Chapter 3 The Adjusting Process
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The Adjusting Process
At the end of the accounting period, many of the account balances in the ledger are reported in the financial statements without change. For example, the balances of
the cash and land accounts are normally the amounts reported on the balance sheet. Some accounts, however, require updating
for the following reasons:
1
1. Some expenses are not recorded daily. For example, the daily use of supplies would require many entries with small amounts. Also, the amount of supplies on hand on
a day-to-day basis is normally not needed. 2. Some revenues and expenses are incurred as time passes rather than as separate
transactions. For example, rent received in advance unearned rent expires and becomes revenue with the passage of time. Likewise, prepaid insurance expires and
becomes an expense with the passage of time. 3. Some revenues and expenses may be unrecorded. For example, a company may have
provided services to customers that it has not billed or recorded at the end of the ac- counting period. Likewise, a company may not pay its employees until the next account-
ing period even though the employees have earned their wages in the current period.
The analysis and updating of accounts at the end of the period before the finan- cial statements are prepared is called the adjusting process. The journal entries that
bring the accounts up to date at the end of the accounting period are called adjust- ing entries
. All adjusting entries affect at least one income statement account and one balance sheet account. Thus, an adjusting entry will always involve a revenue
or an expense account and an asset or a liability account.
Example Exercise
3-1 Accounts Requiring Adjustment
Indicate with a Yes or No whether or not each of the following accounts normally requires an adjusting entry. a. Cash
c. Wages Expense e. Accounts Receivable
b. Prepaid Rent d. Land
f. Unearned Rent
Follow My Example 3-1
a. No c. Yes
e. Yes b. Yes
d. No f. Yes
Practice Exercises: PE 3-1A, PE 3-1B
Example Exercise
3-1 Accounts Requiring Adjustment
Types of Accounts Requiring Adjustment
Four basic types of accounts require adjusting entries as shown below.
1. Prepaid expenses 3. Accrued revenues
2. Unearned revenues 4. Accrued expenses
Prepaid expenses are the advance payment of future expenses and are recorded
as assets when cash is paid. Prepaid expenses become expenses over time or dur- ing normal operations. To illustrate, the following transaction of
NetSolutions
from Chapter 2 is used.
Dec. 1 NetSolutions paid 2,400 as a premium on a one-year insurance policy. On December 1, the cash payment of 2,400 was recorded as a debit to Prepaid Insur-
ance and credit to Cash for 2,400. At the end of December, only 200 2,400 divided
1 Under the cash basis of accounting, accounts do not require adjusting. This is because transactions are recorded only when cash is received or paid. Thus, the matching concept is not used under the cash basis.
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Chapter 3 The Adjusting Process
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