Not every transaction produces an original source document that will alert the bookkeeper that it is time to make an entry. So why are the balances still incorrect? To clear this liability, the company must perform the service.

When a company purchases supplies, the original order, receiptof the supplies, and receipt of the invoice from the vendor willall trigger journal entries. The company followed all of the correct stepsof the accounting cycle up to this point. Having incorrect balances in Supplies and in Unearned Revenue onthe company’s January 31 trial balance is not due to any error onthe company’s part. Since this is a new company,Printing Plus would more than likely use some of their suppliesright away, before the end of the month on January 31. The unadjusted trial balance may have incorrect balances in someaccounts. To answer these questions, let’s first explore the(unadjusted) trial balance, and why some accounts have incorrectbalances.

Effects of Transactions on Accounting Equation

Journal entries are recorded when an activity or event occursthat triggers the entry. Since a portion of the service wasprovided, a change to unearned revenue should occur. If Printing Plus used some ofits supplies immediately on January 30, then why is the full $500still in the supply account on January 31? Recall the trial balance from Analyzing and Recording Transactions for the examplecompany, Printing Plus. For example, why can wenot go from the unadjusted trial balance straight into preparingfinancial statements for public consumption?

Adjusting Entries – Liability Accounts

However, the December income statement and the December 31 balance sheet need to include the wages for December 30-31, but not the wages for January 1-5. Interest Payable is a liability account that reports the amount of interest the company owes as of the balance sheet date. The ending balance in Depreciation Expense – Equipment will be closed at the end of the current accounting period and this account will begin the next accounting year with a balance of $0. The ending balance in the contra asset account Accumulated Depreciation – Equipment at the end of the accounting year will carry forward to the next accounting year. Accumulated Depreciation – Equipment is a contra asset account and its preliminary balance of $7,500 is the amount of depreciation actually entered into the account since the Equipment was acquired. As an asset account, the debit balance of $25,000 will carry over to the next accounting year.

Atthe period end, the company would record the following adjustingentry. Interest Revenue increases (credit)for $1,250 because interest was earned in the three-month periodbut had been previously unrecorded. Accruals are types of adjusting entries thataccumulate during a period, where amounts were previouslyunrecorded. Supplies Expense is an expense account, increasing (debit) for$150, and Supplies is an asset account, decreasing (credit) for$150.

Reporting Summary

(It’s common not to list accounts with $0 balances on balance sheets.) An adjusting entry dated December 31 is prepared in order to get this information onto the December financial statements. Similarly, the income statement should report all revenues that have been earned—not just the revenues that have been billed. A reasonable way to begin the process is by reviewing the amount or balance shown in each of the balance sheet accounts.

A current liability account that reports the amounts owed to employees for hours worked but not yet paid as of the date of the balance sheet. An asset account which is expected to have a credit balance (which is contrary to the normal debit balance of an asset account). The amount in the Supplies Expense account reports the amounts of supplies that were used during the time interval indicated in the heading of the income statement. The credit balance in this account comes from the entry wherein Bad Debts Expense is debited.

Under accrual accounting an item has been “earned” and is reported as revenue when a service has been performed or the ownership to a product has been transferred from the seller to the buyer (not when cash is received). The amount of insurance premiums that have not yet expired should be reported in the current asset account Prepaid Insurance. The amount of insurance that was incurred/used up/expired during the period of time appearing in the heading of the income statement. Revenue accounts are credited when services are performed/billed and therefore will usually have credit balances. This current liability account reports the amount of interest the company tax included and how to back out the sales tax owes as of the date of the balance sheet.

Adjusting Entries Outline

When depreciation is recorded in an adjusting entry,Accumulated Depreciation is credited and Depreciation Expense isdebited. When the company recognizes the supplies usage, thefollowing adjusting entry occurs. Some common examples of prepaidexpenses are supplies, depreciation, insurance, and rent. (Figure)What two accounts are affected by the needed adjusting entries? (Figure)Are there any accounts that would never have an adjusting entry? At the period end, the company would record the following adjusting entry.

Supplies are only an asset when they are unused. The trial balance for Printing Plus shows Supplies of ? What is the purpose of the adjusted trial balance? You might question the purpose of more than one trial balance. In our example the useful life is 5 years, which is 60 months.

• Depreciation occurs through an accounting adjusting entry in which the account Depreciation Expense is debited and the contra asset account Accumulated Depreciation is credited.
• You should consider our materials to be an introduction to selected accounting and bookkeeping topics (with complexities likely omitted).
• A reasonable way to begin the process is by reviewing the amount or balance shown in each of the balance sheet accounts.
• As an asset account, the debit balance of $25,000 will carry over to the next accounting year.
• For example, let’s say the company is a law firm.
• It is the end of the first month and the company needs to record an adjusting entry to recognize the insurance used during the month.

Illustration of Prepaid Insurance

In the first entry, Cash decreases (credit) and Prepaid Rent increases (debit) for $8,000. In the first entry, Cash decreases (credit) and Prepaid Insurance increases (debit) for $4,500. For example, a company pays $4,500 for an insurance policy covering six months. This means that the current book value of the equipment is $1,500, and it will decrease by another $500 when the adjusting entry is made at the end of the next year. Accumulated Depreciation will indirectly reduce the asset account for depreciation incurred up to that point.

Accrual of Expenses

Employees worked three days the following week, but would not be paid for this time until January 9, 20X9. Typically, businesses will pay employees once or twice per month. Accrued revenues might relate to such events as client services that are based on hours worked. Accrued expenses relate to such things as salaries, interest, rent, utilities, and so forth. Equally important, the reported revenue only reflects goods and services actually delivered.

• If the company wanted to compute the book value, it would take the original cost of the equipment and subtract accumulated depreciation.
• However, one important fact that we need to address now is that the book value of an asset is not necessarily it’s market value (the price at which the asset would sell) .
• Taxes the company owes during a periodthat are unpaid require adjustment at the end of a period.
• This aligns with the revenue recognitionprinciple to recognize revenue when earned, even if cash has yet tobe collected.
• The balances in the Supplies and Supplies Expense accounts show as follows.
• Equally important, the reported revenue only reflects goods and services actually delivered.
• The difference between the asset’s value (cost) and accumulated depreciation is called the book value of the asset.

(Figure)Identify annualized salary whether each of the following transactions, which are related to revenue recognition, are accrual, deferral, or neither. (Figure)Why is the adjusting process needed? Only the journal entries require decision-making processes.

A business owner buys a car on credit for his car rental business for $10,000. If a transaction decreases the total assets of a business, then the sum of its total liabilities and owner’s equity may or may not decrease depending on the nature of the transaction. Process of allocating the costs of a tangible asset over the asset’s economic life Salaries Expense increases (debit) and Salaries Payable increases (credit) for $12,500 ($2,500 per employee × five employees). Income Tax Expense increases (debit) and Income Tax Payable increases (credit) for $9,000. Interest Expense increases (debit) and Interest Payable increases (credit) for $300.

For example, a company performs landscaping services in the amount of ? This means the customer has also not yet paid for services. Interest Revenue increases (credit) for ? 1,250 because interest has not yet been paid. For example, assume that a company has one outstanding note receivable in the amount of ?

Under the accrual basis of accounting, the Service Revenues account reports the fees earned by a company during the time period indicated in the heading of the income statement. When the revenues are earned they will be moved from the balance sheet account to revenues on the income statement. Equipment will be depreciated over its useful life by debiting the income statement account Depreciation Expense and crediting the balance sheet account Accumulated Depreciation (a contra asset account).

At the end of the year after analyzing the unearned feesaccount, 40% of the unearned fees have been earned. In this case, Unearned Fee Revenue increases (credit) and Cashincreases (debit) for $48,000. If so, this amountwill be recorded as revenue in the current period. Since the company has not yet provided the product orservice, it cannot recognize the customer’s payment as revenue. Another type of deferral requiring adjustment is unearnedrevenue. Let’s say a company pays $8,000 in advance for four months ofrent.