Principles of Accounting (1)

College of Management and Techology in Alexandria

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Lecture Week 9
The Adjustments

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 Learning Objectives

1. Explain the accrual basis of accounting and the reasons for

adjusting entries.
2. Prepare adjusting entries for accruals.

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Accrual- Versus Cash-Basis Accounting
Accrual-Basis Accounting
• Transactions recorded in the periods in which the events occur
• Companies recognize revenues when earned by performing
services or delivering products (rather than when they receive cash)
• Expenses are recognized when incurred (rather than when paid)
• In accordance with International Financial Reporting Standards
(IFRS)

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Accrual- Versus Cash-Basis Accounting
Cash-Basis Accounting
• Revenues recognized when cash is received
• Expenses recognized when cash is paid
• Cash-basis accounting is not in accordance with International
Financial Reporting Standards (IFRS)

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The Need for Adjusting Entries
Adjusting Entries
• Necessary because the trial balance may not contain up-to-date and
complete data (effects of internal transactions)
• Required every time a company prepares financial statements to
ensure that all balances that appear in financial statements are
adjusted.

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The Need for Adjusting Entries

Journalize and post

Trial
Analyze Journalize Post adjusting entries:
Balance
deferrals/accruals

Adjusted
Financial Closing Post-Closing
Trial
Balance Statements Entries Trial Balance

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Adjusting Entries for Deferrals
Deferrals are expenses or revenues that are recognized at a date later
than the point when cash was originally exchanged. There are two
types:
• Prepaid expenses
• Unearned revenues

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Unearned Revenues
Cash received in advance of providing products and services is recorded
as unearned revenues, also called deferred revenues . In other words, we
have received the cash, but have done nothing to earn it.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

We will apply this cash
• Rent • Magazine subscriptions you gave us towards
your total consulting fees.
• Airline tickets • Customer deposits

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Unearned Revenues
• Adjusting entry is made to record the revenue for services
performed during the period and to show the liability that remains
at the end of the period
• Results in a decrease (debit) to a liability account and an increase
(credit) to a revenue account

Liability Revenue
Debit Unadjusted Credit
Adjusting Balance Adjusting
Entry (-) Entry (+)

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Unearned Revenues
Illustration: Yazici Advertising received ₺1,200 on
October 2 from R. Knox for advertising services
expected to be completed by December 31.
Unearned Service Revenue shows a balance of
₺1,200 in the October 31 trial balance. Analysis
reveals that the company performed ₺400 of
services in October.
Oct. 31
Unearned Service Revenue 400
Service Revenue 400

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Unearned Revenues
Illustration: On December 26, 2011, FastForward agrees to provide consulting
services to a client for a fixed fee of $3,000 for 60 days. On this date, the client
pays the entire consulting fee in advance.
Dec. 26
Cash 3000
Unearned Revenue 3000
On December 31, FastForward earns 5-days of consulting fees. Each day that
passes results in consulting fees of $50 ($3,000 ÷ 60), so FastForward earned
($50 × 5 days) $250.
Dec. 31
Unearned Revenue 250
Service Revenue 250
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Quick Test; Adjusting Entries for Deferrals
The ledger of Hammond Deliveries, on March 31, 2020, includes these selected
accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance € 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment €5,000
Unearned Service Revenue 9,200
An analysis of the accounts shows the following.
1. Insurance expires at the rate of €100 per month.
2. Supplies on hand total €800.
3. The equipment depreciates €200 a month.
4. During March, services were performed for €4,000 of the unearned service
revenue reported.
Prepare the adjusting entries for the month of March.
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Quick Test; Adjusting Entries for Deferrals
The ledger of Hammond Deliveries, on March 31, 2020, includes these selected
accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance € 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment €5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.
1. Insurance expires at the rate of €100 per month.
Insurance Expense 100
Prepaid Insurance 100

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Quick Test; Adjusting Entries for Deferrals
The ledger of Hammond Deliveries, on March 31, 2020, includes these
selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance € 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment €5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.
2. Supplies on hand total € 800.
Supplies Expense 2,000
Supplies 2,000

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Quick Test; Adjusting Entries for Deferrals
The ledger of Hammond Deliveries, on March 31, 2020, includes these
selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance € 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment €5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.
3. The equipment depreciates €200 a month.
Depreciation Expense 200
Accumulated Depreciation—Equipment 200

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Quick Test; Adjusting Entries for Deferrals
The ledger of Hammond Deliveries, on March 31, 2020, includes these
selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance € 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment €5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.
4. During March, services were performed for €4,000 of the unearned service
revenue reported.
Unearned Service Revenue 4,000
Service Revenue 4,000

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 Adjusting Entries for Accruals
Accruals are made to record,
• Revenues for services performed but not yet
received in cash or recorded at the statement date
• Expenses incurred but not yet paid or recorded at
the statement date

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 Accrued Revenues
Revenues for services performed but not yet received in cash or recorded.

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to: Yes, I’ve completed your
consulting job, but have not
• Rent had time to bill you yet.
• Interest
• Services

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Accrued Revenues
• Adjusting entry records the receivable that exists and records the
revenues for services performed.
• Adjusting entry:
 Increases (debits) an asset account and
 Increases (credits) a revenue account

Asset Revenue
Debit Credit
Adjusting Adjusting
Entry (+) Entry (+)

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Accrued Revenues
Illustration: In October Yazici Advertising performed
services worth ₺200 that were not billed to clients on or
before October 31.
Oct. 31
Accounts Receivable 200
Service Revenue 200
On November 10, Yazici receives cash of ₺200 for the
services performed. The journal entry on the 10 th is:
Nov. 10
Cash 200
Accounts Receivable 200
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Accrued Revenues
Illustration: On December 11, 2011, FastForward agrees to render consulting services
under a 30-day fixed fee contract, starting December 12, for $2,700 ($90 per day). All
services are to be completed by January 10, 2012, when the client will pay in full.
Dec. 31
Accounts Receivable 1800
Service Revenue 1800
On January 10, 2012, FastForward completed its obligation under the consulting
contract. The client was billed $2,700 and FastForward received $2,700 in cash.

Jan. 10
Cash 2700
Accounts Receivable 1800
Revenue in January
10 days @ $90 = $900
Service Revenue 900 22
Accrued Expenses
• Expenses incurred but not yet paid in cash or recorded.
• When you use your credit card, often you do not record the transaction until
you pay your monthly invoice; even though you have incurred the cost. Accrued
expenses must be reported on the income statement of the period when
incurred.
Expense Recorded BEFORE Cash Payment We’re about one-half
done with this job and
want to be paid for
Accrued expenses often occur in regard to: our work!
• Rent • Taxes
• Interest • Salaries
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Accrued Expenses
• Adjusting entry records the obligation and recognizes the
expense.
• Adjusting entry:
 Increase (debit) an expense account and
 Increase (credit) a liability account

Expense Liability
Debit Credit
Adjusting Adjusting
Entry (+) Entry (+)

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Accrued Expenses
Accrued Salaries and Wages
Illustration (1): Yazici Advertising paid salaries and wages on October 26; the
next payment of salaries will not occur until November 9. The employees
receive total salaries of ₺2,000 for a five-day work week, or ₺400 per day.

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Accrued Expenses
Accrued Salaries and Wages
Illustration (1): Yazici’s employees have earned but not been paid on October 31,
₺1,200 .
Oct. 31
Salaries Expense 1200
Salaries Payable 1200
On November 9, Yazici will pay the payroll for the two weeks from October 26,
through November 9.
Nov. 9
Salaries Payable (3 days @ ₺400) 1200
Salaries Expense (7 days @₺400) 2800
Cash (10 days @ ₺400) 4000
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Quick Test; Adjusting Entries for Accruals
Mahindra Computer Services began operations on August 1, 2020. At the end of
August 2020, management prepares monthly financial statements. The following
information relates to August (amounts in thousands).
1. At August 31, the company owed its employees INR800 in salaries and wages
that will be paid on September 1.
2. On August 1, the company borrowed INR30,000 from a local bank on a 15-
year mortgage. The annual interest rate is 10%.
3. Revenue for services performed but unrecorded for August totaled INR1,100.
Prepare the adjusting entries needed at August 31, 2020.

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Quick Test; Adjusting Entries for Accruals
Prepare the adjusting entries needed at August 31, 2020.
1. At August 31, the company owed its employees INR800 in
salaries and wages that will be paid on September 1.
Salaries and Wages Expense 800
Salaries and Wages Payable 800
2. On August 1, the company borrowed INR30,000 from a local
bank on a 15-year mortgage. The annual interest rate is 10%.
Interest Expense 250
Interest Payable 250

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Quick Test; Adjusting Entries for Accruals
Prepare the adjusting entries needed at August 31, 2020.
3. Revenue for services performed but unrecorded for August
totaled INR1,100.
Accounts Receivable 1,100
Service Revenue 1,100

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Framework for Adjustments
Adjustments

Paid (or received) cash before expense (or Paid (or received) cash after expense (or revenue)
revenue) recognized recognized

Prepaid (Deferred) Unearned Accrued Accrued

expenses* (Deferred) revenues expense revenues

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Summary of Basic Relationships (All Adjustments)

Type of Adjustment Accounts Before Adjustment Adjusting Entry

Prepaid expenses Assets overstated. Dr. Expense
Expenses understated. Cr. Assets or
Contra Assets

Unearned revenues Liabilities overstated. Dr. Liabilities

Revenues understated. Cr. Revenues

Accrued revenues Assets understated. Dr. Assets

Revenues understated. Cr. Revenues

Accrued expenses Expenses understated. Dr. Expenses

Liabilities understated. Cr. Liabilities

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References
• Wild, J., Shaw, K., Chiappetta, B. and Samaha, K., 2017. Fundamental
Accounting Principles. 2nd ed. McGraw-Hill Education.
• Weygandt, J., Kimmel, P. and Kieso, D., 2019. Accounting Principles
IFRS Version. Global Edition. Wiley.

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