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Financial Accounting
IFRS 4th Edition
Weygandt ● Kimmel ● Kieso

Chapter 3

Adjusting the Accounts

Chapter Preview
In Chapter 1, you learned a neat little formula:
Net income = Revenues – Expenses.
In Chapter 2, you learned some rules for recording revenue and
expense transactions.
Guess what?
Things are not really that nice and neat. In fact, it is often difficult
for companies to determine in what time period they should report
some revenues and expenses. In other words, in measuring net
income, timing is everything.

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Chapter Outline

The learning objectives for Appendix A and B follow below the chapter slides.

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

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Accrual-Basis Accounting and

Adjusting Entries
Time period (or periodicity) assumption:
Accountants divide the economic life of a business into artificial
time periods.

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Fiscal and Calendar Years

• Accounting time periods are generally a month, a quarter, or a
year.
• 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.
• Sometimes a company’s year-end will vary from year to year,
resulting in accounting periods of either 52 or 53 weeks.

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Accrual- versus Cash-Basis Accounting

Accrual-Basis Accounting
• Transactions are 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).
• Accrual-basis accounting is in accordance with IFRS.

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Accrual- versus Cash-Basis Accounting

Cash-Basis Accounting
• Revenues are recorded when cash is received.
• Expenses are recorded when cash is paid.
• Cash-basis accounting is not in accordance with IFRS.

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Accrual- versus Cash-Basis Accounting

Example: Followings are transactions occurred in August 20X8:
1. Sent out an invoice for $5,000 for a web design project
completed this month
2. Received a bill for $1,000 in developer fees for work done this
month
3. Paid $75 in fees for a bill you received last month
4. Received $1,000 from a client for a project that was invoiced last
month
Calculating the company’s profit or loss in August 20X8 based on:
- Accruals basis
- Cash basis

LO 2

Recognizing Revenues and Expenses

REVENUE RECOGNITION PRINCIPLE

Recognize revenue in the accounting

period in which the performance
obligation is satisfied.
Example: Dave’s Dry Cleaning cleans
clothing on June 30 but customers do not
claim and pay for their clothes until the
first week of July.
When should Dave recognize the
revenue?

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Recognizing Revenues and Expenses

EXPENSE RECOGNITION PRINCIPLE

Match expenses with revenues in the

period when the company makes efforts
to generate those revenues.

“Let the expenses follow the revenues.”

Example: Dave’s Dry Cleaning cleans

clothing on June 30. Dave’s does not pay
the salary incurred on June 30 until July.

When should Dave recognize the salary

expense?

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Recognizing Revenues and Expenses

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DO IT! Timing Concepts

Continues on next slide

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The Need for Adjusting Entries

• Adjusting entries ensure that the revenue
recognition and expense recognition principles are
followed.
• Required every time a company prepares financial
statements.
• Will include one income statement account and one
statement of financial position account.

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The Need for Adjusting Entries

Reasons:
1. Some events are not recorded daily because it is not
efficient to do so.
2. Some costs are not recorded during the accounting
period because these costs expire with the passage
of time rather than as a result of recurring daily
transactions.
3. Some items may be unrecorded.

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Types of Adjusting Entries

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Learning Objective 2
Prepare adjusting entries for deferrals.

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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, and
• Unearned revenues.

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Prepaid Expenses
Prepaid expenses are costs that expire either with the passage of
time (e.g., rent and insurance) or through use (e.g., supplies).

Prior to adjustment, assets are overstated and expenses are

understated.

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Supplies

Rather than record supplies expense as the supplies are used,

companies recognize supplies expense at the end of the
accounting period.
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Supplies
Assume: Yazici Advertising purchased supplies costing 2,500 on
October 5. Yazici recorded the purchase 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.

Demonstrate: How do you record the adjustment for supplies?

Continues on next slide

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Supplies

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Insurance

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Insurance
Assume: 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.

Demonstrate: How do you record the adjustment for

insurance?

Continues on next slide

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Insurance

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Depreciation
Depreciation is the process of allocating the
cost of an asset to expense over its useful
life.

Depreciation is an allocation concept, not a

valuation concept.

That is, depreciation allocates an asset’s

cost to the periods in which it is used.

Depreciation does not attempt to report the

actual change in the value of the asset.

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Depreciation
Assume: For Yazici Advertising, depreciation on the equipment is
480 a year, or 40 per month.

Demonstrate: How do you record the adjustment for

depreciation?

Continues on next slide

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Depreciation

HELPFUL HINT
All contra accounts
have increases,
decreases, and
normal balances
opposite to the
account to which
they relate.

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Prepaid Expenses
Statement Presentation.

1 Book value or carrying value: Difference between the cost of any

depreciable asset and its related accumulated depreciation

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Prepaid Expenses Summary

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Unearned Revenues

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Unearned Revenues
When companies receive cash before services are performed, they record a
liability by increasing (crediting) a liability account called unearned revenues.

Prior to adjustment, liabilities are overstated and revenues are understated.

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Service Revenue
Assume: Yazici Advertising received 1,200 on October 2 from R.
Knox for advertising services expected to be completed by
December 31. Yazici credited the payment to Unearned Service
Revenue. This liability account shows a balance of 1,200 in the
October 31 trial balance.

Demonstrate: How do you record the adjustment for advertising

revenue?

Continues on next slide

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Service Revenue

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Unearned Revenues

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Learning Objective 3
Prepare adjusting entries for accruals.

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Adjusting Entries for Accruals

Accruals are made to record the following:

• Revenues for services performed but not yet recorded at the
statement date – accrued revenues
or
• Expenses incurred but not yet paid or recorded at the
statement date – accrued expenses

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Accrued Revenues

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Accrued Revenues

Prior to adjustment, both assets and revenues are understated.

An adjusting entry for accrued revenues results in an increase (a debit) to an asset

account and an increase (a credit) to a revenue account.

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Accrued Revenues
Assume: In October, Yazici Advertising performed
services worth 200 that were not billed to clients on or
before October 31. Because these services were not
billed, they were not recorded.

Demonstrate: How do you adjust for accrued revenue?

Continues on next slide

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Accrued Revenues

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Accrued Revenues
Assume: On November 10, Yazici receives cash of 200
for the services performed in October and makes the
following entry.

Demonstrate: How do you record the collection of the

receivables?

Continues on next slide

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Accrued Revenues

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Accrued Revenues - Summary

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Accrued Expenses

Prior to adjustment, both liabilities and expenses are understated.

An adjusting entry for accrued expenses results in an increase (a debit) to an expense

account and an increase (a credit) to a liability account.

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Accrued Interest
Assume: 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%.

Demonstrate:
(1) How do you determine the interest to be recorded?
(2) How do you create the adjustment for accrued
interest?

Continues on next slide

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Accrued Interest

Continues on next slide

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Accrued Interest

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Accrued Salaries and Wages

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Accrued Salaries and Wages

Assume: At October 31, the salaries and wages for these
three days represent an accrued expense and a related
liability to Yazici. The employees receive total salaries
and wages of 2,000 for a five-day work week, or 400 per
day. Thus, accrued salaries and wages at October 31 are
1,200 ( 400 × 3).

Demonstrate: How do you create the adjustment for

accrued salaries and wages?

Continues on next slide

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Accrued Salaries and Wages

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Accrued Salaries and Wages

Assume: Yazici pays salaries and wages every two weeks.
Consequently, the next payday is November 9, when the company
will again pay total salaries and wages of 4,000. The payment
consists of 1,200 of salaries and wages payable at October 31 plus
2,800 of salaries and wages expense for November (7 working
days, as shown in the November calendar × 400).

Demonstrate: Which entry does Yazici make on November 9?

Continues on next slide

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Accrued Salaries and Wages

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Accrued Expenses - Summary

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Adjusting Entries
1) Adjusting entries should not involve debits or credits to
Cash.
2) Evaluate whether the adjustment makes sense. For example,
an adjustment to recognize supplies used should increase
Supplies Expense.
3) Double-check all computations.
4) Each adjusting entry affects one statement of financial
position account and one income statement account.

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Summary of Basic Relationships

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Summary of Basic Relationships

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DO IT! Adjusting Entries for Accruals

ACTION PLAN
• Make adjusting entries at the end of the period to recognize revenues for services
performed and for expenses incurred.
• Don’t forget to make adjusting entries for accruals. Adjusting entries for accruals will
increase both a statement of financial position account and an income statement
account.

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Learning Objective 4
Describe the nature and purpose of an
adjusted trial balance.

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Adjusted Trial Balance and

Financial Statements

Adjusted trial balance:

• Proves the equality of the total debit balances and the total
credit balances in the ledger after all adjustments.
• Primary basis for the preparation of financial statements.

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Preparing the Adjusted Trial Balance

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Preparing Financial Statements (1/2)

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Preparing Financial Statements (2/2)

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Preparing Financial Statements (2/2)

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DO IT! Trial Balance

Continues on next slide

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