Adjustment: Recognizing Unrecorded Expenses (Accrued Expenses)

Type 2 Adjustment: Recognizing Unrecorded Expenses (Accrued Expenses)

Study Note

The Adjustment Process

FIGURE 3-4 Adjustment for Unrecorded (Accrued) Expenses

BALANCE SHEET Liability

2. Recognizing unrecorded expenses. Liability Account

Expense Account

Adjusting N

I Asset

Adjusting

Entry

Entry C

Debit O

Credit

1. Allocating recorded M

Expense costs between two E or more accounting

Amount equals cost

periods.

of expense incurred.

STAT

4. Recognizing

3. Allocating recorded,

E Revenue unrecorded,

unearned revenues

M earned revenues.

between two or more

EN

accounting periods.

expense of the period, and the corresponding liability to pay the interest. Other common unrecorded expenses are wages, taxes, and utilities. As the expense and the corresponding liability accumulate, they are said to accrue—hence, the term

accrued expenses.

To illustrate how an adjustment is made for unrecorded wages, suppose Miller Design Studio, Inc. has two pay periods a month rather than one. In July, its pay periods end on the 12th and the 26th, as indicated in this calendar:

By the end of business on July 31, Miller’s assistant will have worked three days (Monday, Tuesday, and Wednesday) beyond the last pay period. The employee has earned the wages for those days but will not be paid until the first payday in August. The wages for these three days are rightfully an expense for July, and the liabilities should reflect that the company owes the assistant for those days. Because the assistant’s wage rate is $2,400 every two weeks, or $240 per day ($2,400 ⫼ 10 working days), the expense is $720 ($240 ⫻ 3 days).

CHAPTER 3 Measuring Business Income

Application of Double Entry:

Assets ⫽

Liabilities

Stockholders’ Equity

W AGES P AYABLE W AGES E XPENSE

Dr. Cr.

Dr. Cr.

July 31 720 July 26 4,800

Entry in Journal Form :

Dr. Cr. July 31 Wages Expense

Wages Payable

Comment: Note that the increase in Wages Expense will decrease stockholders’ equity and that total wages for the month are $5,520, of which $720 will be paid next month.

As a corporation, Miller Design Studio, Inc. is subject to federal income taxes. Although the actual amount owed for taxes cannot be determined until after net income is computed at the end of the fiscal year, each month should bear its part of the total year’s expense, in accordance with the matching rule. Therefore, the amount of income taxes expense for the current month must be estimated. Assume that after analyzing the firm’s operations in its first month of business and conferring with its CPA, the company estimates July’s share of income taxes for the year to be $800.

Adjustment for Estimated Income Taxes

July 31: Accrual of estimated income taxes, $800 Analysis: Accrual of income taxes increases the stockholders’ equity account

Income Taxes Expense with a debit and increases the liability account Income Taxes Payable with a credit.

Application of Double Entry:

Assets ⫽

Liabilities

Stockholders’ Equity

I NCOME T AXES P AYABLE I NCOME T AXES E XPENSE

Entry in Journal Form :

Dr. Cr. July 31 Income Taxes Expense

Income Taxes Payable

Comment: Note that the increase in Income Taxes Expense will decrease stock-

The Adjustment Process

income statement. The end result would be an overstatement of the company’s earnings.