CHAPTER – 3

Accountants divide the economic life of a business into artificial time periods. This
convenient assumption is referred to as the time period assumption.

Accounting time periods are generally a month, a quarter, or a year. Monthly and quarterly
time periods are called interim periods.

An accounting time period that is one year in length is a fiscal year. A fiscal year usually
begins with the first day of a month and ends twelve months later on the last day of a month.
Most businesses use the calendar year (January 1 to December 31) as their accounting
period

 What is Accrual basis accounting?

 What is cash basis accounting
 What is revenue recognition principle
 What is matching principle

Types of adjusting entries?

Deferrals
1. Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed.
2. Unearned Revenues. Cash received and recorded as liabilities before revenue is earned.
Accruals
1. Accrued Revenues. Revenues earned but not yet received in cash or recorded.
2. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded.

What is depreciation?
What is accumulated depreciation?
What is adjusted trial balance

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Class Exercise - 1
State whether each situation is a prepaid expense (PE), unearned revenue (UR), accrued
revenue (AR) or an accrued expense (AE).
1. Unrecorded interest on savings bonds is $245.
2. Property taxes that have been incurred but that have not yet been paid or recorded
amount to $300.
3. Legal fees of $1,000 were collected in advance. By year end 60 percent were still
unearned.
4. Prepaid insurance had a $500 balance prior to adjustment. By year end, 40 percent
was still unexpired.

Class Exercise – 2
Jeff Anderer Enterprises purchased computer equipment on May 1, 2010 for $4,500. The
company expects to use the equipment for 3 years. It has no salvage value.
1. What adjusting journal entry should the company make at the end of each month if
monthly financials are prepared (annual depreciation is $1,500)?
2. What is the book value of the equipment at May 31, 2010?

Class Exercise – 3
Rhodes National purchased software on October 1, 2010 for $10,800. The company expects
to use the software for 3 years. It has no salvage value.
1. What adjusting journal entry should the company make at the end of each month if
monthly financials are prepared? (annual depreciation is $3,600)
2. What balance will be reported on the December 31, 2010 balance sheet for
Accumulated Depreciation? (Answer is $900)

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Class Exercise – 4
On January 1, 2010, Dimes and Quarters Corp. purchased a general liability insurance
policy for $3,600 to provide coverage for the calendar year.
1. If the company recorded the policy as an asset when purchased, what is the monthly
adjusting journal entry that should be recorded at January 31, 2010?
*2. If the company expensed the cost of the policy on January 1, 2010, what is the
monthly adjusting entry that should be recorded at January 31, 2010?

Class Exercise – 5
Identify the impact on the balance sheet if the following information is not used to adjust the
accounts.
1. Supplies consumed totaled $3,000.
2. Interest accrues on notes payable at the rate of $200 per month.
3. Insurance of $450 expired during the month.
4. Plant and equipment are depreciated at the rate of $1,200 per month.
5. The company rents extra office space to B & J, CPAs. B & J pays the $12,000 rent
annually on January 1.
6. The company has an outstanding loan to its President in the amount of $100,000. The
loan accrues interest at the annual rate of 4%. Principal and interest are due January 1,
2014.
7. The company completed work on a project during January that was not yet billed to the
client. The client will be charged $2,500.
Solution
1. Assets overstated and Owner’s Equity overstated by $3,000.
2.
3.
4.
5.
6.
7.
Class Exercise – 6 (BE 171)
For each of the following oversights, state whether total assets will be understated (U),
overstated (O), or no affect (NA).
U_____ 1. Failure to record revenue earned but not yet received.
_____ 2. Failure to record expired prepaid rent.
_____ 3. Failure to record accrued interest on the bank savings account.
_____ 4. Failure to record depreciation.
_____ 5. Failure to record accrued wages.
_____ 6. Failure to recognize the earned portion of unearned revenues.

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Class Exercise – 7 (Ex. 179)
Before month-end adjustments are made, the February 28 trial balance of Alice’s
Adventures contains revenue of $9,000 and expenses of $4,400. Adjustments are necessary
for the following items:
 Depreciation for February is $1,800.
 Revenue earned but not yet billed is $2,300.
 Accrued interest expense is $700.
 Revenue collected in advance that is now earned is $3,500.
 Portion of prepaid insurance expired during February is $400.
Instructions
Calculate the correct net income for Alice’s Income Statement for February.

Class Exercise – 8 (E 180)

On December 31, 2010, Speedy Company prepared an income statement and balance
sheet and failed to take into account three adjusting entries. The incorrect income statement
showed net income of $40,000. The balance sheet showed total assets, $120,000; total
liabilities, $45,000; and owner's equity, $75,000.
The data for the three adjusting entries were:
(1) Depreciation of $9,000 was not recorded on equipment.
(2) Wages amounting to $8,000 for the last two days in December were not paid and not
recorded. The next payroll will be in January.
(3) Rent of $14,000 was paid for two months in advance on December 1. The entire
amount was debited to Rent Expense when paid.
Instructions
Complete the following tabulation to correct the financial statement amounts shown (indicate
deductions with parentheses):
Item Net Income Total Assets Total Liabilities Owner’s
Equity
Incorrect balances $ 40,000 $120,000 $ 45,000 $ 75,000
Effects of:
Depreciation
Wages
Rent
Correct Balances

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Class Exercise – 9 (E 181)
Indicate (a) the type of adjustment (prepaid expense, unearned revenue, accrued revenue,
or accrued expense), and (b) the accounts before adjustment (overstated or understated) for
each of the following:
1. Supplies of $200 have been used.
2. Salaries of $600 are unpaid.
3. Rent received in advance totaling $300 has been earned.
4. Services provided but not recorded total $500.
(a) Type of Adjustment (b) Accounts before Adjustment
1. Prepaid Expense Assets Overstated
Expenses Understated
2.

3.

4.

Class Exercise – 10 (Ex. 183)

The adjusted trial balance of the Neighborly Lane Paving Company includes the following
balance sheet accounts that frequently require adjustment. For each account, indicate (a)
the type of adjusting entry (prepaid expenses, unearned revenues, accrued revenues, or
accrued expenses) and (b) the related account in the adjusting entry.
(a) (b)
Balance Sheet Account Type of Adjusting Entry Related Account
1. Supplies Prepaid Expense Supplies Expense
2. Accounts Receivable
3. Prepaid Insurance
4. Accumulated Depreciation— Equipment
5. Interest Payable
6. Salaries Payable
7. Unearned Revenue

Class Exercise – 11 (Ex. 184)

Match the statements below with the appropriate terms by entering the appropriate letter
code in the spaces provided.
TERMS:
A. Prepaid Expenses
B. Unearned Revenues
C. Accrued Revenues
D. Accrued Expenses
STATEMENTS:
_____ 1. A revenue not yet earned; collected in advance.
_____ 2. Office supplies on hand that will be used in the next period.
_____ 3. Interest revenue collected; not yet earned.
_____ 4. Rent not yet collected; already earned.
_____ 5. An expense incurred; not yet paid or recorded.
_____ 6. A revenue earned; not yet collected or recorded.
_____ 7. An expense not yet incurred; paid in advance.
_____ 8. Interest expense incurred; not yet paid.

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Class Exercise – 12 (Ex. 217)
Match the items below by entering the appropriate code letter in the space provided.
A. Time period assumption F. Accrued revenues
B. Fiscal year G. Depreciation
C. Revenue recognition principle H. Accumulated depreciation
D. Prepaid expenses I. Accrued expenses
E. Matching principle J. Book value
______ 1. A twelve month accounting period
______ 2. Expenses paid before they are incurred
______ 3. Cost less accumulated depreciation
______ 4. Divides the economic life of a business into artificial time periods
______ 5. Efforts are related to accomplishments
______ 6. A contra asset account
______ 7. Recognition of revenue when it is recorded when earned
______ 8. Revenues earned but not yet received
______ 9. Expenses incurred but not yet paid
______10. A cost allocation process

Class Exercise – 13 (Ex. 191)

Angus Insurance Agency prepares monthly financial statements. Presented below is an
income statement for the month of June that is correct on the basis of information
considered.
ANGUS INSURANCE AGENCY
Income Statement
For the Month Ended June 30
—————————————————————————————————————————
Revenues
Premium Commission Revenue................................................... $35,000
Expenses
Salary expense............................................................................. $6,000
Rent expense............................................................................... 4,200
Depreciation expense................................................................... 2,800
Advertising expense..................................................................... 800
Total expenses............................................................................. 13,800
Net income............................................................................................ $21,200
Additional Data: When the income statement was prepared, the company accountant
neglected to take into consideration the following information:
1. A utility bill for $2,000 was received on the last day of the month for electric and gas
service for the month of June.
2. A company insurance salesman sold a life insurance policy to a client for a premium of
$35,000. The agency billed the client for the policy and is entitled to a commission of
20%.
3. Supplies on hand at the beginning of the month were $3,000. The agency purchased
additional supplies during the month for $3,500 in cash and $2,200 of supplies were on
hand at June 30.

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4. The agency purchased a new car at the beginning of the month for $19,200 cash. The
car will depreciate $4,800 per year.
5. Salaries owed to employees at the end of the month total $5,300. The salaries will be
paid on July 5.
Instructions
Prepare a correct income statement.