A Business Perspective, 8e
Chapter 3:
Adjustments for
Financial Reporting
Chapter 3
Chapter 3
Adjusting Entries
z Adjusting entries are triggered by the arrival of
the end of the accounting period rather than by
the giving, receiving, or creating of a source
document.
z Their purpose is to bring the accounts to their
proper balances before financial statements
are prepared.
Chapter 3
Chapter 3
Chapter 3
Prepaid insurance
Prepaid rent
Supplies on hand
Depreciation
Accounting Principles: A Business Perspective 8e
Copyright 2005 Hermanson Edwards Maher
Chapter 3
Accrued items
z consist of those entries relating to activity on
which nothing has been previously recorded in
the accounts.
Accounting Principles: A Business Perspective 8e
Copyright 2005 Hermanson Edwards Maher
Chapter 3
Chapter 3
Chapter 3
z Liability/revenue adjustmentsunearned
revenues
Liability is canceled by the rendering of services,
which results in a debit to a liability account and a
credit to a revenue account.
Chapter 3
Chapter 3
z Liability/expense adjustmentsaccrued
liabilities
Arise when expenses are incurred in the current
period, but cash is paid in the next period.
If employee services have been incurred in
generating revenues but have not yet been paid,
both an expense and a liability must be recorded.
Chapter 3
Chapter 3
Depreciation
The three factors involved in the computation of
depreciation are:
1. Asset cost.
2. Estimated useful lifethe estimated number of periods
that a company can make use of an asset.
3. Estimated salvage or scrap valuethe amount for
which an asset can probably be sold at the end of its
estimated useful life.
Chapter 3
Depreciation (continued)
The straight-line depreciation formula is as
follows:
Annual
Asset cost Estimated salvage value
depreciation =
Estimated number of years of useful life
Chapter 3
Depreciation (continued)
The journal entry to record depreciation is as
follows:
Depreciation Expense
Accumulated Depreciation
To record depreciation expense.
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Chapter 3
Accrual Basis
Revenues are
recognized
As cash is
received
Expenses are
recognized
As cash is paid
As earned (goods
are delivered or
services are
performed)
As incurred to
produce
revenues
Chapter 3
Decrease
(Credit)
Liability/Revenue
Adjustment
Liability
Decrease
(Debit)
Previously
recorded date
Previously
recorded date
Expense Increase
(Debit)
Revenue Increase
(Credit)
Chapter 3
Increase
(Debit)
New
Data
Expense Increase
(Credit)
Liability/Revenue
Adjustment
Liability
Increase
(Credit)
New
Data
Revenue Increase
(Debit)
Data not previously recorded are entered into an asset account and a
revenue account or a liability account and an expense account.
Accounting Principles: A Business Perspective 8e
Copyright 2005 Hermanson Edwards Maher
Chapter 3
Effect on
Net Income
Effect on Balance
Sheet Items
1. Consumption of the
benefits of an asset (prepaid
expense)
Overstates
net income
Overstates assets
Overstates retained
earnings
2.Earning of previously
unearned revenues
Understates
net income
Overstates liabilities
Understates retained
earnings
3. Accrual of assets
Understates
net income
Understates assets
Understates retained
earnings
4. Accrual of liabilities
Overstates
net income
Understates liabilities
Overstates retained
earnings
Chapter 3
Trend Percentages
z Calculated by dividing all amounts for an item
such as net income or sales by the amount for
that item in the base year.
Chapter 3
Percentage of 1991
Net Income
1991
1,291
100
1992
1,609
125
1993
1,995
155
1994
2,333
181
1995
2,681
208
1996
2,740
212
1997
3,056
237
1998
3,526
273
1999
4,430
343
2000
5,377
416
2001
6,395
488