At the end of an accounting period, you prepare a trial balance to make sure that debits equals credits. The trial balance lists all of your company's general ledger accounts. However, the unadjusted trial balance may overstate or understate assets or expenses. Hence, the adjusting entries matches revenues and expenses to the period in which you incurred them. After you journalize four types of adjusting entries, you post them to the respective ledger accounts so you can prepare the adjusted trial balance.
Revenues not yet received from customers must be recognized in the accounting period during which the revenue was earned. In other words, you make an adjustment to reflect revenues to which you have a right. For example, you may not yet have billed the customer even though you've already performed the services. In some cases, you may have already sent an invoice but the customer has not sent payment. To make the adjusting entry, you debit the appropriate asset account, such as accounts receivable, and credit a revenue account.
Unlike the adjusting entry to record uncollected revenue, an unearned revenue adjusting entry is one in which you have already received payment from the customer. Unearned revenues represent the work or services yet to be performed or goods yet to be delivered to the customer. Examples include advance payments for subscriptions and service warranties. These advance payments and unearned revenues represent a liability to the business. After the work is performed or goods delivered, you decrease or debit the liability --- unearned revenue --- and increase or credit the asset --- the revenue account --- equal to the amount of revenue earned during the period.
Some business expenses accrue during one accounting period but are not paid until another. Such is the case with wages that employees have earned as of the end of one accounting cycle but are not paid until the end of the next. Aside from salaries expense, other examples include interest expense and income taxes expense. To match the accrued expense to the accounting cycle, you make an entry that increases or debits the expense account and also increases or credits a liability account. In the following accounting period in which the liability is paid, an entry will be made to reflect the payment of the liability.
Like a customer of the company who has made an advance payment on his account, businesses also make prepayments on accounts. Prepaid expenses represent an asset for the business. Common examples include prepaid insurance, advance payments for rent and office supplies that get used up during the course of the accounting period. Some companies also treat depreciation expense as a special type of prepaid expense account. When you make the prepayment, you initially increase one asset, such as prepaid insurance, and decrease another asset, such as cash. The adjusting entry at the end of the period reflects the amount that has been used up or "expensed" during the period. For example, you decrease or credit prepaid insurance and increase or debit insurance expense.
- McGraw Hill; Online Learning Center; Financial and Managerial Accounting; Jan r. Williams et al.
- Saint Leo University; Measuring Business Income: The Adjusting Process; Dr. Deborah Pendarvis
- CliffsNotes: Adjusting Entries
- CliffsNotes: Depreciation
- Middle City; Chapter 4 -- Accruals and Deferrals; Malcolm White
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