Adjusting Entries

Definition

Adjusting entries are journal entries made at the end of an accounting period to update account balances and ensure the financial statements accurately reflect the company's financial position and performance. These entries are necessary to properly match revenues and expenses, as well as to recognize assets, liabilities, and other items that may have been overlooked or incorrectly recorded during the period.

5 Must Know Facts For Your Next Test

1. Adjusting entries are necessary to ensure the financial statements accurately reflect the company's financial position and performance for the period.
2. Adjusting entries are used to recognize accrued expenses, accrued revenues, prepaid expenses, and unearned revenues.
3. Adjusting entries help to match revenues and expenses in the correct accounting period, following the accrual basis of accounting.
4. Failure to record adjusting entries can lead to inaccurate financial statements and distort the company's true financial position.
5. Adjusting entries are made at the end of the accounting period, typically monthly or annually, before the financial statements are prepared.

Review Questions

• Explain the purpose of adjusting entries and how they help ensure the accuracy of financial statements.
  • The purpose of adjusting entries is to update account balances at the end of an accounting period to accurately reflect the company's financial position and performance. Adjusting entries are necessary to recognize accrued expenses, accrued revenues, prepaid expenses, and unearned revenues, which may not have been recorded during the normal course of business. By making these adjustments, the financial statements can be prepared in accordance with the accrual basis of accounting, ensuring that revenues and expenses are matched in the correct accounting period. Failure to record adjusting entries can lead to inaccurate financial statements and distort the company's true financial position.
• Describe the different types of adjusting entries and provide examples of each.
  • The main types of adjusting entries are: 1. Accrued expenses: These entries record expenses that have been incurred but not yet paid, such as accrued salaries, accrued interest, or accrued utilities. 2. Accrued revenues: These entries record revenue that has been earned but not yet received, such as unbilled services or interest earned but not yet received. 3. Prepaid expenses: These entries record the portion of a prepaid expense that has been used up during the period, such as prepaid insurance or rent. 4. Unearned revenues: These entries record the portion of revenue that has been received in advance but not yet earned, such as subscription fees or rental payments received in advance.
• Explain how adjusting entries are used to determine and dispose of underapplied or overapplied overhead in the context of managerial accounting.
  • In the context of managerial accounting, adjusting entries are used to determine and dispose of underapplied or overapplied overhead. Overhead costs are typically applied to products or services based on a predetermined overhead rate. At the end of the accounting period, the actual overhead costs incurred are compared to the applied overhead. If the actual overhead costs are less than the applied overhead, the result is underapplied overhead. Conversely, if the actual overhead costs are greater than the applied overhead, the result is overapplied overhead. Adjusting entries are used to record these differences and dispose of the underapplied or overapplied overhead amounts, either by allocating them to cost of goods sold, work-in-process, or finished goods inventory, depending on the specific circumstances and the company's accounting policies. Properly recording and disposing of underapplied or overapplied overhead through adjusting entries ensures that the company's cost accounting information is accurate and reflects the true cost of production.

Related terms

Accrual Accounting: The accounting method that recognizes revenue when earned and expenses when incurred, regardless of when cash is received or paid.

Deferrals: Accounts that represent prepaid expenses or unearned revenue, which need to be adjusted at the end of the period.

Accruals: Accounts that represent expenses incurred or revenue earned but not yet recorded, which need to be adjusted at the end of the period.