Question

Please describe adjustments required for financial reporting and explain the reason why
adjusting entries must be made. 500 words (Minimum)

Answer 1

Adjusting Enteries:

The accounts are based on accrual system of accounting which requires some expenses and revenues which are not paid but earned / incurred to update the correct concept of accrual accounting.

The preparation of adjusting entries is an application of the accrual concept of accounting and the matching principle.

Use of matching principle is to align expenses with revenues. Which requires that expenses should be recognized in the period when the revenues generated with the help of these expenses are recognized.

The purpose of adjusting enteries is to update the accounts to conform with the accrual concept. If adjusting entries are not passed, some income, expense, asset, and liability accounts may not reflect their true values when reported in the financial statements. For this reason, adjusting entries are necessary.

There are usually 4 types of Adjusting Enteries . They are prepared for the following items:

1.Accrued Income 2.Accrued expense 3.Deferred Income 4.Prepaid expense

Where accrued income is income earned but not yet received, accrued expense is expenses incurred but not yet paid , Deferred Income is income received but not yet earned, Prepaid expense is expenses paid but not yet incurred.

We also pass adjusting enteries for Depreciation expense, Bad debt expense etc.

Next we will reflect on the composition of adjusting enteries.

Usually adjusting enteries affect at least one nominal account and one real account.

Nominal accounts are temporary accounts or income statement accounts and retained earnings or owner’s equity account.

Expenses like Service Revenue, Salaries Expense, Rent Expense, Utilities Expense, Drawing, etc. are nominal accounts

Whereas Real accounts are Permanent accounts or Balance sheet accounts.

Accounts like ash, Accounts Receivable, Rent Receivable, Accounts Payable, Capital account etc.

Adjusting entries are necessary because a single transaction may affect revenues or expenses in more than one accounting period and also because all transactions have not necessarily been documented during the period.

Adjusting enteries are made at the end of the accounting period. Adjusting enteries are internal transactions, non cash transactions .Since it would be inefficient and costly to account for certain types of transactions on a daily basis.

Adjusting enteries are first made in accounting journal, then the same is recorded in accounting ledger similar to other enteries . The purpose of adjusting entries is to show when the money changed hands and to convert your real-time entries to entries that reflect your accrual accounting system.

Adjusting Enteries :

1.Outstanding Expense

Expense a/c                     Dr,

        To Outstanding Expense

(Adjustment entry of expense incurred but not paid)

2. Accrued Income

Accrued Income a/c            Dr.

        To Income

(Being income accrued but not received is recorded)

3. Prepaid Expense

Expense a/c                     Dr,

        To Prepaid Expense

(Being expense paid in advance is adjusted over the respective period by adjustment entry)

4. Unearned Income

Unearned Fees/Income a/c     Dr.

         To Fees\Income

(Being fees or income received but not earned of is recorded)

5. Provision for bad and doubtful debts

Bad Debt Expense a/c                   Dr.

          To Provision for Bad and Doubtful Debts

(Provision is created for doubtful debtors)