Adjusting entries

Abstract

The revenue recognition principle states that revenues are recorded when earned. The matching principle states that expenses are matched to the accounting period, when the revenue they helped produce, was earned. Expenses are recorded when they are incurred or used up. We also refer to this as when they expire. Exxxxxxxxxxxxxxxxxxpenses are recorded when they exxxxxxxxxxxxxxxxxxxxxxxxxpire. An easy way to remember this: Match revenues and expenses to the proper accounting period. Record revenues when earned and expenses when incurred (used up or expired). Why do we need to make adjusting entries? We need to match revenues and expenses to the proper period. This action results in an objective net income because the revenues earned are matched with the expenses incurred to earn that revenue. This is the basis for accrual accounting, which is required by GAAP ‐‐ Generally Accepted Accounting Principles. The result: The determination of an objective net income as well as the correct balances on the Balance Sheet. The problem: At the end of the accounting period (one month, one quarter, six months, or one year – management decides), some revenues and expenses are not properly recorded. The solution: The adjusting process (adjusting entries – AEs) is necessary to make sure that all revenues and expenses are properly recorded. When working with AEs, remember two very important rules. First, cash is not involved. Cash is recorded when it is received or paid. It is adjusted when the monthly bank reconciliation is made. Cash is not part of the end of accounting period adjusting process. Second, adjusting entries will involve either a revenue or expense. There are two categories of adjusting entries – Deferrals and Accruals. Deferrals – The accounting records reflect an account balance. On the last day of the accounting period, an adjustment is needed to bring that account balance to its correct amount. In doing so, either a revenue or expense is also recorded. Can we have some examples? Absolutely Deferral Example: Prepaid Expenses – assets that represent amounts paid in advance. They include insurance, supplies, advertising, and rent. The company pays for these before using them to generate revenue. Equipment ‐‐ PPE) – When an asset that will be used in business operations for more than one year is acquired, the cost is debited to the asset account, for