Adjustments for Financial Reporting

This chapter dives deeper into the importance of making proper adjustments so that the financial statements reflect the current condition of the organization. One of the main principles of accounting is accurate and honest presentation of the financial condition of an organization. Without the proper posting of adjustments and correcting entries, the financial statements will be incorrect. Accounting is typically done within a specified period so that end users can assess the performance of a business entity. This section also discusses accounting periods, fiscal years, calendar years, adjusting entries, the matching principle, and the two classes and four types of adjusting entries.

Classes and types of adjusting entries

Adjusting entries fall into two broad classes: deferred (meaning to postpone or delay) items and accrued (meaning to grow or accumulate) items. Deferred items consist of adjusting entries involving data previously recorded in accounts. These entries involve the transfer of data already recorded in asset and liability accounts to expense and revenue accounts, respectively. Accrued items consist of adjusting entries relating to activity on which no data have been previously recorded in the accounts. These entries involve the initial, or first, recording of assets and liabilities and the related revenues and expenses (see Exhibit 16).

Deferred items consist of two types of adjusting entries: asset/expense adjustments and liability/revenue adjustments. For example, prepaid insurance and prepaid rent are assets until they are used up; then they become expenses. Also, unearned revenue is a liability until the company renders the service; then the unearned revenue becomes earned revenue.

Accrued items consist of two types of adjusting entries: asset/revenue adjustments and liability/expense adjustments. For example, assume a company performs a service for a customer but has not yet billed the customer. The accountant records this transaction as an asset in the form of a receivable and as revenue because the company has earned a revenue. Also, assume a company owes its employees salaries not yet paid. The accountant records this transaction as a liability and an expense because the company has incurred an expense.

MICROTRAIN COMPANY Trial Balance 2010 December 31

Acct.
No. Account Title Debits Credits
100 Cash $ 8,250
103 Accounts Receivable 5,200
107 Supplies on Hand 1,400
108 Prepaid Insurance 2,400
112 Prepaid Rent 1,200
150 Trucks 40,000
200 Accounts Payable $ 730
216 Unearned Service Fees 4,500
300 Capital Stock 50,000
320 Dividends 3,000
400 Service Revenue 10,700
505 Advertising Expense 50
506 Gas and Oil Expense 680
507 Salaries Expense 3,600
511 Utilities Expense 150 $65,930


$65,930

Exhibit 17: Trial balance

In this chapter, we illustrate each of the four types of adjusting entries: asset/expense, liability/revenue, asset/revenue, and liability/expense. Look at Exhibit 17, the trial balance of the MicroTrain Company at 2010 December 31. As you can see, MicroTrain must adjust several accounts before it can prepare accurate financial statements. The adjustments for these accounts involve data already recorded in the company’s accounts.

In making adjustments for MicroTrain Company, we must add several accounts to the company’s chart of accounts shown in Chapter 2. These new accounts are:

Type of Account Acct. Account Title Description
Asset No. Interest Receivable The amount of interest earned but not yet received.
Contra asset* 121 Accumulated The total depreciation expense taken on trucks since the acquisition date.
Liability Revenue 151 Deprecation – Trucks The balance of this account is deducted from that of Trucks on the balance sheet.
Expenses 206 Salaries Payable The amount of salaries earned by employees but not yet paid by the company.
418 Interest Revenue The amount of interest earned in the current period.
512 Insurance Expense The cost of insurance incurred in the current period.
515 Rent Expense The cost of rent incurred in the current period.
518 Supplies Expense The cost of supplies used in the current period.
521 Depreciation Expense Trucks
 The portion of the cost of the trucks assigned to expense during the current period.

Now you are ready to follow as MicroTrain Company makes its adjustments for deferred items. If you find the process confusing, review the beginning of this chapter so you clearly understand the purpose of adjusting entries.


An accounting perspective: Uses of technology

It is difficult to name a publicly owned company that does not provide an extensive website. In fact, websites have become an important link between companies and their investors. Most websites will have a link titled investor relations or merely company information which provides a wealth of financial information ranging from audited financial statements to charts of the company's stock prices. As an example, check out the Gap, Incs website at: http://www.gapinc.com Browse the Gap site and see for yourself the comprehensiveness of the financial information available there.