Lesson 4
Adjusting Accounts for
Financial Statement
Task Team of
FUNDAMENTAL ACCOUNTING
School of Business,Sun Yat-sen University
2
Outline
Describe the purpose of adjusting accounts
at the end of the period.
Prepare and explain adjusting entries for
prepaid expenses,amortization,unearned
revenues,accrued expenses,and accrued
revenues.
Explain how accounting adjustments link to
financial statements.
Explain and prepare an adjusted trial
balance.
3
Definition,the continued life of a business is
divided into time periods of equal length.
Review,Time period concept
This year income
statement
Next year income
statement
Last year income
statement
Past
period
Current
period
Future
period
Dec,31,B/S dateDec,31,B/S date
going concern
(business will not stop)
4
Review,Revenue Recognition Principle
Revenue is recorded at the time it is
earned regardless of whether cash or
another asset has been exchanged.
5
Review,Matching Principle
Expenses are to be matched in the same
accounting period as the revenues they
helped to earn.
6
Accrual and cash basis
The accrual basis of accounting matches
revenues earned with expenses incurred.
The cash basis matches revenues received
with expenses paid,It is not satisfactory for
most businesses because it results in
financial statements that are not
comparable from period to period,except
when the amounts of prepaid,unearned,
and accrued items are not material.
7
Adjust,A Step in Accounting cycle
1,Analyze Transactions
2,Journalize
3,Post
4,Unadjusted trial balance
5,Adjust
6,Adjusted trial balance
7,Prepare finance statements
8.Close
Now that we have
covered the trial
balance,let’s
discuss adjusting
entries.
8
Why Need to Adjust
Some events are not evidenced by the obvious
documents,the effects of these events are recorded
at the end of the accounting period by means of
adjusting entries.
The purpose of adjusting the accounts at the end
of period is to make the accounting information
comparable from period to period.
9
Why Need to Adjust
Adjustments are based on three generally
accepted accounting principles:
Time period principle.
Revenue recognition principle.
Matching principle.
10
Type of Adjusting Entries
Adjusting
entries
Accruing unrecorded
revenues
Converting liabilities to
revenues
Accruing unrecorded
expenses
Converting assets to
expenses
11
Adjusting Entries – Accruals
Accruals occur when revenues have been
earned or expenses incurred but no cash
has been exchanged.
End of
accounting period.
Cash receivedRevenues earned
Example,interest revenue earned during the
period but not received until the next period.
12
Adjusting Entries – Accruals
Example,On Jun 1,2004,Smith Inc,invests
$100,000 for a bonds which pays 5% interest per
year,Smith Inc,will not receive the interest until
March 31,2005,On December 31,2004,Smith,
Inc,need to make the following entry for the
interest earned so far.
D a te D e s c r i p ti o n D e b i t C r e d i t
D e c 31 I n te r e s t R e c e i v a b l e 2 9 1 6,6 7
I n te r e s t R e v e n u e 2 9 1 6,6 7
G EN ER A L J O U R N A L
$100000 × 5% × 7/ 12 = $2916,67
r e c or d t he e a r ne d i nt e r e s t r e v e nue
13
Adjusting Entries – Accrued
Unrecorded expenses incurred
End of
accounting period.
Cash paidExpense incurred
Example,wages should be paid to employees during this
period but not paid until the next period.
14
Adjusting Entries – Accrued
D a te D e s c r i p ti o n D e b i t C r e d i t
D e c 31 W a g e s Ex p e n s e 3 5,0 0 0
W a g e s Pa y a b l e 3 5,0 0 0
G EN ER A L J O U R N A L
re c o rd t h e w a g e e x p e n s e
Example,On the year-end,Dec,31,2004,Smith Inc.’s
employees have earned total wages of $35,000 for the
Monday,but Smith Inc,will not pay the wages until 5th of
next month,So at the end of the accounting period,Smith
need to make the following entries to accrued the wage
expenses.
15
Adjusting Entries – Deferrals
Prepaid expense is used up
Paid cash for
12 month’s rent < from July 2004 to June 2005 >
7/1/04 12/31/04
Year end
6/30/05
16
Adjusting Entries – Deferrals
Example,On July 1,2004,Smith Inc,paid $20000 for
whole year’s rent covered from 1stof July to 30th of June,
At the end of 2004,$10000 of rent expenses have
occurred so Smith Inc,need to make the following
entries to transfer the deferrals to expenses.D a te D e s c r i p ti o n D e b i t C r e d i t
D e c 31 r e n t Ex p e n s e 1 0,0 0 0
p r e p a i d e x p e n s e 1 0,0 0 0
G EN ER A L J O U R N A L
re c o rd t h e re n t e x p e n s e
17
Adjusting Entries – Deferrals
End of
accounting period.
Cash received Revenues earned
Example,service revenue received in advance.
Converting liabilities to revenues:
18
Adjusting Entries – Deferrals
Example,On Oct,1,2004,Smith Inc,signed a contract for
providing a special service to Cone,Smith received $50000 for
the service to be provided,At the end of 2004 half of the
services have been proved to Cone,Smith should make the
following entries to record earned revenue.
D a te D e s c r i p ti o n D e b i t C r e d i t
D e c 31 2 5,0 0 0
Se r v i c e R e v e n u e 2 5,0 0 0
G EN ER A L J O U R N A L
U n e a r n e d R e v e n u e
r e c o r d th e e a r n e d r e v e n u e
19
Adjust,Allocating the Costs of
long-term assets
Certain circumstances require adjusting
entries to record accounting estimates,
Amortization is an example,
Amortization is the process of allocating the
costs of assets over their useful lives.
20
Amortization
Companies acquire capital assets such as equipment,
buildings,vehicles,and patents to generate revenues.
These assets are expected to provide benefits for more
than one period.
The accounting concept of amortization involves
the systematic and rational allocation of cost of a
long-lived asset to the periods during which it is
used to generate revenue.
21
Amortization
On January 1,2004,a company purchased a piece of
equipment for $100,000,The equipment is expected to
have a useful life of five years and have a salvage value of
$5000.Asume the company use the straight-line method.
Asset Cost - Salvage Value
Useful Life
Straight-Line
Amortization
Expense
=
=
$100000 - $5,000
5 years
= $19000/year
22
Amortization
The required journal entry includes a debit
to Amortization expense and a credit to an
account called accumulated amortization.
D a te D e s c r i p ti o n D e b i t C r e d i t
Dec,31 A m o r ti za ti o n Ex p e n s e 1 9,0 0 0
A c c u m u l a te d A m o r ti za ti o n 1 9,0 0 0
G EN ER A L J O U R N A L
re co rd t h e a mo rt i z a t i o n e xp e n se s
23
Adjusted Trial Balance
The adjusted trial balance is used to check if there
are any mistakes in the adjusted accounts and it is
used for the financial statement.
Assume that Smith Inc,has the following
unadjusted trial balance:
24
Adjusted Trial Balance
Debit Credit
Cash 171000
Short-term investment 100000
Accounts Receivable 36000
Prepaid Expense 20000
Inventory 20000
Plant and Equipmemt 250000
Accounts Payable 50000
Unearned Revenue 50000
Paid Capital 500000
Sales Revenue 36000
Cost of Sales 30000
Operating expenses 9000
total 636000 636000
Accounts
unadjusted trial balance
SMITH Inc.
for the year ended Dec.31
25
Adjusted trial balance
Debit Credit Debit Credit Debit Credit
Cash 171000 171000
Short-term investment 100000 100000
Accounts Receivable 36000 36000
Interest receivable 2916.67 2916.67
Prepaid Expense 20000 10000 10000
Inventory 20000 20000
Plant and Equipmemt 250000 250000
Accumulated Depreciation 2600 2600
Accounts Payable 50000 50000
Wages payable 35000 35000
Unearned Revenue 50000 25000.00 25000.00
Paid Capital 500000 500000
Sales Revenue 36000 25000 61000
Interest Revenue 2916.67 2916.67
Cost of Sales 30000 30000
Operating expenses 9000 47600.00 56600.00
total 636000 636000 75516.67 75516.67 676516.67 676516.67
for the year ended Dec.31
Adjusting Entries
SMITH Inc.
Adjusted trial balance
Accounts
unadjusted trial balance
26
Adjustments & Financial
Statements
Adjusting entries bring the accounts up-to-date.
Adjustments are only made when financial
statements are prepared.
Adjust entries will affect both the income
statement and the balance sheet.
Will not affect the cash flow of the company.
The End of Lesson 4
Adjusting Accounts for
Financial Statement
Task Team of
FUNDAMENTAL ACCOUNTING
School of Business,Sun Yat-sen University
2
Outline
Describe the purpose of adjusting accounts
at the end of the period.
Prepare and explain adjusting entries for
prepaid expenses,amortization,unearned
revenues,accrued expenses,and accrued
revenues.
Explain how accounting adjustments link to
financial statements.
Explain and prepare an adjusted trial
balance.
3
Definition,the continued life of a business is
divided into time periods of equal length.
Review,Time period concept
This year income
statement
Next year income
statement
Last year income
statement
Past
period
Current
period
Future
period
Dec,31,B/S dateDec,31,B/S date
going concern
(business will not stop)
4
Review,Revenue Recognition Principle
Revenue is recorded at the time it is
earned regardless of whether cash or
another asset has been exchanged.
5
Review,Matching Principle
Expenses are to be matched in the same
accounting period as the revenues they
helped to earn.
6
Accrual and cash basis
The accrual basis of accounting matches
revenues earned with expenses incurred.
The cash basis matches revenues received
with expenses paid,It is not satisfactory for
most businesses because it results in
financial statements that are not
comparable from period to period,except
when the amounts of prepaid,unearned,
and accrued items are not material.
7
Adjust,A Step in Accounting cycle
1,Analyze Transactions
2,Journalize
3,Post
4,Unadjusted trial balance
5,Adjust
6,Adjusted trial balance
7,Prepare finance statements
8.Close
Now that we have
covered the trial
balance,let’s
discuss adjusting
entries.
8
Why Need to Adjust
Some events are not evidenced by the obvious
documents,the effects of these events are recorded
at the end of the accounting period by means of
adjusting entries.
The purpose of adjusting the accounts at the end
of period is to make the accounting information
comparable from period to period.
9
Why Need to Adjust
Adjustments are based on three generally
accepted accounting principles:
Time period principle.
Revenue recognition principle.
Matching principle.
10
Type of Adjusting Entries
Adjusting
entries
Accruing unrecorded
revenues
Converting liabilities to
revenues
Accruing unrecorded
expenses
Converting assets to
expenses
11
Adjusting Entries – Accruals
Accruals occur when revenues have been
earned or expenses incurred but no cash
has been exchanged.
End of
accounting period.
Cash receivedRevenues earned
Example,interest revenue earned during the
period but not received until the next period.
12
Adjusting Entries – Accruals
Example,On Jun 1,2004,Smith Inc,invests
$100,000 for a bonds which pays 5% interest per
year,Smith Inc,will not receive the interest until
March 31,2005,On December 31,2004,Smith,
Inc,need to make the following entry for the
interest earned so far.
D a te D e s c r i p ti o n D e b i t C r e d i t
D e c 31 I n te r e s t R e c e i v a b l e 2 9 1 6,6 7
I n te r e s t R e v e n u e 2 9 1 6,6 7
G EN ER A L J O U R N A L
$100000 × 5% × 7/ 12 = $2916,67
r e c or d t he e a r ne d i nt e r e s t r e v e nue
13
Adjusting Entries – Accrued
Unrecorded expenses incurred
End of
accounting period.
Cash paidExpense incurred
Example,wages should be paid to employees during this
period but not paid until the next period.
14
Adjusting Entries – Accrued
D a te D e s c r i p ti o n D e b i t C r e d i t
D e c 31 W a g e s Ex p e n s e 3 5,0 0 0
W a g e s Pa y a b l e 3 5,0 0 0
G EN ER A L J O U R N A L
re c o rd t h e w a g e e x p e n s e
Example,On the year-end,Dec,31,2004,Smith Inc.’s
employees have earned total wages of $35,000 for the
Monday,but Smith Inc,will not pay the wages until 5th of
next month,So at the end of the accounting period,Smith
need to make the following entries to accrued the wage
expenses.
15
Adjusting Entries – Deferrals
Prepaid expense is used up
Paid cash for
12 month’s rent < from July 2004 to June 2005 >
7/1/04 12/31/04
Year end
6/30/05
16
Adjusting Entries – Deferrals
Example,On July 1,2004,Smith Inc,paid $20000 for
whole year’s rent covered from 1stof July to 30th of June,
At the end of 2004,$10000 of rent expenses have
occurred so Smith Inc,need to make the following
entries to transfer the deferrals to expenses.D a te D e s c r i p ti o n D e b i t C r e d i t
D e c 31 r e n t Ex p e n s e 1 0,0 0 0
p r e p a i d e x p e n s e 1 0,0 0 0
G EN ER A L J O U R N A L
re c o rd t h e re n t e x p e n s e
17
Adjusting Entries – Deferrals
End of
accounting period.
Cash received Revenues earned
Example,service revenue received in advance.
Converting liabilities to revenues:
18
Adjusting Entries – Deferrals
Example,On Oct,1,2004,Smith Inc,signed a contract for
providing a special service to Cone,Smith received $50000 for
the service to be provided,At the end of 2004 half of the
services have been proved to Cone,Smith should make the
following entries to record earned revenue.
D a te D e s c r i p ti o n D e b i t C r e d i t
D e c 31 2 5,0 0 0
Se r v i c e R e v e n u e 2 5,0 0 0
G EN ER A L J O U R N A L
U n e a r n e d R e v e n u e
r e c o r d th e e a r n e d r e v e n u e
19
Adjust,Allocating the Costs of
long-term assets
Certain circumstances require adjusting
entries to record accounting estimates,
Amortization is an example,
Amortization is the process of allocating the
costs of assets over their useful lives.
20
Amortization
Companies acquire capital assets such as equipment,
buildings,vehicles,and patents to generate revenues.
These assets are expected to provide benefits for more
than one period.
The accounting concept of amortization involves
the systematic and rational allocation of cost of a
long-lived asset to the periods during which it is
used to generate revenue.
21
Amortization
On January 1,2004,a company purchased a piece of
equipment for $100,000,The equipment is expected to
have a useful life of five years and have a salvage value of
$5000.Asume the company use the straight-line method.
Asset Cost - Salvage Value
Useful Life
Straight-Line
Amortization
Expense
=
=
$100000 - $5,000
5 years
= $19000/year
22
Amortization
The required journal entry includes a debit
to Amortization expense and a credit to an
account called accumulated amortization.
D a te D e s c r i p ti o n D e b i t C r e d i t
Dec,31 A m o r ti za ti o n Ex p e n s e 1 9,0 0 0
A c c u m u l a te d A m o r ti za ti o n 1 9,0 0 0
G EN ER A L J O U R N A L
re co rd t h e a mo rt i z a t i o n e xp e n se s
23
Adjusted Trial Balance
The adjusted trial balance is used to check if there
are any mistakes in the adjusted accounts and it is
used for the financial statement.
Assume that Smith Inc,has the following
unadjusted trial balance:
24
Adjusted Trial Balance
Debit Credit
Cash 171000
Short-term investment 100000
Accounts Receivable 36000
Prepaid Expense 20000
Inventory 20000
Plant and Equipmemt 250000
Accounts Payable 50000
Unearned Revenue 50000
Paid Capital 500000
Sales Revenue 36000
Cost of Sales 30000
Operating expenses 9000
total 636000 636000
Accounts
unadjusted trial balance
SMITH Inc.
for the year ended Dec.31
25
Adjusted trial balance
Debit Credit Debit Credit Debit Credit
Cash 171000 171000
Short-term investment 100000 100000
Accounts Receivable 36000 36000
Interest receivable 2916.67 2916.67
Prepaid Expense 20000 10000 10000
Inventory 20000 20000
Plant and Equipmemt 250000 250000
Accumulated Depreciation 2600 2600
Accounts Payable 50000 50000
Wages payable 35000 35000
Unearned Revenue 50000 25000.00 25000.00
Paid Capital 500000 500000
Sales Revenue 36000 25000 61000
Interest Revenue 2916.67 2916.67
Cost of Sales 30000 30000
Operating expenses 9000 47600.00 56600.00
total 636000 636000 75516.67 75516.67 676516.67 676516.67
for the year ended Dec.31
Adjusting Entries
SMITH Inc.
Adjusted trial balance
Accounts
unadjusted trial balance
26
Adjustments & Financial
Statements
Adjusting entries bring the accounts up-to-date.
Adjustments are only made when financial
statements are prepared.
Adjust entries will affect both the income
statement and the balance sheet.
Will not affect the cash flow of the company.
The End of Lesson 4
