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Chapter 3

ACCOU-2140 Chapter 3: Part Two


Department
Accounting
Course Code
ACCOU-2140
Professor
Rien
Chapter
3

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Chapter 3. Adjusting Accounts for Financial Statements
Deferral of Expense
Prepaid expenses, or deferred expenses, are assets paid for in advance of receiving their
benefits. When these assets are used, those advance payments become expenses.
Framework
Adjusting entries for prepaid expenses increase expenses and decrease assets, as shown below
in the T-accounts. This adjustment shows the using up of prepaid expenses. To demonstrate
accounting for prepaid expenses, we look at prepaid insurance, supplies, and depreciation. In
each case we decrease an asset (balance sheet) account and increase and expense (income
statement) account.
Assets
Expenses
Unadjusted
balance
overstated
CREDIT ASSET
DEBIT EXPENSE
Prepaid Insurance
*Prepaid insurance expires with time. We use our three-step process.
- Step 1: Determine what the current account balance equals.
- Step 2: Determine what the current account balance should equal.
- Step 3: Record an adjusting entry to get from step 1 to step 2.
Supplies
We count supplies at period-end and make an adjusting entry.
Example:
Step 1: Paul’s General purchased $ 9,720 of supplies in December, some of which were used
during the same month. When financial statements are prepared at December 31 the cost of
supplies used during December is expensed.
Step 2: When Paul’s General computes (physical counts) its remaining unused supplies at
December 31, finds $8,670 of supplies remaining of the $9,720 total supplies. The $1,050
difference between the two amounts is December’s supplies expense.
Step 3: The adjusting entry to record this expense and reduce the Supplies asset account, along
with T-account posting, follows.
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