Adjusting Journal

Entries: Part 1

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 Matching Revenue and Related Expenses
Accrue: To record revenue or an expense without
• Accrual basis accounting:
the exchange of cash
o is in accordance with U.S. GAAP; and
o matches revenues with expenses.
• In order to properly match revenues with expenses in the periods in which they occur,
it is sometimes necessary to defer or accrue revenues or expenses.

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 Matching Revenue and Related Expenses
• In the case of:
o unearned (deferred) revenues, cash is received before the revenue is earned.
o prepaid (deferred) expenses, cash is paid before the expense is incurred.
o accrued revenues (receivables), cash is received after the revenue has been earned.
o accrued expenses (accrued liabilities, accounts payable, or other payables), cash is paid after
the expense has been incurred.

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 Adjusting Journal Entries
• In order for financial statements to be prepared in accordance with
the accrual basis of accounting, adjusting entries must be recorded.

The purpose of adjusting journal entries is to record

revenues and expenses in the correct periods; not
necessarily when cash is received or paid.

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 Unearned Revenues and Prepaid Expenses
• If revenue has been deferred, the company must calculate the amount of revenue that has
been earned through year-end and make the appropriate adjusting journal entry.
• Journal entry to record unearned revenue:

DR Cash $XXX
Asset = Liability + Equity (No change)
CR Unearned revenue $XXX

• Adjusting journal entry to record unearned revenue that has been earned:

DR Unearned revenue B/S $XXX

Asset (No change) = Liability + Equity
CR Revenue I/S $XXX

Notice how the adjusting entry does NOT affect cash.

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 Unearned Revenues and Prepaid Expenses
• If expenses have been deferred (prepaid), the company must calculate the amount of expenses that have
been incurred through year-end and make the appropriate adjusting journal entry.
• Journal entry to record prepaid expense:
DR Prepaid expenses (asset) $XXX
CR Cash $XXX

• Adjusting journal entry to reverse prepaid expense and record incurred expense:
DR Expense​ I/S $XXX
CR Prepaid expenses B/S $XXX

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 Accrued Revenues and Expense
• An entity must assess whether revenues have been earned prior to the cash being received.
• If so, revenues must be accrued by recording a receivable.
• Journal entry to record accrued revenue:

DR Accounts receivable B/S $XXX

Asset = Liability (No change) + Equity
CR Revenue I/S $XXX

This is not a year-end adjusting entry. Another adjusting

entry will be recorded when the cash is received.

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 Accrued Revenues and Expense
• An entity must also assess if expenses have been incurred prior to the cash being paid.
• If so, expenses must be accrued by recording:
o accrued liabilities;
o accounts payable; or
o other payable.

DR Expense​ I/S $XXX

Asset (No change) = Liability + Equity
CR Accrued liability B/S $XXX

This is not a year-end adjusting entry. Another Upon payment:

adjusting entry will be recorded when the cash is paid. Asset = Liability + Equity (No change)

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 Error Corrections
• In some instances, an entity may record cash receipts (disbursements)
to a revenue/expense account when they should have been recorded to
an asset/liability account.
• An adjusting entry may be required in this case to ensure that the
financial statements are in accordance with the accrual basis of
accounting (e.g., recording the prepayment of insurance directly to
insurance expense rather than prepaid insurance).

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 Rules for Recording Adjusting Journal Entries
• Must be recorded by the end of the entity's fiscal year, before the
preparation of financial statements.
• Never involve the cash account.
• All adjusting entries will hit one income statement account and one
balance sheet account.

Error corrections could affect any account depending on

the specific error made.

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 Adjusting Journal Entries

Example: Adjusting Journal Entries: Solution:

Unearned Revenue Unearned December 1, Year 1—journal entry to record deferred
Facts: On December 1, Year 1, Impact Inc. revenue:
received $250,000 in cash for services to be
performed equally during December Year 1, DR Cash Asset $250,000
and January Year 2. Impact Inc. recorded CR Unearned service revenue Liability $250,000
the entry as a credit to unearned service
revenue
December 31, Year 1–adjusting journal entry to record
Required :Prepare the journal entry to revenue earned during Year 1:
record the unearned revenue on December
1, Year 1, and the adjusting journal entry DR Unearned service revenue B/S $125,000
required at year-end. CR Service revenue I/S $125,000

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 Adjusting Journal Entries

Example: Adjusting Journal Entries: $2,000,000 × 3% = $60,000 interest

Accrued Interest $60,000 ÷ 12 months = $5,000 per month
Facts: On November 1, Year 1, Impact $5,000 × 2 months (11/1 to 12/31) = $10,000 accrued interest
Inc. borrowed $2,000,000 from Federal
Bank at a rate of 3 percent with interest Solution
due annually on November 1. The principal November 1, Year 1–journal entry to record loan from Federal
will be paid back on November 1, Year 2 Bank:
DR Cash Asset $2,000,000
Required: Prepare the journal entry to
record the loan on November 1, Year 1, CR Note payable Liability $2,000,000
and the adjusting journal entry for the
accrued interest at year-end. December 31, Year 1–adjusting journal entry to record the
interest accrued from November–December of Year 1
($2,000,000 × 3% × 2/12 = $10,000):
DR Interest expense I/S $10,000
CR Interest payable B/S $10,000

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 Adjusting Journal
Entries: Part 2

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 Adjusting Journal Entries

Example: Adjusting Journal Entries: Comprehensive Example

Facts: Titan Company reported pretax income in Year 2 of
$8,000. Upon review of the general ledger, the following
information listed in the first column was discovered.
Required: If necessary, record an adjustment to pretax
income in the table provided so that the income statement and
balance sheet will be presented in accordance with the accrual
basis of accounting. Prepare the adjusting journal entries
required to record these adjustments.

• Debit to increase
Expense
• Credit to decrease
• Credit to increase
Revenue
• Debit to decrease

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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Sheet
Year 2 Pretax
Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
1. The company purchased a $300, three-year
insurance policy on 1/1/Year 2 and expensed it
all on the payment date. 200 $200

Actual entry:  Expense

DR Insurance expense $300 Incorrectly booked the full

CR Cash $300 amount as an expense

What should be done? Book insurance for that one year only
$300 ÷ 3 years = $100
Reduce expense
Actual expense for Year 2 = $100
by $200
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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Sheet
Year 2 Pretax
Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
1. The company purchased a $300, three-year
insurance policy on 1/1/Year 2 and expensed it
all on the payment date. 200 $200

The $300 paid for insurance during the year should have been debited to prepaid insurance. At year-end,
two years of insurance coverage are left and one year has expired. The $200 reduction in expense
increases pretax income for the year. The $200 debit under balance sheet reflects the correct balance of
prepaid insurance as of that date. At year-end, two years of insurance coverage remain.

DR Prepaid insurance $200

CR Insurance expense $200

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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Sheet
Year 2 Pretax
Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
2. $2,000 of credit sales made during Year 2
were not recorded in the ledger because they
had not been collected in cash. 2,000 $2,000

 Revenue
What should be done? Record revenue that was earned.

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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Sheet
Year 2 Pretax
Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
2. $2,000 of credit sales made during Year 2
were not recorded in the ledger because they
had not been collected in cash. 2,000 $2,000

According to the revenue recognition principle and accrual accounting, sales should be recorded when the
performance obligation is satisfied. The $2,000 credit to income properly records the sale, and the debit to
the balance sheet properly reflects the claim to cash that exists at year-end.

DR Accounts receivable $2,000

CR Sales revenue $2,000

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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Sheet
Year 2 Pretax
Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
3. Cash totaling $3,000 that was received in
advance from customers was recorded to
service revenue. Only 30 percent of the
services had been performed by year-end. (2,100)  Revenue $2,100
Actual entry:
DR Cash $3,000 Incorrectly booked the full
CR Revenue $3,000 amount as revenue

What should be done? Reduce revenue by $2,100

$3,000 × 30% = $900
Actual revenue for Year 2 = $900
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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Sheet
Year 2 Pretax
Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
3. Cash totaling $3,000 that was received in
advance from customers was recorded to
service revenue. Only 30 percent of the
services had been performed by year-end. (2,100) $2,100

The receipt of cash in advance from a customer should not have been recorded as service revenue
because it represents unearned revenue. At year-end, 30 percent of the services had been performed, so
$900 is valid service revenue. $2,100 had to be removed from income and recorded as an obligation on the
balance sheet at year-end to reflect remaining services to be performed.

DR Sales revenue $2,100

CR Unearned revenue $2,100

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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Sheet
Year 2 Pretax
Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
4. The accountant discovered that a $450 utility
bill covering the month of December had not
been entered in the AP system at year-end. (450) $450

 Expense
What should be done? Record a $450 expense for the month of December

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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Sheet
Year 2 Pretax
Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
4. The accountant discovered that a $450 utility
bill covering the month of December had not
been entered in the AP system at year-end. (450) $450

Expenses should be recorded in the period incurred. The $450 charge to income records the correct
expense incurred. The year-end balance sheet now reflects the $450 as accounts payable (utilities
payable).

DR Utilities expense $450

CR A/P (Utilities payable) $450

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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Year Sheet
2 Pretax Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
5. $4,000 of rent was prepaid on 1/1/Year 1,
covering a four-year rental period. No entry was
recorded in Year 2 related to this prepayment. (1,000) ($1,000)

Actual entry ( Year 1):  Expense

DR Prepaid rent $4,000

CR Cash $4,000

No entry was recorded for Year 2.

What should be done? Record $1,000 of rent expense for Year 2

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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Year Sheet
2 Pretax Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
5. $4,000 of rent was prepaid on 1/1/Year 1,
covering a four-year rental period. No entry was
recorded in Year 2 related to this prepayment. (1,000) ($1,000)

There was no cash outflow in the current year related to the rent expense, but one year of rent expense
must be charged to income. The $1,000 reflects the expense incurred in the current year. The prepaid rent
balance from the prior year-end is reduced and the current year-end prepaid balance would total $2,000,
as two years of benefit remain.
DR Rent expense $1,000
CR Prepaid rent $1,000

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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Sheet
Year 2 Pretax
Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
6. The direct write-off method (non-GAAP
method) was used to write off a $650 bad debt
in Year 2, although the company uses the
allowance approach to estimate bad debts. 650 $650
Actual entry:
DR Bad debt expense $650 Incorrect use of direct
CR Accounts receivable $650 write-off method

What should be done? Modify journal entry to write-off accounts receivable

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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Sheet
Year 2 Pretax
Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
6. The direct write-off method (non-GAAP
method) was used to write off a $650 bad debt
in Year 2, although the company uses the
allowance approach to estimate bad debts. 650 $650
Because the company uses the allowance approach to record estimated bad debts, we can assume that
an estimate of bad debt was recorded when the sale was originally recorded. The direct write-off was
recorded to bad debt expense when it should have been recorded to the allowance account. The effect of
this correction is to increase income and increase assets (assets increase because we are reducing a
contra-asset account).
DR Allowance for doubtful accounts $650
CR Bad debt expense $650
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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Sheet
Year 2 Pretax
Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
7. The company purchased $1,300 of raw
materials at year-end which were shipped FOB
shipping point and were in transit at the end of
the year. The goods were not included in the
actual year-end inventory count (the effect of
this correction on the financial statements is
the same whether the perpetual or periodic
inventory system is used.) $1,300 $1,300

Notice: this entry affects two

balance sheet accounts

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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Sheet
Year 2 Pretax
Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
7. The company purchased $1,300 of raw
materials at year-end which were shipped FOB
shipping point and were in transit at the end of
the year. The goods were not included in the
actual year-end inventory count (the effect of
this correction on the financial statements is
the same whether the perpetual or periodic
inventory system is used.) $1,300 $1,300
The correct journal to record the inventory in transit at year-end:
DR Inventory (perpetual system) or: $1,300
Purchases (periodic system)
CR Accounts payable $1,300
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 Adjusting Journal Entries
Solution: Adjustments to Balance
Adjustment to Sheet
Year 2 Pretax
Income Liabilities and
Assets
Equity
Unadjusted Year 2 pretax income $8,000
8. The company purchased available-for-sale Notice: this entry affects two
securities during Year 2 for $1,500. The fair value balance sheet accounts
at year-end totaled $2,000 but no adjustment to
fair value was recorded in the ledger. $500 $500
Total adjustment $ (700) $3,650 $4,350
Adjusted Year 2 pretax income $(7,300)
Available-for-sale securities must be reported on the balance sheet at fair value. The valuation account
increases the value of the investment on the balance sheet. The unrealized gain affects equity through
accumulated other comprehensive income.
DR Valuation account (fair value adjustment) $500
CR Unrealized gain on available-for-sale securities $500
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 Adjusting Journal Entries: Recap
The $300 paid for insurance during the year should have been debited to prepaid insurance. At year-
1
end, two years of insurance coverage are left and one year has expired. The $200 reduction in
expense increases pretax income for the year. The $200 debit under balance sheet reflects the
correct balance of prepaid insurance as of that date. At year-end, two years of insurance coverage
remain.

DR Prepaid insurance $200

CR Insurance expense $200

According to the revenue recognition principle and accrual accounting, sales should be recorded
2
when the performance obligation is satisfied. The $2,000 credit to income properly records the sale,
and the debit to the balance sheet properly reflects the claim to cash that exists at year-end.

DR Accounts receivable $2,000

CR Sales revenue $2,000

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 Adjusting Journal Entries: Recap
The receipt of cash in advance from a customer should not have been recorded as service revenue
3
because it represents unearned revenue. At year-end, 30 percent of the services had been
performed, so $900 is valid service revenue. $2,100 had to be removed from income and recorded
as an obligation on the balance sheet at year-end to reflect remaining services to be performed.

DR Sales revenue $2,100

CR Unearned revenue $2,100

Expenses should be recorded in the period incurred. The $450 charge to income records the correct
4
expense incurred. The year-end balance sheet now reflects the $450 as accounts payable (utilities
payable).

DR Utilities expense $450

CR A/P (Utilities payable) $450

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 Adjusting Journal Entries: Recap
There was no cash outflow in the current year related to the rent expense, but one year of rent
5
expense must be charged to income. The $1,000 reflects the expense incurred in the current year.
The prepaid rent balance from the prior year-end is reduced and the current year-end prepaid
balance would total $2,000, as two years of benefit remain.
DR Rent expense $1,000
CR Prepaid rent $1,000

Because the company uses the allowance approach to record estimated bad debts, we can assume
6
that an estimate of bad debt was recorded when the sale was originally recorded. The direct write-off
was recorded to bad debt expense when it should have been recorded to the allowance account. The
effect of this correction is to increase income and increase assets (assets increase because we are
reducing a contra-asset account).

DR Allowance for doubtful accounts $650

CR Bad debt expense $650

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 Adjusting Journal Entries: Recap
The correct journal to record the inventory in transit at year-end:
7
Inventory (perpetual system) or:
DR $1,300
Purchases (periodic system)
CR Accounts payable $1,300

Available-for-sale securities must be reported on the balance sheet at fair value. The valuation
8
account increases the value of the investment on the balance sheet. The unrealized gain affects
equity through accumulated other comprehensive income.

Valuation account (fair value

DR $500
adjustment)
Unrealized gain on
CR $500
available-for-sale securities

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