| Chapter 4 Adjusting Entries are needed at the end of each accounting period to make certain that appropriate amounts of revenue and expenses are reported in the company�s income statement. Types of Adjusting Entries 1. Converting Assets to Expenses -record the amount of an asset used up Dr Expense, Cr Asset (or Depreciation acct) 2. Converting Liabilities to Revenue -when pre-collected cash or acct receivable is earned Dr Unearned Revenue, Cr Revenue 3. Accruing Unpaid Expenses - expenses incurred but not yet paid Dr Expense, Cr Liability 4. Accruing Uncollected Revenue -revenue earned but not yet received payment for Dr Receivable, Cr Revenue or Interest Earned Characteristics of Adjusting Entries 1. Involves recognition of either revenue or expenses (representing change in owner�s equity), and a corresponding change in either assets or liabilities. 2. Based on the concepts of accrual accounting, therefore revenue and expenses must be recorded to measure income properly Converting Assets to Expenses * Prepaid Expenses-payments made in advance for things like insurance rent, office supplies, etc. These are assets; become expenses as they are used up. * Shop Supplies-at the end of the month, the supplies that are �missing� are assumed to be used up. * Insurance Policies-each month, a portion of the policy expires. The Concept of Depreciation * Depreciable Assets- physical objects that retain their size and shape but that eventually wear out or become obsolete. * Straight-line Method of Depreciation- the widely used approach of recognizing an equal amount of depreciation expense in each period of a depreciable asset�s useful life. * Depreciation Expense per period = Cost of Asset/Estimated useful life **Depreciation is only an estimate! Converting Liabilities to Revenue * Unearned Revenue - an obligation to deliver goods or render services in the future, stemming from the receipt of advance payment Accruing Unpaid Expenses * Accrual of Wages (or Salaries) Expense � employees have worked and won�t receive payment this month. * Accrual of Interest Expense Accruing Uncollected Revenue * Revenue that has been earned but not yet recorded Adjusting Entries and Accounting Principles * Realization Principle -revenue should be recognized in the period goods are sold or services are rendered. * Matching Principle �requires recognition of expenses in the periods that the goods and services are used in effort to produce revenue. Effects of the Adjusting Entries * Adjusted Trial Balance �a schedule indicating the balances in ledger accounts after end-of-period adjusting entries have been posted. Use these amounts for the Financial Statements. |