CHAPTER 4
ADJUSTMENTS, FINANCIAL STATEMENTS,
AND FINANCIAL RESULTS
Student Learning Objectives and Related Assignment Materials
Student Learning
Objectives
Mini–
Exercises
Exercises
Coached
Problems
Problems
(Groups
A & B)
Compre–
hensive
Problems
Skills
Develop–
ment
Cases
Continuing
Case
LO 4-1 Explain why
adjustments are
needed.
1, 2, 3
2, 3, 4,
5, 6, 7,
8, 10,
19*^
2, 4
A2, A4,
B2, B4,
2+, 3+,
4^+
1, 2, 3,
4^, 5, 6
1†
LO 4-2 Prepare
adjustments
needed at the end
of the period.
3, 4, 5*,
6*, 7, 8,
9*, 10*,
11^, 18,
19, 20*,
21, 22,
23, 24,
26^
3, 4, 5,
6, 7, 8,
9, 10,
12, 13,
14, 15,
16, 19*^
2, 3, 4
A2, A3,
A4, B2,
B3, B4,
1^+, 2+,
3+, 4^+,
5^, 6^+
4^, 5, 6
1†
LO 4-3 Prepare an
adjusted trial
balance.
12, 13,
25^
1, 15, 16
1, 4
A1, A4,
B1, B4,
1^+, 2+,
3+, 4^+
7
LO 4-4 Prepare
financial
statements.
12, 14,
15, 16,
26^
2, 11,
14, 17
A3
1^+, 2+,
3+, 4^+,
5^, 6^+
3, 6, 7
LO 4-5 Explain the
closing process.
17, 26^
12, 18
1
A1, B1
2+, 3+,
4^+
LO 4-6 Explain how
adjustments affect
financial results.
8, 9, 13,
14, 19*^
3, 4
A3, A4,
B3, B4
2+,3+,
4^+
1, 2, 4^,
5, 6, 7
* Animated solution included in the PowerPoint Slides.
^ Particularly challenging; requires students to combine multiple concepts in order to advance to the
next level of accounting knowledge.
+ The Comprehensive Problems are comprised of CP4-1, which also covers LO 2-3, 3-3, 4-2, 4-3, and
4-4, CP4-2, which also covers LO 2-3, 3-3, 4-1, 4-2, 4-3, 4-4, 4-5, and 4-6, and CP4-3, which also
covers LO 2-3, 3-3, 4-1, 4-2, 4-3, 4-4, 4-5, and 4-6.
† CC4-1 is a continuing case that builds on the story of Nicole’s Getaway Spa, introduced in earlier
chapters. This case focuses on identifying the need for and classifying adjustments, preparing the
initial journal entries for deferral adjustments, and analyzing adjustments and preparing adjusting
journal entries. This case will be extended in future chapters.
Overview
The entrepreneur from chapters 1–3 is eager to evaluate SonicGateway’s results, but he first learns the
importance of adjusting the accounting records for deferred items and yet–to-be accrued items.
Students learn how to adjust the accounting records, and prepare an income statement, statement of
retained earnings, and balance sheet.
Synopsis of Chapter Revisions
• New contemporary focus company: replaced pizza company with SonicGateway, thereby allowing
repeated practice with depreciation and amortization
• New illustration to tie adjustments to accounting cycle (Exhibit 4.2)
• New illustration of adjustment effects on balance sheet and income statement (Exhibit 4.5)
• Continued use of new accounting equation format illustrating link between income statement and
balance sheet
• Eliminated journal entry to record the simultaneous declaration/payment of dividends (journal entries
for dividends are explained properly in Chapter 11)
• Reviewed and updated all end-of-chapter material, including new problem formats that automatically
post journal entries to T-accounts and prepare trial balances
PowerPoint Slides
Student Learning Objective
PowerPoint® Slides
LO 4-1 Explain why adjustments are needed.
4-2 through 4-8
LO 4-2 Prepare adjustments needed at the end of the period.
4-9 through 4-27
LO 4-3 Prepare an adjusted trial balance.
4-28 through 4-29
LO 4-4 Prepare financial statements.
4-30 through 4-32
LO 4-5 Explain the closing process.
4-33 through 4-39
LO 4-6 Explain how adjustments affect financial results.
4-40 through 4-41
Animated Builds and Animated Solutions
PowerPoint® Slides
Mini-Exercise 4-5
4-43
Mini-Exercise 4-6
4-44
Mini-Exercise 4-9
4-45 through 4-47
Mini-Exercise 4-10
4-48 through 4-50
Mini-Exercise 4-20
4-51
Exercise 4-19
4-52 through 4-57
Summary of Related Video Program
Spotlight Video Series
Chapter 4 – Anatomy of a Business Failure (approximately 4:00)
This video program covers financial performance. Circuit City once was a leading electronics retailer.
But, as this video demonstrates, the company’s financial problems led to a free fall in the company’s
stock price. This video walks students through the series of events that ultimately ended when Circuit
City liquidated in January 2014.
Chapter Summary
LO 4-1 Explain why adjustments are needed.
Adjustments are needed to ensure:
• Revenues are recorded when earned (the revenue recognition principle),
• Expenses are recorded when incurred to generate revenues (the expense recognition principle),
• Assets are reported at amounts representing the economic benefits that remain at the end of the
current period, and
• Liabilities are reported at amounts owed at the end of the current period that will require a future
sacrifice of resources.
LO 4-2 Prepare adjustments needed at the end of the period.
• The process for preparing adjustments includes
1. Analyzing the unadjusted balances in balance sheet and income statement accounts and
calculating the amount of the adjustment needed, using a timeline where appropriate.
2. Preparing an adjusting journal entry to make the adjustment.
3. Summarizing the adjusting journal entry in the applicable ledger (T-accounts).
• Each adjusting journal entry affects one balance sheet and one income statement account.
LO 4-3 Prepare an adjusted trial balance.
An adjusted trial balance is a list of all accounts with their adjusted debit or credit balances indicated
in the appropriate column to provide a check on the equality of the debits and credits.
LO 4-4 Prepare financial statements.
Adjusted account balances are used in preparing the following financial statements:
• Income Statement: Revenues – Expenses = Net Income.
• Statement of Retained Earnings: Beginning Retained Earnings + Net Income – Dividends =
Ending Retained Earnings.
• Balance Sheet: Assets = Liabilities + Stockholders’ Equity.
• The statement of cash flows and notes to the financial statements are important components of
adjusted financial statements, but they will be studied in later chapters.
LO 4-5 Explain the closing process.
• Closing journal entries are required to (a) transfer net income (or loss) and dividends into retained
earnings, and (b) prepare all temporary accounts (revenues, expenses, dividends) for the following
year by establishing zero balances in these accounts.
• Two closing journal entries are needed:
1. Debit each revenue account for the amount of its balance, credit each expense account for the
amount of its balance, and record the difference (equal to net income) in Retained Earnings.
2. Credit the Dividends account for the amount of its balance and debit Retained Earnings for the
same amount.
LO 4-6 Explain how adjustments affect financial results.
Adjustments help ensure all revenues and expenses are reported in the period in which they are
earned and incurred, as a result of a company’s activities. Without these adjustments, the financial
statements present an incomplete and potentially misleading picture of the company’s financial
performance.
Chapter Outline
Teaching Notes
I. Understanding the Business
LO 4-1 Explain why adjustments are needed.
A. Why Adjustments are Needed
1. Accounting systems are designed to record most recurring
daily transactions, particularly any involving cash.
2. If cash receipts and payments occur in the same
accounting period as the related activities, then
adjustments are not needed to report revenues and
expenses in the proper period.
3. In contrast, activities that lead to revenues and expenses
occur in the current accounting period but their related
cash receipts and payments often occur in other periods.
4. Adjustments––Entries made at the end of every
accounting period to report revenues and expenses in the
proper period and assets and liabilities at appropriate
amounts.
Examples of accounts
affected by adjustments listed
in Exhibit 4.1
5. Adjustments involve both income statement and balance
sheet accounts. They are needed to ensure:
Almost every account could
require adjustment. Stress
a. Revenues are recorded when earned (the revenue
principle),
that students should focus on
learning what types of
b. Expenses are recorded in the same period as the
revenues to which they relate (the expense recognition
(“matching”) principle),
adjustments are needed
rather than trying to
memorize an endless list of
c. Assets are reported at amounts representing the
economic benefits that remain at the end of the current
period, and
adjusting entries.
d. Liabilities are reported at amounts owed at the end of
the current period that will require a future sacrifice of
resources.
B. Deferral Adjustments
1. Deferral adjustments are used to reduce amounts
previously deferred on the balance sheet and increase
corresponding accounts on the income statement.
Remind students that the
word defer means to
postpone until later.
a. Previously deferred amounts exist on the balance sheet
because the company received cash before earning
revenue or paid cash before incurring the expense.
b. When revenues are earned (as defined by the revenue
principle) or expenses incurred (as defined by the
expense recognition (“matching”) principle), the
previously deferred amounts are transferred to the
income statement.
Examples of accounts
affected by deferral
adjustments listed on left-side
of Exhibit 4.1
2. Each deferral adjustment involves a pair of asset and
expense accounts, or liability and revenue accounts.
Chapter Outline
Teaching Notes
C. Accrual Adjustments
1. Accrual adjustments are needed when a transaction has
occurred but has not yet been recorded in the accounting
system.
2. This happens when a company has earned revenue or
incurred an expense in the current period but has not yet
recorded it because the related cash will not be received
or paid until a later period.
3. Accrual adjustments recognize revenue or expenses when
they occur, prior to receipt or payment of cash.
Examples of accounts
affected by accrual
4. Each accrual adjustment involves a pair of asset and
revenue accounts, or liability and expense accounts.
adjustments listed on right–
side of Exhibit 4.1
5. Notice that this differs from deferral adjustments, which
pair assets with expenses and liabilities with revenues.
II. Study the Accounting Methods
LO 4-2 Prepare adjustments needed at the end of the period.
A. Making Required Adjustments
1. Adjustments are made at the end of each accounting
period immediately prior to preparing an adjusted trial
balance and financial statements.
Exhibit 4.2 compares and
contrasts journal entries and
adjusting entries
2. Adjustments are not made on a daily basis because it’s
more efficient to do them all at once at the end of each
period.
Exhibit 4.4 uses unadjusted
trial balance to illustrate and
explain adjustments needed
3. Adjusting journal entries (AJEs)––Record the effects of
each period’s adjustments in a debits-equal-credits
format.
✓ Supplemental Enrichment
Activity (Activity) #1
B. Adjustment Analysis, Recording, and Summarizing
Deferral Adjustments—Used to update amounts that have
been previously deferred on the balance sheet.
(a) Supplies used during the period—Of the $600 in supplies
received in early September, $250 remain on hand at
September 30; $350 (or $600 – $250) were used during
September.
Refer to illustrations of
transactions in textbook for
Step 3—Summarize (which
includes posting to T-
1. Analyze: Assets = Liabilities + Stockholders’ Equity
Supplies (A) –350; Supplies Expense (E) –350
accounts
2. Record:
Supplies Expense (+E, –SE)
350
Supplies (–A)
350
(b) Rent benefits expired during the period—Three months of
rent were prepaid on September 1 for $7,200, but one
month has now expired, $2,400 (or $7,200 ÷ 3) of the
prepaid amount was used.
Timeline for expiration
illustrated in Exhibit 4.
1. Analyze: Assets = Liabilities + Stockholders’ Equity
Prepaid Rent (A) –2,400; Rent Expense (E) –2,400
2. Record:
Rent Expense (+E, –SE)
2,400
Prepaid Rent (–A)
2,400
Chapter Outline
Teaching Notes
Carrying value––The amount at which an asset or liability
is reported (“carried”) in the financial statements; it is also
known as the “net book value” or simply “book value.”
(c) Depreciation is recorded for use of equipment – The
computer equipment, which was estimated to last two
years, has now been used for one month, representing an
estimated expense of $400.
1. Expense recognition (“matching”) principles indicates
that when equipment is used to generate revenues in
the current period, part of its cost should be transferred
to an expense account in that period.
Depreciation might appear to
mirror a decline in market
value but that’s just a fluke.
2. Depreciation––The process of allocating the cost of
buildings, vehicles, and equipment to the accounting
periods in which they are used.
Recording depreciation for
the use of long-lived assets is
a lot like recording the use of
3. Contra-account––An account that is an offset to, or
reduction of, another account.
supplies. Difference is that a
contra-account is used.
4. Accumulated Depreciation––The contra-asset
account that is created to keep track of all the
depreciation recorded against the long-lived asset; like
a negative asset account.
“Contrary” to what you’d
think, this contra-asset (xA)
account has a credit balance
5. Analyze: Assets = Liabilities + Stockholders’ Equity
Accumulated Depreciation (xA) –400; Depreciation
Expense (E) –400
6. Record:
Depreciation Expense (+E, –SE)
400
Accumulated Depreciation
(+xA, –A)
400
7. Four aspects that should be noted:
a. Accumulated Depreciation is a balance sheet
account (that is subtracted from the related long-
lived asset account in the assets section) while
Depreciation Expense is an income statement
account.
b. By recording depreciation in Accumulated
Depreciation distinct from the Equipment account,
you can report both the original cost of equipment
and a running total of the amount that has been
depreciated.
c. A contra-account always is recorded in a way that
opposes the account it offsets.
d. The amount of depreciation depends on the method
used for determining it.
Depreciation methods will be
discussed in Chapter 9.
Chapter Outline
Teaching Notes
(d) Amortization is Recorded for Use of Software—The app
software developed for SonicGateway, estimated to have
three years of usefulness, has not been used for one
month at an estimated expense of $250..
1. Amortization is similar to depreciation and applies to
long-term assets that lack physical substance and have
a limited period of usefulness; the long-term asset
declines in usefulness over time, causing a reduction
in the value of the asset, which creates an expense.
Stress that amortization is not
reported for long-term assets
that have an unlimited period
of usefulness.
2. Analyze: Assets = Liabilities + Stockholders’ Equity
Accumulated Amortization (xA) –250 = Amortization
Expense (E) –250
3. Record:
Amortization Expense (+E, –SE)
250
Accumulated Amortization
(+xA, –A)
250
(e) Gift Cards Redeemed for Service—SonicGateway
redeemed $100 of gift cards that customers used to pay
for game downloads.
1. Analyze: Assets = Liabilities + Stockholders’ Equity
Unearned Revenue (L) –100; Sales Revenue (R) +100
2. Record:
Unearned Revenue (–L)
100
Sales Revenue (+R, +SE)
100
Accrual Adjustments—Make the account records complete
by including transactions that occurred but have not been
recorded:
(f) Revenues Earned but Not Yet Recorded—SonicGateway
provided $2,500 of promotional services to other app
developers in September with payment to be received in
October.
1. Analyze: Assets = Liabilities + Stockholders’ Equity
Accounts Receivable (A) +2,500; Sales Revenue (R)
+2,500
2. Record:
Accounts Receivable (+A)
2,500
Sales Revenue (+R, +SE)
2,500
Chapter Outline
Teaching Notes
(g) Wage Expense Incurred but Not Yet Recorded—
SonicGateway pays its employees $300 per day; as of
September 30, four additional days of work have been
completed at a cost of $1,200 (or $300 x 4); this amount
will not be paid until October.
1. Analyze: Assets = Liabilities + Stockholders’ Equity
Salaries and Wages Payable (L) +1,200; Salaries and
Wages Expense (E) –1,200
2. Record:
Salaries and Wages Expense
(+E, –SE)
1,200
Salaries and Wages Payable (+L)
1,200
3. When these salaries and wages are paid in cash the
following month, SonicGateway will decrease Salaries
and Wages Payable (with a debit) and Cash (with a
credit).
(h) Interest Expense Incurred but Not Yet Recorded—
SonicGateway has not paid or recorded the $100 interest
that it owes for this month on its note payable to the
bank.
1. Analyze: Assets = Liabilities + Stockholders’ Equity
Interest Payable (L) +100; Interest Expense (E) –100
2. Record:
Interest Expense (+E, –SE )
100
Interest Payable (+L)
100
(i) Income Taxes Incurred but Not Yet Recorded—
SonicGateway pays income tax at an average rate equal to
20% of the company’s income before taxes.
1. Income tax is calculated by multiplying (1) the
company’s adjusted income (before income taxes) of
$1,000 by (2) the company’s tax rate of 20% to get the
amount of income tax of $200.
2. The unadjusted trial balance shows that no income tax
has been recorded (both Income Tax Payable and
Income Tax Expense are $0).
3. Analyze: Assets = Liabilities + Stockholders’ Equity
Income Tax Payable (L) +200; Income Tax Expense
(E) –200
4. Record:
Income Tax Expense (+E, –SE)
200
Income Tax Payable (+L)
200
5. Adjusting journal always include one balance sheet
and one income statement account.
Chapter Outline
Teaching Notes
LO 4-3 Prepare an adjusted trial balance.
C. Adjusted Trial Balance
✓ Activity #2
1. Adjusted trial balance––A list of all accounts and their
adjusted balances, which is used to check on the equality
of recorded debits and credits.
2. The only difference between an adjusted trial balance and
an unadjusted trial balance is that the adjusted trial
balance is prepared after all adjustments have been
posted.
LO 4-4 Prepare financial statements.
D. Income Statement and Statement of Retained Earnings
✓ Activity #3
1. Prepare the income statement by listing the names and
amounts for each revenue and expense account from the
adjusted trial balance. Each major category of items is
subtotaled prior to computing net income for period.
See illustrations in Exhibit
4.10
2. Account balances from the adjusted trial balance are also
used in the statement of retained earnings
a. The amount coming from the adjusted trial balance is
the beginning-of-year balance for Retained Earnings.
b. This account balance doesn’t yet include revenues,
expenses, and dividends for the current period because
they’ve been recorded in their own separate accounts
Eventually, we will close
those accounts in the
Retained Earnings account.
c. For now, the Retained Earnings account on the
adjusted trial balance provides the opening amount on
the statement of retained earnings.
e. The amount for Net Income on the next line of the
statement of retained earnings comes from the income
statement, and the Dividends number comes from the
adjusted trial balance.
3. Balance Sheet
a. Like the other statements, the balance sheet is
prepared from the adjusted trial balance.
Illustrated in Exhibit 4.11
b. When preparing, watch out for three things:
i. Remember to classify assets and liabilities as
current if they will be used up, turned into cash, or
fulfilled within 12 months.
ii. Note that Accumulated Depreciation and
Accumulated Amortization are reported in the
assets section (and are subtracted from the accounts
to which they are contra accounts).
iii. Get the Retained Earnings balance from the
statement of retained earnings, not from the
adjusted trial balance. (The adjusted trial balance
still reports the period’s opening Retained Earnings
balance.)