CH 03

3-1
Chapter 3 Adjusting the Accounts

Learning Objectives
After studying this chapter, you should be able to:
1. Explain the time period assumption.
2. Explain the accrual basis of accounting.
3. Explain the reasons for adjusting entries.
4. Identify the major types of adjusting entries.
5. Prepare adjusting entries for deferrals.
6. Prepare adjusting entries for accruals.
7. Describe the nature and purpose of an adjusted trial balance.
3-2
Preview of Chapter 3
Financial Accounting
IFRS Edition, 2e
Weygandt Kimmel Kieso
3-3
Timing Issues
Accountants divide the economic life of a business into

artificial time periods (Time Period Assumption).
.....
Jan. Feb. Mar. Apr. Dec.
Generally a month, a quarter, or a year.
Also known as the Periodicity Assumption
3-4 LO 1 Explain the time period assumption.

Timing Issues
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.

Timing Issues
Question
The time period assumption states that:
a. revenue should be recognized in the accounting
period in which a performance obligation is satisfied.
b. expenses should be matched with revenues.
c. the economic life of a business can be divided into

artificial time periods.
d. the fiscal year should correspond with the calendar

year.

Timing Issues
Accrual- vs. Cash-Basis Accounting

Accrual-Basis Accounting
Transactions recorded in the periods in which the
events occur.
Revenues are recognized when the services are

performed, rather than when cash is received.
Expenses are recognized when incurred, rather than

when paid.
3-7 LO 2 Explain the accrual basis of accounting.

Timing Issues
Accrual- vs. 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).

Timing Issues
Recognizing Revenues and Expenses

Revenue Recognition Principle
Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.
In a service enterprise,
revenue is considered to be
earned at the time the service
is performed.

Timing Issues
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.

Timing Issues
Illustration 3-1
IFRS relationships in revenue
and expense recognition

Timing Issues
Question
Which of the following statements about the accrual basis of
accounting is false.
a. Events that change a companys 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. The accrual basis is in accord with IFRS.
d. Revenue is recorded only when cash is received, and
expenses are recorded only when cash is paid.

A list of concepts is provided in the left column below, with a
description of the concept in the right column below. There are more
descriptions provided than concepts. Match the description of the
concept to the concept.
f
e
c
b
3-14 LO 2
The Basics of 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

statement of financial position account.
3-15 LO 3 Explain the reasons for adjusting entries.

Question
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 provided.
c. statement of financial position and income statement

accounts have correct balances at the end of an
accounting period.
d. all of the above.

3-16 LO 3 Explain the reasons for adjusting entries.
Types of Adjusting Entries

Illustration 3-2
Categories of adjusting entries
Deferrals Accruals
1. Prepaid Expenses. 3. Accrued Revenues.
Expenses paid in cash before Revenues for services
they are used or consumed. performed but not yet
received in cash or recorded.
2. Unearned Revenues. 4. Accrued Expenses.

Cash received before services Expenses incurred but not yet
are performed. paid in cash or recorded.
3-17 LO 4 Identify the major types of adjusting entries.

Types of Adjusting Entries
Trial Balance
Each account is
analyzed to
determine whether
it is complete and
up-to-date.
Illustration 3-3
3-18 LO 4 Identify the major types of adjusting entries.

Adjusting Entries for Deferrals

Deferrals are either:
Prepaid expenses
OR
Unearned revenues.
3-19 LO 5 Prepare adjusting entries for deferrals.

Prepaid Expenses
Payment of cash, that is recorded as an asset because
service or benefit will be received in the future.
Cash Payment BEFORE Expense Recorded
Prepayments often occur in regard to:

insurance rent
supplies equipment
advertising buildings

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

Illustration: Pioneer Advertising Agency

purchased supplies costing $2,500 on
October 5. Pioneer 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

Illustration 3-5
3-23 LO 5
Illustration: On October 4, Pioneer

Advertising paid $600 for a one-year fire
insurance policy. Coverage began on
October 1. Pioneer 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

Illustration 3-6
3-25 LO 5
Depreciation
Buildings, equipment, and vehicles (assets with long
lives) are recorded as assets, rather than an expense,
in the year acquired.
Depreciation allocates a portion of the assets cost as

an expense during each period of the assets useful life.
Depreciation does not attempt to report the actual

change in the value of the asset.

Illustration: For Pioneer 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.

Illustration 3-7
3-28 LO 5
Statement Presentation
Accumulated Depreciation is a contra asset account
(credit).
Appears just after the account it offsets (Equipment) on
the statement of financial position.
Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.
Illustration 3-8

Illustration 3-9

Unearned Revenues
Receipt of cash that is recorded as a liability because service
has not be performed.
Cash Receipt BEFORE Revenue Recorded
Unearned revenues often occur in regard to:

Rent Magazine subscriptions
Airline tickets Customer deposits

Unearned Revenues
Adjusting entry is made to record the revenue for
services performed and to show the liability that remains.
Results in a decrease (debit) to a liability account and

an increase (credit) to a revenue account.
Illustration 3-10

Illustration: Pioneer 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 earned $ 400 of those fees in October.
Oct. 31 Unearned service revenue 400

Service revenue 400

Illustration 3-11
3-34 LO 5
Illustration 3-12

3-36 LO 5
Adjusting Entries for Accruals

Accruals are made to record
Revenues for services performed
OR
Expenses incurred
in the current accounting period that have not been

recognized through daily entries.
3-37 LO 6 Prepare adjusting entries for accruals.

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:

Interest Rent
Services performed

Accrued Revenues
Adjusting entry shows 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
3-39 LO 6
Illustration: In October Pioneer Advertising

Agency recognized $200 for advertising
services performed but not recorded.
Oct. 31
Accounts receivable 200

Service revenue 200
On November 10, Pioneer receives cash of $

200 for the services performed.
Nov. 10 Cash 200

Accounts receivable 200
Illustration 3-14
3-41 LO 6
Illustration 3-15

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

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
3-44 LO 6
Illustration: 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%.
Illustration 3-17
Oct. 31 Interest expense 50

Interest payable 50

Illustration 3-18
3-46 LO 6
Illustration: Pioneer Advertising last paid salaries 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. Thus, accrued salaries at October 31 are
$1,200 ($ 400 x 3 days).
Illustration 3-19

Illustration 3-20
3-48 LO 6
Illustration 3-21

Micro Computer Services Inc. began operations on August 1,
2014. At the end of August 2014, management attempted to
prepare monthly financial statements. The following information
relates to August. Prepare the adjusting journal entries needed at
August 31, 2014. (Amounts are in Chinese yuan.)
1. At August 31, the company owed its employees 8,000 in

salaries and wages that will be paid on September 1.
Salaries and wages expense 8,000

Salaries and wages payable 8,000
3-51 LO 6
2. At August 1, the company borrowed 300,000 from a local

bank on a 15-year mortgage. The annual interest rate is 10%.
Interest expense ( 300,000 x 10% x 1/12) 2,500

Interest payable 2,500
3-52 LO 6
3. Revenue for services performed but unrecorded for August

totaled 11,000.
Accounts receivable 11,000

Service revenue 11,000
3-53 LO 6
Summary of Basic Relationships

Illustration 3-22

The Adjusted Trial Balance
Adjusted Trial Balance

Prepared after all adjusting entries are journalized and
posted.
Purpose is to prove the equality of debit balances and

credit balances in the ledger.
Is the primary basis for the preparation of financial

statements.
3-55 LO 7 Describe the nature and purpose of an adjusted trial balance.

Illustration 3-25
3-56
The Adjusted Trial Balance
Question
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.
3-57 LO 7
Preparing Financial Statements
Financial Statements are prepared directly from the

Adjusted Trial Balance.
Retained Statement
Income
Earnings of Financial
Statement
Statement Position
3-58 LO 7 Describe the nature and purpose of an adjusted trial balance.

Illustration 3-26
3-59 LO 7
Illustration 3-27
3-60 LO 7
APPENDIX 3A
Alternative Treatment of Prepaid Expenses and

Unearned Revenues
When a company prepays an expense, it debits that
amount to an expense account.
When a company receives payment for future

services, it credits the amount to a revenue account.
3-61 LO 8 Prepare adjusting entries for the alternative treatment of deferrals.

APPENDIX 3A
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

APPENDIX 3A
Unearned Revenues
Company may credit (increase) a revenue account when they
receive cash for future services.
Illustration 3A-5

APPENDIX 3A
Summary of Additional Adjustment Relationships

Illustration 3A-7

APPENDIX 3B CONCEPTS IN ACTION
Qualities of Useful Information

Illustration 3B-1
3-65 LO 9 Discuss financial reporting concepts.

Enhancing Qualities
Comparability
Consistency
Verifiability
Timeliness
Understandability

Illustration 3B-2
Assumptions
in Financial
Reporting
3-67 LO 9
Illustration 3B-2
Assumptions
in Financial
Reporting
3-68 LO 9
Principles of Financial Reporting

Measurement Principles
Historical Cost Principle

Fair Value Principle
Revenue Recognition Principle
Expense Recognition Principle
Full Disclosure Principle

Principles of Financial Reporting

Constraints in Financial Reporting
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.
3-70 LO 9
Copyright
Copyright 2013 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility for
errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.
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3-1

Chapter 3 Adjusting the Accounts

1. Explain the time period assumption.

2. Explain the accrual basis of accounting.

3. Explain the reasons for adjusting entries.

4. Identify the major types of adjusting entries.

5. Prepare adjusting entries for deferrals.

6. Prepare adjusting entries for accruals.

7. Describe the nature and purpose of an adjusted trial balance.

Accountants divide the economic life of a business into

Generally a month, a quarter, or a year.

Also known as the Periodicity Assumption

3-4 LO 1 Explain the time period assumption.

Fiscal and Calendar Years

Most large companies must prepare both quarterly and

Fiscal Year = Accounting time period that is one year in

Calendar Year = January 1 to December 31.

3-5 LO 1 Explain the time period assumption.

b. expenses should be matched with revenues.

c. the economic life of a business can be divided into

d. the fiscal year should correspond with the calendar

3-6 LO 1 Explain the time period assumption.

Accrual- vs. Cash-Basis Accounting

Revenues are recognized when the services are

Expenses are recognized when incurred, rather than

3-7 LO 2 Explain the accrual basis of accounting.

Accrual- vs. Cash-Basis Accounting

Expenses recognized when cash is paid.

Cash-basis accounting is not in accordance with

3-8 LO 2 Explain the accrual basis of accounting.

Recognizing Revenues and Expenses

3-9 LO 2 Explain the accrual basis of accounting.

Recognizing Revenues and Expenses

Let the expenses follow

3-10 LO 2 Explain the accrual basis of accounting.

3-11 LO 2 Explain the accrual basis of accounting.

3-13 LO 2 Explain the accrual basis of accounting.

Necessary because the trial balance may not contain

Required every time a company prepares financial

Will include one income statement account and one

3-15 LO 3 Explain the reasons for adjusting entries.

a. expenses are recognized in the period in which they

b. revenues are recorded in the period in which services

c. statement of financial position and income statement

d. all of the above.

Types of Adjusting Entries

2. Unearned Revenues. 4. Accrued Expenses.

3-17 LO 4 Identify the major types of adjusting entries.

Types of Adjusting Entries

3-18 LO 4 Identify the major types of adjusting entries.

Adjusting Entries for Deferrals

3-19 LO 5 Prepare adjusting entries for deferrals.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

3-20 LO 5 Prepare adjusting entries for deferrals.

Decrease (credit) to an asset account.

3-21 LO 5 Prepare adjusting entries for deferrals.

Illustration: Pioneer Advertising Agency

Oct. 31 Supplies expense 1,500

3-22 LO 5 Prepare adjusting entries for deferrals.

Illustration: On October 4, Pioneer

Oct. 31 Insurance expense 50

3-24 LO 5 Prepare adjusting entries for deferrals.