Sincethere was no bill to trigger a transaction, an adjustment isrequired to recognize revenue earned at the end of the period. Recall that unearned revenue represents a customer’s advancedpayment for a product or service that has yet to be provided by thecompany. Since the company has not yet provided the product orservice, it cannot recognize the customer’s payment as revenue. Atthe end of a period, the company will review the account to see ifany of the unearned revenue has been earned. If so, this amountwill be recorded as revenue in the current period. The preceding discussion of adjustments has been presented in great detail because it is imperative to grasp the underlying income measurement principles.
Deferrals versus Accruals
However, one important fact that we needto address now is that the book value of an asset is notnecessarily the price at which the asset would sell. The same is true about just about any asset youcan name, except, perhaps, cash itself. When a company purchases supplies, it may not use all suppliesimmediately, but chances are the company has used some of thesupplies by the end of the period. In all the examples in this article, we shall assume that the adjusting entries are made at the end of each month.
Each month that passes, the company needs to record rent used for the month. The required adjusting entries depend on what types of transactions the company has, but there are some common types of adjusting entries. Before we look at recording and posting the most common types of adjusting entries, we briefly discuss the various types of adjusting entries. This is posted to the Interest Receivable T-account on the debit side (left side).
Accrual Accounting
- However, most public and private companies keep monthly, quarterly, and yearly (annual) period information.
- When depreciation is recorded in an adjusting entry, Accumulated Depreciation is credited and Depreciation Expense is debited.
- Each month that passes, the company needs to record rentused for the month.
Accounts Receivable increases (debit) for $1,500 because thecustomer has not yet paid for services completed. Service Revenueincreases (credit) for $1,500 because service revenue was earnedbut had been previously unrecorded. The unadjusted trial balance may have incorrect balances in someaccounts. Recall the trial balance from Analyzing and Recording Transactions for the examplecompany, Printing Plus. Accounts Receivable increases (debit) for $1,500 because the customer has not yet paid for services completed.
Unearned Revenues
Assume $200 of supplies in a storage room are physically counted at the end of the period. Since the account has a $900 balance from the December 8 entry, one “backs in” to the $700 adjustment on December 31. In other words, since $900 of supplies were purchased, but only $200 were left over, then $700 must have been used.
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When the company provides the printing services for the customer, the customer will not send the company a reminder that revenue has now been earned. Situations such as these are why businesses need to make adjusting entries. Prepaid expenses or unearned revenues – Prepaid expenses are goods or services that have been paid for by a company define depletion in accounting but have not been consumed yet.
However, most public and private companies keep monthly, quarterly, and yearly (annual) period information. This is useful to users needing up-to-date financial data to make decisions about company investment and growth. When the company keeps yearly information, the year could be based on a fiscal or calendar year. Insurance is typically purchased by prepaying for an annual or semi-annual policy.
Adjusting entries
Note that Insurance Expense and Prepaid Insurance accounts have identical balances at December 31 under either approach. In the previous chapter, tentative financial statements were prepared directly from a trial balance. However, a caution was issued about adjustments that may be needed to prepare a truly correct and up-to-date set of financial statements. In other words, the ongoing business activity brings about changes in account balances that have not been captured by a journal entry. Time brings about change, and an adjusting process is needed to cause the accounts to appropriately reflect those changes. This is consistent with the revenue and expense recognition rules.
Recall that depreciation isthe systematic method to record the allocation of cost over a givenperiod of certain assets. This allocation of cost is recorded overthe useful life of the asset, or the time periodover which an asset cost is allocated. The allocated cost up tothat point is recorded in Accumulated Depreciation, a contra assetaccount. A contra account is an account pairedwith another account type, has an opposite normal balance to thepaired account, and reduces the balance in the paired account atthe end of a period. Supplies increases (debit) for $400, and Cash decreases (credit)for $400. When the company recognizes the supplies usage, thefollowing adjusting entry occurs.
This means the asset will lose$500 in value each year ($2,000/four years). In the first year, thecompany would record the following adjusting entry to showdepreciation of the equipment. the best 10 excel bookkeeping templates for free wps office academy Uncollected revenue is revenue that is earned during a period but not collected during that period. Such revenues are recorded by making an adjusting entry at the end of the accounting period. For example, a company pays $4,500 for an insurance policy covering six months. It is the end of the first month and the company needs to record an adjusting entry to recognize the insurance used during the month.
Posting adjusting entries is no different than posting the regular daily journal entries. T-accounts will be the visual representation for the Printing Plus general ledger. In some situations it is just an unethical stretch of the truth easy enough to do because of the estimates made in adjusting entries. Doubling the useful life will cause 50% of the depreciation expense you would have had. This method of earnings management would probably not be considered illegal but is definitely a breach of ethics. In other situations, companies manage their earnings in a way that the SEC believes is actual fraud and charges the company with the illegal activity.
Similarly for unearned revenues, the company would record how much of the revenue was earned during the period. Supplies Expense is an expense account, increasing (debit) for$150, and Supplies is an asset account, decreasing (credit) for$150. This means $150 is transferred from the balance sheet (asset)to the income statement (expense). There is still a balance of $250 (400 – 150) inthe Supplies account. The balances in the Supplies and Supplies Expenseaccounts show as follows. On January 9, thecompany received $4,000 from a customer for printing services to beperformed.
