Question

In: Accounting

learn about Adjusting Entries. These are internal transactions that are required to make sure that all...

learn about Adjusting Entries. These are internal transactions that are required to make sure that all of the revenue and expenses are accurately recorded in the accounting period. They're also important so that our amounts recorded in the Balance Sheet are correct.

There are four categories of Adjusting Entries: Prepaid Expenses (including Depreciation), Unearned Revenue, Accrued Expenses and Accrued Revenue. Within each of these categories, there are a lot of examples that we could show.

For this graded discussion, please choose one category of Adjusting Entries. Within that category, choose one example of an adjusting entry that you might make in a company.

---Please describe why this adjusting entry needs to be made.

---Please describe the accounts that are affected by making the adjusting entry.

----Please describe the impact this adjusting entry has on the Income Statement and the Balance Sheet.

---Which adjusting entry do you think will be most prone to error? It does not have to be the example you chose.

Solutions

Expert Solution

Adjusting entries are entries to be made at the year end based on transactions occurred
Four categories of Adjusting entries
1 Prepaid Expenses
When certain expenses are prepaid for a particular period, that time an asset is created which is known as prepaid expenses and is reflected under current assets
2 Unearned Revenue
When a customers provides advance for services or sales to be performed in future than a liability is created for the service known as unearned revenue and is shown under current liabilities
3 Accrued Expenses
When a particular expenses has been incurred by a company and the expenses are not paid, than a liability is created known as accrued expenses and is shown under current liability
4 Accrued Revenue
When a revenue has become due during the period but not yet received it is known as accrued revenue and is shown under current assets
Let us understand prepaid expenses more in detail
Prepaid expenses
Lets assume the company has paid insurance premium for 24 months which amounts to $ 5000 during the year
This adjusting entry is required because the company has incurred insurance expense for current year and therefore it should be reduced from the income statement, otherwise the income would be overstated. Also since the expense has been incurred in current year partly it should not be now shown as current assets as otherwise the assets would be overstated
The journal entry for the above transaction would be
At the time when insurance is paid
Prepaid Insurance $5,000
To Cash $5,000
Prepaid Insurance - Will be shown as current assets
At the year end adjusting entry for insurance expired
Insurance Expense $2,500
To Prepaid Insurance $2,500
(5000/2)
Insurance expense - will be shown in the profit and loss
Prepaid insurance - will be reduced from $ 5000 to $ 2500
The accounts impacted would be insurance expense and prepaid insurance expenses
With this entry the income would be reduce to the extend of the insurance expired that is $ 2500
With this entry the assets would be reduced to the extend of the insurance expired that is $ 2500
Unearned Revenue entry could be prone to error where the company may miss to recognise revenue in the income statement if the services for which advance has been received is provided partly or completely

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