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Adjusting Entries
Adjusting Entries
Adjusting Entries
Adjusting Entries bring certain account balances up to date at the end of the accounting period.
Adjusting entries are required when changes in certain accounts have not been recorded in the accounting records. Adjustments are necessary for items that have either been deferred or accrued.
It can be inefficient and costly to account for certain types of transactions on a daily basis.
Adjusting Entries are necessary when accrual basis accounting is used. Adjusting entries allow businesses to adhere to the Matching Principle.
Under accrual basis accounting, revenues are recognized when earned (regardless of whether cash has been received) and expenses are recognized when incurred (regardless of cash payment).
The Matching Principle states that expenses should be matched together with the income they produced in the same time period.
When analyzing an adjusting entry, look for the item that has not been recorded but should have been. This information is often not explicit and must be inferred from the data given. For expenses, look for the amount used. For revenue, look for the amount earned.
Original Entry: On Sept 1 the following entry would be recorded when the insurance was prepaid: Prepaid Insurance 15,000 Cash 15,000 Prepaid Insurance is an asset account it is an amount owned by the company that has economic value.
Each month, a portion of the prepaid insurance expires. At the end of the fiscal period, the Prepaid Insurance and Insurance Expense accounts must be updated for the insurance that has expired (been used).
Lets divide the analysis of this transaction into two parts: 1.What accounts are involved? When something is used up it indicates an expense account. In this case, we need to debit Insurance Expense for the expired insurance. Furthermore, the asset, Prepaid Insurance, has decreased so we will credit this asset.
2.What is the amount of the adjustment? See the next slide for the calculation of the amount of expired insurance.
$15,000 for 12 months= $1,250/month (15,000/12) ------Policy purchased on Sept 1. Months that have expired between purchase and fiscal year-end = 4 (Sept, Oct, Nov, Dec) Amount of adjustment = $5,000 ($1,250/month X 4 months)
Adjusting entries are always recorded on the last day of the fiscal period. For our example, the fiscal period closes on Dec 31. The adjustment is journalized as follows:
DATE
ACCOUNT
POST REF
DEBIT
CREDIT
Dec
31
5000 00 5000 00
Lets try another example. You have the following data about an adjustment:
You received $12,000 advance cash on November 1 for a painting job you are to complete over the next three months.
Original Entry: On November 1, Cash would be debited and a liability account called Unearned Painting Revenue would be credited. The liability account is credited because you owe the customer. You owe the customer painting services.) Cash 12,000 Unearned Painting Rev 12,000
Each month as you perform painting services, you are earning a portion of the unearned revenue. At the end of the fiscal period, the Unearned Painting Revenue and Painting Revenue accounts must be updated for the revenue that has now been earned.
We have performed step 1 of the analysis: the accounts involved are Unearned Painting Revenue (a liability) and Painting Revenue (a revenue). So far, the adjusting entry looks as follows:
DATE ACCOUNT POST REF DEBIT CREDIT
Dec
31
Note that as we perform the services owed, the liability decreases (this is accomplished by debiting Unearned Painting Revenue) and the revenue earned increases (this is accomplished by crediting Painting Revenue).
$12,000 for 3 months= $4,000/month (12,000/3) ------Cash advance received on November 1. Two months of work have been completed by the fiscal year-end (Nov and Dec) Amount of adjustment = $8,000 ($4,000/month X 2 months)
DATE
ACCOUNT
POST REF
DEBIT
CREDIT
Dec
31
8,000 00 8,000 00
You are now closer to completing the accounting cycle. You can continue to practice adjusting entries by choosing the Adjusting Entries Practice presentation.
The next step in the accounting cycle is to prepare an Adjusted Trial Balance.