Adjusting entries

(Theory)
There are four main types of accounts that need to be adjusted
• Prepaid expenses
• Accrued expenses
• Unearned revenue
• Accrued revenue

Accrual basic (how it works)

• In accrual accounting, a company recognizes revenue during the period it is

earned and recognizes expenses when they are incurred. This is often
before—or sometimes after—it actually receives or dispenses money.

• Accrual accounting works by recording accruals on the balance sheet that act
like placeholders for cash events. For example, accounts receivable is an asset
account that reflects revenue a company has earned but hasn’t yet been paid for.
Similarly, accounts payable is a liability account that reflects amounts the
business owes but hasn’t yet paid.

Deferral basic (how it works)

• In accounting, the revenue or expense on an income statement should match

the service or product at the same time when they are received or delivered. But
when companies and businesses make payments in advance, accountants
defer the expenses and revenue until they can be recorded on the financial
statements.

• Both accruals and deferrals can be broken down into revenues and expenses,
although they are different. A revenue deferral acts as a liability to be
recognized in future fiscal periods. This is done when the company has
received the payment for a contract that has yet to be delivered.

there the two general types of adjustments made at the end of the accounting period-
deferral and accrual
Deferral is the posting of the recognition of an expense already paid but not yet
incurred or of revenue already collected but not yet earned. This adjustment deals
with an amount already recorded in a balance sheet account; the entry in effect,
decreases the balance sheet account and increases an income statement
account

Accrual is the recognition of an expense already incurred but unpaid or revenue

earned but uncollected. This adjustment deals with an amount unrecorded in any
account; the entry in effect increases both a balance sheet and an income
statement account.

Adjustment for deferral (step 5)

ALLOCATING ASSETS TO EXPENSES

Entities often make expenditures that benefit more than one period. These
expenditures are generally debited to an asset account. At the end of each accounting
period the estimated amount that has expired during the period or that has benefited
during the period is transferred from adjustment are prepaid expenses and
depreciation of property and equipment. Like prepaid expenses, prepaid rent,
prepaid insurance, supplies, depreciation of property and equipment, service
vehicle, and office equipment.

Explanation: Prepaid expenses are future expenses that are paid in advance.

Allocating revenue received in advance to revenues

These are the times when an entity receives cash for service or goods even before
service is rendered or goods are delivered. When such is received in advance. The
entity has an obligation to perform service or deliver goods. The liability referred to is
unearned revenue. Like unearned referral revenue

Explanation: Deferred revenue is a liability on a company's balance sheet that

represents a prepayment by its customer for goods or services that have yet to be
delivered.
Adjustment for accruals (step5)

Accrual expenses – an entity often incur expenses before paying for them. Cash
payments are usually made at regular intervals of time such as weekly, monthly,
quarterly, or annually. If the accounting period ends on a date that does not coincide
with the scheduled cash payment date, an adjusting entry is needed to reflect the
expense incurred since the last payment. This adjustment helps the entity avoid the
impractical preparation of hourly or daily journal entities just to accrue expenses.
Salaries, interest, utilities, (e.g., electricity, telecommunication and water) and
taxes are examples of expenses that are incurred before payment is made

Explanation: Accrued expenses are those incurred for which there is no invoice or other
documentation.

Accrued revenue- an entity may provide services during the period that are neither
paid for by the client nor billed at the end of the period. The value of these services
represents revenue earned by the entity. Any revenue that has been earned but not
recorded during the accounting period calls for an adjusting entry that debits an assets
account and credits an income

Explanation: Accrued revenue is revenue that has been earned by providing a good or
service, but for which no cash has been received.