Adjusting Entries.docx

Adjusting Entries.docx

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AdjustingEntries

AdjustingEntries

Part1IntroductiontoAdjustingEntries

Adjustingentriesareaccountingjournalentriesthatconvertacompany'saccountingrecordstotheaccrualbasisofaccounting.Anadjustingjournalentryistypicallymadejustpriortoissuingacompany'sfinancialstatements.

Todemonstratetheneedforanaccountingadjustingentrylet'sassumethatacompanyborrowedmoneyfromitsbankonDecember1,2010andthatthecompany'saccountingperiodendsonDecember31.ThebankloanspecifiesthatthefirstinterestpaymentontheloanwillbedueonMarch1,2011.Thismeansthatthecompany'saccountingrecordsasofDecember31donotcontainanypaymenttothebankfortheinterestthecompanyincurredfromDecember1throughDecember31.（Ofcoursetheloaniscostingthecompanyinterestexpenseeveryday,buttheactualpaymentfortheinterestwillnotoccuruntilMarch1.）Forthecompany'sDecemberincomestatementtoaccuratelyreportthecompany'sprofitability,itmustincludeallofthecompany'sDecemberexpenses—notjusttheexpensesthatwerepaid.Similarly,forthecompany'sbalancesheetonDecember31tobeaccurate,itmustreportaliabilityfortheinterestowedasofthebalancesheetdate.AnadjustingentryisneededsothatDecember'sinterestexpenseisincludedonDecember'sincomestatementandtheinterestdueasofDecember31isincludedontheDecember31balancesheet.TheadjustingentrywilldebitInterestExpenseandcreditInterestPayablefortheamountofinterestfromDecember1toDecember31.

Anothersituationrequiringanadjustingjournalentryariseswhenanamounthasalreadybeenrecordedinthecompany'saccountingrecords,buttheamountisformorethanthecurrentaccountingperiod.Toillustratelet'sassumethatonDecember1,2010thecompanypaiditsinsuranceagent$2,400forinsuranceprotectionduringtheperiodofDecember1,2010throughMay31,2011.The$2,400transactionwasrecordedintheaccountingrecordsonDecember1,buttheamountrepresentssixmonthsofcoverageandexpense.ByDecember31,onemonthoftheinsurancecoverageandcosthavebeenuseduporexpired.HencetheincomestatementforDecembershouldreportjustonemonthofinsurancecostof$400（$2,400dividedby6months）intheaccountInsuranceExpense.ThebalancesheetdatedDecember31shouldreportthecostoffivemonthsoftheinsurancecoveragethathasnotyetbeenusedup.（ThecostnotusedupisreferredtoastheassetPrepaidInsurance.ThecostthatisusedupisreferredtoastheexpiredcostInsuranceExpense.）ThismeansthatthebalancesheetdatedDecember31shouldreportfivemonthsofinsurancecostor$2,000（$400permonthtimes5months）intheassetaccountPrepaidInsurance.Sinceitisunlikelythatthe$2,400transactiononDecember1wasrecordedthisway,anadjustingentrywillbeneededatDecember31,2010togettheincomestatementandbalancesheettoreportthisaccurately.

Thetwoexamplesofadjustingentrieshavefocusedonexpenses,butadjustingentriesalsoinvolverevenues.Thiswillbediscussedlaterwhenweprepareadjustingjournalentries.

Fornowwewanttohighlightsomeimportantpoints.

Therearetwoscenarioswhereadjustingjournalentriesareneededbeforethefinancialstatementsareissued:

Nothinghasbeenenteredintheaccountingrecordsforcertainexpensesorrevenues,butthoseexpensesand/orrevenuesdidoccurandmustbeincludedinthecurrentperiod'sincomestatementandbalancesheet.

Somethinghasalreadybeenenteredintheaccountingrecords,buttheamountneedstobedividedupbetweentwoormoreaccountingperiods.

Adjustingentriesalmostalwaysinvolveabalancesheetaccount（InterestPayable,PrepaidInsurance,AccountsReceivable,etc.）andanincomestatementaccount（InterestExpense,InsuranceExpense,ServiceRevenues,etc.）

Part2AdjustingEntries-AssetAccounts

Adjustingentriesassurethatboththebalancesheetandtheincomestatementareup-to-dateontheaccrualbasisofaccounting.Areasonablewaytobegintheprocessisbyreviewingtheamountorbalanceshownineachofthebalancesheetaccounts.Wewillusethefollowingpreliminarybalancesheet,whichreportstheaccountbalancespriortoanyadjustingentries:

ParcelDeliveryService

PreliminaryBalanceSheet–beforeadjustingentries

December31,2010

Assets

$

Liabilities

$

Cash

1,800

NotesPayable

5,000

AccountsReceivable

4,600

AccountsPayable

2,500

Supplies

1,100

WagesPayable

1,200

PrepaidInsurance

1,500

UnearnedRevenues

1,300

Equipment

25,000

TotalLiabilities

10,000

AccumulatedDepreciation

（7,500）

Owner'sEquity

MarySmith,Capital

16,500

TotalAssets

$26,500

TotalLiabilities&Owner'sEquity

$26,500

Let'sbeginwiththeassetaccounts:

Cash$1,800

TheCashaccounthasapreliminarybalanceof$1,800—theamountinthegeneralledger.Beforeissuingthebalancesheet,onemustask,"Is$1,800thetrueamountofcash?

Doesitagreetotheamountcomputedonthebankreconciliation?

"Theaccountantfoundthat$1,800wasindeedthetruebalance.（IfthepreliminarybalanceinCashdoesnotagreetothebankreconciliation,entriesareusuallyneeded.Forexample,ifthebankstatementincludedaservicechargeandacheckprintingcharge—andtheywerenotyetenteredintothecompany'saccountingrecords—thoseamountsmustbeenteredintotheCashaccount.SeethemajortopicBankReconciliationforathoroughdiscussionandillustrationofthelikelyjournalentries.）

AccountsReceivable$4,600

Todetermineifthebalanceinthisaccountisaccuratetheaccountantmightreviewthedetailedlistingofcustomerswhohavenotpaidtheirinvoicesforgoodsorservices.（Thisisoftenreferredtoastheamountofopenorunpaidsalesinvoicesandisoftenfoundintheaccountsreceivablesubsidiaryledger.）Whenthoseopeninvoicesaresortedaccordingtothedateofthesale,thecompanycantellhowoldthereceivablesare.Suchareportisreferredtoasanagingofaccountsreceivable.Let'sassumethereviewindicatesthatthepreliminarybalanceinAccountsReceivableof$4,600isaccurateasfarastheamountsthathavebeenbilledandnotyetpaid.

However,undertheaccrualbasisofaccounting,thebalancesheetmustreportalltheamountsthecompanyhasanabsoluterighttoreceive—notjusttheamountsthathavebeenbilledonasalesinvoice.Similarly,theincomestatementshouldreportallrevenuesthathavebeenearned—notjusttherevenuesthathavebeenbilled.Afterfurtherreview,itislearnedthat$3,000ofworkhasbeenperformed（andthereforehasbeenearned）asofDecember31butwon'tbebilleduntilJanuary10.Becausethis$3,000wasearnedinDecember,itmustbeenteredandreportedonthefinancialstatementsforDecember.AnadjustingentrydatedDecember31ispreparedinordertogetthisinformationontotheDecemberfinancialstatements.

Toassistyouinunderstandingadjustingjournalentries,doubleentry,anddebitsandcredits,eachexampleofanadjustingentrywillbeillustratedwithaT-account.

Hereistheprocesswewillfollow:

1DrawtwoT-accounts.（Everyjournalentryinvolvesatleasttwoaccounts.Oneaccounttobedebitedandoneaccounttobecredited.）

2IndicatetheaccounttitlesoneachoftheT-accounts.（Rememberthatalmostalwaysoneoftheaccountsisabalancesheetaccountandonewillbeanincomestatementaccount.InasmallerfontsizewewillindicatethetypeofaccountnexttotheaccounttitleandwewillalsoindicatesometipsaboutdebitsandcreditswithintheT-accounts.）

3EnterthepreliminarybalanceineachoftheT-accounts.

4Determinewhattheendingbalanceoughttobeforthebalancesheetaccount.

5Makeanadjustmentsothattheendingamountinthebalancesheetaccountiscorrect.

6Enterthesameadjustmentamountintotherelatedincomestatementaccount.

7Writetheadjustingjournalentry.

Let'sfollowthatprocesshere:

AccountsReceivable（balancesheetaccount）

Debit

Increasesanasset

Credit

Decreasesanasset

PreliminaryBalance

4,600

ADJUSTINGENTRY

3,000

CorrectBalance

7,600

ServiceRevenues（incomestatementaccount）

Debit

DecreasesRevenues

Credit

IncreasesRevenues

60,234

PreliminaryBalance

3,000

ADJUSTINGENTRY

63,234

CorrectBalance

TheadjustingentryforAccountsReceivableingeneraljournalformatis:

Date

AccountName

Debit

Credit

Dec.31,2010

AccountsReceivable

3,000

ServiceRevenues

3,000

NoticethattheendingbalanceintheassetAccountsReceivableisnow$7,600—thecorrectamountthatthecompanyhasarighttoreceive.Theincomestatementaccountbalancehasbeenincreasedbythe$3,000adjustmentamount,becausethis$3,000wasalsoearnedintheaccountingperiodbuthadnotyetbeenenteredintotheServiceRevenuesaccount.ThebalanceinServiceRevenueswillincreaseduringtheyearastheaccountiscreditedwheneverasalesinvoiceisprepared.ThebalanceinAccountsReceivablealsoincreasesifthesalewasoncredit（asopposedtoacashsale）.However,AccountsReceivablewilldecreasewheneveracustomerpayssomeoftheamountowedtothecompany.ThereforethebalanceinAccountsReceivablemightbeapproximatelytheamountofonemonth'ssales,ifthecompanyallowscustomerstopaytheirinvoicesin30days.

Attheendoftheaccountingyear,theendingbalancesinthebalancesheetaccounts（assetsandliabilities）willcarryforwardtothenextaccountingyear.Theendingbalancesintheincomestatementaccounts（revenuesandexpenses）areclosedaftertheyear'sfinancials