Question

Identify the purposes and types of adjusting entries that an entity might make.

Answer 1

Purpose of adjustment entries:

Adjustments entries can thought of as updation entries that are passed by the business to keep the accounts up-to-date as on the last date of preparation of the financial statements. This helps the business comply with the principles of accrual and matching. It is common for businesses to have not recorded some of the income or expense items which pertain to the balance sheet period (financial year), till the end of the financial year. This is where adjustment entries come into play. Adjustment entries are passed(at the end of a financial year) to bring into records these unrecorded items and this is their purpose; to keep the accounts up-to-date and not miss any item of income or expense.

Types of adjustment entries:

Adjustment entries always involve one balance sheet item and one income statement item.

1. Accrued income: income that had been earned but not yet received. For this the receivable account is debited and income account (ie, revenue account) is credited.
2. Accrued expense: expense that have been incurred for the relevant period but not yet paid. For this, the expense account is debited while the payable (liability) account is credited.
3. Depreciation expense: this refers to the yearly depreciation chargeable to the value of the asset. For this, the depreciation account is debited and the accumulated depreciation account is credited.
4. Bad debts- this refers to the debts receivable but due to some reason they have become unrealizable. They will be recorded as an expense by debiting the bad debts account and crediting the receivable account.
5. Deferred income: income received before it has accrued. For recording this, the cash account is debited and the unearned revenue account is credited.
6. Deferred expense: refer to expenses for which payment has been made in advance. In this case the prepaid expense account is debited and cash account is credited.