Chapter 4 The Adjustment Process Principles of Accounting Financial Accounting

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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. During theyear, it collected retainer fees totaling $48,000 from clients.Retainer fees are money lawyers collect in advance of starting workon a case. When the company collects this money from its clients,it will debit cash and credit unearned fees. Even though not all ofthe $48,000 was probably collected on the same day, we record it asif it was for simplicity’s sake.

Adjusted Trial Balance

This creates a liability that the company must pay at a future date. You cover more details about computing interest in Current Liabilities, so for now amounts are given. Returning to Supreme Cleaners, Mark identified the accounts needed to represent the $200 sale and recorded them in his journal. He will then take the account information and move it to his general ledger. All of the accounts he used during the period will be shown on the general ledger, not only those accounts impacted by the $200 sale.

  1. 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.
  2. Previously unrecorded service revenue can arise when a company provides a service but did not yet bill the client for the work.
  3. 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.
  4. Usually to rent a space, a company will need to pay rentat the beginning of the month.

Accrued Expenses

4,000 from a customer for printing services to be performed. The company recorded this as a liability because it received payment without providing the service. To clear this liability, the company must perform the service. Assume that as of January 31 some of the printing services have been provided. Since a portion of the service was provided, a change to unearned revenue should occur.

Discuss the Adjustment Process and Illustrate Common Types of Adjusting Entries

At left below is a “balance sheet approach” for Prepaid Insurance. The expenditure was initially recorded into a prepaid account on the balance sheet. The alternative approach is the “income statement approach,” wherein the Expense account is debited at the time of purchase. The appropriate end-of-period adjusting entry establishes the Prepaid Expense account with a debit for the amount relating to future periods. The offsetting credit reduces the expense to an amount equal to the amount consumed during the period. Note that Insurance Expense and Prepaid Insurance accounts have identical balances at December 31 under either approach.

Why Some Accounts Have Incorrect Balances on the Trial Balance

An original source is a traceable record of information that contributes to the creation of a business transaction. For example, a sales invoice is considered an original source. Activities would include paying an employee, selling products, providing a service, collecting cash, borrowing money, and issuing stock to company owners. Once the original source has been identified, the company will analyze the information to see how it influences financial records.

Illustration of Prepaid Rent

Similar to prepaid insurance, rent also requires advancedpayment. Usually to rent a space, a company will need to pay rentat the beginning of the month. The company may also enter into alease agreement that requires several months, or years, of rent inadvance. Each month that passes, the company needs to record rentused for the month. As one can see on each year’s balance sheet, the asset continues to be reported at its $150,000 cost. However, it is also reduced each year by the ever-growing accumulated depreciation.

Step 5: Post the Adjusting Journal Entries

For example, a magazine publisher may sell a multi-year subscription and collect the full payment at or near the beginning of the subscription period. Such payments received in advance are initially recorded as a debit to Cash and a credit to Unearned Revenue. Unearned revenue is reported as a liability, reflecting the company’s obligation to deliver product in the future. Remember, revenue cannot be recognized in the income statement until the earnings process is complete. Accruals are types of adjusting entries that accumulate during a period, where amounts were previously unrecorded.

Accumulated Depreciation will indirectly reduce the asset account for depreciation incurred up to that point. The difference between the asset’s cost and accumulated depreciation how to create a cash flow statement is called the book value of the asset. When depreciation is recorded in an adjusting entry, Accumulated Depreciation is credited and Depreciation Expense is debited.

For example, a business may choose its fiscal year to begin on April 1, 2019, and end on March 31, 2020. This can be common practice for corporations and may best reflect the operational flow of revenues and expenses for a particular business. In addition to annual reporting, companies often need or choose to report financial statement information in interim periods. There are several other accounting methods or concepts that accountants will sometimes apply. The first is modified accrual accounting, which is commonly used in governmental accounting and merges accrual basis and cash basis accounting.

The asset cost minus accumulated depreciation is known as the book value (or “net book value”) of the asset. For example, at December 31, 20X2, the net book value of the truck is $50,000, https://www.simple-accounting.org/ consisting of $150,000 cost less $100,000 of accumulated depreciation. By the end of the asset’s life, its cost has been fully depreciated and its net book value has been reduced to zero.

For example, the employee is paid for the prior month’s work on the first of the next month. The financial statements must remain up to date, so an adjusting entry is needed during the month to show salaries previously unrecorded and unpaid at the end of the month. For example, a company pays $4,500 for an insurance policy covering six months. It is the end of the first month and the company needs to record an adjusting entry to recognize the insurance used during the month.

Let’s say a company has five salaried employees, each earning ? In our example, assume that they do not get paid for this work until the first of the next month. The following is the adjusting journal entry for salaries. The accounting period a company chooses to use for financialreporting will impact the types of adjustments they may have tomake to certain accounts. In order for information to be useful to the user, it must betimely—that is, the user has to get it quickly enough so it isrelevant to decision-making. You may recall from Analyzing and Recording Transactions that this is the basisof the time period assumption in accounting.

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