Chapter 3
The Adjusting Process
Review Questions
1. What is the difference between cash basis accounting and accrual basis accounting?
2. Which method of accounting (cash or accrual basis) is consistent with Generally Accepted
Accounting Principles?
Accrual basis accounting is consistent with generally accepted accounting principles.
3. Which accounting concept or principle requires companies to divide their activities into small
time segments such as months, quarters, or years?
4. What is a fiscal year? Why might companies choose to use a fiscal year that is not a calendar
year?
5. Under the revenue recognition principle, when is revenue recorded?
Under the revenue recognition principle, revenue is determined using a five step process:
6. Under the matching principle, when are expenses recorded?
Under the matching principle, expenses are linked to the revenues they generate. Expenses
7. When are adjusting entries completed, and what is their purpose?
Adjusting entries are completed at the end of the accounting period to record revenues in the
8. What are the two basic categories of adjusting entries? Provide two examples of each.
The two basic categories of adjusting entries are deferrals and accruals.
9. What is a deferred expense? Provide an example.
A deferred expense is an advance payment of a future expense, and is considered an asset
10. What is the process of allocating the cost of a plant asset over its useful life called?
The process of allocating the cost of a plant asset over its useful life is called depreciation.
11. What is a contra account?
12. In the recording of depreciation expense, which account is credited?
When recording depreciation expense, the Accumulated Depreciation account is credited.
13. What does accumulated depreciation represent?
14. How is book value calculated, and what does it represent?
Book value is a depreciable asset’s cost minus accumulated depreciation. Book value
represents the cost invested in the asset that the company has not yet expensed.
15. What is a deferred revenue? Provide an example.
16. What is an accrued expense? Provide an example.
17. What is an accrued revenue? Provide an example.
18. What are the two rules to remember about adjusting entries?
The two rules to remember about adjusting entries are:
19. When is an adjusted trial balance prepared, and what is its purpose?
An adjusted trial balance is prepared after adjustments have been journalized and posted. An
20. If an accrued expense is not recorded at the end of the year, what is the impact on the
financial statements?
21. What is a worksheet, and how is it used to help prepare an adjusted trial balance?
A worksheet is an internal document that helps summarize data for the preparation of the
A. If a payment of a deferred expense was recorded under the alternative treatment, what
account would be debited at the time of payment?
If a payment of a deferred expense was recorded under the alternative treatment, an
expense account would be debited at the time of payment.
A. If a payment of a deferred expense was recorded under the alternative treatment, what
account would be debited in the adjusting entry?
If a payment of a deferred expense was recorded under the alternative treatment, an asset
account would be debited in the adjusting entry.
Short Exercises
S3-1 Comparing cash and accrual basis accounting for expenses
Learning Objective 1
The Pink Peonies Law Firm prepays for advertising in the local newspaper. On January 1, the
law firm paid $3,000 for 10 months of advertising.
How much advertising expense should Pink Peonies Law Firm record for the two months ending
February 28 under the
a. cash basis?
b. accrual basis?
SOLUTION
S3-2 Comparing cash and accrual basis accounting for revenues
Learning Objective 2
Protection Home provides house-sitting for people while they are away on vacation. Some of its
customers pay immediately after the job is finished. Some customers ask that the business send
them a bill. As of the end of the year, Protection Home has collected $900 from cash-paying
customers. Protection Home’s remaining customers owe the business $1,300.
How much service revenue would Protection Home have for the year under the
a. cash basis?
b. accrual basis?
SOLUTION
S3-3 Applying the revenue recognition principle
Learning Objective 2
Seacoast Magazine sells subscriptions for $36 for 18 issues. The company collects cash in
advance and then mails out the magazines to subscribers each month.
Apply the revenue recognition principle to determine
a. when Seacoast Magazine should record revenue for this situation.
b. the amount of revenue Seacoast Magazine should record for eight issues.
SOLUTION
a. Seacoast Magazine should record revenue when each performance obligation has
S3-4 Applying the matching principle
Learning Objective 2
Suppose on January 1, Andrew’s Tavern prepaid rent of $16,800 for the full year.
At November 30, how much rent expense should be recorded for the period January 1 through
November 30?
SOLUTION
S3-5 Identifying types of adjusting entries
Learning Objective 3
A select list of transactions for Anuradha’s Goals follows:
Apr.
1
Paid six months of rent, $4,800.
10 Received $1,200 from customer for six-month service
contract that began April 1.
15 Purchased a computer for $1,000.
18 Purchased $300 of office supplies on account.
30 Work performed but not yet billed to customer, $500.
30 Employees earned $600 in salaries that will be paid May
2.
For each transaction, identify what type of adjusting entry would be needed. Select from the
following four types of adjusting entries: deferred expense, deferred revenue, accrued expense,
and accrued revenue.
SOLUTION
S3-6 Journalizing and posting adjusting entries for prepaid rent
Learning Objective 3
On September 1, Big Fan of Toledo prepaid six months of rent, $3,300.
Requirements
1. Record the journal entry for the September 1 payment.
2. Record the adjusting entry required at September 30.
3. Using T-accounts, post the journal entry and adjusting entry to the accounts involved and
show their balances at September 30. (Ignore the Cash account.)
SOLUTION
Requirement 1
S3-7 Journalizing and posting an adjusting entry for office supplies
Learning Objective 3
On November 1, Carlisle Equipment had a beginning balance in the Office Supplies account of
$600. During the month, Carlisle purchased $2,300 of office supplies. At November 30, Carlisle
Equipment had $500 of office supplies on hand.
Requirements
1. Open the Office Supplies T-account, and enter the beginning balance and purchase of office
supplies.
2. Record the adjusting entry required at November 30.
3. Post the adjusting entry to the two accounts involved, and show their balances at November
30.
SOLUTION
Requirement 3
S3-8 Journalizing and posting an adjusting entry for depreciation and determining book
value
Learning Objective 3
On October 1, Orlando Gold Exchange paid cash of $57,600 for computers that are expected to
remain useful for three years. At the end of three years, the value of the computers is expected to
be zero.
Requirements
1. Calculate the amount of depreciation for the month of October using the straight-line
depreciation method.
2. Record the adjusting entry for depreciation on October 31.
3. Post the purchase of October 1 and the depreciation on October 31 to T-accounts for the
following accounts: Computer Equipment, Accumulated Depreciation—Computer
Equipment, and Depreciation Expense—Computer Equipment. Show their balances at
October 31.
4. What is the computer equipment’s book value on October 31?
SOLUTION
