Vous êtes sur la page 1sur 33

VALUES

EXCELLENCE. To provide the best professionals, medical technology


and systems in support of a comprehensive stroke program with a focus on
best outcomes.
COMPASSION AND PARTNERSHIP. To provide care with sensitivity
and warmth respecting the utmost dignity and rights of individuals at all times
in an environment that builds trust and understanding with patients and their
families.
TEAMWORK. To provide a work place where communication is ensured
and coordination integrates all members of the team.
INNOVATION AND LEADERSHIP. To provide mechanisms where new
ideas, trends and changes are constantly embraced for continuous
improvement.

Adjusting entries, or adjusting journal entries (AJE), are made to update the accounts and bring
them to their correct balances.
The preparation of adjusting entries is an application of the accrual concept of accounting and
the matching principle.
The accrual concept states that income is recognized when earned regardless of when
collected and expense is recognized when incurred regardless of when paid.
The matching principle aims to align expenses with revenues. Expenses should be recognized
in the period when the revenues generated by such expenses are recognized.
Purpose of Adjusting Entries
The main purpose of adjusting entries is to update the accounts to conform with
the accrual concept. At the end of the accounting period, some income and expenses may
have not been recorded, taken up or updated; hence, there is a need to update the
accounts.
If adjusting entries are not prepared, some income, expense, asset, and liability accounts
may not reflect their true values when reported in the financial statements. For this reason,
adjusting entries are necessary.
Types of Adjusting Entries
Generally, there are 4 types of adjusting entries. Adjusting entries are prepared for the
following:
1. Accrued Income income earned but not yet received
2. Accrued Expense expenses incurred but not yet paid
3. Deferred Income income received but not yet earned
4. Prepaid Expense expenses paid but not yet incurred
Also, adjusting entries are made for:
5. Depreciation
6. Doubtful Accounts or Bad Debts, and other allowances
Composition of an Adjusting Entry
Adjusting entries affect at least one nominal account and one real account.
A nominal account is an account whose balance is measured from period to period. Nominal
accounts include all accounts in the Income Statement, plus owner's withdrawal. They are
also called temporary accounts or income statement accounts.
Examples of nominal accounts are: Service Revenue, Salaries Expense, Rent Expense,
Utilities Expense, Mr. Gray Drawing, etc.
A real account has a balance that is measured cumulatively, rather than from period to
period. Real accounts include all accounts in the balance sheet. They are also
called permanent accounts or balance sheet accounts.
Real accounts include: Cash, Accounts Receivable, Rent Receivable, Accounts Payable, Mr.
Gray Capital, and others.
All adjusting entries include at least a nominal account and a real account.
Note: "Adjusting entries" refer to the 6 entries mentioned above. However, in some branches
of accounting (especially auditing), the term adjusting entries could refer to any entry that
aims to adjust incorrect account balances.
As a result, there is little distinction between "adjusting entries" and "correcting entries"
today. In the traditional sense, however, adjusting entries are those made at the end of the
period to take up accruals, deferrals, prepayments, depreciation and allowances.
In the next lessons, we will illustrate how to prepare adjusting entries for each type and
provide examples as we go.

Accrued income (or accrued revenue) refers to income already earned but has not yet been
collected.
At the end of every period, accountants should make sure that they are properly included as
income, with a corresponding receivable.
When a company has performed services or sold goods to a customer, it should be
recognized as income even if the amount is still to be collected at a future date.
If no journal entry was ever made for the above, then an adjusting entry is necessary.
Pro-Forma Entry
The adjusting entry to record an accrued revenue is:
mmm dd Receivable account* x,xxx.xx
Income account** x,xxx.xx
*Appropriate receivable account such as Accounts Receivable, Rent Receivable, Interest Receivable, etc.
**Income account such as Service Revenue, Rent Income, Interest Income, etc.
Here's an Example
In our previous set of transactions, assume this additional information:
On December 31, 2016, Gray Electronic Repair Services rendered $300 worth of services to
a client. However, the amount has not yet been collected. It was agreed that the customer
will pay the amount on January 15, 2017. The transaction was never recorded in the books
of the company.
In this case, we should make an adjusting entry in 2016 to recognize the income since it has
already been earned. The adjusting entry would be:
Dec 31 Accounts Receivable 300.00
Service Revenue 300.00
Here are some more illustrations.
More Examples: Adjusting Entries for Accrued Income
Example 1: Company ABC leases its building space to a tenant. The tenant agreed to pay
monthly rental fees of $2,000 covering a period from the 1st to the 30th or 31st of every
month. On December 31, 2016, ABC Company did not receive the rental fee for December
yet and no record was made in the journal.
Under the accrual basis, the rent income above should already be recognized because it has
already been earned even if it has not yet been collected. The adjusting journal entry would
be:
Dec 31 Rent Receivable 2,000.00
Rent Income 2,000.00
Example 2: ABC Company lent $9,000 at 10% interest on December 1, 2016. The amount will
be collected after 1 year. At the end of December, no entry was entered in the journal to
take up the interest income.
Interest is earned through the passage of time. In the case above, the $9,000 principal plus
a $900 interest will be collected by the company after 1 year. The $900 interest pertains to 1
year.
However, 1 month has already passed. The company is already entitled to 1/12 of the
interest, as prorated. Therefore the adjusting entry would be to recognize $75 (i.e. $900 x
1/12 ) as interest income:
Dec 31 Interest Receivable 75.00
Interest Income 75.00
The basic concept you need to remember is recognition of income. When is income recognized?
Under the accrual concept of accounting, income is recognized when earned regardless of
when collected.
If the company has already earned the right to it and no entry has been made in the journal,
then an adjusting entry to record the income and a receivable is necessary.
Accrued expenses refer to expenses that are already incurred but have not yet been paid.
At the end of period, accountants should make sure that they are properly recorded in the
books of the company as an expense, with a corresponding payable account.
Here's the rule. If a company incurred, used, or consumed all or part of an expense, that
expense or part of it should be properly recognized even if it has not yet been paid.
If such has not been recognized, then an adjusting entry is necessary.
Pro-Forma Entry
The pro-forma adjusting entry to record an accrued expense is:
mmm dd Expense account* x,xxx.xx
Liability account** x,xxx.xx
*Appropriate expense account (such as Utilities Expense, Rent Expense, Interest Expense, etc.)
**Appropriate liability account (Utilities Payable, Rent Payable, Interest Payable, Accounts Payable, etc.)
For Example
For the month of December 2016, Gray Electronic Repair Services used a total of $1,800
worth of electricity and water. The company received the bills on January 10, 2017. When
should the expense be recorded, December 2016 or January 2017?
Answer in December 2016. According to the accrual concept of accounting, expenses are
recognized when incurred regardless of when paid. The amount above pertains to
utilities used in December. Therefore, if no entry was made for it in December then an
adjusting entry is necessary.
Dec 31 Utilities Expense 1,800.00
Utilities Payable 1,800.00
In the adjusting entry above, Utilities Expense is debited to recognize the expense and
Utilities Payable to record a liability since the amount is yet to be paid.
Here are some more examples.
More Examples: Adjusting Entries for Accrued Expense
Example 1: VIRON Company entered into a rental agreement to use the premises of DON's
building. The agreement states that VIRON will pay monthly rentals of $1,500. The lease
started on December 1, 2016. On December 31, the rent for the month has not yet been
paid and no record for rent expense was made.
In this case, VIRON Company already incurred (consumed/used) the expense. Even if it has
not yet been paid, it should be recorded as an expense. The necessary adjusting entry would
be:
Dec 31 Rent Expense 1,500.00
Rent Payable 1,500.00
Example 2: VIRON Company borrowed $6,000 at 12% interest on August 1, 2016. The
amount will be paid after 1 year. At the end of December, the end of the accounting period,
no entry was entered in the journal to take up the interest.
Let's analyze the above transaction.
VIRON will be paying $6,000 principal plus $720 interest after a year. The $720 interest
covers 1 year. At the end of December, a part of that is already incurred, i.e. $720 x 5/12 or
$300. That pertains to interest for 5 months, from August 1 to December 31. The adjusting
entry would be:
Dec 31 Interest Expense 300.00
Interest Payable 300.00
Expenses are recognized when incurred regardless of when paid. What you need to
remember here is this: when it has been consumed or used and no entry was made to
record the expense, then there is a need for an adjusting entry.

Unearned revenue (also known as deferred revenue or deferred income)


represents revenue already collected but not yet earned.
Hence, they are also called "advances from customers".
Following the accrual concept of accounting, unearned revenues are
considered as are liabilities.
It is to be noted that under the accrual concept, income is recognized when
earned regardless of when collected.
And so, unearned revenue should not be included as income yet; rather, it is
recorded as a liability. This liability represents an obligation of the company
to render services or deliver goods in the future. It will be recognized as
income only when the goods or services have been delivered or rendered.
At the end of the period, unearned revenues must be checked and adjusted if
necessary. The adjusting entry for unearned revenue depends upon the
journal entry made when it was initially recorded.
There are two ways of recording unearned revenue: (1) the liability method,
and (2) the income method.
Liability Method of Recording Unearned Revenue
Under the liability method, a liability account is recorded when the amount is
collected. The common accounts used are: Unearned Revenue, Deferred
Income, Advances from Customers, etc. For this illustration, let us use
Unearned Revenue.
Suppose on January 10, 2016, ABC Company made $30,000 advanced
collections from its customers. If the liability method is used, the entry would
be:
Jan 10 Cash 30,000.00
Unearned Revenue 30,000.00
Take note that the amount has not yet been earned, thus it is proper to
record it as a liability. Now, what if at the end of the month, 20% of the
unearned revenue has been rendered? This will require an adjusting entry.
The adjusting entry will include: (1) recognition of $6,000 income, i.e. 20% of
$30,000, and (2) decrease in liability (unearned revenue) since some of it has
already been rendered. The adjusting entry would be:
Jan 31 Unearned Revenue 6,000.00
Service Income 6,000.00

We are simply separating the earned part from the unearned portion. Of the
$30,000 unearned revenue, $6,000 is recognized as income. In the entry
above, we removed $6,000 from the $30,000 liability. The balance of
unearned revenue is now at $24,000.
Income Method of Recording Unearned Revenue
Under the income method, the accountant records the entire collection under
an incomeaccount. Using the same transaction above, the initial entry for the
collection would be:
Jan 10 Cash 30,000.00
Service Income 30,000.00
If at the end of the year the company earned 20% of the entire $30,000,
then the adjusting entry would be:
Jan 31 Service Income 24,000.00
Unearned Income 24,000.00
By debiting Service Income for $24,000, we are decreasing the income
initially recorded. The balance of Service Income is now $6,000 ($30,000 -
24,000), which is actually the 20% portion already earned. By crediting
Unearned Income, we are recording a liability for $24,000.
Notice that the resulting balances of the accounts under the two methods
are the same (Cash: $30,000; Service Income: $6,000; and Unearned
Income: $24,000).
Another Example
On December 1, 2016, DRG Company collected from TRM Corp. a total of
$60,000 as rental fee for three months starting December 1.
Under the liability method, the initial entry would be:
Dec 1 Cash 60,000.00
Unearned Rent Income 60,000.00
On December 31, 2016, the end of the accounting period, 1/3 of the rent
received has already been earned (prorated over 3 months).

We should then record the income through this adjusting entry:


Dec 31 Unearned Rent Income 20,000.00
Rent Income 20,000.00
In effect, we are transferring $20,000, one-third of $60,000, from the
Unearned Rent Income (a liability) to Rent Income (an income account) since
that portion has already been earned.
If the company made use of the income method, the initial entry would be:
Dec 1 Cash 60,000.00
Rent Income 60,000.00
In this case, we must decrease Rent Income by $40,000 because that part
has not yet been earned. The income account shall have a balance of
$20,000. The amount removed from income shall be transferred to liability
(Unearned Rent Income). The adjusting entry would be:
Dec 31 Rent Income 40,000.00
Unearned Rent Income 40,000.00
Conclusion
If you have noticed, what we are actually doing here is making sure that the
earned part is included in income and the unearned part into liability. The
adjusting entry will always depend upon the method used when the initial
entry was made.
If you are having a hard time understanding this topic, I suggest you go over
and study the lesson again. Sometimes, it really takes a while to get the
concept. Preparing adjusting entries is one of the most challenging (but
important) topics for beginners.

Prepaid expenses (a.k.a. prepayments) represent payments made for


expenses which have not yet been incurred.
In other words, these are "advanced payments" by a company for supplies,
rent, utilities and others that are still to be consumed. Hence, they are
included in the company's assets.
Expenses are recognized when they are incurred regardless of when paid.
Expenses are considered incurred when they are used, consumed, utilized or
has expired.
Because prepayments they are not yet incurred, they are not recorded as
expenses. Rather, they are classified as current assets since they are readily
available for use.
Prepaid expenses may need to be adjusted at the end of the accounting
period. The adjusting entry for prepaid expense depends upon the journal
entry made when it was initially recorded.
There are two ways of recording prepayments: (1) the asset method, and (2)
the expense method.
Asset Method
Under the asset method, a prepaid expense account (an asset) is recorded
when the amount is paid. Prepaid expense accounts include: Office Supplies,
Prepaid Rent, Prepaid Insurance, and others.
In one of our previous illustrations (if you have been following our
comprehensive illustration for Gray Electronic Repair Services), we made this
entry to record the purchase of service supplies:
Dec 7 Service Supplies 1,500.00
Cash 1,500.00
Take note that the amount has not yet been incurred, thus it is proper to
record it as an asset.
Suppose at the end of the month, 60% of the supplies have been used. Thus,
out of the $1,500, $900 worth of supplies have been used and $600 remain
unused. The $900 must then be recognized as expense since it has already
been used.
In preparing the adjusting entry, our goal is to transfer the used part from
the asset initially recorded into expense for us to arrive at the proper
balances shown in the illustration above.
The adjusting entry will include: (1) recognition of expense and (2) decrease
in the asset initially recorded (since some of it has already been used). The
adjusting entry would be:
Dec 31 Service Supplies Expense 900.00
Service Supplies 900.00
The "Service Supplies Expense" is an expense account while "Service
Supplies" is an asset. After making the entry, the balance of the unused
Service Supplies is now at $600 ($1,500 debit and $900 credit). Service
Supplies Expense now has a balance of $900. Now, we've achieved our goal.
Expense Method
Under the expense method, the accountant initially records the entire
payment as expense. If the expense method was used, the entry would have
been:
Dec 7 Service Supplies Expense 1,500.00
Cash 1,500.00
Take note that the entire amount was initially expensed. If 60% was used,
then the adjusting entry at the end of the month would be:
Dec 31 Service Supplies 600.00
Service Supplies Expense 600.00
This time, Service Supplies is debited for $600 (the unused portion). And
then, Service Supplies Expense is credited thus decreasing its balance.
Service Supplies Expense is now at $900 ($1,500 debit and $600 credit).
Notice that the resulting balances of the accounts under the two methods
are the same (Cash paid: $1,500; Service Supplies Expense: $900; and
Service Supplies: $600).
Another Example
GVG Company acquired a six-month insurance coverage for its properties on
September 1, 2016 for a total of $6,000.
Under the asset method, the initial entry would be:
Sep 1 Prepaid Insurance 6,000.00
Cash 6,000.00
On December 31, 2016, the end of the accounting period, part of the prepaid
insurance already has expired (hence, expense is incurred). The expired part
is the insurance from September to December. Thus, we should make the
following adjusting entry:
Dec 31 Insurance Expense 4,000.00
Prepaid Insurance 4,000.00
Of the total six-month insurance amounting to $6,000 ($1,000 per month),
the insurance for 4 months has already expired. In the entry above, we are
actually transferring $4,000 from the asset to the expense account (i.e., from
Prepaid Insurance to Insurance Expense).

If the company made use of the expense method, the initial entry would be:
Sep 1 Insurance Expense 6,000.00
Cash 6,000.00
In this case, we must decrease Insurance Expense by $2,000 because that
part has not yet been incurred (not used/not expired). Insurance Expense
shall then have a balance of $4,000. The amount removed from the expense
shall be transferred to Prepaid Insurance. The adjusting entry would be:
Dec 31 Prepaid Insurance 2,000.00
Insurance Expense 2,000.00
Conclusion
What we are actually doing here is making sure that the incurred
(used/expired) portion is included in expense and the unused part into asset.
The adjusting entry will always depend upon the method used when the
initial entry was made.
If you are having a hard time understanding this topic, I suggest you go over
and study the lesson again. Sometimes, it really takes a while to get the
concept. Preparing adjusting entries is one of the challenging (but important)
topics for beginners.

When a fixed asset is acquired by a company, it is recorded


at cost (generally, cost is equal to the purchase price of the asset). This cost
is recognized as an asset and not expense.
The cost is to be allocated as expense to the periods in which the asset is
used.This is done by recording depreciation expense.
There are two types of depreciation physical and functional depreciation.
Physical depreciation results from wear and tear due to frequent use and/or
exposure to elements like rain, sun and wind.
Functional or economic depreciation happens when an asset becomes
inadequate for its purpose or becomes obsolete. In this case, the asset
decreases in value even without any physical deterioration.
Understanding the Concept of Depreciation
There are several methods in depreciating fixed assets. The most common
and simplest is the straight-line depreciation method.
Under the straight line method, the cost of the fixed asset is
distributed evenly over the life of the asset.
For example, ABC Company acquired a delivery van for $40,000 at the
beginning of 2012. Assume that the van can be used for 5 years. The entire
amount of $40,000 shall be distributed over five years, hence a depreciation
expense of $8,000 each year.
Straight-line depreciation expense is computed using this formula:
Depreciable Cost Residual Value
Estimated Useful Life
Depreciable Cost: Historical or un-depreciated cost of the fixed asset
Residual Value or Scrap Value: Estimated value of the fixed asset at the end of
its useful life
Useful Life: Amount of time the fixed asset can be used (in months or years)
In the above example, there is no residual value. Depreciation expense is
computed as:
= $40,000 $0
5 years
= $8,000 / year
With Residual Value
What if the delivery van has an estimated residual value of $10,000? The
depreciation expense then would be computed as:
= $40,000 $10,000
5 years
= $30,000
5 years
= $6,000 / year
How to Record Depreciation Expense
Depreciation is recorded by debiting Depreciation Expense and crediting
Accumulated Depreciation. This is recorded at the end of the period (usually,
at the end of every month, quarter, or year).
The entry to record the $6,000 depreciation every year would be:
Dec 31 Depreciation Expense 6,000.00
Accumulated Depreciation 6,000.00
Depreciation Expense: An expense account; hence, it is presented in the
income statement. It is measured from period to period. In the illustration
above, the depreciation expense is $6,000 for 2012, $6,000 for 2013, $6,000
for 2014, etc.
Accumulated Depreciation: A balance sheet account that represents the
accumulated balance of depreciation. It is continually measured; hence the
accumulated depreciation balance is $6,000 at the end of 2012, $12,000 in
2013, $18,000 in 2014, $24,000 in 2015, and $30,000 in 2016.
Accumulated depreciation is a contra-asset account. It is presented in the
balance sheet as a deduction to the related fixed asset. Here's a table
illustrating the computation of the carrying value of the delivery van.
2012 2013 2014 2015 2016
Delivery Van - Historical Cost $40,000 $40,000 $40,000 $40,000 $40,000
Less: Accumulated Depreciation 6,000 12,000 18,000 24,000 30,000
Delivery Van - Carrying Value $34,000 $28,000 $22,000 $16,000 $10,000

Notice that at the end of the useful life of the asset, the carrying value is
equal to the residual value.
Depreciation for Acquisitions Made Within the Period
The delivery van in the example above has been acquired at the beginning of
2012, i.e. January. Therefore, it is easy to calculate for the annual straight-line
depreciation. But what if the delivery van was acquired on April 1, 2012?
In this case we cannot apply the entire annual depreciation in the year 2012
because the van has been used only for 9 months (April to December). We
need to prorate.
For 2012, the depreciation expense would be: $6,000 x 9/12 = $4,500.
Years 2013 to 2016 will have $6,000 annual depreciation expense.
In 2017, the van will be used for 3 months only (January to March) since it
has a useful life of 5 years (i.e. April 1, 2012 to March 31, 2017).
The depreciation expense for 2017 would be: $6,000 x 3/12 = $1,500, and
thus completing the accumulated depreciation of $30,000.
2012 (April to December) $ 4,500
2013 (entire year) 6,000
2014 (entire year) 6,000
2015 (entire year) 6,000
2016 (entire year) 6,000
2017 (January to March) 1,500
Total for 5 years $ 30,000

Companies provide services or sell goods for cash or on credit. Allowing credit
tends to encourage more sales.
However, businesses that allow credit are faced with the risk that their
receivables may not be collected.
Accounts receivable should be presented in the balance sheet at net
realizable value, i.e. the most probable amount that the company will be able
to collect.
Net realizable value for accounts receivable is computed like this:
Accounts Receivable - Gross Amount $ 100,000
Less: Allowance for Bad Debts 3,000
Accounts Receivable - Net Realizable Value $ 97,000

Allowance for Bad Debts (also often called Allowance for Doubtful Accounts)
represents the estimated portion of the Accounts Receivable that the
company will not be able to collect.
Take note that this amount is an estimate. There are several methods in
estimating doubtful accounts.The estimates are often based on the
company's past experiences.
To recognize doubtful accounts or bad debts, an adjusting entry must be
made at the end of the period. The adjusting entry for bad debts looks like
this:
Dec 31 Bad Debts Expense xxx.xx
Allowance for Bad Debts xxx.xx

Bad Debts Expense a.k.a. Doubtful Accounts Expense: An expense account;


hence, it is presented in the income statement. It represents the estimated
uncollectible amount for credit sales/revenues made during the period.
Allowance for Bad Debts a.k.a. Allowance for Doubtful Accounts: A balance sheet
account that represents the total estimated amount that the company will
not be able to collect from its total Accounts Receivable.
What is the difference between Bad Debts Expense and Allowance for Bad Debts?
Bad Debts Expense is an income statement account while the latter is a
balance sheet account. Bad Debts Expense represents the uncollectible
amount for credit sales made during the period. Allowance for Bad Debts, on the
other hand, is the uncollectible portion of the entire Accounts Receivable.
You can also use Doubtful Accounts Expense and Allowance for Doubtful Accounts in
lieu of Bad Debts Expense and Allowance for Bad Debts. However, it is a
good practice to use a uniform pair. Some say that Bad Debts have a higher
degree of uncollectibility that Doubtful Accounts. In actual practice, however,
the distinction is not really significant.
Here's an Example
Gray Electronic Repair Services estimates that $100.00 of its credit revenue
for the period will not be collected. The entry at the end of the period would
be:
Dec 31 Bad Debts Expense 100.00
Allowance for Bad Debts 100.00

Again, you may use Doubtful Accounts. Just be sure to use a logical (and
uniform) pair every time. For example:
Dec 31 Doubtful Accounts Expense 100.00
Allowance for Doubtful Accounts 100.00
If the company's Accounts Receivable amounts to $3,400 and its Allowance
for Bad Debts is $100, then the Accounts Receivable shall be presented in
the balance sheet at $3,300 the net realizable value.
Accounts Receivable (Gross Amount) $ 3,400
Less: Allowance for Bad Debts 100
Accounts Receivable - Net Realizable Value $ 3,300

An adjusted trial balance is prepared after adjusting entries are made and
posted to the ledger.
This is the second trial balance prepared in the accounting cycle. Its purpose
is to test the equality between debits and credits after adjusting entries are
entered into the books of the company.
To illustrate how it works, here is a sample unadjusted trial balance:
Gray Electronic Repair Services
Unadjusted Trial Balance
December 31, 2016

Account Title Debit Credit


Cash $ 7,480.00
Accounts Receivable 3,400.00
Service Supplies 1,500.00
Furniture and Fixtures 3,000.00
Service Equipment 16,000.00
Accounts Payable $ 9,000.00
Loans Payable 12,000.00
Mr. Gray, Capital 13,200.00
Mr. Gray, Drawing 7,000.00
Service Revenue 9,550.00
Rent Expense 1,500.00
Salaries Expense 3,500.00
Taxes and Licenses 370.00
Totals $ 43,750.00 $ 43,750.00
At the end of the period, the following adjusting entries were made:
Dec 31 Accounts Receivable 300.00
Service Revenue 300.00

31 Utilities Expense 1,800.00


Utilities Payable 1,800.00

31 Service Supplies Expense 900.00


Service Supplies 900.00

31 Depreciation Expense 720.00


Accumulated Depreciation 720.00

After posting the above entries, the values of some of the items in
the unadjusted trial balance will change. Take the first adjusting entry. Accounts
Receivable is debited hence is increased by $300. Service Revenue is
credited for $300.
The balance of Accounts Receivable is increased to $3,700, i.e. $3,400
unadjusted balance plus $300 adjustment. Service Revenue will now be
$9,850 from the unadjusted balance of $9,550.
Next entry. Utilities Expense and Utilities Payable did not have any balance in
the unadjusted trial balance. After posting the above entries, they will now
appear in the adjusted trial balance.
Third. Service Supplies Expense is debited for $900. Service Supplies is
credited for $900. The Service Supplies account had a debit balance of
$1,500. After incorporating the $900 credit adjustment, the balance will now
be $600 (debit).
And fourth. There were no Depreciation Expense and Accumulated
Depreciation in the unadjusted trial balance. Because of the adjusting entry,
they will now have a balance of $720 in the adjusted trial balance.
Adjusted Trial Balance Example
After incorporating the adjustments above, the adjusted trial balance would
look like this. Just like in the unadjusted trial balance, total debits and total
credits should be equal.
Gray Electronic Repair Services
Adjusted Trial Balance
December 31, 2016

Account Title Debit Credit


Cash $ 7,480.00
Accounts Receivable 3,700.00
Service Supplies 600.00
Furniture and Fixtures 3,000.00
Service Equipment 16,000.00
Accumulated Depreciation $ 720.00
Accounts Payable 9,000.00
Utilities Payable 1,800.00
Loans Payable 12,000.00
Mr. Gray, Capital 13,200.00
Mr. Gray, Drawing 7,000.00
Service Revenue 9,850.00
Rent Expense 1,500.00
Salaries Expense 3,500.00
Taxes and Licenses 370.00
Utilities Expense 1,800.00
Service Supplies Expense 900.00
Depreciation Expense 720.00
Totals $ 46,570.00 $ 46,570.00

Unadjusted Trial Balance

A trial balance is a list of the balances of ledger accounts of a business at a specific point of time
usually at the end of a period such as month, quarter or year.

An unadjusted trial balance is the one which is created before any adjustments are made in the ledger
accounts.

The preparation of a trial balance is very simple. All we have to do is to list the balances of the ledger
accounts of a business.

Example

Following is the unadjusted trial balance prepared from the ledger accounts of Company A.

Company A

Unadjusted Trial Balance

January 31, 2010

Debit Credit

Cash $20,430

Accounts Receivable 5,900

Office Supplies 22,800

Prepaid Rent 36,000

Equipment 80,000

Accounts Payable $5,200

Notes Payable 20,000

Utilities Payable 3,964

Unearned Revenue 4,000

Common Stock 100,000

Service Revenue 82,600

Wages Expense 38,200


Miscellaneous Expense 3,470

Electricity Expense 2,470

Telephone Expense 1,494

Dividend 5,000

Total $215,764 $215,764

Since, in double entry accounting we record each transaction with two aspects, therefore the total of
debit and credit balances of the trial balance are always equal. Any difference shall indicate some
mistake in the recording process or in the calculations. Although each unbalanced trial balance
indicates mistake, but this does not mean that all errors cause the trial balance to unbalance. There
are few types of mistakes which will not unbalance the trial balance and they may escape un-noticed if
we do not review our work carefully. For example, to omit an entry, to record a transaction twice, etc.

After the preparation of an unadjusted trial balance, adjusting entries are passed.

Adjusting Entries

Adjusting entries are journal entries recorded at the end of an accounting period to adjust income and
expense accounts so that they comply with the accrual concept of accounting. Their main purpose is to
match incomes and expenses to appropriate accounting periods.

The transactions which are recorded using adjusting entries are not spontaneous but are spread over
a period of time. Not all journal entries recorded at the end of an accounting period are adjusting
entries. For example, an entry to record a purchase on the last day of a period is not an adjusting
entry. An adjusting entry always involves either income or expense account.

Types

There are following types of adjusting entries:

Accruals:
These include revenues not yet received nor recorded and expenses not yet paid nor recorded. For
example, interest expense on loan accrued in the current period but not yet paid.
Prepayments:
These are revenues received in advance and recorded as liabilities, to be recorded as revenue and
expenses paid in advance and recorded as assets, to be recorded as expense. For example,
adjustments to unearned revenue, prepaid insurance, office supplies, prepaid rent, etc.
Non-cash:
These adjusting entries record non-cash items such as depreciation expense, allowance for doubtful
debts etc.
Example
This example is a continuation of the accounting cycle problem we have been working on. In the
previous step we prepared an unadjusted trial balance. Here we will pass adjusting entries.
Relevant information for the preparation of adjusting entries of Company A
Office supplies having original cost $4,320 were unused till the end of the period. Office
supplies having original cost of $22,800 are shown on unadjusted trial balance.
Prepaid rent of $36,000 was paid for the months January, February and March.
The equipment costing $80,000 has useful life of 5 years and its estimated salvage value is
$14,000. Depreciation is provided using the straight line depreciation method.
The interest rate on $20,000 note payable is 9%. Accrue the interest for one month.
$3,000 worth of service has been provided to the customer who paid advance amount of
$4,000.
The adjusting entries of Company A are:

Date Account Debit Credit


Jan 31 Supplies Expense 18,480
Office Supplies 18,480
Supplies Expense = $22,800 $4,320 = $18,480
Jan 31 Rent Expense 12,000
Prepaid Rent 12,000
Rent Expense = $36,000 3 = $12,000
Jan 31 Depreciation Expense 1,100
Accumulated Depreciation 1,100
Depreciation Expense = ($80,000 $14,000) (5 12) = $1,100
Jan 31 Interest Expense 150
Interest Payable 150
Interest Expense = $20,000 (9% 12) = $150
Jan 31 Unearned Revenue 3,000
Service Revenue 3,000
An adjusted trial balance is prepared in the next step of accounting cycle.

Adjusted Trial Balance

An Adjusted Trial Balance is a list of the balances of ledger accounts which is created after the
preparation of adjusting entries. Adjusted trial balance contains balances of revenues and expenses
along with those of assets, liabilities and equities. Adjusted trial balance can be used directly in the
preparation of the statement of changes in stockholders' equity, income statement and the balance
sheet. However it does not provide enough information for the preparation of the statement of cash
flows.

The format of an adjusted trial balance is same as that of unadjusted trial balance.

Example
The following adjusted trial balance was prepared after posting the adjusting entries of Company A to
its general ledger and calculating new account balances:

Company A

Adjusted Trial Balance

January 31, 2010

Debit Credit

Cash $20,430

Accounts Receivable 5,900

Office Supplies 4,320

Prepaid Rent 24,000

Equipment 80,000

Accumulated Depreciation $1,100

Accounts Payable 5,200

Utilities Payable 3,964

Unearned Revenue 1,000

Interest Payable 150

Notes Payable 20,000

Common Stock 100,000

Service Revenue 85,600

Wages Expense 38,200

Supplies Expense 18,480

Rent Expense 12,000

Miscellaneous Expense 3,470

Electricity Expense 2,470

Telephone Expense 1,494

Depreciation Expense 1,100

Interest Expense 150

Dividend 5,000
Company A

Adjusted Trial Balance

January 31, 2010

Total $217,014 $217,014

The totals of an adjusted trial balance must be equal. Any difference indicates that there is some error
in the journal entries or in the ledger or in the calculations.

The next step of accounting cycle is the preparation of closing entries.

Reversing Entries
Reversing entries, or reversing journal entries, are journal entries made at the beginning of
an accounting period to reverse or cancel out adjusting journal entries made at the end of
the previous accounting period. This is the last step in the accounting cycle. Reversing
entries are made because previous year accruals and prepayments will be paid off or used
during the new year and no longer need to be recorded as liabilities and assets. These
entries are optional depending on whether or not there are adjusting journal entries that
need to be reversed.

Reversing entries are usually made to simplify bookkeeping in the new year. For example, if
an accrued expense was recorded in the previous year, the bookkeeper or accountant can
reverse this entry and account for the expense in the new year when it is paid. The
reversing entry erases the prior year's accrual and the bookkeeper doesn't have to worry
about it.

If the bookkeeper doesn't reverse this accrual enter, he must remember the amount of
expense that was previously recorded in the prior year's adjusting entry and only account for
the new portion of the expenses incurred. He can't record the entire expense when it is paid
because some of it was already recorded. He would be double counting the expense.

Example
It might be helpful to look at the accounting for both situations to see how difficult
bookkeeping can be without recording the reversing entries. Let's look at let's go back to
your accounting cycle example of Paul's Guitar Shop.

In December, Paul accrued $250 of wages payable for the half of his employee's pay period
that was in December but wasn't paid until January. This end of the year adjusting journal
entry looked like this:

Accounting with the reversing entry:

Paul can reverse this wages accrual entry by debiting the wages payable account and
crediting the wages expense account. This effectively cancels out the previous entry.
But wait, didn't we zero out the wages expense account in last year's closing entries? Yes,
we did. This reversing entry actually puts a negative balance in the expense. You'll see why
in a second.

On January 7th, Paul pays his employee $500 for the two week pay period. Paul can then
record the payment by debiting the wages expense account for $500 and crediting the cash
account for the same amount.

Since the expense account had a negative balance of $250 in it from our reversing entry,
the $500 payment entry will bring the balance up to positive $250-- in other words, the half
of the wages that were incurred in January.

See how easy that is? Once the reversing entry is made, you can simply record the
payment entry just like any other payment entry.

Accounting without the reversing entry:

If Paul does not reverse last year's accrual, he must keep track of the adjusting journal entry
when it comes time to make his payments. Since half of the wages were expensed in
December, Paul should only expense half of them in January.

On January 7th, Paul pays his employee $500 for the two week pay period. He would debit
wages expense for $250, debit wages payable for $250, and credit cash for $500.
The net effect of both journal entries have the same overall effect. Cash is decreased by
$250. Wages payable is zeroed out and wages expense is increased by $250. Making the
reversing entry at the beginning of the period just allows the accountant to forget about the
adjusting journal entries made in the prior year and go on accounting for the current year
like normal.
As you can see from the T-Accounts above, both accounting method result in the same
balances. The left set of T-Accounts are the accounting entries made with the reversing
entry and the right T-Accounts are the entries made without the reversing entry.

Recording reversing entries is the final step in the accounting cycle. After these entries are
made, the accountant can start the cycle over again with recording journal entries. This
cycle repeats in the exact same format throughout the current year.

Adjusting Entries
Why adjusting entries are needed

In order for a company's financial statements to be complete and to reflect the accrual method of
accounting, adjusting entries must be processed before the financial statements are issued. Here are
three situations that describe why adjusting entries are needed:

Situation 1
Not all of a company's financial transactions that pertain to an accounting period will have been
processed by the accounting software as of the end of the accounting period. For example, the bill
for the electricity used during December might not arrive until January 10. (The reason for the 10-day
lag is that the electric utility reads the meters on January 1 in order to compute the electricity actually
used in December. Next the utility has to prepare the bill and mail it to the company.)

Situation 2
Sometimes a bill is processed during the accounting period, but the amount represents the expense
for one or more future accounting periods. For example, the bill for the insurance on the company's
vehicles might be $6,000 and covers the six-month period of January 1 through June 30. If the
company is required to pay the $6,000 in advance at the end of December, the expense needs to be
deferred so that $1,000 will appear on each of the monthly income statements for January through
June.

Situation 3
Something similar to Situation 2 occurs when a company purchases equipment to be used in the
business. Let's assume that the equipment is acquired, paid for, and put into service on May 1.
However, the equipment is expected to be used for ten years. If the cost of the equipment is
$120,000 and will have no salvage value, then each month's income statement needs to report
$1,000 for 120 months in order to report depreciation expense under the straight-line method.

These three situations illustrate why adjusting entries need to be entered in the accounting software
in order to have accurate financial statements. Unfortunately the accounting software cannot
compute the amounts needed for the adjusting entries. A bookkeeper or accountant must review the
situations and then determine the amounts needed in each adjusting entry.

Steps for Recording Adjusting Entries

Some of the necessary steps for recording adjusting entries are

You must identify the two or more accounts involved


o One of the accounts will be a balance sheet account
o The other account will be an income statement account
You must calculate the amounts for the adjusting entries
You will enter both of the accounts and the adjustment in the general journal
You must designate which account will be debited and which will be credited.

Types of Adjusting Entries

We will sort the adjusting entries into five categories.

1. Accrued revenues
Under the accrual method of accounting, a business is to report all of the revenues (and related
receivables) that it has earned during an accounting period. A business may have earned fees from
having provided services to clients, but the accounting records do not yet contain the revenues or the
receivables. If that is the case, an accrual-type adjusting entry must be made in order for the
financial statements to report the revenues and the related receivables.

If a business has earned $5,000 of revenues, but they are not recorded as of the end of the
accounting period, the accrual-type adjusting entry will be as follows:

2. Accrued expenses
Under the accrual method of accounting, the financial statements of a business must report all of the
expenses (and related payables) that it has incurred during an accounting period. For example, a
business needs to report an expense that has occurred even if a supplier's invoice has not yet been
received.

To illustrate, let's assume that a company utilized a worker from a temporary personnel agency on
December 27. The company expects to receive an invoice on January 2 and remit payment on
January 9. Since the expense and the payable occurred in December, the company needs to accrue
the expense and liability as of December 31 with the following adjusting entry:

3. Deferred revenues
Under the accrual method of accounting, the amounts received in advance of being earned must be
deferred to a liability account until they are earned.

Let's assume that Servco Company receives $4,000 on December 10 for services it will provide at a
later date. Prior to issuing its December financial statements, Servco must determine how much of
the $4,000 has been earned as of December 31. The reason is that only the amount that has been
earned can be included in December's revenues. The amount that is not earned as of December 31
must be reported as a liability on the December 31 balance sheet.

If $3,000 has been earned, the Service Revenues account must include $3,000. The remaining
$1,000 that has not been earned will be deferred to the following accounting period. The deferral will
be evidenced by a credit of $1,000 in a liability account such as Deferred Revenues or Unearned
Revenues.
The adjusting entry for this deferral depends on how the receipt of $4,000 was recorded on
December 10. If the receipt of $4,000 was recorded with a credit to Service Revenues (and a debit to
Cash), the December 31 adjusting entry will be:

If the entire receipt of $4,000 had been credited to Deferred Revenues on December 10 (along with a
debit to Cash), the adjusting entry on December 31 would be:

4. Deferred expenses
Under the accrual method of accounting, any payments for future expenses must be deferred to an
asset account until the expenses are used up or have expired.

To illustrate, let's assume that a new company pays $6,000 on December 27 for the insurance on its
vehicles for the six-month period beginning January 1. For December 27 through 31, the company
should have an asset Prepaid Insurance or Prepaid Expenses of $6,000.

In each of the months January through June, the company must reduce the asset account by
recording the following adjusting entry:

5. Depreciation expense
Depreciation is associated with fixed assets (or plant assets) that are used in the business.
Examples of fixed assets are buildings, machinery, equipment, vehicles, furniture, and other
constructed assets used in a business and having a useful life of more than one year. (However, land
is not depreciated.)

Depreciation allocates the asset's cost (minus any expected salvage value) to expense in the
accounting periods in which the asset is used. Hence, office equipment with a useful life of 5 years
and no salvage value will mean monthly depreciation expense of 1/60 of the equipment's cost. A
building with a useful life of 25 years and no salvage value will result in a monthly depreciation
expense of 1/300 of the building's cost.

Additional information on adjusting entries

To learn more about adjusting entries use any of the following links:

Explanation
Quiz
Questions and Answers (Q&A)
Crossword Puzzles

Reversing Entries
The first two categories of adjusting entries that we had discussed above were:

1. Accrued revenues
2. Accrued expenses

These categories are also referred to as accrual-type adjusting entries or simply accruals. Accrual-
type adjusting entries are needed because some transactions had occurred but the company had
not entered them into the accounts as of the end of the accounting period. In order for a company's
financial statements to include these transactions, accrual-type adjusting entries are needed.

In all likelihood, an actual transaction (that required an accrual-type adjusting entry) will get routinely
processed and recorded in the next accounting period. This presents a potential problem in that the
transaction could get entered into the accounting records twice: once through the adjusting entry and
also when it is routinely processed in the subsequent accounting period. The purpose of reversing
entries is to remove the accrual-type adjusting entries.

Reversing entries will be dated as of the first day of the accounting period immediately following the
period of the accrual-type adjusting entries. In other words, for a company with accounting periods
which are calendar months, an accrual-type adjusting entry dated December 31 will be reversed on
January 2.

To illustrate, let's assume that the company had accrued repairs expenses with the following
adjusting entry on December 31:
This accrual-type adjusting entry was needed so that the December repairs would be reported as 1)
part of the expenses on the December income statement, and 2) a liability on the December 31
balance sheet.

On January 2, the following reversing entry is recorded in order to remove the accrual-type adjusting
entry of December 31:

The reversing entry removes the liability established on December 31 and also puts a credit balance
in the Repairs Expense account on January 2. When the vendor's invoice is processed in January, it
can be debited to Repairs Expenses (as would normally happen). If the vendor's invoice is $6,000
the balance in the account Repairs Expenses will show a $0 balance after the invoice is entered.
(The $6,000 credit from the reversing entry on January 2, plus the $6,000 debit from the vendor's
invoice equals $0.) Zero is the correct amount because the expense of $6,000 belonged in
December and was reported in December as the result of the December 31 adjusting entry.

Some accounting software will allow you to indicate the adjusting entries you would like to have
reversed automatically in the next accounting period.