ACC 211 Chapter 3 – Adjusting Accounts and Preparing Financial Statements
Chapter Notes
These notes are my ramblings of selected topics that are found in this chapter. Please do not substitute
these notes for the text!
This is an important chapter as this chapter will emphasize the accrual method of accounting,
preparation of adjusting journal entries and a classified balance among other topics. Recall from chapter
1 that we keep track of a company’s assets, liabilities and equity items (revenue, expenses, common
stock and dividends) using a worksheet. In chapter 2, we used the rules of double-entry accounting to
record with journal entries and post transactions to ledger accounts. We will continue to record
transactions using the rules of double-entry accounting and introduce adjusting-type journal entries that
are required to make sure all of our ledger account balances re3ect the accrual method of accounting.
This is a difficult chapter as it hinges greatly on your understanding of everything that we have covered
to-date. So make sure you are comfortable with the material that we covered in chapters 1 and 2 before
you start reading the text and other materials that are available to you for this chapter. As always, post
any questions to the Discussion Board.
Reminder – Don’t lose sight of the BIG picture! What accountants do is keep track of the assets, liabilities
and equity of a business in accordance with the generally accepted accounting principles and report the
results in the form of financial statements.
Okay. First thing (rst. Let’s introduce the accrual method of accounting. Recall from earlier chapters that
much of what accountants do is dictated by general accepted accounting principles or GAAP. The only
method of accounting that is allowable under GAAP is the accrual method. The accrual method of
accounting requires that companies record 1) revenues in the period (year) that they are earned,
regardless of when the cash is received, and 2) expenses in the period that they are incurred, regardless
of when the cash is paid. That said, we will have to make “adjusting journal entries” at the end of year, to
make sure that this occurs. As a result, all of the adjusting entries that we will be introduced to in this
chapter will be dated Dec 31 and will impact one income statement account (revenue or expense) and a
balance sheet account (asset or liability). You will never debit or credit the account Cash though.
Knowing this will go a long way to determine what accounts you will debit and credit to record one of
(ve types of adjusting journal entries (AJE).
The (ve types of adjusting journal entries include:
1. Adjusting prepaid expenses, including supplies. Recall from chapter two that when a company
pays for an expense such as rent or insurance in advance, they are to record it to the asset
account prepaid rent or prepaid insurance. Supplies are viewed as prepaid items too as we had
been recorded the cost of supplies to an asset account called supplies. Now, fast forward to
chapter 3! As we received the benefit associated with the rent or insurance that we paid for in
advance (as we occupy the space or receive the insurance coverage) or as we ”use up” supplies,
we need to record an adjusting journal entry that increases an expense account (such as rent
expense, insurance expense or supplies expense) and reduces the asset account (prepaid rent,
prepaid insurance or supplies). So, the adjusting journal entry associated with adjusng prepaid
expenses, including supplies, will always look like this:
Date Account Name Debit Credit
Dec 31 Expense Account $
Prepaid or Supplies Account $
Note (rst the date of the adjusting entry is Dec 31 as it is assumed in the textbook world that
companies make these type of adjustments once a year, at the end of the year, just prior to
preparing their (nancial statements. Second, note that this adjusting journal entry (as will all
AJEs), impacts one income statement account (an expense account such as rent, insurance or
supplies expense) and one balance sheet account (prepaid or supplies). In a nutshell, this AJE
records the cost of the prepaid expense or cost of supplies that we incurred during the year.
OBen, you will have to calculate this number. For example, if the company had supplies costing
$1,000 at the beginning of the current year, and it had purchased, say, $2,000 of supplies during
the year, then the company had $3,000 of supplies available during the year. Now to chapter 3.
What if you had me count the supplies on hand or unused supplies at the end of the year (Dec
31), which I did and told you that you had $500 worth of supplies on hand as of Dec 31. What is
