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On January 9, the
company received $4,000 from a customer for printing services to be
performed. The company recorded this as a liability because it
received payment without providing the service. Assume that as of
January 31 some of the printing services have been provided. Since a portion of the service was
provided, a change to unearned revenue should occur. The company
needs to correct this balance in the Unearned Revenue account. When expenses are prepaid, a debit asset account is created together with the cash payment.

The two specific types of adjustments are accrued revenues and accrued expenses. 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) in the Supplies account.

The Need for Adjusting Entries

This aligns with the revenue recognition principle to recognize revenue when earned, even if cash has yet to be collected. Accrued revenues are revenues earned in a period but have yet to be recorded, and no money has been collected. Some examples include interest, and services completed but a bill has yet to be sent to the customer. During the year, it collected retainer fees totaling $48,000 from clients.

  • These entries are necessary to ensure the income statement and balance sheet present the correct, up-to-date numbers.
  • The salary the
    employee earned during the month might not be paid until the
    following month.
  • This is posted to the Interest Revenue T-account on the credit side (right side).
  • However, there are times — like when you have made a sale but haven’t billed for it yet at the end of the accounting period — when you would need to make an accrual entry.

When you actually pay your employees, the checking account for the business — also on the balance sheet — is impacted. But when you record accrued expenses, a liability account is created and impacted with your adjusting entry. Regardless of how meticulous your bookkeeping is, though, you or your accountant will have to make adjusting entries from time to time. An adjusting entry is simply an adjustment to your books to better align your financial statements with your income and expenses. Adjusting entries are made at the end of the accounting period to make your financial statements more accurately reflect your income and expenses, usually — but not always — on an accrual basis. Accruals are types of adjusting entries that accumulate during a period, where amounts were previously unrecorded.

2: Discuss the Adjustment Process and Illustrate Common Types of Adjusting Entries

The depreciation expense shows up on your profit and loss statement each month, showing how much of the truck’s value has been used that month. This means it shows up under your Vehicle asset account on your balance sheet as a negative number. This has the net effect of reducing the value of your assets on your balance sheet while still reflecting the purchase value of the vehicle. On January 9, the company received $4,000 from a customer for printing services to be performed. The company recorded this as a liability because it received payment without providing the service.

Adjusting Entries

Accrual accounting instead allows for a lag between payment and product (e.g., with purchases made on credit). These entries are posted into the general ledger in the same way as any other accounting journal entry. The purpose of adjusting entries is to show when money changed hands and to convert real-time entries to entries that reflect your accrual accounting.

Prepaid Expenses

Retainer fees are money lawyers collect in advance of starting work on a case. When the company collects this money from its clients, it will debit cash and credit unearned fees. Even though not all of the $48,000 was probably collected on the same day, we record it as if it was for simplicity’s sake.

Bookkeeping and accounting software

The same principles we discuss in the previous point apply to revenue too. You should really be reporting revenue when it’s earned as opposed to when it’s received. For instance, you decide to prepay your rent for the year, writing a check for $12,000 to your landlord that covers rent for the entire year. For the sake of balancing the books, you record that money coming out of revenue.

At
the period end, the company would record the following adjusting
entry. Accrued revenues are revenues earned in a
period but have yet to be recorded, and no money has been
collected. Some examples include interest, and services completed
but a bill has yet to be sent to the customer. During the
year, it collected retainer fees totaling $48,000 from clients.

Not all accounts require updates, only those not naturally triggered by an original source document. There are two main types of adjusting entries that we explore further, deferrals and accruals. The unadjusted trial balance may have incorrect balances in some accounts. Recall the trial balance from Analyzing and Recording Transactions for the example company, Printing Plus. Accrued expenses are expenses incurred in a
period but have yet to be recorded, and no money has been paid. Interest can be earned from bank account holdings, notes
receivable, and some accounts receivables (depending on the
contract).

The purpose of adjusting entries is to convert cash transactions into the accrual accounting method. Accrual accounting is based on the revenue recognition principle that seeks to recognize revenue in the period in which it was earned, rather than the period in which descending order of current assets cash is received. Adjusting entries are a crucial part of the accounting process and are usually made on the last day of an accounting period. They are made so that financial statements reflect the revenues earned and expenses incurred during the accounting period.