Financial Accounting Notes


Adjusting Entries (a brief chapter)

Many transactions affect the revenue or expenses of two or more accounting periods. For example, a business may purchase equipment that will last for many years, insurance policies that cover 12 months. Each of these assets is gradually used up – that is, becomes expense. How do accountants allocate the cost of these assets to expense over a span of several accounting periods? The answer is adjusting entries.

Types of Adjusting Entries:

Adjusting entries fall into one of four general categories:

  • Entries to apportion recorded costs:

When a business makes an expenditure that will benefit more than one acc

ounting period, the amount is usually debited to an asset account. At the end of each period benefiting from this expenditure, an adjusting entry is made to transfer an appropriate portion of the cost from the asset account to an expense account. This adjusting entry reflects the fact that part of the asset has been used up – that is, become expense - during the current accounting period.
An adjusting entry to apportion a recorded cost consists of a debit to an expense account and a credit to an asset account. Examples of these adjustments include the entries to record depreciation expense, and the costs of prepaid expenses.

  • Prepaid expenses:

Payments in advance are often made for such items as insurance, rent, and office supplies. If the advance payment will benefit more than just the current accounting period, the cost represents an asset rather than an expense. In short prepaid expenses are assets; they become expenses only as the goods or services are used up.

  • Insurance:

To illustrate these concepts, assume that on November 1, Robert Real Estate Company paid $600 for a one-year fire insurance policy covering the building. This expenditure was debited to an asset account by the following journal entry:

Unexpired Insurance …………………………………………… 600
Cash …………………………………………………………          600
Purchased a one-year fire insurance policy.

 
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