Question

In real life, adjusting journal entries (AJE's) are often needed to correct bookkeeping errors or omissions that have occurred during the period. But for the purpose of this course, it is assumed that the bookkeeper is flawless and has made no errors or omissions. If not to correct errors, why is one or more adjusting journal entries almost always needed under the accrual basis of accounting? But why if there are no bookkeeping errors relating to cash do they never, never, never involve the Cash account?

Answer 1

The accrual basis of accounting needs one or more adjusting entries to convert the original cash transactions into accrual based transactions. As the cash transactions are converted to accrual based transactions, cash account is never a part of adjusting entries.

In adjusting entries a Balance sheet account ( like unearned revenue , Accumulated depreciation, Prepaid Expense, Accrued Liability , Allowance for Doubtful debts etc) is used on one side and one income statement revenue or expense account ( Sale revenue, insurance expense, rent expense, depreciation expense, Software subscription expense etc) is used on the other side of the adjusting entry.

Adjsuting entries are needed to fulfill the need of matching periciple by which the expenses to the corresponding revenue is recognized in the same period whether the cash payment is made beforehand or will be paid later or paymnet for revenue has been already made or not.

For example , the payment for 12 months of a magazine subscriptionfor $1200 is made on Oct 1,2020. So cash is recognized for $1200, but we cannot recognize the revenue immediately as the performance obligations will continue for 12 months. We recognize cash payment and create a Liability account unearned revenue for $1200

on Oct 1. Then each month end we shall recognize $100 of Subscription revenue ( as we deliver the monthly magazines to customer) by an Adjusting entry of Credit to Service Revenue $100 and Debt to Unearned Revenue of $100 . This is converting the cash transaction to Accrual based transaction. All the adjusting entries like this are related to accruals, deferrals or estimates .

So , even if the bookekeeper is flawless, we need to record the adjsuting entries for maintaining accrual based accounting .