Chapter 3

The Matching Concept and

The Adjusting Process
 Objectives
Explain how the matching concept relates to the
Explain accrual basis of accounting

Explain why adjustments are necessary and list

Explain the characteristics of adjusting entries

Journalise entries for accounts requiring

Journalise adjustment
 Content

• Time difference!
• Cash Basis and Accrual Basis
• Matching concept
• Adjusting process
 Time difference

Remember “accounting period concept”?

 Cash Basis

• Revenues and expenses are reported in the profit

and loss statement in the period in which cash is
received or paid.

• Example: Your company sold goods to customer

on credit on 1st May. The customer paid the debt
on 4th June.
 Accrual Basis
• Revenues/Expenses are reported in the
profit and loss statement in the period in
which they are earned/incurred.
 Matching Concept

• Accounting concept that supports reporting

revenues and related expenses in the same
period is called the Matching Concept, or
Matching Principle
 Adjusting Process

• 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.
 Deferrals

• Cash received or paid in the

Difference current period, but these items
relates to future period
between
Deferrals Accruals
and
Accruals • Cash will not be received or paid
until a future period, the revenue
and expense relates to the
current period
 Current Accounting Period Future Accounting Period

Prepaid expenses
Unearned revenues Revenue Earned
Deferrals or Expense
Cash Received or Incurred
Paid

Accrued revenues
Accrued expenses
Cash Received or
Accruals Revenue Earned Paid
or Expense
Incurred
 Deferred Expenses
(Prepaid expenses)

• Initially recorded as assets but are expected to

become expenses.

• Supplies and Supplies Expense

• Prepaid Insurance and Insurance Expense

• Prepaid rent and rental expense

Prepaid Expenses

◆ Expire either with the passage of time or through use.

◆ Adjusting entry:
► Increase (debit) to an expense account and

► Decrease (credit) to an asset account.

Illustration 3-4
Adjusting entries for prepaid
expenses
Prepaid Expenses

Illustration: Pioneer Advertising Inc. Inc.

purchased supplies costing $2,500 on
October 5. Pioneer recorded the
purchase 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
Prepaid Expenses

On October 4, Pioneer Advertising Inc. 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
Prepaid Expenses

Depreciation
◆ Buildings, equipment, and motor vehicles (assets that
provide service for many years) are recorded as assets,
rather than an expense, on the date acquired.

◆ Depreciation is the process of allocating the cost of

an asset to expense over its useful life.

◆ Depreciation does not attempt to report the actual

change in the value of the asset.
Prepaid Expenses

For Pioneer Advertising, assume that

depreciation on the equipment is $480 a year,
or $40 per month.

Oct. 31

Depreciation Expense 40
Accumulated Depreciation 40

Accumulated Depreciation is called

a contra asset account.

Helpful Hint
All contra accounts have increases,
decreases, and normal balances opposite
to the account to which they relate.
Prepaid Expenses

Statement Presentation
◆ Accumulated Depreciation is a contra asset account
(credit).
◆ Appears just after the account it offsets (Equipment) on
the balance sheet.
◆ Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.
Illustration 3-8
 Prior to adjustment,
assets are overstated
and expenses are
understated
 Deferred Revenue/
Unearned Revenues
• Initial recorded as liabilities but are expected to
become revenues.

◆ Rent ◆ Magazine subscriptions

◆ Airline tickets
 Unearned Rent and Rent
Revenue
• Let assume I have a house to rent out for students @
$100 per month.

• What if you guys sign a 6-months rent contract with

me at 1st December? (Paid in full)
 Accrued Expenses

• These are expenses that have been incurred but have

not been recorded in the accounts.

• Accrued expenses are services that are paid for after

the services has been performed.

• Salaries owned to employees, interest

 Salaries Payable and
Salaries Expense
• You are hired as sale assistants in Ms.Thao’s food
store on 1st March

• Salaries: 3 mil per month

• How Ms.Thao record this at the beginning and the end

of March? Knowing that Ms.Thao has paid the amount
of the salaries at the end of March
Interest Payable
and Interest
Expense
 Accrued Revenue

• Are revenues that have been earned but have not

been recorded in the accounts.

• Ex: Lawyer has provided services to a client but has

not send an invoice till the end of the month
• Account Receivable and Sales
Account Receivable and
Revenue

• I signed an agreement with students on January

15th . Binding by the agreement, I will help
students to answer their accounting-related-
questions $10 per question. Invoice will be sent to
students on the 15th of each month. Given that I
had answered 20 questions at the end of
January.

• How do I record this at the end of the month?

Summary of Adjusting Process
Dr
Cr
• Deferred Expense
Dr
• Deferred Revenue Cr

Dr
• Accrued Expense Cr

Dr
• Accrued Revenue Cr

• Depreciation Dr
Cr
 Exercise 1
You have the following information for ACB company in January 20X0:
1st Owner contributes capital of 100,000 in cash and also signs a 6-month rental contract for
the office ($200 per month and pay full in advance).
1st Borrow 5,000 cash from the bank. The annual interest rate is 10%
3rd Purchase goods at a cost of 3,000 on credit.
5th Purchase car at a cost of 20,000 by cash (Depreciation is estimated at $500 per month)
6th Sell all of the above goods for $4,500 and receive cash
11th Pay for the goods which are bought on the 3rd in cash
15th Sign a contract with the customer to lease a house from 15th January to 15th June. The
lease is $500/month. The customer will pay money at the beginning of the month.
Requirement: Record the transactions in January and prepare the Trial Balance for the month
 Exercise 2
1st Invest 20,000 in cash to the company’s capital
1st Sign a 6-month rental contract for the office (@4,000 per month and pay full in advance)
3rd Purchase goods at the cost of 10,000 on credit
5th Purchase machine at the cost of 10,000 on credit (Depreciation is estimated at $50 per
month)
6th Sell goods @4,500 and receive cash (the amount of goods originally costs 3,100)
11th Pay for the machine by cash ($6,000)
17th Invest more 8,000 in cash to the business
26th Purchase goods at the cost of 10,000 on credit
31st Sell goods (which originally cost 7,000) $9,000 on credit.
 Exercise 3
1st Hire an accountant @800 per month, salary is paid at the end of each month.
2nd Invest more 4,000 cash into the business.
5th Purchase goods at cost of 6,000 on credit.
12th Make a payment of 6,000 cash to supplier of goods.
18th Sell goods (which originally cost 5,000) @8,000 in cash.
20th Borrow 3,000 cash from bank.
25th Sell goods (which originally cost 4,000) @6,000 and 50% of this is received in cash
(the rest is on credit).
28th Pay salary for accountant.