Adjusting Entries and the Work Sheet

Heintz & Parry th Edition Chapter 5 th Edition College Accounting Adjusting Entries and the Work Sheet 1 Prepare end-of-period adjustments. END-OF-PERIOD ADJUSTMENTS Changes occur that affect the business s financial condition: Equipment wearing out Prepaid insurance and supplies being used up Employees earning wages that have not yet been paid Since these events have not been entered into the accounting system, ADJUSTING ENTRIES must be made. MATCHING PRINCIPLE FISCAL YEAR Requires the matching of REVENUES EARNED during an accounting period with the EXPENSES INCURRED Provides the best measure of net income Necessitates accounts be brought up to date before financial statements are prepared A 12-month period of time used as an accounting period Does not need to be the same as a calendar year Many businesses schedule their fiscal year to end when business is slow

2 ADJUSTING ENTRIES Let s look at some adjusting entries for Jessie Jane s Campus Delivery. Post adjusting entries to the general ledger. During June, Jessie purchased supplies for $. These were debited to the supplies account. During June, Jessie purchased supplies for $. These were debited to the supplies account. PURCHASED IN JUNE Bal. According to an inventory of supplies, there are only $ of supplies on hand at the end of June. During June, Jessie purchased supplies for $. These were debited to the supplies account. During June, Jessie purchased supplies for $. These were debited to the supplies account. Bal. But unless there is an adjusting entry made, $ of supplies will be shown on the balance sheet. Bal. ADJUSTING ENTRY NEEDED!!!!

Bal. $ Purchased during month remaining $ used Bal. $ is credited to to remove the amount of supplies used during June. EXPENSE EXPENSE Bal. $ is debited to Expense to recognize the amount of supplies used during June. Bal. Bal. Now the balance sheet will show $ of supplies! Bal. Bal. EXPENSE Bal. The income statement will show $ of supplies used during June. 8-month policy June 1 Jan. 31 During June, Jessie paid $ for an eight-month liability insurance policy with coverage beginning on June 1.

During June, Jessie paid $ for an eight-month liability insurance policy with coverage beginning on June 1. Now that June is over, we need to remove the cost of one month s insurance from this account. 19 $ for 8 months: $ 8 = $ per month PREPAID INSURANCE INSURANCE EXPENSE Prepaid Insurance is credited for $ to remove June s insurance coverage that has expired. Insurance Expense is debited for $ to recognize the amount of insurance coverage for June. PREPAID INSURANCE INSURANCE EXPENSE PREPAID INSURANCE INSURANCE EXPENSE Bal. Bal. Bal. The balance sheet will show $ (7 months) of prepaid insurance! The income statement will show $ (1 month) of insurance consumed! 24

Jessie paid her part-time employees $6 on June 27. Since then, they have earned an additional $, but have not yet been paid. Bal. $6 does not include all of the wages earned by employees during June. 6 6 Jessie paid her part-time employees $6 on June 27. Since then, they have earned an additional $, but have not yet been paid. Bal. 6 An ADJUSTING ENTRY is needed! 6 6 6 WAGES PAYABLE $ debit to Wages Expense for the additional wages earned during June. Jessie Jane owes the employees for the additional wages. This liability is recorded in the wages payable account. 6 WAGES PAYABLE 6 WAGES PAYABLE Bal. Bal. Bal. The income statement will show ALL wages earned by employees in June! The balance sheet will show the liability for wages earned in June that will be paid in July.

HISTORICAL COST PRINCIPLE USEFUL LIFE Assets are recorded at their actual cost. The cost remains on the books as long as the business owns the asset. No adjustments are made for changes in the market value of the asset. The period of time that an asset is expected to help produce revenues. Useful life expires as a result of wear and tear or because it no longer satisfies the needs of the business. As this happens, depreciation expense should be recognized and the value of the asset should be reduced. DEPRECIATION EXPENSE SALVAGE VALUE Depreciation is a method of matching an asset s original cost against the revenue produced over the useful life. There are many depreciation methods. (We will use the straight-line method.) Depreciation expense is based on estimates of useful lives and salvage values. The expected market value or selling price of an asset at the end of its useful life Also called: Scrap value, or Residual value STRAIGHT-LINE DEPRECIATION EXAMPLE Jessie has motor scooters with an estimated useful live of 3 years, no salvage value, and an original cost of $3,0. Because Jessie expects the scooters to be of no value when the three years are over, the whole $3,0 cost needs to be spread over the next three years. STRAIGHT-LINE DEPRECIATION EXAMPLE 1st step: Calculate the depreciable cost. FORMULA: Original Cost Salvage Value = Depreciable Cost $3,0 $0 = $3,0

STRAIGHT-LINE DEPRECIATION EXAMPLE 2nd step: Determine depreciation expense for this accounting period. FORMULA: STRAIGHT-LINE DEPRECIATION EXAMPLE 2nd step: Determine depreciation expense for this accounting period. FORMULA: Depreciable Cost Estimated Useful Life $3,0 = Since we are trying to compute depreciation for one month, we will use months instead 37 of years. Depreciable Cost Estimated Useful Life = $3,0 36 months STRAIGHT-LINE DEPRECIATION EXAMPLE DEPRECIATION EXPENSE 2nd step: Determine depreciation expense for this accounting period. FORMULA: Depreciable Cost Estimated Useful Life $3,0 = = 36 months $ per month Now that we know depreciation for June is $, let s figure out the adjusting entry. DEPRECIATION ACCUMULATED DEPRECIATION DELIVERY EQUIPMENT 3,0 DELIVERY EQUIPMENT 3,0 ACCUMULATED DEPRECIATION DELIVERY EQUIPMENT We do NOT adjust this account. It should always reflect the ORIGINAL COST of the asset. Depreciation is credited to this account instead of the asset account.

ACCUMULATED DEPRECIATION BOOK VALUE Is a contra-asset account Contra means opposite Has a credit balance (the opposite of an asset) Is deducted from the related asset account on the balance sheet The value carried on the books or in the accounting records Book Value = Cost of Plant Assets Accumulated Depreciation Also called undepreciated cost DEPRECIATION EXPENSE DELIVERY EQUIPMENT 3,0 DEPRECIATION EXPENSE DEL. EQUIP. ACCUMULATED DEPRECIATION DEL. EQUIP. 3 Prepare a work sheet. THE WORK SHEET Pulls together all of the information needed to: Enter adjusting entries Prepare financial statements Is not a financial statement Is not a formal part of the accounting system Ordinarily, only the accountant uses a work sheet Commonly in a 10-column format PREPARING THE WORK SHEET 5 STEPS 1. Prepare the Trial Balance. 2. Prepare the Adjustments. 3. Prepare the Adjusted Trial Balance. 4. Extend Adjusted Balances to the Income Statement and Balance Sheet columns. 5. Complete the Work Sheet.

Jessie Jane s Campus Delivery Work Sheet For Month Ended June 30, -- TRIAL BALANCE Jessie Jane s Campus Delivery Work Sheet For Month Ended June 30, -- TRIAL BALANCE Heading includes: Name of the company Name of the working paper Date of the accounting period just ended Step #1: Prepare the trial balance (before any adjustments) in the first pair of amount columns. Accounts Receivable Prepaid Insurance Delivery Equipment Accum. Depr. Del. Equip. Accounts Payable Wages Payable Jessica Jane, Capital TRIAL BALANCE 6 3,0 1,0 0 Jessica Jane, Drawing This is 1 the same Delivery Fees 21 Wages Expense trial balance 6 Rent Expense from Chapter 3, Expense Telephone Expense now being shown Insurance Expenseon a 10-column work sheet. Depr. Exp. Del. Equip. 5,9 5,9 ADJUSTMENTS Accounts Receivable Prepaid Insurance Delivery Equipment Accum. Depr. Del. Equip. Accounts Payable Wages Payable Jessica Jane, Capital TRIAL BALANCE 6 3,0 1,0 2,000 Jessica Jane, Drawing 1 Delivery Fees 2,1 Wages Expense 6 Rent Expense Step #2: Prepare the Expense adjustments. Telephone Expense Insurance Expense Depr. Exp. Del. Equip. 5,9 5,9 ADJUSTMENTS Accounts Receivable Prepaid Insurance Delivery Equipment Accum. Depr. Del. Equip. Accounts Payable Wages Payable Jessica Jane, Capital TRIAL BALANCE 6 3,0 1,0 2,000 Jessica Jane, Let s Drawing record the supplies 1 adjustment Delivery Fees we computed earlier: 2,1 Wages Expense 6 Rent Expense $ debit to Expense; Expense $ credit to. Telephone Expense Insurance Expense Depr. Exp. Del. Equip. 5,9 5,9 ADJUSTMENTS TRIAL BALANCE Accounts Receivable 6 Prepaid Insurance Delivery Equipment 3,0 Accum. Depr. Del. Equip. Accounts Payable 1,0 Wages Payable Jessica Adjustments Jane, Capital are identified 2,000 Jessica Jane, Drawing 1 Delivery with a Fees letter in parentheses. Wages Expense 6 Rent Expense Expense Telephone Expense Insurance Expense Depr. Exp. Del. Equip. 2,1 5,9 5,9 ADJUSTMENTS (a) (a)

Accounts Receivable Prepaid Insurance Delivery Equipment Accum. Depr. Del. Equip. Accounts Payable Wages Payable TRIAL BALANCE ADJUSTMENTS 6 (a) 3,0 1,0 Jessica Jane, The Capital remaining adjustments 2,000 Jessica Jane, Drawing are entered 1 on the Delivery Fees work sheet and the 2,1 Wages Expense 6 Rent Expense Adjustments columns Expense are totaled. Telephone Expense Insurance Expense Depr. Exp. Del. Equip. 5,9 5,9 (a) Accounts Receivable Prepaid Insurance Delivery Equipment Accum. Depr. Del. Equip. Accounts Payable Wages Payable Jessica Jane, Capital Jessica Jane, Drawing Delivery Fees Wages Expense Rent Expense Expense Telephone Expense Insurance Expense Depr. Exp. Del. Equip. TRIAL BALANCE 6 3,0 1 6 1,0 2,000 2,1 5,9 5,9 ADJUSTMENTS (c) (a) (b) (d) (a) (b) (d) (c) Accounts Receivable Prepaid Insurance Delivery Equipment Accum. Depr. Del. Equip. Accounts Payable Wages Payable Jessica Jane, Capital Jessica Jane, Drawing Delivery Fees Wages Expense Rent Expense Expense Telephone Expense Insurance Expense Depr. Exp. Del. Equip. TRIAL BALANCE 6 3,0 1 6 1,0 2,000 2,1 5,9 5,9 ADJUSTMENTS (a) (b) (d) (c) (c) The Adjustments (a) columns (b) BALANCE!!! (d) 235 235 TRIAL BAL. ADJUSTMENTS 6 (a) (b) (d) 1 6 0 59 59 (c) 21 Step #3: Prepare the (c) adjusted trial balance. (a) (b) (d) 235 235 ADJ. TRIAL BAL. TRIAL BAL. ADJUSTMENTS ADJ. TRIAL BAL. 6 (a) (b) Del. Eq A. D..-Del $ Eq. +/ $0 (d) = $ Accts Pay Wages Balance Pay before (c) J. J., Cap 0 +/ Adjustment = Adjusted Adjustments Balance 1 21 6 (c) (a) (b) (d) 59 59 235 235 TRIAL BAL. ADJUSTMENTS ADJ. TRIAL BAL. 6 6 (a) (b) A. D. Del Eq. (d) $6 +/ $0 = $6 Wages Pay (c) J. J., Cap Balance before 0 1 +/ Adjustment = Adjusted Adjustments 21 Balance Wages Exp 6 (c) (a) (b) (d) 59 59 235 235

TRIAL BAL. ADJUSTMENTS ADJ. TRIAL BAL. 6 6 (a) (b) (d) Accts Pay Wages Pay$ $ (c) = $ J. J., Cap 0 Balance 1 before +/ 21 Adjustment = Adjusted Adjustments Wages Exp 6 (c) Balance Rent Exp (a) (b) (d) 59 59 235 235 Sup. Exp Tel. Exp TRIAL BAL. 6 ADJUSTMENTS (a) (b) ADJ. TRIAL BAL. 6 (d) (c) 0 1 This process continues 21 until ALL accounts 6 (c) are included in the Adjusted (a) Trial Balance columns. (b) (d) 59 59 235 235 Wages Pay Wages Exp TRIAL BAL. 6 1 6 0 21 59 59 ADJUSTMENTS (c) (a) (a) (b) (d) (c) (b) (d) 235 235 ADJ. TRIAL BAL. 6 0 1 21 The Adjusted Trial Balance columns balance!!!! 6 6 Wages Pay 6 Step #4: 0 Extend adjusted balances 1 to the 21 Income Statement and Wages Exp Balance Sheet columns. Rent Exp Ins. Exp 6 6 Wages Pay J. J., Cap Wages Exp Rent Exp Sup. Exp 6 Each account in the 0 Adjusted 1 Trial Balance columns is extended 21 to either the Income Statement columns or the Balance Sheet columns, but not both. 6 6 Wages Pay 6 The Income 0 Statement columns 1 include all 21 accounts found on the Wages Exp income statement Rent Exp REVENUES AND EXPENSES Sup. Exp 6 6

Wages Pay 6 The Balance 0 Sheet columns 1 include 21 the remaining accounts Wages Exp ASSETS, LIABILITIES, Rent Exp CAPITAL, AND DRAWING Sup. Exp 6 6 6 1 0 21 6 6 ASSETS 6 6 1 0 21 6 6 CONTRA-ASSET 6 6 1 0 21 6 6 LIABILITIES 6 6 1 0 21 6 6 CAPITAL 6 0 Tel. Exp 6 1 0 21 6 6 DRAWING 6 0 1

6 0 1 REVENUE 21 6 6 21 6 0 1 6 1 0 21 6 6 21 6 0 1 EXPENSES INCOME STMT 6 6 Step#5: Complete the work sheet. A. D. Del Eq. a. Rule and total the Income Statement Accts Pay. and Balance Sheet columns. 0 0 1 1 21 21 Wages Exp 6 6 6 1 0 21 6 6 21 6 0 1 1135 21 4965 39 6 6 Step #5: Complete the work sheet. b. Calculate the difference between Wages Pay the Income Statement Debit and 0 0 1 Credit columns. 1 ($2,1 21 $1,135 = 21 $1,015) 6 6 1135 21 4965 39 6 6 Step #5: Complete the work sheet. c. Calculate the difference between the 0 Balance Sheet Debit and 0 1 Credit columns. 1 ($4,965 21 $3,9 21 = $1,015) 6 6 1135 21 4965 39

6 6 Del. Eq The differences are the same!!!! The work sheet balances!!! Since the Income Statement Credit 0 0 column 1 (REVENUES) exceeds 1 the Income 21 Statement 21 Debit Wages Exp column (EXPENSES), the difference is called NET INCOME. 6 6 1135 21 4965 39 6 6 Step #5: Complete the work sheet. d. Add the net income to the Income 0 Statement Debit and 0 1 the Balance Sheet Credit column 1 (columns 21with the smallest 21 totals). 6 6 1135 21 4965 39 Rent Exp Net Income 6 Step #5: Complete the work sheet. e. Total and double rule (underline) 0 the columns. 1 1 21 21 6 6 6 0 1135 1015 21 4965 39 1015 6 1 0 21 6 6 21 6 0 1 1135 1015 21 4965 39 1015 21 21 4965 4965 4 Describe methods for finding errors on the work sheet. FINDING ERRORS ON THE WORK SHEET If any of the columns on the work sheet do not balance, you must find the error before you continue.

FOUR TIPS FOR FINDING ERRORS ON THE WORK SHEET Check the addition of all columns. Check the addition and subtraction required when extending to the Adjusted Trial Balance columns. Make sure the adjusted account balances have been extended to the appropriate columns. 5 Journalize adjusting entries from the work sheet. Make sure that the net income or net loss has been added to the appropriate columns. JOURNALIZING ADJUSTING ENTRIES The work sheet helps the accountant organize the end-of-period financial information, including adjusting entries. The accounts are not adjusted until a general journal entry is made and posted to the general ledger accounts. 1 2 3 4 5 6 7 8 9 10 11 ADJUSTING ENTRIES DATE DESCRIPTION PR Adjusting Entries Instead of an explanation after each adjusting entry, Adjusting Entries is written before the first adjusting entry. ADJUSTING ENTRIES ADJUSTING ENTRIES DATE DESCRIPTION PR 1 Adjusting Entries -- 2 June 30 3 4 5 6 7 8 9 10 11 Each adjusting entry is dated the last day of the accounting period. DATE DESCRIPTION PR 1 Adjusting Entries -- 2 June 30 Expense 00 3 4 00 5 6 7 8 9 10 11 30 Insurance Expense 00 Prepaid Insurance 30 Wages Expense 00 00 Wages Payable 00

1 2 3 4 5 6 7 8 9 10 11 ADJUSTING ENTRIES DATE DESCRIPTION PR Adjusting Entries (cont.) -- June 30 Depr. Exp. Del. Equip. 00 Accum. Depr. Del. Equip. 00 POSTING THE ADJUSTING ENTRIES Account: Expense Account No. 523 BALANCE DATE ITEM PR -- June 30 Adjusting Posting adjusting entries is the same as posting other entries except Adjusting is written in the item area. POSTING THE ADJUSTING ENTRIES Account: Expense Account No. 523 BALANCE DATE ITEM PR -- June 30 Adjusting 6 Explain the cash, modified cash, and accrual bases of accounting. ACCRUAL BASIS OF ING Revenues are recorded when EARNED Expenses are recorded when INCURRED Recognizes receivables and payables Offers the best matching of revenues and expenses The best method of measuring income for most businesses Smaller service organizations often use the cash or modified cash basis CASH BASIS OF ING Revenues are recorded when cash is RECEIVED Expenses are recorded when cash is PAID Similar to the accrual basis if: There are few receivables, payables, and assets Can vary significantly if: A business has many receivables, payables, and assets

MODIFIED CASH BASIS Combines aspects of the cash and accrual methods A business uses the cash basis for recording revenues and most expenses Exceptions are made when cash is paid for assets with useful lives greater than one accounting period If cash is paid for equipment, buildings, supplies, or insurance, these are recorded as assets, and adjustments are made each period as under the accrual basis