Adjusting Entries (Word Scrambles with Coaching)

Adjusting entries are associated with the matching principle. Ideally, expenses are matched with the revenues which caused the expenses. Otherwise expenses are reported in the accounting period when they occurred.

Example: A retailer’s income statement will match the cost of goods sold and sales commissions expense with the sales that caused them. This will require an adjusting entry since not all expenses are paid for in the period of the sale.

Accruals are adjusting entries dated for the last day of an accounting period to record revenues earned or expenses incurred that had not yet been recorded. Accruals ensure that financial statements reflect all financial activities that occurred in an accounting period.

Example: If a company incurs an expense in December but is not billed until January, the company makes an adjusting entry on December 31 to record the expense in December.

Deferrals, also known as prepayments, involve postponing the recognition of revenues for money that was received in advance, or expenses that have been paid in advance. Generally, the amounts paid overlap two or more accounting periods. Deferral adjusting entries makes sure that the amount is spread over the correct accounting periods.

Example: When a company pays for a year’s insurance in advance, it initially records the payment in an asset account such as a Prepaid Expense. Each month, a portion is then moved to Insurance Expense through a deferral adjusting entry.

In the context of deferrals, a liability account is used to record money received in advance of being earned. This account balance represents the company’s obligation to provide the goods or services in the future (or to return the money).

Example: If a company receives payment for a one-year subscription in advance, it records the amount in a liability account such as Unearned Revenues. Each month the amount earned will be moved to Subscription Revenues.

An asset account is involved in accruing revenues that have been earned but not yet received or recorded. The accrual adjusting entry for revenues ensures that the income statement reflects all the revenues earned, and the balance sheet reports the amount it has a right to receive in the asset account Accrued Receivables.

Example: If a company earns interest on a certificate of deposit but has not yet received the interest, it records an adjusting entry to accrue the interest earned. This accrual adjusting entry increases the asset account Interest Receivable, and it increases the income statement account Interest Income.

Adjusting entries for accruing expenses typically involve an expense account and a liability account. This entry ensures that the income statement reflects all expenses incurred during the period, even if they have not yet been paid or recorded, and the balance sheet reports all the liabilities.

Example: When a company incurs wages at the end of December but will not pay them until January, it records an adjusting entry on December 31 to accrue Wages Expense and to record the liability Wages Payable.

Depreciation is a common adjusting entry for tangible assets. The depreciation entry spreads the cost of an asset over its useful life. This process matches the expense to the accounting period when the revenues were generated by the asset.

Example: At the end of each accounting period, an adjusting entry is made to debit Depreciation Expense and credit Accumulated Depreciation. This entry assigns or allocates the asset’s cost to the accounting periods in which the asset will be generating revenues.

The Allowance for Doubtful Accounts is a contra asset account used to report the estimated amount of accounts receivable that may not be collected. This account ensures that receivables are reported on the balance sheet at their net realizable value.

Example: If a company anticipates that $8,000 of its accounts receivable will be uncollectible, it records an adjusting entry to have the credit balance in the Allowance for Doubtful Accounts be $8,000. The amount of the needed adjustment is recorded in Bad Debts Expense.

Adjusting entries are typically dated for the last day of the accounting period, which is also the balance sheet date. The adjusting entries ensure that the financial statements reflect all transactions for that period.

Example: For a company with a December 31 year-end, adjusting entries are dated December 31 to capture all relevant financial activities and adjustments necessary for the year ended December 31.

Accrual-type adjusting entries are often reversed on the first day of the next accounting period. The reason for the reversing entry is to prevent double-counting of accrued expenses or revenues, since the actual transaction for the accrued item will be recorded in the next accounting period.

Example: An adjusting entry to accrue interest expense as of December 31 is reversed on January 1. The reason is that the actual interest will be paid in January but some of the amount was rightly reported as an expense in December.

As prepaid insurance premiums expire they are reported in the account Insurance Expense. Insurance premiums that were paid, but have not yet expired are reported in an asset account such as Prepaid Insurance or prepaid Expenses.

Example: If a company pays $1,200 on June 25 for the 6-month insurance premium for July 1 to December 31, each of the six monthly income statements beginning in July should report $200 of Insurance Expense.

Accrued revenues are revenues that have been earned but money was not yet received nor was the transaction recorded. Adjusting entries for accrued revenues ensure that the balance sheet will report a current asset for the amont it has a right to receive.

Example: Under the accrual method of accounting, a company that completes a consulting service in December but bills the client in January will record an adjusting entry on December 31. The entry will accrue the revenue in December and will report a current asset for the amount that is receivable.

Adjusting entries affect at least one income statement account and one balance sheet account.

Example: An adjusting entry for wages earned by employees, but not yet paid, requires a debit to Wages Expense (the income statement account) and a credit to Accrued Wages Payable (the balance sheet account).

Accumulated depreciation is a contra asset account that reports the cumulative amount of depreciation expense for an asset since it was acquired.

Example: For a piece of machinery purchased for $10,000 with an annual depreciation of $1,000, the accumulated depreciation account would report a credit balance of $8,000 after eight years of being put into service.

One purpose of adjusting entries is to ensure that revenues are recognized in the period in which they are earned. This provides a more accurate picture of a company’s financial performance than using the cash method.

Example: If a company delivers goods to a customer in December but the payment is not due until January, an adjusting entry dated December 31 ensures that the revenue is recorded and reported in December, the period when the goods were delivered.

Accruing revenues typically involves a debit to an asset account such as accounts receivable. This entry recognizes revenues that have been earned but not yet collected.

Example: When a company earns $1,000 for services provided in December but the customer is not billed until January 2, the company debits Accounts Receivable or Accrued Revenues Receivable on December 31 and credits Service Revenues for $1,000 to record the revenue earned.

Adjusting entries for accrued expenses typically involve crediting a liability account to report the obligations owed at the end of the accounting period.

Example: Assume a company owes $500 in wages to employees for work performed in December, but not paid or recorded as of December 31. An adjusting entry is made on December 31 to credit Wages Payable (a liability account) and debit Wages Expense.

Reversing entries are made on the first day of the accounting period after accrual adjusting entries were recorded. A reversing entry will offset the entry for the actual expense that will be processed in the new accounting period.

Example: If an adjusting entry was made to accrue interest expense in December, a reversing entry on January 1 will remove the accrued interest. This will offset the expense being recorded when the interest is paid in January.

An accrual-type adjusting entry is required when an expense has been incurred but not yet recorded or paid. This entry ensures that expenses are reported on the income statement for the period when they occurred.

Example: For the utilities that a company used in December but will be billed in January, an adjusting entry is made on December 31 to accrue the utilities expense in December. This accrual-type adjusting entry ensures that the expense is matched to the period in which the service was consumed.

Unearned revenues refer to payments received by a company for goods or services it has not yet provided. These amounts are recorded as a liability (such as Unearned Revenues or Customer Deposits) until the revenue is earned.

Example: If a customer pays $1,200 in advance for a year-long subscription, the company records the payment as unearned revenue and recognizes $100 in revenue each month as the subscription is fulfilled.