The trial balance-the first summarization of the transaction data-may not contain up-to-date and complete data. This is true for several reason :
- Some event are not recorded daily because is it not efficient to do so. For example, companies do not record the daily use of supplies or the earning of wages by employees.
- Some costs are not recorded during the accounting period because they expire with the passage of time rather than as a result of daily transactions. Examples are rent, insurance, and charges related to the use of equipment.
- Some items may be unrecorded. An example is a utility bill that the company will not receive until the next accounting period.
A company must make adjusting entries every time it prepares financial statements. It analyzes each account in the trial balance to determine whether it is complete and upto-date. For example, the company may need to make inventory counts of supplies. It may also need to prepare supporting schedules of insurance polices, rental agreements, and other contractual commitments. Because the adjusting and closing process can be time-consuming, companies often prepare adjusting entries after the balance sheet date, but date them as of the balance sheet date.
Adjusting Entries for Deferrals
Deferrals are either prepaid expenses or unearned revenues. Companies make adjustments for deferrals to record the portion of the deferral that represents the expense incurred or the revenue earned in the current period.
PREPAID EXPENSES
Companies record payments of expenses that will benefit more than one accounting period as assets called prepaid expenses or prepayments. When expenses are prepaid, an asset account is increased (debited) to show the service or benefit that the company will receive in the future. Example of common prepayments are insurance, supplies, advertising, and rent. In addition, companies make prepayments when they purchase buildings and equipment.
Prepaid expenses are cost that expire either with the passage of time (e.g., rent and insurance) or through use (e.g., supplies). The expiration of these costs does not require daily journal entries. Companies postpone recognizing these costs until they prepare financial statements. At each statement date, they make adjusting entries: (1) to record the expenses that apply to current accounting period, and (2) to show the unexpired costs in the asset accounts.
Prior to adjustment for prepaid expenses, assets are overstated and expenses are understated. As shown in Illustration 3-4, an adjusting entry for prepaid expense increases (debits) an expenses account and a decreases (credits) an asset account.
On the next few pages, we will look in more detail at some specific types of prepaid expenses, begining with supplies.
Supplies. Business use various types of supplies such as paper, envelopes, and printer cartridges. Companies generally debit supplies to an asset account when they acquire them. In the course of operations, supplies are used, but companies postpone recognizing their use until the adjustment process. At the end of the accounting period, a company counts the remaining supplies. The difference between the balance in the Supplies (asset) account and the supplies on hand represents the supplies used (an expense) for the period.
Pioneer Advertising Agency purchased advertising supplies costing $2,500 on October 5. Pioneer recorded that transaction by increasing (debiting) the asset Advertising Supplies. This account shows a balance of $2,500 in the October 31 trial balance. An inventory count at the close of business on October 31 reveals that $1,000 of supplies are still on hand. Thus, the cost of supplies used is $1,500 ($2,500-$1,000). Pioneer makes the following adjusting entry.
The asset acount Advertising Supplies now shows a balance of $1,000, which is equal to the cost of supplies on hand at the statement date. In addition, Advertising Supplies Expense shows a balance of $1,500, which equals the cost of supplies used in October. If Pionerr does not make the adjusting entry, October expenses will be understated and net income overstated by $1,500. Also, both assets and owner's equity will be overstated by $1,500 on the October 31 balance sheet.
post by : Rony Sutiyanto
Adjusting Entries for Deferrals
Deferrals are either prepaid expenses or unearned revenues. Companies make adjustments for deferrals to record the portion of the deferral that represents the expense incurred or the revenue earned in the current period.
PREPAID EXPENSES
Companies record payments of expenses that will benefit more than one accounting period as assets called prepaid expenses or prepayments. When expenses are prepaid, an asset account is increased (debited) to show the service or benefit that the company will receive in the future. Example of common prepayments are insurance, supplies, advertising, and rent. In addition, companies make prepayments when they purchase buildings and equipment.
Prepaid expenses are cost that expire either with the passage of time (e.g., rent and insurance) or through use (e.g., supplies). The expiration of these costs does not require daily journal entries. Companies postpone recognizing these costs until they prepare financial statements. At each statement date, they make adjusting entries: (1) to record the expenses that apply to current accounting period, and (2) to show the unexpired costs in the asset accounts.
Prior to adjustment for prepaid expenses, assets are overstated and expenses are understated. As shown in Illustration 3-4, an adjusting entry for prepaid expense increases (debits) an expenses account and a decreases (credits) an asset account.
On the next few pages, we will look in more detail at some specific types of prepaid expenses, begining with supplies.
Supplies. Business use various types of supplies such as paper, envelopes, and printer cartridges. Companies generally debit supplies to an asset account when they acquire them. In the course of operations, supplies are used, but companies postpone recognizing their use until the adjustment process. At the end of the accounting period, a company counts the remaining supplies. The difference between the balance in the Supplies (asset) account and the supplies on hand represents the supplies used (an expense) for the period.
Pioneer Advertising Agency purchased advertising supplies costing $2,500 on October 5. Pioneer recorded that transaction by increasing (debiting) the asset Advertising Supplies. This account shows a balance of $2,500 in the October 31 trial balance. An inventory count at the close of business on October 31 reveals that $1,000 of supplies are still on hand. Thus, the cost of supplies used is $1,500 ($2,500-$1,000). Pioneer makes the following adjusting entry.
The asset acount Advertising Supplies now shows a balance of $1,000, which is equal to the cost of supplies on hand at the statement date. In addition, Advertising Supplies Expense shows a balance of $1,500, which equals the cost of supplies used in October. If Pionerr does not make the adjusting entry, October expenses will be understated and net income overstated by $1,500. Also, both assets and owner's equity will be overstated by $1,500 on the October 31 balance sheet.
post by : Rony Sutiyanto
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