Adjusting Entries in Accounting

Introduction

• Presenter: James from Accounting Stuff
• Purpose: Complete guide to adjusting entries in accounting
• Duration: Approximately 40 minutes
• Sections:
  1. Why adjusting entries are needed
  2. Prepayments
  3. Accruals
  4. Examples of each type
  5. Summary

Why Adjusting Entries?

• Definition: Journal entries posted at the end of an accounting period to align with accrual accounting.
• Objective: Produce financial statements in compliance with GAAP or IFRS which require accrual accounting.
• Accrual Accounting: Revenue recognized when earned; expenses when incurred, not when cash changes hands.

Financial Statements

• Purpose: Summarize financial performance, position, and cash flow.
• Users: Investors, lenders, creditors.
• Principles: Follow GAAP or IFRS.

Adjusting Entries Types

Prepayments

• Definition: Payment for goods/services made in advance.
• Accounting: Initially recorded in the balance sheet; expenses/revenue recognized when incurred/earned.
• Types:
  • Prepaid Expenses: Buyer’s perspective, e.g., insurance; initially recorded as an asset.
  • Deferred Revenue: Seller's perspective, e.g., advance service payment; initially recorded as a liability.

Accruals

• Definition: Recognition of revenues/expenses when goods/services delivered or consumed before payment or invoice.
• Accounting: Recorded as revenue/expenses in the income statement; opposite entry affects balance sheet.
• Types:
  • Accrued Expenses: Buyer’s perspective; liability recognized in balance sheet.
  • Accrued Revenue: Seller’s perspective; asset recognized in the balance sheet.

Examples of Adjusting Entries

Prepaid Expenses Example (Insurance)

• Scenario: Payment of $2,400 for car insurance made in December 2018 for 2019.
• Journal Entries:
  • December 2018:
    • Credit Cash, debit Insurance Expense.
    • Adjusting entry: Debit Prepaid Expenses, Credit Insurance Expense.
  • Throughout 2019: Monthly adjusting entries to release insurance cost from balance sheet to income statement.

Deferred Revenue Example (Airline Ticket)

• Scenario: $800 ticket payment made in June for flights in July and August.
• Journal Entries:
  • June:
    • Debit Cash, credit Deferred Revenue.
  • July/August: Adjusting entries to recognize earned revenue in income statement.

Accrued Expenses Example (Utility Bill)

• Scenario: Water usage billed quarterly, estimated monthly cost $50.
• Journal Entries:
  • Each month: Accrue estimated $50 as utility expense.
  • January: Actual bill of $153 received, adjust entries accordingly.

Accrued Revenue Example (Web Development)

• Scenario: $500 website development completed in June, billed in July.
• Journal Entries:
  • June: Recognize revenue earned but not yet invoiced.
  • July: Invoice raised, adjust accrued revenue to accounts receivable.

Conclusion

• Summary: Adjusting entries necessary for accurate financial reporting under accrual basis.
• Resources: Adjusting entries cheat sheet available for recap of key concepts.