
costs are
are expensed
expensed asas they
they are
are used
used to
to
generate
generate revenue.
revenue.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Monthly Adjusting Entry for Insurance
Jan. 31 Insurance Expense 200
Unexpired Insurance 200
Insurance expense for January.

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Converting Assets to Expenses
Balance
Balance Sheet
Sheet Income
Income Statement
Statement
Cost
Cost of
of assets
assets Cost
Cost of
of assets
assets
that
that benefit
benefit used
used this
this period
period to
to
future
future periods.
periods. generate
generate revenue.
revenue.

Unexpired Insurance Insurance Expense

1/1 2,400 1/31 200 1/31 200
Bal. 2,200

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 The Concept of Depreciation

Depreciable
Depreciable assets
assets are
are physical
physical objects
objects
that
that retain
retain their
their size
size and
and shape
shape but
but lose
lose
their
their economic
economic usefulness
usefulness over
over time.
time.

Depreciation
Depreciation isis the
the systematic
systematic allocation
allocation of
of the
the
cost
cost of
of aa depreciable
depreciable asset
asset to
to expense.
expense.
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MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Depreciation Is Only an Estimate
On May 2, 2018, JJ’s Lawn Care Service
purchased a lawn mower with a useful
life of 50 months for $2,500 cash.
Using the straight-line method, calculate
the monthly depreciation expense.

Depreciation
Cost of the asset
expense (per =
Estimated useful life
period)
$50 = $2,500
50
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Depreciation Is Only an Estimate

JJ’s
JJ’s Lawn
Lawn Care
Care Service
Service would
would make
make the
the
following
following adjusting
adjusting entry.
entry.

GENERAL JOURNAL
P
Date Account Titles and Explanation RDebit Credit
May 31 Depreciation Expense: Tools & Eq. 50
Accumulated Depreciation: Tools & Eq. 50
To record one month's depreciation.

Contra-asset
Contra-asset
McGraw-Hill/Irwin
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MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
 Depreciation Is Only an Estimate

JJ’s
JJ’s $15,000
$15,000 truck
truck is
is depreciated
depreciated over
over 60
60
months
months as as follows:
follows:
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
May 31 Depreciation Expense: Truck 250
Accumulated Depreciation: Truck 250
To record one month's depreciation.

$15,00060
$15,00060 months
months == $250
$250 per
per month
month
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
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 Accumulated
Accumulated depreciation
depreciation would
would
appear
appear on
on the
the balance
balance sheet
sheet as
as
follows:
follows:

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Converting Liabilities to Revenue
End of Current Period
Prior Periods Current Period Future Periods

Transaction
Transaction
Collected
Collected Adjusting
AdjustingEntry
Entry
from
from Recognize
 Recognizeportion
portion
customers
customersin in earned
earnedas asrevenue,
revenue,
advance
advance and
and
(creates
(createsaa  Reduce
 Reducebalance
balanceofof
liability).
liability). liability
liability account.
account.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Converting Liabilities to Revenue
$6,000 Rental Contract
Coverage for 12 Months

$500 Monthly Rental Revenue

Jan. 1 Dec. 31
On
On January
January 1,
1, Webb
Webb Co.
Co. received
received $6,000
$6,000 in
in
advance
advance for
for aa one-year
one-year rental
rental contract.
contract.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Converting Liabilities to Revenue

Initially,
Initially, revenues
revenues that
that benefit
benefit more
more than
than one
one
accounting
accounting period
period are
are recorded
recorded as
as liabilities.
liabilities.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Jan. 1 Cash 6,000
Unearned Rental Revenue 6,000
Collected $6,000 in advance for rent.

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
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 Converting Liabilities to Revenue

Over
Over time,
time, the
the revenue
revenue is
is recognized
recognized as
as itit is
is
earned.
earned.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Monthly Adjusting Entry for Rent Revenue
Jan. 31 Unearned Rental Revenue 500
Rental Revenue 500
Rental revenue for January.
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MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
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 Converting Liabilities to Revenue

Balance
Balance Sheet
Sheet Income
Income Statement
Statement
Liability
Liability for
for Revenue
Revenue earned
earned
future
future periods.
periods. this
this period.
period.

Unearned Rental Revenue Rental Revenue

1/31 500 1/1 6,000 1/31 500
Bal. 5,500

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Accruing Unpaid Expenses
End of Current Period
Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry Transaction
Transaction
Recognize
 Recognizeexpense
expense Liability
Liabilitywill
will
incurred,
incurred,and
and be
bepaid.
paid.
Record
 Recordliability
liabilityfor
for
future
futurepayment.
payment.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Accruing Unpaid Expenses

Hey, when do
we get paid?
Examples Include:
Interest
Wages and Salaries
Property Taxes

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Accruing Unpaid Expenses

$3,000 Wages
Expense

Monday, Wednesday, Friday,

May 29 May 31 June 2
On
On May
May 31,
31, Webb
Webb Co.
Co. owes
owes wages
wages of
of $3,000.
$3,000.
Pay
Pay day
day is
is Friday,
Friday, June
June 2.
2.
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 Accruing Unpaid Expenses

Initially,
Initially, an
an expense
expense and
and aa liability
liability are
are
recorded.
recorded.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
May 31 Wages Expense 3,000
Wages Payable 3,000
To accrue wages owed to employees.

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
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 Accruing Unpaid Expenses
Balance
Balance Sheet
Sheet Income
Income Statement
Statement
Liability
Liability toto be
be Cost
Cost incurred
incurred this
this
paid
paid in
in aa future
future period
period toto generate
generate
period.
period. revenue.
revenue.

Wages Payable Wages Expense

5/31 3,000 5/31 3,000

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
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 Accruing Unpaid Expenses
$5,000 Weekly Wages

$3,000 Wages $2,000 Wages

Expense Expense

Monday, Wednesday, Friday,

May 29 May 31 June 2
Let’s
Let’s look
look at
at the
the entry
entry for
for June
June 2.
2.
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 Accruing Unpaid Expenses

The
The liability
liability is
is extinguished
extinguished when
when the
the debt
debt is
is
paid.
paid.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
June 2 Wages Expense (for June) 2,000
Wages Payable (accrued in May) 3,000
Cash 5,000
Weekly payroll for May 29-June 2.
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MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
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 Accruing Uncollected Revenue
End of Current Period
Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry Transaction
Transaction
Recognize
 Recognizerevenue
revenue Receivable
Receivable
earned
earned but
butnot
notyet
yet will
will be
be
recorded,
recorded,and
and collected.
collected.
Record
 Recordreceivable.
receivable.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Accruing Uncollected Revenue

Examples Include:
Interest Earned
Work Completed But Not
Yet Billed to Customer

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Accruing Uncollected Revenue

$170 Interest
Revenue

Saturday, Monday, Tuesday,

Jan. 15 Jan. 31 Feb. 15
On
On Jan.
Jan. 31,
31, the
the bank
bank owes
owes Webb
Webb Co.
Co.
interest of $170. Interest is paid on the 15
interest of $170. Interest is paid on the 15th th

day
day ofof each
each month.
month.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Accruing Uncollected Revenue

Initially,
Initially, the
the revenue
revenue isis recognized
recognized and
and aa
receivable
receivable is
is created.
created.
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Jan. 31 Interest Receivable 170
Interest Revenue 170
To recognize interest revenue.

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
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 Accruing Uncollected Revenue
Balance
Balance Sheet
Sheet
Income
Income Statement
Statement
Receivable
Receivable toto
be
be collected
collected in
in aa Revenue
Revenue earned
earned
future
future period.
period. this
this period.
period.

Interest Receivable Interest Revenue

1/31 170 1/31 170

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 Accruing Uncollected Revenue
$320 Monthly Interest

$170 Interest $150 Interest

Revenue Revenue

Saturday, Monday, Tuesday,

Jan. 15 Jan. 31 Feb. 15

Let’s
Let’s look
look at
at the
the entry
entry for
for February
February 15.
15.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Accruing Uncollected Revenue

The
The receivable
receivable is
is collected
collected in
in aa future
future period.
period.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Feb. 15 Cash 320
Interest Revenue (for February) 150
Interest Receivable (accrued Jan. 31) 170
To record interest received.

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Accruing Income Taxes Expense: The Final
Adjusting Entry
As
As aa corporation
corporation earns
earns taxable
taxable income,
income, itit
incurs
incurs income
income taxes
taxes expense,
expense, and
and also
also aa
liability
liability to
to governmental
governmental tax
tax authorities.
authorities.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Dec. 31 Income Ta xes Expense 780
Income Ta xes Payable 780
Estimated income taxes applicable to
taxable income earned in December.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 The Concept of Materiality

An
An item
item isis “material”
“material” ifif knowledge
knowledge ofof the
the item
item
might
might reasonably
reasonably influence
influence the
the decisions
decisions of of
users
users of
of financial
financial statements.
statements.

Many companies
immediately charge the Lightbulbs
cost of immaterial items
to expense.
Supplies
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Effects of the Adjusting Entries

Make end-of-
Journalize year
Post entries to Prepare trial
transactions. adjustments.
the ledger balance.
accounts.

Recall
Recallfrom
fromthe
theaccounting
accounting cycle
cycle
discussed
discussedin inChapter
Chapter2,2,that
thatafter
after the
the
adjusting
adjustingentries
entriesare
aremade,
made,ananadjusted
adjusted
trial
trialbalance
balanceis prepared..
isprepared Prepare adjusted
Maqsood Ali Jamali [BBA(Hons), trial balance.
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Pioneer Advertising Company-Recall
from chapter#2
Pioneer Advertising’s Trial Balance As On
October 31st ,2020 is as follows:

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Pioneer Advertising-Data for Adjustment

• An inventory count at the close of business on

October 31 reveals that $1,000 of supplies are
still on hand.
• Insurance policy was expired for one moth.
• Depreciation on the equipment is $480 a year,
or $40 per month.
• Pioneer performed for R. Knox during
October, the company determines that it
should recognize $400 of revenue in October.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Pioneer Advertising-Data for Adjustment
• In October, Pioneer Advertising performed services
worth $200 that were not billed to clients on or before
October 31.
• Pioneer Advertising signed a three-month note payable
in the amount of $5,000 on October 1. The note
requires Pioneer to pay interest at an annual rate of
12%.
• At October 31, the salaries and wages for these three
days represent an accrued expense and a related
liability to Pioneer. The employees receive total
salaries and wages of $2,000 for a five-day work week,
or $400 per day.
Prepare Adjusting Entries and Prepare Adjusted Trial
Balance. Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
Air & Sea Travel Inc. Trial Balance as on Dec 31 st
2019
Title of account Debit Credit
Cash $24,800
A/c Receivable $2,250
Supplies $700
Prepaid rent $3,000
Furniture $16,500
A/c Payable $13,100
Unearned service Revenue $450
Common Stock $20,000
Retained earnings $11,250
Dividends $3,200
Service Revenue $7,000
Salaries Expense $950
Utilities Expense $400
Total $51,800 $51,800

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Information for adjustment
• A. Accrued service revenue $250.
• B. Supplies on hand $400.
• C. Prepaid rent expired $1000.
• D. Depreciation on furniture $275.
• E. Accrued salary expense $950.
• F. Amount of unearned service revenue that
has been earned $150.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Crane Service Company’s Trial Balance as on
year ended on Dec 31st 2019
Title of account Debit Credit
Cash 198,000
Account receivable 370,000
Supplies 6,000
Furniture & fixture 100,000
Accumulated depreciation furniture & fixture 40,000
Building 250,000
Accumulated depreciation building 130,000
Account payable 380,000
Unearned service Revenue 45,000
Common Stock 100,000
Retained earnings 193,000
Dividend 65,000
Service revenue 286,000
Salary expenses 172,000
Miscellaneous expenses 13,000 _______
Total 1174,000 1174,000

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Data for adjustment

• Supplies on hand at year end, $2,000.

• Depreciation on furniture & fixture $20,000.
• Depreciation on building $10,000.
• Salaries owed but not yet paid $5,000.
• Accrued service revenue $12,000.
• Of the $45,000 balance of unearned service
revenue, $32,000 was earned during the year.

Maqsood Ali Jamali [BBA(Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Practice Problem
The Green Thumb Lawn Care Company began
operations on April 1. At April 30, the trial
balance shows the following balances for
selected accounts:
•Prepaid Insurance $ 3,600
•Equipment 28,000
•Notes Payable 20,000
•Unearned Service Revenue 4,200
•Service Revenue 1,800
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Analysis reveals the following additional data:
• 1. Prepaid insurance is the cost of a 2-year insurance
policy, effective April 1.
• 2. Depreciation on the equipment is $500 per month.
• 3. The note payable is dated April 1. It is a 6-month,
12% note.
• 4. Seven customers paid for the company’s 6-month
lawn service package of $600 beginning in April. The
company performed services for these customers in
April.
• 5. Lawn services performed for other customers but
not recorded at April 30 totaled $1,500.
Prepare the adjusting entries for the month of April.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 End of Chapter 3

Maqsood Ali Jamali [BBA (Hons),

MBA(Finance)] © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin