The Adjusting
Process
Chapter 3
©2014 Pearson Education, Inc. Publishing as Prentice Hall 3-1
Completing the Accounting cycle
6-Preparing 7-Preparing
5-Adjusting
adjusted financial
entries
trial balance statements
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The Need for Adjusting Entries
Adjusting entries update accounting records at the end of a period .
These entries are necessary to ensure the income statement and balance
sheet present the correct, up-to-date numbers. Adjusting entries are also
necessary because the initial trial balance may not contain complete and
current data due to several factors such as:
• The inefficiency of recording every single day-to-day event, such as the
use of supplies.
• Some costs are not recorded during the period but must be recognized
at the end of the period, such as depreciation, rent, and insurance.
• Some items are forthcoming for which original source documents have
not yet been received.
There are a few other guidelines that support the
need for adjusting entries:
©2014 Pearson Education, Inc. Publishing as Prentice Hall 3-3
Cash Basis and Accrual basis
CASH BASIS ACCRUAL BASIS
• Revenue is recorded • Revenue is recorded
when Cash is when it is earned
received • Expenses are
• Expenses are recorded when
recorded when Cash incurred
is paid • Generally used by
• Not allowed under larger businesses
GAAP
©2014 Pearson Education, Inc. Publishing as Prentice Hall 3-4
The Revenue Recognition Principle
Revenue should be
recorded when it is
EARNED.
A good has
been delivered
or a service
has been
performed.
©2014 Pearson Education, Inc. Publishing as Prentice Hall 3-5
The Matching Principle
Expenses are matched at
Expenses are the end of the period
recorded when against the revenues for
they are that period.
incurred during
the period.
For example, rent expense
for January should be
matched against January
revenues, even if was
actually paid in December.
©2014 Pearson Education, Inc. Publishing as Prentice Hall 3-6
Adjusting Journal Entries
Adjusting Journal Entries (AJE’s) can be
divided into two basic categories:
Prepaids Accruals
1. Prepaid Expenses 1. Accrued revenues
2. Unearned 2. Accrued expenses
Revenues
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Prepaid Expenses
Are assets for which advanced payment has occurred, before the
company can benefit from use. As soon as the asset has provided benefit
to the company, the value of the asset used is transferred from the
balance sheet to the income statement as an expense. Some common
examples of prepaid expenses are supplies, depreciation, insurance, and
rent.
Cash Payment BEFORE Expense Recorded
Prepayments often occur in regard to:
insurance rent
supplies equipment
advertising buildings
LO 2
Supplies
Illustration: Pioneer Advertising
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
LO 2
Insurance
Illustration: On Dec. 1, 2022 Pioneer
Advertising paid $600 for a one-year fire
insurance policy. Coverage began on Dec.
1,2022, Pioneer recorded the payment by
increasing (debiting) Prepaid Insurance. This
account shows a balance of $600 in the Dec.
31 trial balance. Insurance of $50 ($600 ÷ 12)
expires each month.
Dec. 31 Insurance Expense 50
Prepaid Insurance 50
LO 2
Insurance
Illustration 3-6
LO 2
