Chapter 3: Recording adjusting entries Accounting Business and Society

This procedure is known as the postponement or deferral of revenue. At the end of the accounting period, the unearned revenue is converted into earned revenue by making an adjusting entry for the value of goods or services provided during the period. Accumulated Depreciation is contrary to an asset account, such as Equipment. This means that the normal balance for Accumulated Depreciation is on the credit side.

( . Adjusting entries that convert liabilities to revenue:

For example, let’s say a company pays $2,000 for equipment thatis supposed to last four years. The company wants to depreciate theasset over those four years equally. 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. Supplies increases (debit) for $400, and Cash decreases (credit)for $400.

Guidelines Supporting Adjusting Entries

Interest expense arises from notes payable and other loan agreements. The company has accumulated interest during the period but has not recorded or paid the amount. This creates a liability that the company must pay at a future date. You cover more details about computing capex opex ratio interest in Current Liabilities, so for now amounts are given.

c. The final step is to post to a trial balance so financial statements can be prepared.

The mechanics of accounting for prepaid expenses and unearned revenues can be carried out in several ways. At left below is a “balance sheet approach” for Prepaid Insurance. The expenditure was initially recorded into a prepaid account on the balance sheet.

Similarly, for unearned revenue,when the company receives an advance payment from the customer forservices yet provided, the cash received will trigger a journalentry. When the company provides the printing services for thecustomer, the customer will not send the company a reminder thatrevenue has now been earned. Situations such as these are whybusinesses need to make adjusting entries. Also, companies, public or private, using US GAAP or IFRS prepare their financial statements using the rules of accrual accounting. It is because of accrual accounting that we have the revenue recognition principle and the expense recognition principle (also known as the matching principle).

Deferrals are prepaid expense and revenueaccounts that have delayed recognition until they have been used orearned. This recognition may not occur until the end of a period orfuture periods. When deferred expenses and revenues have yet to berecognized, their information is stored on the balance sheet. Assoon as the expense is incurred and the revenue is earned, theinformation is transferred from the balance sheet to the incomestatement. Two main types of deferrals are prepaid expenses andunearned revenues. Some nonpublic companies may choose to use cash basis accounting rather than accrual basis accounting to report financial information.

1. Some examples include interest, and services completed but a bill has yet to be sent to the customer.
2. Previously unrecorded service revenue can arise when a company provides a service but did not yet bill the client for the work.
3. The accounting cycle is a collective process of identifying, analyzing, and recording the accounting events of a company.
4. Before we look at recording and posting the most common types of adjusting entries, we briefly discuss the various types of adjusting entries.

The accounting cycle focuses on historical events and ensures that incurred financial transactions are reported correctly. Interest expense arises from notes payable and other loanagreements. The company has accumulated interest during the periodbut has not recorded or paid the amount. This creates a liabilitythat the company must pay at a future date. You cover more detailsabout computing interest in Current Liabilities, so for now amounts are given. Accrued expenses are expenses incurred in aperiod but have yet to be recorded, and no money has been paid.Some examples include interest, tax, and salary expenses.

They must be assigned to the relevant accounting periods and reported on the relevant income statements. Prepaid expenses or unearned revenues – Prepaid expenses are goods or services that have been paid for by a company but have not been consumed yet. This means the company pays for the insurance but doesn’t actually get the full benefit of the insurance contract until the end of the six-month period. This transaction is recorded as a prepayment until the expenses are incurred. Only expenses that are incurred are recorded, the rest are booked as prepaid expenses. When a company purchases supplies, the original order, receipt of the supplies, and receipt of the invoice from the vendor will all trigger journal entries.

For example, a company performs landscaping services in theamount of $1,500. Atthe period end, the company would record the following adjustingentry. Interest Receivable increases (debit) for $1,250 becauseinterest has not yet been paid. Interest Revenue increases (credit)for $1,250 because interest was earned in the three-month periodbut had been previously unrecorded. Accrued revenues are revenues earned in aperiod but have yet to be recorded, and no money has beencollected. Some examples include interest, and services completedbut a bill has yet to be sent to the customer.

Illustration of Prepaid Insurance

This trigger does not occur when using supplies from the supply closet. Similarly, for unearned revenue, when the company receives an advance payment from the customer for services yet provided, the cash received will trigger a journal entry. 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. Deferrals are prepaid expense and a beginner’s guide to bookkeeping basics revenue accounts that have delayed recognition until they have been used or earned.