Chapter 5

PART 1 of 3
(Step 5)
Adjusting the Accounts:
Accrual vs. Cash Basis, Prepayments

(based on Accounting Principles, 13th

Edition; Weygandt, Kimmel and Kieso)
MIDTERMS COVERAGE

September 18 & 20
September 20 & 22
September 22 & 25
September 25 & 27

September 27 & 29
October 2 & 4
October 4 & 6
October 6 & 9
 Stages of the Accounting Cycle
Reversing
Entries
8 1
Transaction
Analysis
Closing
Entries 7 Journaliz
2 ing

Financial 6
Statements Posti
3 ng

Adjusting 5 4
Entry Trial
Balance
Chapter Outline
Learning Objectives
LO 1 Explain the accrual basis of accounting and the reasons
for adjusting entries.
LO 2 Prepare adjusting entries for deferrals.
LO 3 Prepare adjusting entries for accruals.
LO 4 Describe the nature and purpose of an adjusted trial
balance.

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Accrual-Basis and Adjusting Entries
Accountants divide the economic life of a business into
artificial time periods (Time Period Assumption).

Generally a
Alternative terminology
• month,
The time period assumption is also
• quarter, or called the periodicity assumption.
• year.
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Fiscal and Calendar Years (1 of 5)
• Monthly and quarterly time periods are called interim
periods
• Most large companies must prepare both quarterly
and annual financial statements
• Fiscal Year = Accounting time period that is one year
in length
• Calendar Year = January 1 to December 31

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QUESTION 1:
Fiscal and Calendar Years
(answer in next slide)

The time period assumption states that:

a. companies must wait until the calendar year is
completed to prepare financial statements.
b. companies use the fiscal year to report financial
information.
c. the economic life of a business can be divided into
artificial time periods.
d. companies record information in the time period in
which the events occur.

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QUESTION 1:
Fiscal and Calendar Years
(answer to previous slide)

The time period assumption states that:

a. companies must wait until the calendar year is
completed to prepare financial statements.
b. companies use the fiscal year to report financial
information.
c. Answer: the economic life of a business can be divided
into artificial time periods.
d. companies record information in the time period in
which the events occur.

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Accrual- versus Cash-Basis Accounting
(1 of 2)
Accrual-Basis Accounting
• Transactions recorded in the periods in which the events
occur
• Companies recognize revenues when they perform
services (rather than when they receive cash)
• Expenses are recognized when incurred (rather than when
paid)
• In accordance with generally accepted accounting
principles (GAAP)

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Accrual- versus Cash-Basis Accounting
(2 of 2)
Cash-Basis Accounting
• Revenues recognized when cash is received
• Expenses recognized when cash is paid
• Cash-basis accounting is not in accordance with generally
accepted accounting principles (GAAP)

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Recognizing Revenues and Expenses (1 of 3)

Revenue Recognition Principle

Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.

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Recognizing Revenues and Expenses (2 of 3)

Expense Recognition Principle

Companies recognize expenses
in the period in which they
make efforts (consume assets
or incur liabilities) to generate
revenue.
“Let the expenses follow
the revenues.”

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Recognizing Revenues and Expenses (3 of 3)

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Question 2:
Fiscal and Calendar Years
(ANSWER IN NEXT SLIDE)

Which of the following statements about the accrual basis

of accounting is false?
a. Events that change a company’s financial statements are
recorded in the periods in which the events occur.
b. Revenue is recognized in the period in which services are
performed.
c. This basis is in accordance with generally accepted
accounting principles.
d. Revenue is recorded only when cash is received, and
expense is recorded only when cash is paid.

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ANSWER TO Question 2:
Fiscal and Calendar Years
(ANSWER TO PREVIOUS SLIDE)

Which of the following statements about the accrual basis of

accounting is false?
a. Events that change a company’s financial statements are
recorded in the periods in which the events occur.
b. Revenue is recognized in the period in which services are
performed.
c. This basis is in accordance with generally accepted
accounting principles.
d. Answer: Revenue is recorded only when cash is received,
and expense is recorded only when cash is paid.

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The Need for Adjusting Entries (1 of 3)
Adjusting Entries
• Ensure that the revenue recognition and expense
recognition principles are followed.
• Necessary because the trial balance may not contain
up-to-date and complete data.
• Required every time a company prepares financial
statements.
• Will include one income statement account and one
balance sheet account.

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QUESTION 3:
The Need for Adjusting Entries
(ANSWER IN NEXT SLIDE)

Adjusting entries are made to ensure that:

a. expenses are recognized in the period in which they are
incurred.
b. revenues are recorded in the period in which services are
performed.
c. balance sheet and income statement accounts have correct
balances at the end of an accounting period.
d. All the responses above are correct.

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ANSWER TO QUESTION 3:
The Need for Adjusting Entries
(ANSWER TO PREVIOUS SLIDE)

Adjusting entries are made to ensure that:

a. expenses are recognized in the period in which they are
incurred.
b. revenues are recorded in the period in which services are
performed.
c. balance sheet and income statement accounts have correct
balances at the end of an accounting period.
d. Answer: All the responses above are correct.

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Types of Adjusting Entries
Deferrals Accruals
1. Prepaid Expenses. Expenses 1. Accrued Revenues. Revenues
paid in cash before they are for services performed but not
used or consumed. yet received in cash or recorded.
2. Unearned Revenues. Cash 2. Accrued Expenses. Expenses
received before services are incurred but not yet paid in cash
performed. or recorded.

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Types of Adjusting Entries
Trial Balance – Each account is analyzed to determine
whether it is complete and up-to-date.

2023

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Exercise 1: Timing Concepts (5 mins.)
(ANSWERS IN NEXT SLIDE = 8 POINTS)
Below is a list of timing concepts in the (a) Monthly and quarterly time periods.
left column, with a description of the
concept in the right column. There are (b) Efforts (expenses) should be recognized in the
more descriptions provided than period in which a company uses assets or
concepts. Match the description to the incurs liabilities to generate results
concept (revenues).
(c) Accountants divide the economic life of a
1. ______ Accrual-basis accounting. business into artificial time periods.
2. ______ Calendar year.
(d) Companies record revenues when they
3. ______ Time period assumption. receive cash and record expenses when they
4. ______ Expense recognition principle. pay out cash.
(e) An accounting time period that starts on
January 1 and ends on December 31.
(f) Companies record transactions in the period in
which the events occur.
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Exercise 1: Timing Concepts
(ANSWERS TO PREVIOUS SLIDE)
Below is a list of timing concepts in the (a) Monthly and quarterly time periods.
left column, with a description of the
concept in the right column. There are (b) Efforts (expenses) should be recognized in the
more descriptions provided than period in which a company uses assets or
concepts. Match the description to the incurs liabilities to generate results
concept (revenues).
(c) Accountants divide the economic life of a
1. f Accrual-basis accounting. business into artificial time periods.
DELETE TO REVEAL ANSWER
2. e Calendar year.
(d) Companies record revenues when they
3. c Time period assumption. receive cash and record expenses when they
4. b Expense recognition principle. pay out cash.
(e) An accounting time period that starts on
January 1 and ends on December 31.
(f) Companies record transactions in the period in
which the events occur.
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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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Prepaid Expenses (1 of 5)
Payments of expenses that are recorded as an asset to show
the service or benefit the company will receive in the future.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

• insurance • rent

• supplies • equipment

• advertising • buildings

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Prepaid Expenses (2 of 5)
• Expire either with the passage of time or through use
• Adjusting entry:
o Increase (debit) to an expense account and
o Decrease (credit) to an asset account

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Prepaid Expenses (3 of 5)
2023

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Adjustment for Supplies (1 of 2)
Illustration: Pioneer Advertising purchased
supplies costing $2,500 on October 5.
Pioneer recorded the payment by increasing
(debiting) the asset Supplies.
This account shows a balance of $2,500 in the
October 31 trial balance.
An inventory count at the close of business on
October 31 reveals that $1,000 of supplies are
still on hand.

Oct. 31 Supplies Expense 1,500

Supplies 1,500

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Adjustment for Supplies (2 of 2)

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Adjustment for Insurance (1 of 2)
Illustration: On October 4, Pioneer Advertising paid
$600 for a one-year fire insurance policy.
Coverage began on October 1.
Pioneer recorded the payment by increasing
(debiting) Prepaid Insurance.
This account shows a balance of $600 in the October
31 trial balance.
Insurance of $50 ($600 ÷ 12) expires each month.

Oct. 31 Insurance Expense 50

Prepaid Insurance 50

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Adjustment for Insurance (2 of 2)

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CHECK UP QUIZ#1 (30 points):
Assume the following adjustment data for Pioneer Ads Agency on
October 31, 2023:

1. Marketing Supplies on hand at October 31 total $900. (recorded

as part of Marketing Supplies Expense upon purchase)
2. Expired personnel insurance for the month is $75. (the agency
records all insurance payments as Prepaid Insurance upon payment
of premium).
3. Car Insurance expired during October of $600 was omitted.
4. Office Supplies Expense includes $250 of supplies that are still
on hand at October 31.
5. Commercial Film Supplies on hand total $1,300. This was part of
the Commercial Film Production Expense recorded during the year
upon release of their budget.
6. The Agency paid $2,520 for 12 months of insurance coverage for
digital film production and processing equipment on August 1,
2023.

Instructions
Prepare the adjusting entries for the items above.
END OF PART 1

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