WILEY

IFRS EDITION

Prepared by
Coby Harmon
University of California, Santa Barbara
3-1
Westmont College
 PREVIEW OF CHAPTER 3

Financial Accounting
IFRS 3rd Edition
Weygandt ● Kimmel ● Kieso
3-2
 CHAPTER

3 Adjusting the Accounts

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Explain the time period assumption.

2. Explain the accrual basis of accounting.
3. Explain the reasons for adjusting entries.
4. Identify the major types of adjusting entries.
5. Prepare adjusting entries for deferrals.
6. Prepare adjusting entries for accruals.
7. Describe the nature and purpose of an adjusted trial balance.

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 Timing Issues
Learning
Objective 1 Accountants divide the economic life of
Explain the time
period a business into artificial time periods
assumption.
(Time Period Assumption).

.....
Jan. Feb. Mar. Apr. Dec.

◆ Generally a month, a quarter, or a year.

◆ Also known as the “Periodicity Assumption”

3-4 LO 1
 Fiscal and Calendar Years

◆ 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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 Accrual- versus Cash-Basis Accounting
Learning
Accrual-Basis Accounting Objective 2
Explain the
accrual basis of
◆ Transactions recorded in the periods in accounting.
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).

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 Accrual- versus Cash-Basis Accounting

Cash-Basis Accounting
◆ Revenues are recorded when cash is received.

◆ Expenses are recorded when cash is paid.

◆ Cash-basis accounting is not in accordance with

International Financial Reporting Standards (IFRS).

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 Recognizing Revenues and Expenses

REVENUE RECOGNITION PRINCIPLE

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

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 Recognizing Revenues and Expenses

EXPENSE RECOGNITION PRINCIPLE

Match expenses with
revenues in the period when
the company makes efforts
to generate those revenues.

“Let the expenses follow

the revenues.”

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 Illustration 3-1
IFRS relationships in
revenue and expense
recognition

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 > DO IT!
A list of concepts is provided in the left column below, with a description of the
concept in the right column below. There are more descriptions provided than
concepts. Match the description of the concept to the concept.

f Accrual-basis accounting.
1. ___ (a) Monthly and quarterly time periods.
(b) Efforts (expenses) should be matched
e Calendar year.
2. ___
with results (revenues).
c Time period assumption.
3. ___ (c) Accountants divide the economic life of
b Expense recognition
4. ___ a business into artificial time periods.
principle. (d) Companies record revenues when they
receive cash and record expenses
when they 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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 The Basics of Adjusting Entries
Learning
Adjusting Entries Objective 3
Explain the
reasons for
◆ Ensure that the revenue recognition and adjusting entries.
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

statement of financial position account.

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 Adjusting Entries

Question
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. statement of financial position 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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 Types of Adjusting Entries Learning
Objective 4
Identify the major
types of adjusting
entries.
Deferrals Accruals

1. Prepaid Expenses. 1. Accrued Revenues.

Expenses paid in cash Revenues for services
before they are used or performed but not yet
consumed. received in cash or recorded.

2. Unearned Revenues. 2. Accrued Expenses.

Cash received before Expenses incurred but not
services are performed. yet paid in cash or recorded.

Illustration 3-2
Categories of adjusting entries

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 Illustration 3-3
Trial balance Each account is analyzed to determine whether it is
complete and up-to-date for financial statement purposes.
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 Adjusting Entries for Deferrals
Learning
Deferrals are expenses or revenues that are Objective 5
Prepare adjusting
recognized at a date later than the point when entries for
deferrals.
cash was originally exchanged. There are
two types:
◆ Prepaid expenses and

◆ Unearned revenues.

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 PREPAID EXPENSES

Payments of expenses that will benefit more than one

accounting period.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

◆ insurance ◆ rent
◆ supplies ◆ buildings and equipment
◆ advertising

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 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
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 PREPAID EXPENSES

Illustration: Yazici Advertising Inc. Inc.

purchased supplies costing ₺2,500 on
October 5. Yazici 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

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Illustration 3-5
Adjustment for supplies

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 PREPAID EXPENSES

Illustration: On October 4, Yazici Advertising

Inc. paid ₺600 for a one-year fire insurance
policy. Coverage began on October 1. Yazici
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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Illustration 3-6
Adjustment for insurance

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 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.

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 PREPAID EXPENSES

Illustration: For Yazici 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.
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 Illustration 3-7
3-25 Adjustment for depreciation LO 5
 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
3-26 Statement of financial position presentation of accumulated depreciation LO 5
 PREPAID EXPENSES

Illustration 3-9
Accounting for prepaid expenses

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 UNEARNED REVENUES

Receipt of cash that is recorded as a liability because the

service has not been performed.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

◆ Rent ◆ Magazine subscriptions
◆ Airline tickets ◆ Customer deposits

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 UNEARNED REVENUES

◆ Adjusting entry is made to record the revenue for

services performed during the period and to show the
liability that remains at the end of the accounting period.

◆ Results in a decrease (debit) to a liability account and

an increase (credit) to a revenue account.
Illustration 3-10
Adjusting entries
for unearned
revenues

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 UNEARNED REVENUES

Illustration: Yazici Advertising Inc. received ₺1,200 on October 2

from R. Knox for advertising services expected to be completed by
December 31. Unearned Service Revenue shows a balance of
₺1,200 in the October 31 trial balance. Analysis reveals that the
company performed ₺400 of services in October.

Oct. 31 Unearned Service Revenue 400

Service Revenue 400

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 Illustration 3-11
Service revenue accounts after adjustment

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 UNEARNED REVENUES

Illustration 3-12
Accounting for unearned revenues

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 > DO IT!
The ledger of Zhu Company on March 31, 2017, includes these
selected accounts before adjusting entries are prepared.
(amounts in thousands) Debit Credit
Prepaid Insurance ¥ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment ¥ 5,000
Unearned Service Revenue 9,200
An analysis of the accounts shows the following.
1. Insurance expires at the rate of ¥100 per month.
2. Supplies on hand total ¥800.
3. The equipment depreciates ¥200 a month.
4. One-half of the unearned service revenue was performed in
March.
Prepare the adjusting entries for the month of March.
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 > DO IT!
The ledger of Zhu Company on March 31, 2017, includes these
selected accounts before adjusting entries are prepared.
(amounts in thousands) Debit Credit
Prepaid Insurance ¥ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment ¥ 5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.
1. Insurance expires at the rate of ¥100 per month.

Insurance Expense 100

Prepaid Insurance 100

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 > DO IT!
The ledger of Zhu Company on March 31, 2017, includes these
selected accounts before adjusting entries are prepared.
(amounts in thousands) Debit Credit
Prepaid Insurance ¥ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment ¥ 5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.
2. Supplies on hand total ¥800.

Supplies Expense 2,000

Supplies 2,000

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 > DO IT!
The ledger of Zhu Company on March 31, 2017, includes these
selected accounts before adjusting entries are prepared.
(amounts in thousands) Debit Credit
Prepaid Insurance ¥ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment ¥ 5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.
3. The equipment depreciates ¥200 a month.

Depreciation Expense 200

Accumulated Depreciation—Equipment 200

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 > DO IT!
The ledger of Zhu Company on March 31, 2017, includes these
selected accounts before adjusting entries are prepared.
(amounts in thousands) Debit Credit
Prepaid Insurance ¥ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment ¥ 5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.
4. One-half of the unearned service revenue was performed in
March.

Unearned Service Revenue 4,600

Service Revenue 4,600

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 Adjusting Entries for Accruals
Learning
Accruals are made to record Objective 6
Prepare adjusting
entries for
◆ Revenues for services performed but not accruals.
yet recorded at the statement date
(accrued revenues).

OR

◆ Expenses incurred but not yet paid or recorded at the

statement date (accrued expenses).

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 ACCRUED REVENUES

Revenues for services performed but not yet received in cash

or recorded.

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

◆ Rent ◆ Services performed
◆ Interest

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 ACCRUED REVENUES

◆ Adjusting entry records the receivable that exists and

records the revenues for services performed.

◆ Adjusting entry:
► Increases (debits) an asset account and
► Increases (credits) a revenue account.

Illustration 3-13
Adjusting entries
for accrued
revenues

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 ACCRUED REVENUES

Illustration: In October, Yazici Advertising

Inc. performed services worth ₺200 that were
not billed to clients in October.

Oct. 31

Accounts Receivable 200

Service Revenue 200

On November 10, Yazici receives cash of ₺200 for the services

performed.

Nov. 10 Cash 200

Accounts Receivable 200
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 Illustration 3-14
Adjustment for accrued revenue

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 ACCRUED REVENUES

Illustration 3-15
Accounting for accrued revenues

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 ACCRUED EXPENSES

Expenses incurred but not yet paid in cash or recorded.

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

◆ Interest
◆ Taxes
◆ Salaries

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 ACCRUED EXPENSES

◆ Adjusting entry records the obligation and recognizes the

expense.

◆ Adjusting entry:
► Increase (debit) an expense account and
► Increase (credit) a liability account.
Illustration 3-16
Adjusting entries
for accrued
expenses

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 ACCRUED INTEREST

Illustration: Yazici Advertising Inc. signed a three-month note

payable in the amount of ₺5,000 on October 1. The note requires
Yazici to pay interest at an annual rate of 12%. Illustration 3-17
Formula for
computing interest

Oct. 31 Interest Expense 50

Interest Payable 50

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 Illustration 3-18
Adjustment for accrued interest

3-47 LO 6
 ACCRUED SALARIES AND WAGES

Illustration: Yazici paid salaries and wages on October 26; the

next payment of salaries will not occur until November 9. The
employees receive total salaries of ₺2,000 for a five-day work
week, or ₺400 per day. Thus, accrued salaries at October 31 are
₺1,200 (₺400 x 3 days).
Illustration 3-19
Calendar showing
Yazici’s pay
periods

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 Illustration 3-20
Adjustment for accrued salaries and wages

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 ACCRUED EXPENSES

Illustration 3-21
Accounting for accrued expenses

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 > DO IT!

Micro Computer Services began operations on August 1, 2017. At

the end of August 2017, management prepares monthly financial
statements. The following information relates to August.
1. At August 31, the company owed its employees ¥8,000 in
salaries and wages that will be paid on September 1.
2. On August 1, the company borrowed ¥300,000 from a local
bank on a 15-year mortgage. The annual interest rate is
10%.
3. Revenue for services performed but unrecorded for August
totaled ¥11,000.
Prepare the adjusting entries needed at August 31, 2017.

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 > DO IT!

Prepare the adjusting entries needed at August 31, 2017.

1. At August 31, the company owed its employees ¥8,000 in
salaries and wages that will be paid on September 1.
Salaries and Wages Expense 8,000
Salaries and Wages Payable 8,000
2. On August 1, the company borrowed ¥300,000 from a local
bank on a 15-year mortgage. The annual interest rate is 10%.
Interest Expense 2,500
Interest Payable 2,500

3. Revenue for services performed but unrecorded for August

totaled ¥11,000.
Accounts Receivable 11,000
Service Revenue 11,000
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 Summary of Basic Relationships

Illustration 3-22
Summary of adjusting entries

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 The Adjusted Trial Balance and
Financial Statements
Learning
Preparing the Adjusted Trial Balance Objective 7
Describe the
nature and
◆ Prepared after all adjusting entries are purpose of an
adjusted trial
journalized and posted. balance.

◆ Purpose is to prove the equality of debit balances and

credit balances in the ledger.

◆ Is the primary basis for the preparation of financial

statements.

3-54 LO 7
 Illustration 3-25
Adjusted trial balance LO 7
3-55
 Preparing Financial Statements

Financial Statements are prepared directly from the

Adjusted Trial Balance.

Retained Statement
Income
Earnings of Financial
Statement
Statement Position

3-56 LO 7
 Illustration 3-26
Preparation of the income statement and retained
earnings statement from the adjusted trial balance
3-57 LO 7
 Illustration 3-27
Preparation of the statement of financial
position from the adjusted trial balance
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 Alternative Treatment of Prepaid
APPENDIX 3A
Expenses and Unearned Revenues
Learning
Alternate Treatment Objective 8
Prepare
adjusting
◆ When a company prepays an expense, it
entries for the
debits that amount to an expense account. alternative
treatment of
deferrals.
◆ When it receives payment for future services,
it credits the amount to a revenue account.

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 Prepaid Expenses

Company may choose to debit (increase) an expense account

rather than an asset account. This alternative treatment is simply
more convenient.

Illustration 3A-2
Adjustment approaches—a comparison

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 Unearned Revenues

Company may credit (increase) a revenue account when they

receive cash for future services.

Illustration 3A-5
Adjustment approaches—a comparison

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 Summary of Additional Adjustments
Relationships

Illustration 3A-7
Summary of basic relationships for deferrals

3-62 LO 8
 APPENDIX 3B Concepts in Action
Learning
Qualities of Useful Information Objective 9
Discuss
financial
Two fundamental qualities, relevance and reporting
faithful representation. concepts.

Relevance

◆ Make a difference in a business decision.

◆ Provides information that has predictive value and

confirmatory value.

◆ Materiality is a company-specific aspect of relevance.

► An item is material when its size makes it likely to influence

the decision of an investor or creditor.

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 Qualities of Useful Information

Two fundamental qualities, relevance and faithful representation.

Faithful Representation

◆ Information accurately depicts what really happened.

◆ Information must be

► complete (nothing important has been omitted),

► neutral (is not biased toward one position or another), and

► free from error.

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 Qualities of Useful Information

ENHANCING QUALITIES

Comparability Information is Information has the

results when different verifiable if quality of
companies use the independent understandability
same accounting observers, using the if it is presented in a
principles. same methods, obtain clear and concise
similar results. fashion.

Consistency means
that a company uses For accounting information
the same accounting to have relevance, it must
principles and methods be timely.
from year to year.

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 Assumptions in Financial Reporting

Monetary Unit Economic Entity

Requires that only those things States that every economic
that can be expressed in entity can be separately
money are included in the identified and accounted for.
accounting records.

Illustration 3B-2
Key assumptions in
financial reporting
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 Assumptions in Financial Reporting

Time Period Going Concern

States that the life of a The business will remain in
business can be divided into operation for the
artificial time periods. foreseeable future.

Illustration 3B-2
Key assumptions in
financial reporting
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 Principles of Financial Reporting

MEASUREMENT PRINCIPLES

Historical Cost Fair Value

Or cost principle, Indicates that
dictates that assets and
companies record liabilities should be
assets at their reported at fair
cost. value (the price
received to sell an
asset or settle
a liability).

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 Principles of Financial Reporting

REVENUE EXPENSE FULL

RECOGNITION RECOGNITION DISCLOSURE
PRINCIPLE PRINCIPLE PRINCIPLE
Requires that Dictates that Requires that
companies efforts (expenses) companies disclose
recognize revenue be matched with all circumstances
in the accounting results (revenues). and events that
period in which the Thus, expenses would make a
performance follow revenues. difference to
obligation is financial statement
satisfied. users.

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 Cost Constraint

Cost Constraint
Accounting standard-setters weigh
the cost that companies will incur to
provide the information against the
benefit that financial statement
users will gain from having the
information available.

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 Copyright

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