2 3: Adjusting Entries Business LibreTexts

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). 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. Because prepayments they are not yet incurred, they should not be classified as expenses.

Adjusting Journal Entries:Prepaid Expenses (Accrual Accounting Method)

Companies that take the time to properly record and adjust their accounts will be better equipped to make informed business decisions and meet their financial obligations. Deferred revenue is revenue that has been received but not yet earned. To record deferred revenue, an adjusting entry is made to decrease the liability account and increase the corresponding revenue account. Unearned revenues are revenues that have been received in advance. An example of an unearned revenue would be a deposit for services.

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Similarly, the amount adjusting journal entry for prepaid insurance not yet allocated is not an indication of its current market value. The accounting method under which revenues are recognized on the income statement when they are earned (rather than when the cash is received). Notice that the ending balance in the asset Accounts Receivable is now $7,600—the correct amount that the company has a right to receive.

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Adjustment entries can also impact a business’s profitability by affecting the amount of revenue and expenses that are recorded in a particular accounting period. For example, if an adjustment entry is made to increase revenue, this will increase the business’s profitability for that period. Conversely, if an adjustment entry is made to increase expenses, this will decrease the business’s profitability for that period. Adjustment entries are important accounting tools that help businesses to accurately record their financial transactions and ensure that their financial statements are accurate. These entries are made at the end of an accounting period to adjust the accounts to their correct balances.

• Supplies Expense will start the next accounting year with a zero balance.
• The contra asset account Accumulated Depreciation is related to a constructed asset(s), and the contra asset account Accumulated Depletion is related to natural resources.
• In this article, we shall first discuss the purpose of adjusting entries and then explain the method of their preparation with the help of some examples.
• (The depreciation journal entry includes a debit to Depreciation Expense and a credit to Accumulated Depreciation, a contra asset account).
• In this article, we shall have a closer look at what prepaid insurance means and why adjusting entries for prepaid insurance are made.

There are several types of adjustment entries, including accruals, deferrals, estimates, and reclassifications. Adjustment entries are an essential aspect of accounting that helps ensure the accuracy and completeness of financial statements. These entries are made at the end of an accounting period to correct errors, omissions, and discrepancies in financial transactions. It refers to the portion of the outstanding insurance premium paid by the company in advance and is currently not due.

• As the prepaid amount expires, the balance in Prepaid Insurance is reduced by a credit to Prepaid Insurance and a debit to Insurance Expense.
• In subsequent quarters, further adjusting entries for prepaid insurance will be made as each quarter ends and the insurance for that particular quarter expires.
• Such receipt of cash is recorded by debiting the cash account and crediting a liability account known as unearned revenue.
• This is crucial for providing an accurate financial picture of a company.
• When a company prepays for an expense, such as rent or insurance, it has not yet received the benefit of that payment.

To begin, the bookkeeper or accountant must identify the need for an adjustment entry. This could be due to an error in the original journal entry, the need to accrue expenses or revenue, or the need to record depreciation. Adjustment entries are an important part of the accounting period and the accounting cycle. The Certified Public Accountant accounting period is the period of time for which financial statements are prepared, usually one year. The accounting cycle is the process of recording, classifying, and summarizing financial transactions for a given accounting period.

• Let us look at the balance sheet at the end of one month on December 31, 2017.
• Let’s assume the review indicates that the preliminary balance in Accounts Receivable of $4,600 is accurate as far as the amounts that have been billed and not yet paid.
• The $100 balance in the Insurance Expense account will appear on the income statement at the end of the month.
• Here are the Prepaid Taxes and Taxes Expense ledgers AFTER the adjusting entry has been posted.
• The $1,500 balance in the asset account Prepaid Insurance is the preliminary balance.

Mistake: Incorrect Accounting Entries

Let’s assume you used $100 of the $1,000 of supplies you purchased on 6/1. If you DON’T “catch up” and adjust for the amount you used, you will show on your balance sheet that you have $1,000 worth of supplies at the end of the month when you actually have only $900 remaining. In addition, on your income statement you will show that you did not use ANY supplies to run the business during the month, when in fact you used $100 worth. Adjustment entries are an important tool for businesses to ensure that their financial statements are accurate.