Adjusting Accounts For

Financial Statements
Chapter 3

Wild and Shaw

Financial and Managerial Accounting
9th Edition

Copyright ©2022 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
 Chapter 3 Learning Objectives
• Accrual vs Cash Basis of Accounting
• Adjusting journal entries
• The adjusted trial balance
• Preparing the financial statements
• Preparing closing journal entries and closing the
books
• Compute and analyze the profit margin and
current ratio.

Not covering Appendix

© McGraw-Hill Education 3-2
 The Accounting Period
Exhibit
3.1

© McGraw-Hill Education 3-3

Learning Objective C1: Explain the importance of periodic reporting and the role of accrual accounting.
Accrual Basis versus Cash Basis
Accrual Basis Cash Basis
Revenues are recorded Revenues are recorded
when products or when cash is received and
services are delivered, expenses are recorded
and records expenses when cash is paid.
when incurred.

© McGraw-Hill Education 3-4

Learning Objective C1: Explain the importance of periodic reporting and the role of accrual accounting.
 Recognizing Revenues
The revenue recognition principle
requires that revenue be recorded
when the goods or services are
provided to customers and at an
amount expected to be received
from customers.

© McGraw-Hill Education 3-5

Learning Objective C1: Explain the importance of periodic reporting and the role of accrual accounting.
 Recognizing Expenses
The expense recognition (or matching)
principle requires that expenses be recorded
in the same accounting period as the
revenues that are recognized as a result of
those expenses. This matching of expenses
with the revenue benefits is a major part of
the adjusting process.

© McGraw-Hill Education 3-6

Learning Objective C1: Explain the importance of periodic reporting and the role of accrual accounting.
 Accrual Accounting

Deferral Accrual

A revenue or A revenue or
expense event that is expense event that is
recognized after cash recognized before
has been exchanged cash is exchanged
Recognizing revenue when it is earned and expenses when they are
incurred, regardless of when cash changes hands, is commonly
called accrual accounting.
Accruals – Expense and Revenue
happens before cash changes
hands
 Deferrals – Expense and Revenue -
cash is received first

ASSET

LIABILITY
 Adjusting for Prepaid Insurance
•• FastForward paid $2,400 to cover insurance for 24 months
that began on December 1, 2021.
•• FastForward recorded the expenditure as Prepaid Insurance
on December 1.

PREPAID INSURANCE
24-month policy
Beginning 12/01
$2,400

Learning Objective P1: Prepare adjusting entries for deferral of

expenses. © McGraw-Hill Education 3-10
 Adjusting Entry –
Prepaid Insurance
On 12/31, $100 for one month’s worth of insurance has expired.

Prepaid Insurance 128 Insurance Expense 637

Dec. 1 2,400 Dec. 31 100 Dec. 31 100
Bal. 2,300

Dec. 31 Insurance Expense 100

Prepaid Insurance 100
To record first month's expired insurance
Learning Objective P1: Prepare adjusting entries for deferral of © McGraw-Hill Education 3-11
expenses.
 Adjusting for Supplies
Steps 1 and 2
•• FastForward purchased $9,720 of supplies in
December. Some of these supplies were used during
December.
•• Step 2: A physical count performed on 12/31 shows
that unused supplies equal $8,670.

SUPPLIES
Purchases during December $9,720

Learning Objective P1: Prepare adjusting entries for deferral of © McGraw-Hill Education 3-12
expenses.
 Adjusting Entry – Supplies
We’ve seen the adjustment in the T-accounts but
we need to record the adjustment on Dec. 31
in the General Journal
Supplies 126 Supplies Expense 652
Dec. 9,720 Dec. 31 1,050 Dec. 31 1,050
Bal. 8,670

Dec. 31 Supplies Expense 1,050

Supplies 1,050
To record supplies used
Learning Objective P1: Prepare adjusting entries for deferral of © McGraw-Hill Education 3-13
expenses.
 Depreciation
Instead of expensing the cost of a plant (long-
term) asset (equipment, building, cars, etc.) in
the year it is purchased we allocate, or spread
out, the cost over their expected useful lives.
This is called depreciation.
The formula for straight-line depreciation is:

Straight-Line Asset Cost - Salvage Value

Depreciation =
Useful Life

Learning Objective P1: Prepare adjusting entries for deferral of © McGraw-Hill Education 3-14
expenses.
 Adjusting for Depreciation
• FastForward purchased equipment on Dec. 1 for
$26,000.
• It has an estimated useful life of five years.
• The equipment is expected to be worth about
$8,000 at the end of five years.
• They purchased the equipment on Dec. 1 but it is
now Dec. 31.

Because FastForward expects the equipment to be worth $8,000

when the five years are over, only $18,000 of the cost will be
spread over the next 5 years (60 months).
Learning Objective P1: Prepare adjusting entries for deferral of © McGraw-Hill Education 3-15
expenses.
 Adjusting for Depreciation
• Equipment has a useful life of 5 years. The equipment
is expected to be worth $8,000 at the end of five
years. FastForward is using straight-line depreciation.
$18,000 ($26,000 – $8,000) of the cost needs to be
spread over the next 60 months.
One month = $18,000 / 60 = $300.

Learning Objective P1: Prepare adjusting entries for deferral of © McGraw-Hill Education 3-16
expenses.
 Adjusting for Depreciation – Step 3
Depreciation adjustment reflected in our
T-accounts looks like this:
Equipment Depreciation Expense
12/1 26,000 12/31 300

Accumulated Depreciation
12/31 300

• Record adjusting entry for $300 for one month.

• The depreciation amount of $300 is credited to the
Accumulated Depreciation account instead of the
asset account.
Learning Objective P1: Prepare adjusting entries for deferral of © McGraw-Hill Education 3-17
expenses.
 Depreciation – Balance Sheet
Exhibit
3.7

On February 28, 2022, after three months of depreciation

have been taken, the Equipment is shown at its $25,100
book value, or net of accumulated depreciation.

Learning Objective P1: Prepare adjusting entries for deferral of © McGraw-Hill Education 3-18
expenses.
 Adjusting for Unearned Revenues

FastForward’s client paid a 60-day fee in advance covering

the period from 12/27 – 2/24 and recorded:
Dec. 26 Cash 3,000
Unearned Consulting Revenue 3,000
Received advance payment for services
FastForward earns payment as time passes.
At 12/31, 5 days’ service is earned, 5/60 × $3,000 =
$250.
Adjusting entry reduces liability, Unearned Consulting
Revenue, by $250 for 5 days’ of revenue. Consulting
Revenue of $250 is earned.
Learning Objective P2: Prepare adjusting entries for deferral of revenues. © McGraw-Hill Education 3-19
 Adjusting Entry – Unearned Revenue
Adjusting entry recorded on Dec. 31 transfers $250
from unearned to earned consulting revenue.

Dec. 31 Unearned Consulting Revenue 250

Consulting Revenue 250
To record earned revenue received in advance

Learning Objective P2: Prepare adjusting entries for deferral of revenues. © McGraw-Hill Education 3-20
 Adjusting for Accrued Salaries
•• FastForward pays its employee $70 per day, or $350
for a five-day work week. Salaries are paid every two
weeks on a Friday.
•• 12/31 is a Wednesday, so three day’s salaries are
owed at year end which equals $70 × 3 = $210.
•• Adjusting entry increases a liability, Salaries Payable,
and increases Salaries Expense for $210 with the
following journal entry:

Dec. 31 Salaries Expense 210

Salaries Payable 210
To record three days' accrued salaries
Learning Objective P3: Prepare adjusting entries for accrued expenses. © McGraw-Hill Education 3-21
 Future Cash Payment of Accrued Expenses
Accrued expenses at the end of one period result in a
cash payment in a future period.
On 12/31, FastForward recorded accrued salaries of
$210.
On 1/9 of the next year, the following entry will reduce
the accrued liability, salaries payable, and record the
expense for 7 days of work in January.
Jan 9 Salaries Payable (3 x $70) 210
Salaries Expense (7 x $70) 490
Cash 700
To record earned revenue received in advance
© McGraw-Hill Education 3-22
Learning Objective P3: Prepare adjusting entries for accrued expenses.
 Adjusting for Accrued Services Revenue

•• On 12/12, FastForward’s customer agreed to pay $2,700

on 1/10 of the next year for future services over the next
30 days.
•• On 12/31, 20 days worth of services have been provided
and earned which totals $1,800 ($2,700 × 20/30 days).
•• Adjusting entry increases an asset, Accounts Receivable,
and increases the Consulting Revenue account for $1,800
with the following journal entry:

Dec. 31 Accounts Receivable 1,800

Consulting Revenue 1,800
To record 20 days' accrued revenue.
Learning Objective P4: Prepare adjusting entries for accrued © McGraw-Hill Education 3-23
revenues.
 Future Cash Receipt of Accrued Revenues
Accrued revenue at the end of one period results in a cash
receipt in a future period.
On 12/31, FastForward recorded accrued revenue earned of
$1,800.
On 1/10 of the next year, the following entry will reduce the
accounts receivable, record revenue earned for 10 days and
receipt of $2,700 cash.

Jan. 10 Cash 2,700

Accounts Receivable (20 days) 1,800
Consulting Revenue (10 days) 900
To record earned revenue received in advance
Learning Objective P4: Prepare adjusting entries for accrued © McGraw-Hill Education 3-24
revenues.
 Adjusted Trial Balance
Exhibit
3.13

Learning Objective P5: Prepare financial statements from an adjusted trial © McGraw-Hill Education 3-25
balance.
 Preparing Financial Statements from an Adjusted Trial Balance

Exhibit
3.14

© McGraw-Hill Education 3-26

Learning Objective P5: Prepare financial statements from an adjusted trial balance.
 Closing Process
1. Resets revenue,
expense, and
Identify accounts
dividends account
for closing.
balances to zero at
the end of the period.
Record and post
2. Updates Retained closing entries.
Earnings account to
match that reported
in the balance sheet
and statement of Prepare post-closing
retained earnings. trial balance.

© McGraw-Hill Education 3-27

Learning Objective P6: Prepare closing entries and a post-closing trial balance.
 Recording Closing Entries
1. Close Credit Balances in Revenue Accounts to
Income Summary.
2. Close Debit Balances in Expense accounts to
Income Summary.
3. Close Income Summary account to Retained
Earnings.
4. Close Dividends to Retained Earnings.

© McGraw-Hill Education 3-28

Learning Objective P6: Prepare closing entries and a post-closing trial balance.
 Recording Closing Entries Example
Exhibit
3.15

© McGraw-Hill Education 3-29

Learning Objective P6: Prepare closing entries and a post-closing trial balance.
Steps in the Accounting Cycle
 Accounting Cycle
Exhibit
3.19

Learning Objective P6: Prepare closing entries and a post-closing trial balance. © McGraw-Hill Education 3-31
 Classified Balance Sheet
Exhibit
3.20

Current items are expected to come due (collected and

owed) within the longer of one year or the company’s
normal operating cycle.
Most operating cycles are less than one year, so most
companies use a one year period in deciding what assets
and liabilities are current.
© McGraw-Hill Education 3-32
Learning Objective C2: Explain and prepare a classified balance sheet.
 Classified Balance Sheet Example
Exhibit
3.21

© McGraw-Hill Education 3-33

Learning Objective C2: Explain and prepare a classified balance sheet.
 Profit Margin
The profit margin ratio measures the company’s net
income to net sales.
Exhibit
Profit Net income 3.22
=
Margin Net sales

Visa and Mastercard’s Profit Margin

Exhibit
3.23

© McGraw-Hill Education 3-34

Learning Objective A1: Compute and analyze profit margin and current ratio.
 Current Ratio
Helps assess the company’s ability to pay its
debts in the near future

Exhibit
Current assets
Current ratio = Current liabilities 3.24

Exhibit
3.25

© McGraw-Hill Education 3-67

Learning Objective A1: Compute and analyze profit margin and current ratio.
End of Chapter 3

© McGraw-Hill Education 3-36