Lesson Objectives:- Defining adjusting entries.
- Accounting cycle rules
- How to perform an adjusting entry for accrued expenses.
- Types of adjusting entries
We've now reached the midpoint in the accounting cycle and over the next several lessons we will be reviewing the different types of adjusting entries. Performing the adjusting entries are the fourth step in the accounting cycle depicted above.
At the end of the accounting period, the company must record adjusting entries for income and expense accounts, in order to remain in compliance with accounting principles. The different adjustments, which include prepaid expenses, unearned income, and accrued expenses and revenue, arise from business events that took place in the current period but were not actually recorded in the accounting system. Adjusting entries are another step that is required, before the company can start to prepare their financial statements.
Before we dive into the main topic of this lesson, which is the first type of accrued expenses, lets take a look at a few rules that apply to adjusting entries.
1. Always focus on revenues and expenses - For example, unearned revenue would be debited and revenue would be credited. For expenses, salaries expenses would be debited and salaries payable would be credited. You will never see revenues and expenses together, you will either see an adjusting entry for a revenue or an adjusting entry for an expense. Adjusting entries always include one income statement account and one balance sheet account.
2. Adjusting entries never involve cash - While journal entries show cash transactions, you will never be debiting or crediting cash when using adjusting entries. All adjusting entries will involve either income or an expense but not involving cash accounts.
3. The passage of time is shown - This means that the entries ensure that all of the revenues and expenses are shown, to avoid understating or miscalculating figures. The adjusting entries account for a certain amount of time passing.
To demonstrate the concept of accrued expense adjusting entries, we will use the example of expenses that are paid out to employees. If the company pays an employee biweekly and the accounting period ends in the middle of the pay cycle, the company will need to use an adjusting entry to payroll expense for the month to date.
They pay a salary amount of $1,400 on a biweekly basis. For the month of March, the employees have been paid on the 10th and 24th. At the end of the month, the company must record the salaries expense that is owed but not yet paid on the 31st.
Accrued expense means the expense is owed. Due to the fact that the current pay period hasn't ended yet, the $700 is owed to the employee. The salary expense is listed as a debit and the salaries payable to the employee is listed as a credit
The four types of adjusting entries include prepaid expenses, accrued expenses, unearned revenue and accrued revenue. Any given adjusting entry will either be account for a revenue or expense. Let's define how each type is used in the accounting world.
Prepaid expense - Accounts for expenses paid in advance.
Accrued expense - Expenses have already been incurred but not paid for.
Unearned revenue - Revenues that have been received and recorded as liabilities before being earned by the company.
Accrued revenue - Revenues already earned but not yet recorded.
We will be reviewing the different types of adjustments in much more depth over the next few lessons. The graphic above will give you a glimpse into each account relationship and how the adjusting entries are recorded.