Financial and Managerial Accounting, 8th Edition
3-2
CHAPTER 3
ADJUSTING ACCOUNTS FOR FINANCIAL STATEMENTS
Related Assignment Materials
Student Learning
Objectives
Questions
Quick Studies*
Exercises*
Problems*
AA and BTN
Conceptual objectives:
C1. Explain the importance
of periodic reporting
and the role of accrual
accounting.
1, 2, 3
3-1, 3-2
3-1
BTN 3-1,
BTN 3-6
Analytical objectives:
analyzing company
performance.
AA 3-2,
AA 3-3,
BTN 3-2,
BTN 3-3
Procedural objectives:
P1. Prepare and explain
adjusting entries for
deferral of expenses.
4, 5, 9, 10
3-3, 3-4, 3-5, 3-6, 3-
7, 3-8, 3-9, 3-15,
3-16
3-2, 3-4, 3-6
3-7, 3-14
3-1, 3-2, 3-3, 3-
4, SP,
GL:3-1, 3-2,
3-5
BTN 3-1,
BTN 3-4
P2. Prepare and explain
adjusting entries for
deferral of revenues.
9, 11
3-3, 3-4, 3-10,
3-11, 3-15, 3-20
3-2, 3-6, 3-14
3-1, 3-2, 3-3,
3-4, SP, GL: 3-
2, 3-5
BTN 3-4,
BTN 3-5
adjusting entries for
3-13, 3-15, 3-16
3-7, 3-9, 3-14
3-4, SP, GL: 3-
2, 3-5
P4. Prepare and explain
adjusting entries for
accrued revenues.
7, 9
3-3, 3-4, 3-14,
3-15
3-2, 3-7, 3-9
3-14
3-1, 3-2, 3-3,
3-4, SP, GL: 3-
2, 3-5
BTN 3-4
adjusted trial balance.
3-17
3-8
3-4, SP,
GL: 3-1, 3-2, 3-5
statements from an
GL: 3-1, 3-2, 3-5
accounting for
prepaids. (Appendix
3A)
*See additional information on next page that pertains to these quick studies, exercises, and problems.
SP refers to the Serial Problem
AA refers to Accounting Analysis
Accrual Basis versus Cash Basis – Accrual Basis Illustration
1:25
Accrual Basis versus Cash Basis – Cash Basis Illustration
1:05
Recognizing Revenues and Expenses
1:19
Compute profit margin and describe its use in analyzing company performance.
Profit Margin
0:46
Profit Margin Illustration
1:37
Prepare and explain adjusting entries for deferral of expenses.
Framework for Adjustments
0:54
Adjusting Entries
0:44
Prepaid (Deferred) Expenses
2:45
Depreciation
3:37
Prepare and explain adjusting entries for deferral of revenues.
Unearned (Deferred) Revenue
3:05
Financial and Managerial Accounting, 8th Edition
3-3
Additional Information on Related Assignment Material
See Chapter 1 of the Instructor’s Resource Manual for more information on materials for this text available in
Connect.
Connect
Available on the instructor’s course-specific website, Connect:
• All numerical Quick Studies, all Exercises and Problems Set A.
Hints/Guided Examples
Please note that the Guided Examples are labeled as “Hints” in Connect assignments. The animated PowerPoints without
Need-to-Know Videos
LO
Need–to-Know
Title
Time
P1
3-1
Prepaid Expenses
4:51
P4
3-4
Accrued Revenues
2:14
Concept Overview Videos
Each video is paired with a Knowledge Check question.
LO
Title
Time
C1
Explain the importance of periodic reporting and the role of accrual accounting.
The Accounting Period
0:45
Annual Reporting Periods
1:17
Accrual Basis versus Cash Basis
1:15
Financial and Managerial Accounting, 8th Edition
3-4
P3
Prepare and explain adjusting entries for accrued expenses.
Accrued Expense
2:48
P4
Prepare and explain adjusting entries for accrued revenues.
Accrued Revenue
2:20
Links to Financial Statements
1:47
P5
Explain and prepare an adjusted trial balance.
Adjusted Trial Balance
1:13
P6
Prepare financial statements from an adjusted trial balance.
Preparing Financial Statements
0:24
Income Statement and Statement of Owner’s Equity
0:08
Balance Sheet
0:19
P7
Explain the alternatives in accounting for prepaids.
Recording Prepaid Expenses
2:21
Recording Prepaid Revenues
2:25
Synopsis of Chapter Revisions
NEW opener—Urban One and entrepreneurial assignment.
Revised learning objectives and chapter preview—each type of adjusting entry is assigned its own learning objective.
Financial and Managerial Accounting, 8th Edition
3-5
Chapter Outline
I. Timing and Reporting
A. The Accounting Period
To provide timely information, accounting systems prepare reports at regular intervals.
1. Time period principle assumes that an organization’s activities can be divided into
specific time periods such as a month, a three-month quarter, a six-month interval, or a
B. Accrual Basis versus Cash Basis
3. Accrual basis accounting—uses the adjusting process to recognize revenues when earned
and expenses when incurred with revenues (match the expenses with the revenue). This
C. Recognizing Revenues and Expenses
1. The revenue recognition principle requires that revenue be recorded when goods or
services are provided to customers and at an amount expected to be received from
customers.
2. The expense recognition principle (often called the matching principle) aims to record
expenses in the same period as the revenues recognized as a result of these expenses.
D. Framework for Adjustments—An adjusting entry is recorded to bring an asset or liability
II. Deferral of Expense
Financial and Managerial Accounting, 8th Edition
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Adjusting Deferral of Expenses
3. Adjusting entries for prepaids involves increasing (debiting) expenses and decreasing
1. Prepaid expenses (including depreciation) are items paid for in advance of receiving their
B. Adjusting for Depreciation
1. Depreciation is the process of allocating the cost of plant assets over their expected useful
lives.
III. Deferral of Revenue
IV. Accrued Expense
A. Accrued expenses are costs or expenses incurred in a period but are both unpaid and
unrecorded.
V. Accrued Revenue
sheet accounts. Failure to make a necessary adjustment will result in misstatements of amounts on
A. Accrued revenues are revenues earned in a period that are both unrecorded and not yet received in
cash.
VI. Trial Balance and Financial Statements
A. Adjusted Trial Balance—A list of accounts and balances prepared after adjusting entries are
recorded and posted to the ledger.
Financial and Managerial Accounting, 8th Edition
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VII. Closing Process—The closing process occurs at the end of the accounting period after financial
statements are completed.
A Steps in closing process:
B. Purpose of closing process:
C. Temporary and Permanent Accounts
1. Temporary accounts relate to one accounting period. They include all income statement,
dividends, and Income Summary accounts. Closing process applies only to temporary accounts.
D. Recording Closing Entries – the purpose is to transfer the end-of-period balances in revenue,
expense, and dividends accounts to the permanent retained earnings account.
1. Use a new temporary account called Income Summary. The four closing entries are:
a. Close credit balances in revenue (and gain) accounts by debiting the accounts and
crediting Income Summary. This transfers revenue balances to the credit side Income
Summary.
2. After all closing entries are posted, all temporary accounts have a zero balance and retained
earnings is up to date.
E. Post-Closing Trial Balance — a list of permanent accounts and their balances after all closing
entries.
VIII. Accounting Cycle — steps in preparing financial statements (see Exhibit 3.19).
The ten steps repeated each accounting cycle are as follows:
1. Analyze transactions
2. Journalize
3. Post
Financial and Managerial Accounting, 8th Edition
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IX. Classified Balance Sheet – organizes assets and liabilities into important subgroups.
A. Classification Structure
1. One of the classifications is the separation between current and noncurrent assets and
liabilities.
B. Classification Categories
1. Current assets—cash or other assets that are expected to be sold, collected, or used within one
year or the operating cycle, whichever is longer. Examples: cash, short-term investments,
accounts receivable, short-term notes receivable, merchandise inventory, and prepaid
expenses.
2. Long-term investments—assets held for more than one year, that are not used in business
operations. Examples: stocks, bonds, promissory notes, and land held for future expansion.
X. Decision Analysis: Profit Margin
A. Profit margin is used to evaluate operating results by measuring the ratio of a company’s net income
to sales. Also called return on sales.
Financial and Managerial Accounting, 8th Edition
XII. Alternative Accounting for Prepayments (Appendix 3A)
A. Prepaid expenses may originally be recorded with debits to expense accounts instead of assets. If so,
then adjusting entries must transfer the cost of the unused portions from expense accounts to prepaid
XIII. Work Sheet as a Tool (Appendix 3B)
A. The work sheet is an internal document that serves as a useful tool for organizing accounting
information. It is not a required report.
B. Benefits of a Work Sheet: helps in preparing financial statements, reduces risk of errors, links
accounts and adjustments to financial statements, and shows the effect of proposed or “what if”
transactions.
C. Use of a Work Sheet – constructed at the end of a period before the adjusting process. Steps to
prepare a work sheet:
1. Enter Unadjusted Trial Balance in the first two columns.
XIV. Reversing Entries (Appendix 3C)
A. Accounting without reversing entries
1. To construct proper entries when the cash receipt/payment occurs in the new accounting period,
B. Accounting with reversing entries (an optional step)
1. Linked to asset and liability account balances that arose from the accrual of revenues and
expenses.
Financial and Managerial Accounting, 8th Edition
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Chapter 3 Alternate Demonstration Problem #1
On July 1, 2019, Howard M. Tenant, Inc., rents office space from John Q.
Financial and Managerial Accounting, 8th Edition
Solution: Chapter 3 Alternate Demonstration Problem #1
Tenant
Landlord
7/1/19
Prepaid Rent
2,400
Cash
2,400
Cash
2,400
Unearned Rent Rev.
2,400
12/31/19
Rent Expense
Unearned Rent Rev.
Prepaid Rent
Rent Revenue
Rent Expense
1,200
Unearned Rent Rev.
1,200
*Prepaid Rent
1,200
Rent Revenue
1,200
*Rent Expense
Unearned Rent Rev.
Prepaid Rent
Rent Revenue
An Alternative Solution (Based on the Appendix)
Tenant
Landlord
7/1/19
Rent Expense
2,400
Cash
2,400
Cash
2,400
Rent Rev.
2,400
12/31/19
Prepaid Rent
1,800
Rent Rev.
1,800
Rent Expense
1,800
1,800
Rent Expense
1,200
Unearned Rent Rev.
1,200
Prepaid Rent
1,200
Rent Revenue
1,200
Unearned Rent Rev.
Prepaid Rent
Rent Revenue
Financial and Managerial Accounting, 8th Edition
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Chapter 3 Alternate Demonstration Problem #2
The trial balance of Large Company, Inc., at the end of its annual
accounting period is as follows:
LARGE COMPANY, INC.
Trial Balance
December 31, 2019
Cash ………………………………………………………………..
$ 4,000
Accounts Receivable………………………………..
400
Prepaid Insurance ……………………………………………
1,200
Supplies …………………………………………………………
2,100
Equipment ………………………………………………………
Accumulated Depreciation—Equipment ……………
$ 2,000
Common Stock ……………………………………….
Dividends ……………………………………………………….
2,000
Revenue ………………………………………………………….
Salaries Expense ……………………………………………..
Totals ………………………………………………………………
$54,000
$54,000
Additional information:
1. Expired insurance, $400.
Required: Prepare adjusting entries.
Financial and Managerial Accounting, 8th Edition
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Solution: Chapter 3 Alternate Demonstration Problem #2
1.
Insurance Expense …………………………………….
400
Prepaid Insurance ………………………………..
400
Supplies Expense ………………………………………
1,300
Supplies ………………………………………………
1,300
Depreciation Expense Equip. ……………………..
1,000
Accumulated Depreciation Equip. …………
1,000
Salaries Expense ……………………………………….
Salaries Payable …………………………………..
Accounts Receivable …………………………………
Financial and Managerial Accounting, 8th Edition
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Chapter 3 Alternate Demonstration Problem #3
The trial balance of Large Company, Inc. at the end of its annual
accounting period is as follows:
LARGE COMPANY, INC.
Trial Balance
December 31, 2019
Cash ………………………………………………………………..
$ 4,000
Prepaid Insurance ……………………………………………
1,600
Supplies …………………………………………………………
2,100
Equipment ………………………………………………………
Accumulated Depreciation—Equipment ……………
$ 2,000
Common Stock ……………………………………………….
Retained Earnings
2,000
Dividends ………………………………………………………..
2,000
Revenue ………………………………………………………….
Salaries Expense ……………………………………………..
Rent Expense ………………………………………………….
Totals ………………………………………………………………
$54,000
$54,000
Additional information:
6. Expired insurance, $600.
Required
1. Prepare adjusting entries.
Financial and Managerial Accounting, 8th Edition
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Chapter 3 Solution: Alternate Demonstration Problem #3
1.
Insurance Expense …………………………………….
600
Prepaid Insurance ………………………………..
600
Supplies Expense ………………………………………
1,300
Supplies ………………………………………………
1,300
Depreciation Expense Equip. ……………………..
1,000
Salaries Expense ……………………………………….
700
Salaries Payable …………………………………..
700
2.
Revenue …………………………………………………….
33,000
Income Summary …………………………………
33,000
Income Summary ……………………………………….
27,900
Salaries Expense ………………………………….
19,000
Rent Expense ……………………………………….
6,000
Insurance Expense ……………………………….
600
Supplies Expense …………………………………
1,300
Depreciation Expense …………………………..
1,000
Income Summary ……………………………………….
5,100
Retained Earnings ………………………………..
5,100
Retained Earnings ……………………………………..
2,000
Dividends …………………………………………….
2,000
Financial and Managerial Accounting, 8th Edition
3.
LARGE COMPANY, INC.
Post-Closing Trial Balance
December 31, 2019
Dr.
Cr.
Cash ………………………………………………………….
$4,000
Prepaid Insurance ………………………………………
1,000
Supplies …………………………………………………….
Equipment …………………………………………………
20,000
Accumulated Depreciation, Equipment ……….
Salaries Payable ………………………………………..
Common Stock
17,000
Retained Earnings ……………………………………..
5,100
Totals ………………………………………………………..