Chapter 5

Adjusting
Accounts and Preparing
Financial Statements

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

LO1

Learning Objective 1
Explain
accounting
and
how
it
Accrual
basisaccrual
accounting
Cash
basis
accounting
improves
financial
uses
the adjusting
processstatements.
to
recognizes revenue when
recognize revenues when
cash is received and
earned and expenses when
records expenses when
incurred.
cash is paid.
It is commonly held that accrual accounting better
reflects business performance than cash basis
accounting.
As an example, consider FastForwards Prepaid Insurance account.
FastForward paid $2,400 for 24 months of insurance coverage beginning
December 1, 2010. Accrual accounting requires that $100 of insurance
expense be reported on December 2010s income statement keeping the
accounts more accurate.
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LO2

Learning Objective 2
Identify
the types of accounting adjustments and
their
purpose.
Reflects unearned
Reflects
transactions
revenues and prepaid
expenses.

Adjustments

Cash before work

(Deferrals)

Unearned
(Deferred)
revenues

Prepaid
(deferred)
expenses

when cash is paid or

received after a related
expense or revenue is
recognized.

Work before cash

(Accruals)

Accrued
revenues

Accrued
expenses

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LO3

Learning Objective 3
Prepare and explain adjusting entries.
An adjusting entry is recorded to bring an asset or
liability account balance to its proper amount. This
entry also updates a related expense or revenue
account.
Three-step Process
1. Determine the current account
balance.
2. Determine what the current account
balance should be.
3. Record the adjusting journal entry to
get from step 1 to step 2.
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LO3

Prepaid Expenses
Resources paid
for prior to
receiving the
actual benefits.
Asset
Unadjusted
Balance

Credit
Adjustment

Remember that a
prepaid expense is an
asset that results from
the payment of cash
before the expense is
recognized.

Expense
Debit
Adjustment

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LO3

Prepaid Insurance
On December 1, 2010, FastForward paid $4,800 for
insurance for 24 months. FastForward recorded the
expenditure as Prepaid Insurance on December 1.
What adjustment is required?

637

128

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LO3

Supplies
During December, FastForward purchased $9,720 of
supplies. FastForward recorded the expenditures with
a debit to Supplies. On December 31, a count of the
supplies indicated $8,670 on hand.

Dec. 31 Supplies Expense

Supplies

1,050
1,050

To record supplies used during December

Bought
Bal.

Supplies
9,720 Dec. 31
8,670

126

1,050

Supplies Expense
Dec. 31
1,050

652

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LO3

Depreciation
Depreciation is the process of spreading the
costs of plant and equipment over their
expected useful lives.
Straight-Line
Asset Cost - Salvage Value
Depreciation =
Useful Life
Expense

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LO3

Depreciation
FastForward purchased equipment for $20,000
in early December. The equipment is expected
to have a useful life of four years and a salvage
value of $8,000.
Monthly
$20,000 - $8,000
Depreciation =
=
Expense
48 months

$250

Accumulated
Accumulated depreciation
depreciation is
is
aa contra
contra asset
asset account.
account.
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LO3

Depreciation
Notice the contraaccount, accumulated
depreciation, will be
shown as a reduction
in the cost of the
asset

Equipment is shown net of

accumulated depreciation.
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LO3

Accrued Salaries Expense

FastForwards
FastForwards employee
employee earns
earns $70
$70 per
per day,
day,or
or $350
$350 for
for aa five-day
five-day
workweek
workweek beginning
beginning on
on Monday
Monday and
and ending
ending on
on Friday.
Friday. This
This employee
employee is
is
paid
paid every
every two
two weeks
weeks on
on Friday.
Friday. On
On December
December 12
12 and
and 26,
26, the
the wages
wages are
are
paid,
paid, recorded
recorded in
in the
the journal,
journal, and
and posted
posted to
to the
the ledger.
ledger. At
At December
December 31,
31,
the
the employee
employee has
has worked
worked for
for three
three days
days for
for FastForward
FastForward and
and will
will be
be paid
paid
on
on January
January 9,
9, 2011.
2011.
Last pay
date
12/26/10

Next pay
date
1/9/11

12/31/10
Year end
Dec. 31 Salaries Expense
Salaries Payable

Record
Record adjusting
adjusting
journal
journal entry
entry..

210
210

To accrue three days' salary

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Learning Objective 4
Explain and prepare an adjusted trial balance.

LO4

An adjusted trial balance is a list of accounts and balances prepared after adjusting
entries have been recorded and posted to the ledger.

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LO5

LearningNotice
Objective
5
how we took the information directly from the

Prepare financial
statements
from
an statement.
adjusted trial
worksheet
and prepared the
income
balance.

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LO5

Preparing Financial Statements

Note: Investment by owner
and withdrawals by owner
come from the adjusted
trial balance.

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LO5

Preparing Financial Statements

Notice assets and liabilities balances are transferred
over from the adjusted trial balance to the Balance
Sheet.

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End of Chapter 5

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