Question

In this chapter, we are discussing adjusting entries that are important to the accrual basis of accounting. There are four main classifications of journal entries, and each serves its own purpose and has several examples. Identify one specific type of journal entry and answer the following questions about it.

Briefly provide answers to the following questions:

1. What is the classification of the journal entry in question?
2. What accounts get debited and credited to account for the transaction?
3. How would the accounts be in error if the adjusting entry was not recorded at all?
4. Most journal entries have a counterpart on the other side of the transaction. For example, if we are buying something from a supplier, it would be an expense to us, but revenue to the supplier. Considering this, what is the counterpart adjusting journal entry for the one that you have selected?

Answer 1

In accounting, there're four main classifications of adjusting entries:

1. adjusting entries for accrual of revenues
2. adjusting entries for accrual of expenses
3. adjusting entries for deferred revenues
4. adjusting entries for deferred expenses

Revenues are accrued based on accrual system once the goods/services have been provided and their risk & reward have been transferred even if they're not collected

Expenses are accrued based on matching principle in accordance with the goods/services provided.

Revenues, if earned in advance, are deferred over the entire period of the contract so that they're evenly allocated over the contract period.

Expenses are deferred if they're incurred in lumpsum but covers multiple periods which need to be allocated.

For revenue accrual, customer account is debited and sales revenue account is credited.

For expense accrual, expense account is debited and vendor account is credited.

If the adjusting entries are not passed, revenues will not reflect unless they're collected and we'll see a steep rise in income in one period and nil in the other.

If expenses are not accrued correctly, the revenues and cost will not reflect in same period creating a distorted picture of the business. It might reflect losses in one period and high profits in the other.

Revenue & expenses are deferred so they're covered evenly. In absence of these entries, the burden of cost will fall on the booking period while subsequent months won't reflect any cost.

Similarly, prepaid revenues will result in high profits in the booking period and nil revenue in the rest of the period.

Counterpart entry for revenue accrual is as follows:

Customer A/c (Debtor) Dr.

To Sales Revenues A/c (Income)