Adjusting Entries: Does Your Small Business Need Them?

Deferrals are adjusting entries that update a previous transaction. The first journal entry is a general one; the journal entry that updates an account in this original transaction is an adjusting entry made before preparing financial statements. There are two types of adjusting entries—deferrals and accruals.

Adjusting Entries: Does Your Small Business Need Them?

Several internet sites can provide additional information for you on adjusting entries. One very good site where you can find many tools to help you study this topic is Accounting Coach which provides a tool that is available to you free of charge. Visit the website and take a quiz on accounting basics to test your knowledge. The company was deferring the recognition of supplies from supplies expense until it had used the supplies. The company recorded salaries that had been earned by employees but were previously unrecorded and have not yet been paid.

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The accumulated depreciation account on the balance sheet is called a contra-asset account, and it’s used to record depreciation expenses. When an asset is purchased, it depreciates by some amount every month. For that month, an adjusting entry is made to debit depreciation expense and credit accumulated depreciation by the same amount. Adjusting Entries are journal entries made at the end of the accounting period in order to bring the books into alignment with the matching and revenue recognition principles required by GAAP . They help accountants to better match revenues and expenses to the accounting period in which the activity took place.

Adjusting Entries: Does Your Small Business Need Them?

Assume its actual useful life is 10 years and the equipment is estimated to be worth $0 at the end of its useful life (residual value of $0). Therefore, the $100,000 cost must be spread over the asset’s five-year life. After posting the adjustment, the $100 remaining balance in unearned revenue ($400 − $300) represents the amount at the end of January that will be earned in the future. It makes sense since it follows the same pattern as supplies.

Adjusting for Accrued Expense Accounts

Adjusting entries are made in your accounting journals at the end of an accounting period after a trial balance is prepared. Adjusting entries are typically made after the trial balance has been prepared and reviewed by your accountant or bookkeeper. Sometimes, your bookkeeper can enter a recurring transaction, and these entries will be posted automatically each month before the close of the period. The Inventory Loss account Adjusting Entries: Does Your Small Business Need Them? could either be a sub-account of cost of goods sold, or you could list it as an operating expense. We prefer to see it as an operating expense so it doesn’t skew your gross profit margin. The Reserve for Inventory Loss account is a contra asset account, and it shows up under your Inventory asset account on your balance sheet as a negative number. Or perhaps a customer has made a deposit for services you have not yet rendered.

Therefore, office equipment with a five-year useful life and no salvage value will result in a monthly depreciation charge equal to one-sixth of the equipment’s cost. The $100 balance in the Taxes Expense account will appear on the income statement at the end of the month. The remaining $1,100 in the Prepaid Taxes account will appear on the balance sheet. This amount is still an asset to the company since it has not expired yet. The $1,000 balance in the Rent Expense account will appear on the income statement at the end of the month.

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Oppositely, debit an expense account to increase it, and credit an expense account to decrease it. A customer paid in advance for services, and the company recorded revenue earned after providing service to that customer. Since the company has not yet paid salaries for this time period, Printing Plus owes the employees this money. Interest is revenue for the company on money kept in a savings account at the bank. The company only sees the bank statement at the end of the month and needs to record interest revenue that has not yet been collected or recorded.

These categories can include prepaid expenses, depreciation, accrued expenses, accrued income, unearned income, bad debts, and other allowances. Unearned revenues are payments for goods/services that are yet to be delivered.

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When would a correcting entry not be needed?

Some accounting errors do not require a correcting entry because they are counterbalanced. A counterbalancing error happens when one mistake cancels out another mistake.

The same adjusting entry above will be made at the end of the month for 12 months to bring the Prepaid Taxes amount down by $100 each month. Here is an example of the Prepaid Taxes account balance at the end of October. Here are the ledgers that relate to the purchase of prepaid taxes when the transaction above is posted. After 12 full months, at the end of May in the year after the rent was initially purchased, all of the prepaid rent will have expired.

What Is Impacted on the Balance Sheet and Income Statement When Assets Are Overstated?

The adjusting entry TRANSFERS $100 from Prepaid Taxes to Taxes Expense. It is journalized and posted BEFORE financial statements are prepared so that the income statement and balance sheet show the correct, up-to-date amounts. “Deferred” means “postponed into the future.” In this case you have purchased something in “bulk” that will last you longer than one month, such as supplies, insurance, rent, or equipment. Rather than recording the item as an expense when you purchase it, you record it as an asset since you will not use it all up within a month. At the end of the month, you make an adjusting entry for the part that you did use up—this is an expense, and you debit the appropriate expense account. The credit part of the adjusting entry is the asset account, whose value is reduced by the amount used up.

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But unless your company qualifies for and uses a cash accounting bookkeeping system, adjusting entries will also be necessary to keep your accounting records accurate. Let’s pause here for a moment for an explanation of what happened “behind the scenes” when you made your insurance payment on Dec. 17. When you entered the check into your accounting software, you debited Insurance Expense and credited your checking account. However, that debit — or increase to — your Insurance Expense account overstated the actual amount of your insurance premium on an accrual basis by $1,200. So, we make the adjusting entry to reduce your insurance expense by $1,200. And we offset that by creating an increase to an asset account — Prepaid Expenses — for the same amount.