NOTES ON ADJUSTMENTS

• Purpose of adjustments: improve the accuracy of

the financial statements, particularly the income
statement as to reporting of revenue/expense to
several periods, instead of in just one period
• Basis: accrual accounting, NOT cash basis of
accounting
• Accrual principle: recognize revenues when earned
and expenses when incurred
• Matching concept: match the expenses to the
revenues generated
 Continuation…adjustments
• Period: adjustments resorted to when a
transaction pertains to several periods
• Internal: Adjustments are purely internal
transactions at the end of the period
• Adjustments do not entail cash; cash is not a
valid account as an adjusting entry since the
basis is accrual and not cash
• Adjustments always entail a balance sheet and
an income statement account
 DEFERRALS VS ACCRUALS
DEFERRALS
• Deferrals: cash disbursement or cash receipt already
happened as of the end of the period
• For instance, cash disburse for insurance for the future
periods; or cash received for services still to be rendered
in future periods
• Deferrals are already in the balance sheet and what was
deferred was the recognition of the revenue or the
expense in the income statement; thus adjustments in
the case of deferrals transfer amounts from the balance
sheet to the income statement
 ACCRUALS
• The cash flow (disbursement or receipt) will
be in a future period;
• The revenue accrual or recording (in the
income statement) will create an accounts
receivable (balance sheet)
• The expense accrual or recording (in the
income statement) will create an accounts
payable (in the balance sheet)
SUMMARY TABLE: ADJUSTING
PROCESS
ADJUSTING PROCESS

DEFERRAL/CASH AT BEGINNING ACCRUAL/CASH AT END

Dr.Prepaid Assets/Cr. Cash Dr. AP/Cr. Cash
Dr.Cash/Cr. Unearned Revenues Dr. Cash/Cr. AR

DR UNEARNED DR AR(BS) DR
DR EXPENSE(IS)/CR
REVENUE(BS) PREPAID ASSET(BS) CR EXPENSE(IS)
CR REVENUES(IS) REVENUES(IS) CR AP(BS)
 GUIDELINES FOR ADJUSTING
ENTRIES
1. No CASH entry
2. Always has a balance sheet and an income
statement entry
3. Dated end of the period
 MATERIALITY AND ABUSE ADJUSTMENTS
ADDRESS
• Materiality: significance of accuracy;
cost/benefit evaluation
• Abuse: in the form of recognizing revenues
when not yet earned or expenses not yet
reported when already incurred
• Principle of conservatism