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Lecture 1

COMMERCE 1AA3 Lecture 1: COMMERCE 1AA3- Chapter 3

Course Code
Emad Mohammad

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September 18, 2018
Chapter 3
Adjustments and the conceptual Framework
Adjustments are end-of-year journal entries to update account balances
Going-concern and periodicity dictate that financial statements be prepared periodically
Faithful representation requires updating account balances
November 1, 2017 a company receives newspaper subscriptions, $120, 000 from customers to
cover subscriptions for one, starting immediately.
The Journal Entry…
Cash 120,000
Unearned Subscription Revenue 120,000
Assuming a fiscal year- end on December 31, the company must account for the revenue
earned since November 1. With respect to Unearned subscription revenue, the company has
earned two months of revenue (November and December)
Subscription revenue earned = (120,000/ 12) x 2 = $20,000
The journal entry to recognize that revenue is called an adjusting entry.
When the company earns $20, 000 of revenues, what happens to unearned revenue? They
decrease, which means UR is debited in the adjusting entry.
The Adjusting entry
Unearned Subscriptions Revenue 20,000
Subscriptions Revenue 20,000
On May 1, 2017 a company pays $36000 for one year’s rent, effective immediately.
Prepaid Rent 36,000
Cash 36,000

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September 18, 2018
By December 31, 2017 the company would have occupied the property for 8 months
Rent Expense = (36,000/ 12) x 8 =$24,000
What happened to prepaid rent by December 31, 2017? It decreased by $24,000, and it should
be credited in the adjusting entry. The adjusting entry is:
Rent Expense 24,000
Prepaid Rent 24,000
What Is the balance of unearned revenue after the adjusting entry?
120, 000 20,000 = $100,000
Without the adjusting entry, the Unearned Revenue balance would be $120,00
Why Adjusting Entries?
Accrual basis, not cash basis
With cash basis, there is no need for adjusting entries
Timing differences between cash and performance
Long-term assets
The Need for Adjusting Entries: An Example
On March 1, 2013 a company pays $12,000 for one year’s rent
The Journal Entry:
March 1, 2013
Prepaid Rent 12,000
Cash 12, 000

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September 18, 2018
Why Adjusting Entries?
By December 31, 2013, the firm would have occupied the property for 10 months. Also, there
are only two months left in Prepaid Rent:
Monthly rent = 12,000 / 12 = $1,000
Rent expense for 2013 = 1,000 x 10 = $10,000
Prepaid rent as of 12/31/2013 = 1,000 x 2 = $2,000
But so far, prepaid rent has a balance of $12,000 and rent expense is not recorded yet
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