Adjusting Entries

Definition

Adjusting entries are journal entries made at the end of an accounting period to update the accounts and ensure the financial statements accurately reflect the company's financial position and performance. These entries are necessary to properly match revenues and expenses, and to record accruals and deferrals.

5 Must Know Facts For Your Next Test

1. Adjusting entries are made at the end of an accounting period, such as a month, quarter, or year, to ensure the financial statements accurately reflect the company's financial position and performance.
2. Adjusting entries are necessary to properly match revenues and expenses, as well as to record accruals and deferrals.
3. Common types of adjusting entries include recording depreciation, amortization, prepaid expenses, unearned revenue, and accrued expenses.
4. Adjusting entries are made using the accrual basis of accounting, which recognizes revenue when earned and expenses when incurred, rather than when cash is received or paid.
5. Failure to make appropriate adjusting entries can result in inaccurate financial statements and potentially misleading information for decision-makers.

Review Questions

• Explain the purpose of adjusting entries and how they relate to the accrual basis of accounting.
  • The purpose of adjusting entries is to ensure the financial statements accurately reflect the company's financial position and performance at the end of an accounting period. Adjusting entries are necessary to properly match revenues and expenses, as well as to record accruals and deferrals, in accordance with the accrual basis of accounting. The accrual basis recognizes revenue when earned and expenses when incurred, rather than when cash is received or paid. Adjusting entries help bridge the gap between the cash basis and the accrual basis, providing a more accurate representation of the company's financial activities.
• Describe the types of adjusting entries a company might need to make and how they impact the financial statements.
  • Common types of adjusting entries include recording depreciation, amortization, prepaid expenses, unearned revenue, and accrued expenses. Depreciation and amortization entries reduce the value of long-lived assets on the balance sheet and recognize the expense on the income statement. Prepaid expense and unearned revenue entries allocate these items to the correct accounting period. Accrued expense entries record liabilities for goods or services received but not yet paid for. These adjusting entries ensure the financial statements accurately reflect the company's financial position, income, and cash flows.
• Analyze the potential consequences of failing to make appropriate adjusting entries and the importance of the accrual basis of accounting.
  • Failing to make appropriate adjusting entries can result in inaccurate financial statements that do not properly reflect the company's financial position and performance. This can lead to poor decision-making by management, investors, and other stakeholders. The accrual basis of accounting, which underpins the need for adjusting entries, is crucial because it provides a more comprehensive and meaningful representation of a company's financial activities. By recognizing revenue when earned and expenses when incurred, rather than when cash is received or paid, the accrual basis gives a better understanding of the company's true financial health and allows for more informed decision-making.

Related terms

Accrual Basis Accounting:

An accounting method that recognizes revenue when earned and expenses when incurred, rather than when cash is received or paid.

Deferrals: Expenses paid in advance or revenues received in advance that need to be allocated to the correct accounting period.

Accruals: Revenues earned but not yet received or expenses incurred but not yet paid that need to be recorded in the correct accounting period.