Time Period Assumption

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1 ILLUSTRATION 3-1 GUIDELINES TO REPORT REVENUE AND EXPENSES Time Period Assumption Economic life of business can be divided into artificial time periods Revenue Recognition Principle Revenue recognized in the accounting period in which it is earned Matching Principle Expenses matched with revenues in the period when efforts are expended to generate revenues 3-17

2 ILLUSTRATION 3-2 DEPRECIATION PREPAYMENT ASSET EXPENSE ENTRY: Truck ASSET Cost of Truck $ /1/01 12/31/01 12/31/02 12/31/ Expense Accumulated EXPENSE CONTRA ASSET Statement Presentation: Balance Sheet Asset Contra Asset Book Value Truck $1 Less: Accum. Depr. $10,000 Expense Accumulated $1 10,000 $ Expense Accumulated $1 1 $ 3-18

3 ILLUSTRATION 3-3 PREPAYMENT RELATIONSHIPS PREPAYMENTS Benefits More Than One Accounting Period RECORD AS ASSET RECORD AS LIABILITY Prepaid Insurance 1,200 1,200 (Acquired one year policy) Insurance Expense 100 Prepaid Insurance (One month expired) 100 Initial Adjusting 6,000 Unearned Rent 6,000 (Received one year's rent) Unearned Rent Rent Revenue (One month elapsed) Account Effects: Prepaid Insurance 1, Bal. 1,100 Benefits Consumed or Earned in Current Period Balance Sheet Unearned Rent 6,000 Bal. 5, Insurance Expense 100 Income Statement Rent Revenue 3-19

4 ILLUSTRATION 3-4 ACCRUAL RELATIONSHIPS ACCRUALS Expense or Revenue Not Yet Recorded RECORD EXPENSE RECORD REVENUE Salary Expense Salaries Payable (Accrued salary owed) Adjusting Accounts Receivable 1,000 Service Revenue 1,000 (Accrued revenue for services provided) Salaries Payable (Paid salaries) Subsequent 1,000 Accounts Receivable 1,000 (Collected account receivable) 3-20

5 3-21 Type of Adjustment Reason for Adjustment 1. Prepaid Expenses (a) Prepaid expenses originally recorded in asset accounts have been used. 2. Unearned Revenues (b) Unearned revenues initially recorded in liability accounts have been earned. Account Balances Before Adjustment Assets Overstated Expenses Understated Liabilities Overstated Revenues Understated Adjusting Dr. Expenses Cr. Assets Dr. Liabilities Cr. Revenues ILLUSTRATION 3-5 TYPES OF ADJUSTING ENTRIES 3. Accrued Revenues (c) Revenues earned but not yet received in cash or recorded. Assets Understated Revenues Understated Dr. Assets Cr. Revenues 4. Accrued Expenses (d) Expenses incurred but not yet paid in cash or recorded. Expenses Understated Liabilities Understated Dr. Expenses Cr. Liabilities Each adjusting entry affects a balance sheet account and an income statement account.

6 ILLUSTRATION 3-6 EXAMPLES OF ADJUSTING ENTRIES Instructions: For each entry indicate the name of the account debited and account credited. Adjusting 1. To record expired rent which had been prepaid. 2. To record supplies used during the period. 3. To record depreciation on furniture. 4. To record unearned revenue that has been earned. 5. To record salary owed but not paid. 6. To record rent earned but not recorded. Account Debited Account Credited Answer: Account Debited Account Credited 1. Rent Expense 2. Supplies Expense 3. Expense 4. Unearned Revenue 5. Salary Expense 6. Rent Receivable Prepaid Rent Supplies Accumulated Revenue Salary Payable Rent Revenue 3-22

7 ILLUSTRATION 3-7 POSTING OF ADJUSTING ENTRIES The following unadjusted accounts and related balances are provided at September 30: Accounts Receivable $ 2,400 Supplies 1,200 Salary Payable Unearned Revenue Revenue 1 Salary Expense 2,100 Expense Accumulated 3,000 Instructions: Open T-accounts and post the adjusting entries indicated Accounts Receivable 2,400 (b) 900 3,300 from the following data. (a) Supplies on hand, $200. (b) Revenue earned but not accrued, $900. (c) Unearned revenue earned but not recorded, $400. (d) Salary owed to employees, $700. (e) of $200 is recognized. Answer: Supplies 1,200 (a) 200 1,000 Salary Payable (d) Unearned Revenue (c) (a) Supplies Expense 1,000 1,000 (d) Salary Expense 2, ,800 Revenue (b) (c) ,300 Expense (e) Accumulated 3,000 (e) 200 3,

8 ILLUSTRATION 3-8 REVIEW CHAPTER CONCEPTS Topic Applied 1. Time Period Assumption 2. Revenue Recognition 3. Matching Prinicple 4. Accrual Basis Accounting Results Economic life of business is divided into time periods. Revenue is recorded in period earned. Requires adjusting entries. Record expenses in the period they occur. Requires adjusting entries. Applies revenue recognition principle, matching principle, and time period assumption. Justification To provide information to prepare financial statements and tax return. To record assets or decreases in liabilities and proper reporting of revenue earned. To record liabilities or use of assets and expenses incurred in earning revenues. To record revenue when earned and expenses when incurred. 3-24

9 ILLUSTRATION 3-9 PREPAYMENT ALTERNATIVE TREATMENT PREPAYMENTS Benefits More Than One Accounting Period RECORD AS EXPENSE RECORD AS REVENUE Insurance Expense 1,200 1,200 (Acquired one year policy) Prepaid Insurance 1,100 Insurance Expense 1,100 (Eleven months unexpired) Initial Adjusting 6,000 Rent Revenue 6,000 (Received one year's rent) Rent Revenue 5, Unearned Rent 5, (Eleven months unearned) Account Effects: Prepaid Insurance 1,100 Balance Sheet Unearned Rent 5, Income Statement Insurance Expense 1,200 1,100 Bal. 100 Rent Revenue 5, 6,000 Bal. 3-25

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